Blessed by the Potato

I love CinemaSins, and when you watch a few episodes you start to pick up on the recurring jokes. One in particular is the Prometheus School of Running Away From Things, when a character runs in a straight line away from something instead of just ducking to the side, with that stupid scene in Prometheus being the ridiculous over-the-top example that gave the meme its name.

After seeing one movie sinned for that recently, I got to thinking that it’s not entirely fair: our flight responses evolved for perils (like wolves, dire rats, and frost spiders) that can turn in a chase, where moving at right angles just gets you eaten faster. So in some cases doing something like that can make sense from the character’s point of view — they shouldn’t do that for many inanimate movie perils, because physics, but it makes sense why they did anyway, because evolutionary psychology. And running at least with a vector component away from the thing does give you a bit more time to get out of the way, so running perpendicular might not be optimal, either.

So I started to write up a little blog post to explore the idea further, maybe do some math to find if there were cases where there was an optimum angle to run away from something, and started by stopping off at TV Tropes to see if they had a list of the times the Prometheus School of Running Away from things appeared. And wouldn’t you know it, they already made that point above (along with other examples like The Temple of Doom). So this is an invitation to just go ahead and get sucked into TV Tropes for a while because they have already covered this ground.

There was an article in the Globe & Mail a while ago claiming that it’s best to go with a smaller house because the bigger the house, the bigger the associated bills. Ok, that makes perfect sense.

But then it went on to claim that “it would seem reasonable to assume that it would cost twice as much to heat (or air condition) a 3,200 square foot home than it would one that is 1,600 square feet. But, as reasonable as this seems, it’s incorrect; it actually costs more than twice as much. […] Circumstances vary, but it can cost up to three times as much or more to heat and cool a home that is only twice as big.”

Now that just doesn’t make physical sense to me. We all know how scaling laws work: assume you have a spherical house, then the surface area will scale by r^2, while the volume will scale by r^3.

Ok, we don’t live in spherical houses, but still, this guy’s math must be way off. So I thought about it, and scaling with houses is actually a problem without any clear answer. Let’s set aside the complications like your own body heat or the waste heat of your home server farm (everyone has that, right?) and just talk about heat loss through the outside walls: even narrowed down with all that ceteris paribus it’s still a tricky question because houses are not spherical.

The simplest case I can think of is to take a cubical house. It has 6 unit surfaces: the roof, floor, and 4 walls. Now if you make that house twice as big by adding a second storey, the roof and ground floor are the same, and you’ve doubled the size of your walls (8 unit-walls). So doubling your floor space was less than doubling in your heat transfer area: only 1.67 times as much.

There are other ways to double the size of a house. You could go longer: expanding your floor plan from a unit square to a 2×1 rectangle. You only save on one shared wall between the unit squares in that case, so you do nearly double the outside area: 6 unit walls facing the outside, 2 floors, 2 roofs… but that’s again a 1.67 times increase (though more roof and floor with fewer walls added). Oh yeah, that’s just the first case turned sideways.

If you want to go crazy with shapes you could try find a way to get really inefficient. If you built a really long house (or made a C-shaped house to fit it on the lot — same difference for walls) that was 5 times as big as our unit square house, then it would be 3.67 times as costly to heat… wait that’s still going in the way I thought it would, with bigger houses being more costly, but scaling less than the increase in space.

In fact, the only way the author’s math works out is if you do non-apples-to-apples comparisons, like one house at 1,600 sq.ft. with 8’ ceilings and one at 3,200 sq.ft. with 16’ ceilings to drive the volume up but not the livable space measured in square feet. Or maybe it comes down to one of the complications I ignored, like floors and walls being roughly equivalent in terms of heat loss… but I doubt it.

He does mention more windows and doors just after the part I quoted, but again that doesn’t make sense to me. Yes, I lose more heat through my door than through a solid wall, but my house has two doors. A slightly bigger house would still have two doors. My parents’ house, which is maybe 2.5-3 times the size of our house, does have four doors, and my friend’s parents’ house, which is in-between, has three. But again, the number of doors are not scaling up faster than the increase in the size of the house. And the portion of the walls that are windows is not really any different with the bigger house.

So I will conclude for now that yes, a larger house will cost more to heat and cool, but it’s likely to scale less than the difference in size, because math. Fortunately, the massive building boom of recent times means that somewhere out there are a few developments with good test houses, ones built with the same insulation and materials and styles, but to different sizes. If anyone has some experimental data to back up (or refute) the spherical house reasoning, I’d love to hear it.

I didn’t like the recent MoneySense tale of a capitulating bear in Toronto. It had some good stuff in there, but it was sandwiched by some awful thinking that does the readers a disservice.

