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Blessed by the Potato

Conservatives and a Disdain for Data

June 17th, 2014 by Potato

I did not have the chance to follow the Ontario election in depth, and haven’t commented at all on it. Now that it’s over, there isn’t much to say.

Except one thing: Hudak’s “million jobs plan” was shown fairly early on to be based on flawed math. This was an excellent opportunity for him to take the race* by changing his platform based on the data and corrected information. Not only could he then have run on a sounder plan (though in the end that plan would likely have looked very much like the other parties’), but he could have distanced the provincial party from the federal cons and their well-known disdain for data.

Instead, the message was “well, in my heart and mind…” [it’s true]. For so long I have had so much trouble relating to conservatives — there is a perfectly valid basis for disagreeing with one another on how we should run the country, what roles the government should play, and whether that should be minimized or optimized based on various value systems and circumstances of the day. But some opinions and plans are so out there that I’m just left shaking my head. And now I know: the disdain for data goes so deep that — Hudak at least — lives in a fantasy world. That or the conspiracy version where he is so interested in appeasing the corporations/lobbyists he truly works for that it doesn’t matter if the thin veneer of reason for playing into their interests comes off, he’s sticking to that flawed plan.

I know the centre and left are far from perfect, and at both the federal and provincial level the Liberals have had their share of scandals and waste, but it’s the lesser evil in my mind. Hopefully Toronto at least has seen enough of reactionary leaps to the right — with Rob Ford, Mike Harris, Harper, and now a glimpse at a near-miss of the Hudak fantasy — to perhaps give us a generation or two of respite from the conservative fantasies.

* - Not that I was rooting for the provincial conservatives — I’m definitely a left-leaning centrist if anything — but as many commenters had said going into the election, with the sentiment against the Liberals and the illogical move by the NDP to trigger the election in the first place over a budget they should have been crowing about, it was his race to lose.

Home Maintenance Rule-of-Thumb

May 23rd, 2014 by Potato

Back when we talked about the gross debt service ratio, we discussed how sometimes a simple rule can scale in surprising ways.

A set percentage of your house’s value is a very common rule-of-thumb for estimating ongoing maintenance costs — 1% is typically seen these days (and what I use), though older articles from before the massive run-up in prices can be double that. It’s a tough thing to estimate accurately because there are so many line items and they’re all irregular; however, maintenance is a pretty big part of the cost of ownership so you can’t ignore it when considering the costs of shelter. A rule-of-thumb at least gets it in people’s minds — people who might otherwise only consider the costs they had to pay in the last few months (indeed, so many bad amateur rent-vs-buy considerations just use the mortgage payment). So if it’s even approximately right to +/- 50% I’m happy to continue to spread the rule-of-thumb.

In a comment this morning, Geoff says:

My issue with such articles about homeownership is that anytime they mention home maintenance, they use a percentage of the house value to estimate costs; this worked maybe when home price reflected the size of the house. But there’s no way that my 1961 built 1200 sq.ft house in toronto (worth I’d say $750,000 easy) costs more to maintain than my in-laws 3500 sq.ft house in Trenton (worth I’d say $150,000).

And that’s totally fair. The rule-of-thumb isn’t perfect, indeed even for Geoff and his immediate neighbours their maintenance costs may not be that close because of luck or the materials and workmanship they choose. To some extent size will matter, but a maintenance rule-of-thumb won’t scale perfectly with size, either: it costs so much to get a new furnace in the first place, and only a bit more for a bigger one; likewise the expensive kitchen/bathroom/etc. stuff only scales up a bit for larger houses, with most of the extra space being bedrooms/offices/living rooms that are basically simple shells. And within a jurisdiction size is usually captured by price increases anyway.

But keep in mind that there are other factors that will make a smaller place in the city more expensive to maintain than a larger one in the country, so there will be some scaling with price (though it’s never going to be a perfect set percentage).

For instance, the potentially higher labour costs in the city is a somewhat obvious one, but a much bigger factor is that the standards will be different. More expensive houses (larger or smaller) will be more expensive to maintain because they are lived in by people with more expensive tastes (or are situated in neighbourhoods with more expensive standards). For example, on PEI my parents’ kitchen is now about 20 years old, and still perfectly fine — heck, it’s probably still one of the more recent ones out there! In Toronto a 20-year-old kitchen would be scandalous and require a reno — a 10-year refresh is de rigueur — though in that case it may not be a cash cost as you can choose to not do it and just suffer relative depreciation (or reduced appreciation) relative to the trendy neighbourhood. Likewise, when a kitchen renovation does come up on PEI a whole new set of appliances would likely come in a fair bit under $5000; in a prestigious Toronto ‘hood each stainless steel, celebrity-chef-approved piece might run that much. Similarly for the rest: the standard for outdoor appearance in a less-expensive area might be a bag of grasseed and patience whereas in a million-dollar neighbourhood landscapers, sod, and shrubbery would be expected. Etc.

Indeed, it’s for this reason that I think the more common rule-of-thumb is value-based rather than size-based. And for cases of extremely expensive small properties or very cheap large ones, well, you’ll hopefully know to nudge your estimates up or down appropriately.

Fixing Carrick’s Renter’s Guide

May 22nd, 2014 by Potato

I want to be clear up front: I like Rob Carrick. He talks a lot of sense, and is one of the few voices out there talking about the potential dangers to homeownership-at-any-cost, and breaking the misconceptions about renting. I also think the “rent and invest the difference” message is incredibly important — it was the central idea behind creating the rent-vs-buy calculator.

That said, I had a lot of head-shaking moments at his column this weekend called “the renter’s guide to successful investing.” These are mostly quibbles to be sure, but there are a lot of quibbles for a thousand-word article.

I really get the concept of trying to make advice bite-sized and manageable: something close enough that people actually follow is better than precise advice that people tune out (indeed, I have been guilty of that often enough). However, the maxim is that things should be made as simple as possible but no simpler. I think this is unfortunately a case of over-simplifying. Similarly, I just don’t get his “real life ratio”1.

First off the message about saving is confusing. At the start he says “Homeowners build wealth by paying their mortgage down and increasing their equity in a house that they will presumably be able to sell for more than they paid. […] A homeowner with a paid off house has the luxury of choosing to: continue living mortgage-free in the home (and rent-free, for that matter);[…]” which leaves off the issue of homeowners also needing to save. He doesn’t actually say “forced savings” at any point, but this statement brings that terrible idea to mind. Homeowners also need to save — indeed, you can’t live “rent-free” in a paid-off house because you have to pay property tax, upkeep, insurance, etc. That notion does come in at the end, off-handedly: “Just as a homeowner needs to have dedicated savings for retirement, so does the renter.” That idea really doesn’t come through in the article, unfortunately, and I’m sure many missed it.

The big issue though is this mysterious 1.5% rule-of-thumb he comes up with. I mean, the logical thing to do would be to take some average figure for the principal paid down with a mortgage payment and use that. Or to go to a rent-vs-buy calculator and find out what the actual cost difference is and invest that. Instead, he takes an estimate based on maintenance + (1/2)*(property tax). What?

This is not remotely accurate for the areas where the rent-vs-buy debate is most important. Check it out for Toronto: the so-called “renter’s dividend” is almost twice what Rob’s rule-of-thumb predicts. I get 2.7% (if you insist on putting it into a percentage of the house price instead of a dollar value for each situation), and that’s for the apples-to-apples case. If you’re a renter saving up for your first place and plan to move up from your rented accommodations (e.g. to move to a house from a small apartment), then you should be saving that difference, which might be 5% of the house’s value.

Secondly, it really irks me that he doesn’t ever suggest that you should calculate it accurately. The rule-of-thumb is all that’s presented, and that is further simplified down to 1.5%.

Now rather than just bitch and not provide a solution, here is a new rule-of-thumb derivation:

Rule-of-Thumb for Amount of “Renter’s Dividend” for Apples-to-Apples Comparisons

How much does it cost to own a house? Roughly speaking property taxes are a hair under 1% in many municipalities, combine that with insurance to make the estimate an even 1%; insurance maintenance rules-of-thumb are about 1% (as Rob has in the article); transaction fees and/or discretionary “while we’re at it…” renovations run about 0.5%/yr amortized out (~10% every 20 years); the last tricky part is figuring out the mortgage payment — remember the renter wants to save the cash flow difference, so this time we do want to include the principal repayment portion. For a 25-year mortgage with 10% down at 3.5%, the mortgage is 5.5% of the property value. The total cash cost of owning is thus 8.0% (which includes principal repayment).

So find what your rent is as a portion of that, subtract, and voila.
Toronto: price-to-rent of 240X translates to rent being 5% of the price of a house; thus save 3%.
Vancouver: price-to-rent of 330X translates to rent being 3.6% of the price of a house; thus save 4.4%
Canada: if the more typical price-to-rent is 180X in other centres in the country, then rent would be 6.7%, so save 1.3% (I guess this is kinda close to what Rob got).

[Note the rule-of-thumb figures are not quite in perfect agreement with the spreadsheet — people should also save what the homeowner would be (e.g., 10% of income for retirement, depending on your guideline of choice]

Rule-of-Thumb for Amount of “Renter’s Dividend” for Moving-Up Comparisons

Now if you’re in a small apartment but planning to move up to a house it gets a bit more complicated. If you want to budget as though you were already in that house and saving the difference, then you would be saving much more. To make the rule-of-thumb simple, assume that the move up is for double the cost of your current place. That is, if you’re in a 2-bedroom apartment and want to move up to a 3-bedroom detached house, assume that if the house is $500,000, your apartment is $250,000.