Sandi picked up on one good bit: “It’s a purchase—it’s what I’ve been saving my money for.” While I do harp a lot on the insane costs and the importance of making a good comparison to renting, the purpose of that comparison is to make an informed choice of how to best spend your money for you. Many people are willing to spend more to own for the “pride of ownership” (me? Well, given how awesome this house is and the services our landlords provide, as well as seeing the risks inherent to owning, I would need a discount to owning to take the plunge). But how much more is always the question. So you do your comparison and you may say “meh, an extra $2k per year plus so much extra risk, that’s worth it to us.” Of course for many in Toronto and Vancouver, after running some scenarios it may be more like “Fuckity-buckity! It costs how much more to own?” So he said that money is for spending (which it is), and that his house is not an investment (which I suppose it’s not), but then never really clarified for readers how much more he was looking at or that it was a trade-off he was willing to make because yearly beach vacations are dumb and bad and nobody likes them anyway.

He does do a number of things right: he checks to see if his budget can handle an increase in rates; that he can survive a decent 20% correction and still stay above water in case he needs to move; he acknowledges that prices may fall and is not buying with visions of future gains in his eyes; and he’s not planning to move for a long time (though as a snarky aside, the assumption that he’s not planning to sell for at least 20 years may be a bit optimistic for someone in the magazine industry…).

However, the article also uses some seriously specious reasoning which brackets that good stuff. The worst was right up front:

“The reason is simple: I want to eventually retire with a paid-off house, and I was running out of time.”

There are many paths between not having a paid-off house today, and having a paid-off one in retirement (and that is not even commenting on the goal itself). For example, you can rent your larger family home right up until the day you retire — investing the difference the whole time — and then buy your retirement pad (which may be a downsizer from your working/family life place you rented) all in cash. Boom, paid off in one day and saved one round of transaction fees too. At no point does a mortgage have to come into it. Indeed, given the basic affordability issues he talked about in the preceding paragraph, the last way to get to a paid-off house in retirement should be to buy one now. The last part of that statement also makes no sense: there is no time limit, other than actually entering retirement. You don’t get to having a paid-off retirement pad any more surely from paying off a mortgage on a too-costly house at a young age than you do from renting and saving.

Let’s replace “house” with some other thing that isn’t so loaded and traditionally linked with a mortgage and the point should be clearer: “I want to eventually retire with a paid-off boat.” Well now it’s clearer: you could buy a boat now with a boat loan and pay it down, or you could rent a boat, save up, and buy one with cash when appropriate. That makes even more sense if you think there’s a good chance boats might be 20% cheaper in the future and that renting is less expensive for now — how does buying now make sense if your goal is to have one at some point before retirement? If there was a big boat sale on then maybe it would make sense to take the plunge and get a loan if you needed to. Instead, it looks like many buyers these days are getting suckered by the no interest until 2018 promotional event.

This whole “running out of time” thing reminds me of the Stockdale Paradox*: James Stockdale was in a POW camp in the Vietnam war for almost 8 years. When asked about his coping strategy, he said:

“I never lost faith in the end of the story, I never doubted not only that I would get out, but also that I would prevail in the end…”

When asked who didn’t make it out of Vietnam, Stockdale replied: “Oh, that’s easy, the optimists. Oh, they were the ones who said, ‘We’re going to be out by Christmas.’ And Christmas would come, and Christmas would go. Then they’d say, ‘We’re going to be out by Easter.’ And Easter would come, and Easter would go. And then Thanksgiving, and then it would be Christmas again. And they died of a broken heart.”

The paradox is that you have to believe in the fundamentals, that sanity will return. Trust the math, trust the logic, and trust that you will prevail in the end, but do not be too optimistic — the unrealistic hope for short-term salvation that is dashed again and again will wear you down and end you over time. You need to live in the gritty reality we face. When the bubble first started becoming a “popular” concern around 2008, some were calling for corrections to be as fast or faster than the US, especially given that we had the opportunity of witnessing their meltdown as a kind of sneak preview. I always figured it would be a slow, grinding process — but even I have been greatly surprised by how long the insanity has gone on for, originally pegging 2012 as the timeframe to be prepared to wait (4-5 years). The differences between the US and Canada that people loved to point out (such as how subprime lending was arranged, or non-recourse states) were largely differences of accelerating factors. It would make a Canadian implosion a painful, drawn-out affair compared to the US’s relatively fast (but still multi-year) implosion, but did not immunize us from a bubble.

Christmas has come and gone, and Easter too, but that does not mean that prices will continue to grow at triple the rate of inflation forever until only the Pentaverate** can buy in Toronto.

That’s why I focus so much on the price:rent metric and rent-vs-buy comparison: you have to live somewhere, so you may as well settle in somewhere nice because it’s gonna be a while. Even after the crash, it’s likely that there will be an undershoot in prices that will last for years, so you’ll have plenty of time to dance out of a stock portfolio. Of course you invest it.