So if you’re in a Toronto apartment, saving up for your first house (and planning on living to that budget — i.e., it’s not so far in the future that you’re counting on significant wage increases to make it work), then you’d want to save the “renter’s dividend” from your rental versus a comparable condo (half the house) plus all of the cost of owning on the difference between that condo and the house (approximated as half the house). So that first half would depend on the price-to-rent in your city, say 3% in Toronto, plus 8% of the difference, for a total of 11% on the half the value of the house, or 5.5% on the full value of the house.

Now maybe Rob went through a similar rule-of-thumb derivation, and was simply afraid that the numbers were too large — either that no one would believe the so-called “renter’s dividend” would be so enormous in this environment, or that the suggested amount to save would shock people. Moving on.

“Whether you’re a renter or an everyday investor, there’s only one way to set up a disciplined investing program. You need to have money transferred electronically into your investment account from your chequeing account every time you get paid, or once per month.” [emphasis mine] Ok, maybe it’s just hyperbole, but there are lots of ways to set up a disciplined investing program — as individual as the person. Sure, I’m a big advocate for automation: there are lots of good reasons for it to work and it’s proven2. I make a strong case for it in my new book, too. But it’s not the only way. Indeed, automation is very much a do-as-I-say-not-as-I-do recommendation: for my situation, with highly seasonal spending and freelance income, I do almost all of my saving in the first half of the year. If I went automated I would just have to compensate with a larger savings account to buffer the changes in my budget. Plus a natural frugal inclination means I don’t worry about blowing my budget just because I don’t hide my money from myself. I recognize that there can be better ways: some people for instance, respond best by taking out a loan for the next year’s savings to invest, and then target paying down the loan. Others may target a few “no spend” pay periods and save in say 3-4 bi-weekly binges (even those who just save the “triple bonus” pay periods that come up twice per year on a bi-weekly paycheque system manage to hit a 7.6% savings rate, which is not terrible). Whatever works3.

A penultimate, minor quibble: the first table is near-useless. It’s a table of “if you get X% return saving $Y per month, after 30 years you’ll have $Z pile of money.” It’s completely dissociated from the message of the article. Would have been much more useful to combine the first and second tables: pick a rate of return (say 6%) and show that you would have enough to buy the average house price (or not, or buy two, whatever the case is) for each city if you rent and invest the difference.

A final complaint: he ends off with a specific mutual fund recommendation. I know he doesn’t phrase it precisely as a recommendation, instead as an example backing up what returns to expect (which is sadly needed when many readers may think investing means a HISA at 1.2% nominal), but still, the mention of one specific fund to end a column titled “…guide to successful investing” irked.

1. As an aside, if the real life ratio spreadsheet is targeted at potential home buyers I would have built-in defaults on some of the calculations based off purchase price, like mortgage payments, property tax, insurance, and maintenance, because first-time buyers may not know these numbers in advance.

2. Well, as proven as something like that can get.

3. Which yes, is usually automation/pay-yourself-first.

Blueberry: Life at Two

May 12th, 2014 by Potato

I had a good day with Blueberry today. In reading the anecdotes I chose to share it might not sound that way, but any day that includes an uninterrupted 2.25-hour nap and a few hours snuggling and reading books is a pretty good day.

We had our first potty-training accident of the past few days at lunch. I should have known better and asked if she needed a break before giving her the blueberry* course: nothing interrupts blueberry dessert. She’s started learning her numbers and counting, which means that at lunch I can now say that “she stuffed 8 blueberries in her mouth” rather than the previous estimates of “holy crap she just stuck two giant handfuls of blueberries in her mouth at once!” Counting them individually as she crams them in is also way cuter and seems more refined than the simultaneous two-handed “holy crap, Blueberries! I need them all in my face right now!” approach she used before.

As she is now entering the “terrible twos” I have seen a lot more random meltdowns. Today’s meltdown seemed to be triggered by the fact that the inside of her mouth was wet. We had just finished on the potty, and she was crying “wet, wet, weeeeeet.” I tried to reassure her that in fact she was a good girl and had done everything in the potty, and had kept everything important bone-dry. “No, wet.” She’d continue to scream and cry. Then she’d start pointing to her mouth, finally licking and goobering all over her hands and showing me: “WeeeEEEeeEEEeeeEEEEt!!!!”

“…Your mouth is wet?”


“Ummm… Daddy doesn’t know how to make this better.”

She has a little sweater that says “bookworm” on it, and we did spend a large part of the day reading books. Today’s innovation was to read a book, then read the same book backwards. I personally didn’t find it added much to the experience, but she seemed to think it worked. I’m just hoping she didn’t overhear the idiom of knowing something “forwards and backwards” and taking it literally. She knows that her sweater says that on it, and pointed that out many times through the process (in a way that is way more adorable than I’m making it sound).

We also built a little garage for her toy boats and cat. She’s really into her building blocks lately, but usually gets frustrated when I try to help engineer things (though she also gets frustrated when her towers collapse under their own weight). So today she seemed fully willing to take direction, and listened raptly as I explained at a level entirely unlike that appropriate for a toddler, how important braces and structural support were for stiffening the frame against sheer forces. One day she’s going to talk like a total weirdo and I don’t know if it will be my proudest moment as a father, or if I will realize the folly of letting scientists raise small children in their crucial language-development years.

* - She acquired the Blueberry nickname when she was that size in the womb, but they’re also totally her favourite fruit.

The Not Dead Post

May 6th, 2014 by Potato

I hate the “I know I haven’t posted in a while, but relax guys I’m not dead.” posts. They usually signal the end of an author’s involvement in a blog, and tend to be the epitaph that stands until the domain registration expires. Yet here I am with one.

I know I haven’t posted in a while, but relax guys, I’m not dead.

Of course, I’ve been at this for 16 years now (nearly 10 on the WordPress platform) so I’m not too worried about this lame set of excuses becoming my site’s final post. I don’t think I can stop blogging, so you’re stuck with me.

The obligatory excuse paragraph: I had a massive non-blog-related to-do list going into my Potatomas vacation. That was completely deep-sixed by the ice storm that left me without electricity, couch-surfing (with a 2-year-old no less) for 10 days. With deadlines at work through January and February, and continued craptacular winter weather, I didn’t make much headway on anything — including projects like the Ballparkinator — until March/early April. Then just as I put the Ballparkinator up, I had to sacrifice a weekend of free time to get my taxes done. Though I’ve been working on a few other posts (which are not yet ready for posting), I haven’t wanted to bump the Ballparkinator from the top until it’s fixed and I can try to push it on you all again.

Unfortunately, for the past few weeks my amazing, incredible baby girl has suddenly forgotten how to sleep through the night or how to sleep-in in the mornings, so I’m chronically sleep-deprived*. Though I’m nearly done fixing the Ballparkinator, I just can’t brain at the moment for careful Excel formula debugging. I also need to rewrite the accompanying post because, to give you a glimpse inside my own mind, I thought the Ballparkinator was something amazing and incredibly useful for people, yet the reception was very “meh” — zero comments! — and I suspect that’s because I didn’t do a good enough job at linking it back to my thoughts on the importance of preparing for multiple scenarios (plus perhaps the fact that it had bugs for early retirement). So it’s going to take a little bit longer to get up, and as I was trying to find a well-rested night off to finish it, my other projects suddenly leapt up in importance.

I’m proud to say that one of those projects was working on the second edition of my book, as hinted at earlier. I completed the first draft of the 2nd edition and sent it around to some friends and colleagues for feedback — I’m a strong believer in beta testing something like this and in the power of constructive criticism and early substantive editing. I expected a few minor changes: typos and requests to a few small sections for clarity, with general criticisms. What came back was amazing: everyone (who has replied so far) has loved it (or lied to me in a way that helps my ego but not my material). By and large, people liked how clearly I explained one thing or another and requested new sections to cover common investing problems and things that confused them or were commonly confused. In other words, I’ve been dealing with a major case of scope/feature creep for the past few weeks. So even though I’ve been writing like a madman** almost every spare minute that I’m not at work or watching Blueberry, none of it has shown up here (yet). For the curious, it is now well over twice as long as the original book, and has gone from the “booklet/short guide” range to “typical trade paperback” length, and I still have a few thousand words to go with the last few suggested section additions (and there are at least 4 readers I’m still hoping/expecting to hear back from). It’s a real book!

I’ve spoken with some people who have gone through the traditional publishing route (Preet Banerjee was particularly helpful) and learned that personal finance books tend to be released in “RRSP season” (even if said book explicitly encourages ignoring such a thing), which with what I’ve read about typical publishing timelines means that if I want to get published this year I need to be pitching to publishers now. I had set Victoria Day as a personal deadline anyway because I know my free time will disappear then due to other commitments, so that just moves my timeline up a bit — but that “just a bit” means that I’ve pretty much had to drop any blog writing for the time being. Though nothing is showing up for you now, I have generated a lot of new material — in addition to posts that I’ll throw up as preview chapters to help promote the book, I have a fair bit of excised material that just didn’t quite fit the book but which could be adapted into a future post.

Then on top of my book writing self-commitments, my dad asked me to take on a personal writing project for him and a friend of his. That friend is now seriously ill and so a project I had hoped to push off to August has taken on rather more urgency. So even once I send off my proposals and manuscripts to potential publishers, my writing focus won’t be coming back to BbtP just yet.

Excuses and litanies aside, what can you, dear BbtP reader, expect in the future?

  1. I will fix the Ballparkinator and revise the accompanying post, but likely not until after Victoria Day now. The top half still works in the meantime.
  2. I will dust off an excised chapter or another old draft post in a week’s time so you’ll have something to chew on and stop issuing amber alerts on my behalf.
  3. The summer is going to seriously, seriously suck for me on a free-time-to-blog basis.
  4. An awesome, much needed book on index investing for Canadians that focuses on implementation and process and still needs a punchy title. If I can’t sell it to a publisher by Christmas, I will self-publish by early 2015. Stay tuned. Until then, I will keep the original up and available as-is.

* - to be fair, much of that is my own fault for working on side projects until too late at night, leaving me with no margin of error for being awakened by screams or yodeling.
** - in that I’m going fast and putting in crazy hours, not in that I am ranting about the oil cartel conspiracy to keep Harper in power by controlling our thoughts with orbital mind-control lasers.

The Automagical Financial Planning Ballparkinator

April 14th, 2014 by Potato

Update: Hi everyone, there’s a bug in the “backwards” calculation for early retirement scenarios. I’m going to work on it, and finish typing up the full instructions which should help explain the thinking behind it and why I think it’s neat.

I think hands-down the most common two questions I get related to finances are “how do I…” (for which I’ve written and am now revising a whole book) and “how much do I need to save, anyway?” There are a host of tools available on the internet to try to answer this, but they’re all fairly simplistic — as few as three factors are considered, with many hard-coded variables. If you’re still decades away from retirement then you really just need a ballpark number to get started, and for that those tools are pretty good — heck the “save 10% of your income” rule-of-thumb is not terrible, and it doesn’t even specify whether it refers to pre-tax or after-tax income, or to what age range it applies.

But of course I wanted something a little more detailed with more things to tweak. More importantly, I wanted to put up side-by-side comparisons of some important scenarios so people didn’t have to refresh their web browser a dozen times to get an idea of where to go. May I present Potato’s Automagical Financial Planning Ballparkinator. Available in Excel only for now, until I’m satisfied it’s debugged enough to also put on Google Docs Drive Docs.

There are many possible shapes to the future, so how much you need to save decades in advance will only ever be a rough estimate. This will help you figure out what the general ballpark estimate of that number should be. It’s based on my retirement planning spreadsheet calculator — I added a more robust tax calculation (including OAS clawbacks), and of course the whole soup-to-nuts saving through retirement component, but have removed some of the finer features (like non-flat budgets and personal inflation rates). It does include a separate field for your investing fees (MERs) so you can see the impact of those without having to directly adjust the returns in the scenarios (and more directly, to put that factor front-of-mind).

It calculates forward based on your current savings rate (and a bunch of other assumptions) to find out how long your money will last under that plan, and also estimates backwards from your budget needs to rough out how much you should be saving (annually). Note that the backwards calculation bundles all account types together for the calculation and guesses at a tax rate — a much rougher estimate and more similar to the simplistic web-based tools common on many bank websites.

The results for both methods are presented in a little table to examine three scenarios for future returns (a base, worst, and best case), which you can of course define yourself, and for four risk profiles/asset allocations: ultra-conservative (all fixed income), balanced (50/50), risk tolerant (mostly stocks), and all stocks. This is important as the rules of thumb like “save 10%” are based on having enough of a balance to get something close to equity-like returns on your savings. If you are like many people today, scarred by 2008 and unable to contemplate anything more volatile than a package of bonds, then you will have to cut your spending budgets and save substantially more every year to make up for that ultra-conservatism in your investments. Similarly, if you don’t start investing until you’re in your 50’s, then you’ll have to put away substantially more than 10% of your income.

Figuring out your future spending needs may be the most difficult part. For your future budget you can start with your current spending needs, and take your best guess as to how they will change in the future. More travel, but less commuting? No more mortgage payments, but added expenses for lawn care & snow removal that you used to handle yourself? The default in the spreadsheet is to take 75% of your current spending budget, but definitely put careful consideration into this figure — and try out a few iterations.

Note that this is not a full financial plan, not by a long shot. There’s nothing here about contingency plans, goals, motivations, asset allocation, rebalancing plans, insurance, emergency contacts1, taxes and tax shelters, short-term savings goals, or really much of anything else. I’m hoping one day Noel D’Souza will get around to showing us what a good, complete financial plan looks like. Until then: ballpark, get started, evaluate, adjust.

1 - no, not poison control. Who will calm you down when markets are roiling? Who will your family call if you’re dead or incapacitated, who has your will?

Update, April 16, 2014: Thanks to Spudd at CMF (no relation) for pointing out that there was a problem with early retirement scenarios and the RRIF table. I’ve provided rough guidance for that going back to age 20 — it might not be the right amount to start withdrawing from an RRSP right away, but it should be reasonably close and at least returns something for early retirement scenarios now. I’ve replaced the sheet on the site, the link remains the same.

Rebalancing Spreadsheet

April 4th, 2014 by Potato

Canadian Capitalist and Squawkfox have created rebalancing spreadsheets to help you when it comes time to rebalance your portfolio. They are somewhat simplistic and hard-coded with the funds — this is a good thing if you’re following the Sleepy Portfolio or one of the Couch portfolios: just enter the current value, the money you have to add, and see how to split your new purchase up.

I wanted one with a bit more flexibility: one that would allow for a few broad categories of investments, with sub-investments. For instance, if I had small bits of cash left over at various points through the year I might throw them into a TD e-series fund, and as long as my overall Canadian/US/International split was ok I wouldn’t worry about rebalancing the e-series versus ETF splits. Or similarly if I had several sub-products to make up one sector, like counting BRK.B and VTI together for US exposure, but not caring too much whether that split was 50/50 or 60/40. Also rather than just entering the current value, the sheet lets you enter the price and the number of units in your various accounts. With the units entered, half the work is done for the next time you want to rebalance (just update the unit prices).

The sheet calculates and displays the variances (how much you are off by), and then also calculates how many units of each fund you need to buy to get back into balance. Note that you should generally round down so that you don’t over-spend the funds in your brokerage account. In the top row you can enter how much new cash you have to invest, or enter a negative value to withdraw cash from your portfolio.

The spreadsheet is available here in Excel, or through Google Docs* here. Enjoy!

* - Google can try to call it Drive, but Docs has stuck with me.

Regulatory Burden

March 30th, 2014 by Potato

In the comments to the first post on regulating financial advisors someone brought up the issue of regulatory burden: the extra paperwork and delays imposed on businesses. Nicole went so far as to call it “onerous” and “strangling” — and that’s just for the regulation already in place, which we’ve criticized as not providing enough protection.

There are lots of examples of regulatory burden out there, for many stakeholders. I regularly suggest that people go with TD Waterhouse to be able to invest in e-series funds over TD Mutual Funds because of the extra steps and forms needed to fill out and mail in to convert an account and the possible limitations of the KYC forms. I never got my CFP/CSC because it’s just not worth my time to take the courses and exam for what the designations would bring me; if something like that were to be a mandatory requirement to talk to clients about investing and their financial plans that would keep me and several other part-time educators/planners/coaches/DIY-support people out of business.

But a certain amount of form-filling, records-keeping, and education overhead should be expected in any business. The correct amount of regulatory burden is highly unlikely to be zero, and if it brings important consumer protections then that’s a good thing.

However, the way regulations and reporting are structured can have huge impacts on the eventual regulatory burden. Consider for example something I have some experience with: applying for a grant to do some medical research. You could apply to the US National Institutes of Health (NIH) and or to the Canadian Institutes of Health Research (CIHR). In both cases the basic document outlining the experiment you’re looking to fund would be say 13 pages. On top of that you’d have a detailed 5-year budget and a justification for the funds you were seeking, a half-page lay summary for the funding agencies to release to the press or the elected government representatives, and some kind of CV to demonstrate that you had the experience and ability to carry out the research you proposed.

Now both funding agencies take very seriously the protection of research participants and have fairly similar rules and regulations in place for that protection, but the implementation and regulatory burden is night and day in my mind. In Canada, your grant would now basically be complete: CIHR’s protection of research subjects rules are separate from the grant process, and all institutions sign on to it before they can enter a competition. They know that any research is going to be reviewed by a research ethics board that meets their standards, and will get a copy of the approval before releasing funds (if you’re successful in the first place). If the experiment calls for anything terribly out of the ordinary, then it’ll have to be explained in the proposal anyway. Compare this to the US, where the proposal part of the grant submission is almost like an afterthought to the stacks of appendices and tables that have to be filled out — including some that no one really seems to understand (including the NIH help staff I’ve spoken to), where you have to predict the racial breakdown for any proposed study (how many whites, blacks, asians, etc. will you recruit), but then also the “latino/non-latino ethnic breakdown” (how many latino asians vs non-latino asians will you include in your study??). It’s stressful and confusing (Spain and Portugal aren’t included in the countries of origin for people considered hispanic?) and totally bizarre (why do they care about this stuff? Will they really reject my grant over this?). For basically the same mandate and ultimate protection of research subjects, the regulatory burden is quite different between the agencies because of how they approach the problem and where they place the reporting requirements. By having so much paperwork up at the application stage it creates a lot of work for the ~80% of NIH applicants who will not get their grants funded because the scientific component wasn’t competitive enough for the severely limited funds.

Also, some protection comes with virtually no on-going regulatory burden. The Residential Tenancies Act sets out many protections for tenants, but aside from modifying what you can put into a lease there is no paperwork for landlords or tenants to fill out in the regular course of business beyond what you’d need anyway. Indeed, you get some of that for better than free: by standardizing certain terms, responsibilities, and practices they don’t have to be separately negotiated and drawn up in a lease. Everything is handled on an enforcement basis: only after a problem arises does someone end up having paperwork to fill out. Now at that point it can be very onerous (dealing with the LTB is no picnic, especially for landlords), mostly due to the delays involved. But for most people most of the time, it’s reasonably strong regulation with little overhead cost.

So I think that implementing a better model for financial advice and regulation thereof can be done in a way that minimizes the regulatory burden. It’s something that can and should be kept in mind as a new regulatory framework is thought out (especially the implementation aspect), and kept in balance with the benefits.

He Asked For It

March 29th, 2014 by Potato

Sometimes being mean can be fun. No, that’s not right. Sometimes when I’m having fun I can come off as mean. I don’t aim to be mean, so this is a tough blog post to approach because that is just about all I have to offer. Let us pretend that I have been possessed by Greg McFarlane and this is a guest post FRotM: Book Edition.

A little while ago I got a piece of email that I ignored as being basically spam: a request to review and blurb a new book (actually titled: “A Free Investment Book for You”). Pitched as “a “How to” guide to obtaining compound returns of 20 percent, 30 percent, or more annually from investing in stocks and to do so in a manner that’s worry-free for the investor.” and “The Sane Approach to Investing in Stocks for Insane Profits.” I decided to be nice and junk it. That kind of pitch turned me right off: it looked like it was either not refined enough to know it’s contradictory, or a scam.

Then he followed-up. Clearly this was a real person and not a robot emailing me, so I wanted to put him out of his misery. This is what I sent back:

“I don’t think I would be a good choice for you as a reviewer/blurber. I don’t think 20-30%+ returns and “worry-free” can be put together like that, so seeing it as the central part of your message is troubling. I work as an editor so my reviews tend to be critical in the first place, and starting off on a bad foot already might not lead to a review you would like.”

He still wanted to send me a book, calling me “an excellent candidate for reviewing my book… my desiring your participation at this stage is a testimonial to the respect that I have for you and your work.” Ok kid, flattery will get you everywhere. I got the book. I read the book. I was open to having my mind changed: maybe it was a good investing book and he just needed to work on his email marketing. Alas, it was about as bad as I feared, shy of not advocating that readers borrow money from friends or remortgage their houses to invest.

Rather than tearing into it wholly, I just want to pick on one specific part: those worry-free 20-30% returns. In the book he lays out the 10-stock portfolio that brought him a 128% return in under 5 years. He compares that to just 45% on the S&P500. But that is a mistake. This is basically a giant case of getting a little bit lucky with stock picking, and a lot lucky with timing. He bought in 10 chunks through the end of 2008 and the beginning of 2009 — yes, he just happened to start investing at a generational low in the market that was followed by a massive, unrelenting bull market. No wonder he thinks 20% returns are worry-free. Anyway, it looks like he’s comparing his portfolio purchased across several time-points that span the market lows to a single time-point for the S&P500 from before the Lehman Bros event. It was easy enough to look up the S&P500 total returns and compare an index portfolio that made purchases on the same dates as he did, and the actual comparison would then be 104%. Yes, his picks out-performed, but it’s not nearly as impressive. Oh, and most of those same picks were hit way harder in 2008/2009 than the index was, so if there’s a repeat then so much for the “worry-free” part.

Then he lays out a second 16-stock portfolio that only has a bit over a year of tenure. He boasts a 29.6% return versus the S&P500 at 26.3% [figures not audited]. Yet that portfolio includes one position that just so happened to return 243% in a year. Exclude just that one outlier, and the portfolio underperformed. By a lot. Sure, sometimes that’s how investing works, but that’s not the kind of track record you base a book around (and again, hoping for a single lottery-ticket-stock to pay off while almost half your portfolio declines in an amazing bull market year is not my definition of “worry-free”).

I cannot in any way recommend this book — I haven’t even mentioned the title because I feel bad for the kid, and I don’t want this to be the only review that comes up in Google. But I warned him, and he asked for the review anyway.

Now he did start off by thanking his editors (amongst others), and on a micro level it’s a fairly tight text. With my own self-interest in mind paying for a few editing passes can help make a book more digestible (especially a self-published one). Unfortunately, the over-arching shortcomings cannot be saved by layout and grammar. It really needed a peer review — and some robust back-testing — before being sent off for a copy edit as the basic premise appears to be flawed, based on a mistaken return comparison and a great deal of luck. Though mentioned often in how the book was presented, the issue of worrying and freedom thereof was not covered.

Page distribution:
Completely blank, not even page numbers (colouring fodder for your young daughter!), 10%.
Small investing nuggets not even fleshed out enough for a blog post (e.g. 431 words on coattail investing does not blow me away with content), 30%.
Specific information* on companies found in a stock screener that will be instantly out-of-date in book format, 25%.
Index (the kind to look stuff up, not the S&P500), 4%.
Drivel, 7%.**
The purported approach/method/secret, 2%.***

* - Includes estimated future EPS growth rates to two decimal places, though all the percentages round precisely to X.00% so I don’t know why the digits were necessary in the first place.
** - Harsh but accurate summary.
*** - Totals may not add to 100% because math is hard and fact-checking is for losers who don’t have insane profits to chase. Also, yes, depending on how liberal you want to be on what counts as part of the approach versus general rehashing of Warren Buffett quotes, just ~2% on that topic. Spoilers: use PEG, buy when below 0.75-1.

Regulation Examples

March 24th, 2014 by Potato

In the last post we talked about the importance of regulation: to create an environment where a non-expert, without the ability to independently evaluate an expert, can come to trust a complete stranger because of the regulations and mechanisms in place to create and maintain quality and ethics. There are lots of examples of industries and professions with varying degrees of regulation that we can learn from.

Car salesmen are regulated (OMVIC in Ontario). The regulations set some minimum standards for disclosure and how prices can be advertised: it’s not especially strong legislation (for instance, the dealer does not have an obligation to work in the best interest of the customer), but then the general public understands explicitly that the car salesperson sitting across the desk from them is in a sales role. They don’t couch themselves as “transportation advisors”, and if you went to one you would know that they would try to sell you a car (and you would not walk away with a recommendation for a bicycle and transit pass even if those might suit your situation better). They might be able to help you pick a particular car that’s suitable: compact over a truck, but even then you know that if you walk into a Chrysler dealership with a need for something fuel efficient you won’t be driving out in a Prius or Leaf: the best they could do is a 4-cylinder gasser that their dealership sells. To my mind, this is most analogous to the current MFDA designation in the financial sphere, but without the universal, mutual understanding of the sales and commission-driven nature of the role.

Some trade organizations exist more to protect their members and a monopoly than to protect consumers and build trust with the public. Since it’s been a while since I’ve done so, let’s pick on realtors: there are minimal barriers to entry, and no formalized processes to manage conflicts-of-interest (except for those set up at individual brokerage offices). There is a dispute mechanism, but from casually looking at cases and allegations, they seem to take realtor-on-realtor aggro way more seriously than allegations of misleading or mistreating the lay public. In other words, CREA/TREB is not a model I would want to copy: the initial quality standard is not rigourous, there’s no continuous improvement, there’s next to no policing or efforts to maintain the public trust: it appears to be a trade organization out to serve its own interests.

In cases where the decisions are literally life-or-death the regulatory body tends to take a more active role. Medical physicists for instance are responsible for calculating radiation doses in cancer therapy and ensuring that the machines are accurately delivering the doses prescribed. Over-dosing can kill through radiation effects, underdosing can allow cancer to proliferate. The Canadian College of Physicists in Medicine requires a graduate degree in one of several related fields, a fellowship program (education), examination, continuing education, periodic re-certification, and practice reviews.

Banking, at least the deposit-taking part, is a highly regulated industry. Not just anyone can rent out a space with marble pillars and a vault and call themselves a bank. Because trust is essential to preventing a run on the banks, a government-backed insurance scheme (CDIC) is in place to guarantee that if all of the regulations and oversight somehow still manages to fail, depositors will get their money back (up to a limit of $100,000 per account). Now, that’s not to say that a bank won’t ding you with service charges or sell you services you don’t need — they walk a fine but well-defined line of trust and conflicting interests for sales.

Franchises are not something handed down by the government or enshrined in law, yet by building strong brands people know that stopping at McDonald’s or Subway for a meal will provide a fairly uniform meal experience — they can trust that even in a strange city far from home that they’re going to get what they expect. It’s a way of accomplishing the end goal of letting someone with no easy way of independently evaluating quality to walk in off the street and know that they’ll be in good hands.

So what would I like to see? I think good regulation will be stronger and faster* than building up a brand/franchise, though the end result might be better that way as an organization shooting for excellence doesn’t have to play to the lowest common denominator. Either way, I think getting rid of embedded commissions and their inherent conflicts-of-interest and obfuscation is the first step: it’s an uphill battle for education and standards if that basic component of the business model isn’t fixed first. We could follow the UK and Australia in that direction, and it will be interesting to see how their experience plays out over the next few years.

Either way, training and examination requirements at the start, including an ability to explain how fees work, the impact of fees, cash flow planning, and managing behavioural issues. Explaining risk at some level is necessary but is tough because even experts have trouble defining it precisely — perhaps just understanding that there are aspects of risk. Levels or specializations of certification, and an understanding that some situations should be kicked up the chain. Re-examination, auditing of practices, and other systems to keep quality high. And a correction mechanism: some way to feed back new or unresolved problems back through continuing education, to arbitrate disputes, and compensate customers who were wronged.

The regulatory body should ideally be separated from the body that looks to maintain a monopoly or promote the profession so that it can be client-serving and not self-serving. Because it can be confusing as to what the responsibilities of the advisor are (especially if a term like “advisor” is used), someone (who?) should make it clear to the public what the relationship is, possibly disclosed up front (”Hi, I’m a salesperson and I do not have a responsibility to do what’s best for you, just to make my commission and not recommend something egregiously bad. Let’s look at a 7-seater, shall we?”).

Unfortunately I still haven’t had a chance to read the private member’s bill in Ontario so this might all be covered already.

* - from implementation to helping people. It will likely be slower to be crafted and passed in the first place.