Anyway, back to the MoneySense article at hand and the other half of the bracket — the conclusion:

“So do I feel like I got a good deal on my house? Not at all. By historical measures, I overpaid by quite a bit. But it was either that or no house at all…”

Either that or no house at all? That’s a false dichotomy. A really obviously bad one at that. Where has he been living until today? Is this another instance of the implicit assumption that if you don’t own you must be homeless, that renting is somehow equivalent to cowering under a sheet of cardboard? For such a massive purchase and component of the typical household budget, there is a surprising degree of reliance on memes, mantras, tradition, false dichotomies, and surface analysis. A bubble is as much about belief and memes as it is about interest rates, new developments, and price momentum. To see it as the conclusion in MoneySense by a self-described happy renter was infuriating. This isn’t “native advertising” in the Sun saying that, this is the concluding remark from the MoneySense editor-in-chief, and it just washes away all that good stuff about considering risks that came right above it.

Ugh.

Update/clarification from G+: in the article I’m not trying to slam the individual choice he made (the outcome). It’s not the choice I made, it may be sub-optimal, but he’s done his risk assessment and whatever, that’s his choice. So it’s all good there in the middle “here’s my choice, I’ve got my eyes open, and I’m prepared to deal with the consequences.” What set me off was that the good part is undermined by bracketing it in with things that basically say “and I had no choice whatsoever and was forced to do this.” Which just kind of blew the top off Mt. St. Potato, because I know people who would see that as being just as good as “rent is throwing your money away” or whatever. All the careful risk stuff sounds like an unnecessary aside when it’s the only choice there is anyway.

* – Hat-tip to Brooklin Investor for reminding me of this tale at precisely the right time for this rant.
** – The Queen, the Vatican, the Gettys, the Rothschilds, and Colonel Sanders before he went tits-up.

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.

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

CBC Marketplace recently ran an episode looking at financial “advisors”, sending a woman in to several with money to invest and a hidden camera that has made some waves. Some advisors were ok (which of course didn’t air), but there were some that were just atrocious. They provided shockingly bad advice, or couldn’t answer simple questions about how much they were paid and what fees would be.

I don’t know how the advisors were selected: the show gave the appearance of picking randomly from large firms, but they may have been tipped off about bad ones in advance. The industry has tried to couch this as just a case of running into a few bad apples, but as Sandi says, that’s a load of bull and lets them continue to get away with a broken model for the industry. Some of them were so bad that a bad apple metaphor doesn’t cut it, but rather one with a grenade in it. That should never have happened.

Yet such incredibly bad advice is not so unusual — the system and the major firms do not set a high bar for financial advice.

This is a major issue. Financial advice/planning has a large impact on people’s lives, yet conflicts of interest abound and problems take years to show up. Moreover, people who need advice largely do not have the ability to evaluate the quality of their advisors (even with the benefit of hindsight), so recommendations from friends are basically useless. Combine all that with hidden and confusing fees, and this is an industry that cries out for regulation. A we-can-do-better retreat and voluntary code of conduct is not going to cut it.

Regulation can come in many forms: the government can step in to regulate from the top down, or industry groups can self-regulate. Often a hybrid emerges, where the government will help legally protect a professional title, and members of that organization will self-regulate.

Right now, the conflicts of interest inherent to the existing salescritter-cum-advisor model are making it to the public consciousness. That erodes trust in the whole system, yet there’s very little in place to replace it.

Here is the central issue as I see it: the system needs to be reformed so that someone with no knowledge and no way to evaluate quality in advance can go to get advice from someone and trust in that advice (and get reasonable value for the fees that they pay while they’re at it). And really the best way to build trust for the lay public is to have a trustworthy expert give the thumbs-up — that is, regulation.

What does good regulation look like? There’s some kind¹ of quality standard set, with a mechanism to get it there in the first place (training, examinations). There’s a mechanism to maintain quality, through reducing conflicts-of-interest; ongoing training and continuing education; ongoing oversight, evaluation, and auditing; and even formalized specializations. And a way to make things right when the few bad apples inevitably get in: dispute resolution mechanisms, compensation funds. In return, a profession gets formalized and protected credentials and naming rights. Culture is important: a focus on ethics and client needs, on openness and honesty.

Not every element is required there. And government isn’t necessarily required: creating a brand that people can trust can also work. That can be a faster approach to get started, but doesn’t carry as much weight without the government behind it. In the next post I’ll look at some examples of professions that are out there now and how they are regulated. In the meantime, check out this week’s BecauseMoney podcast where I discussed this issue with hosts Sandi Martin, Jackson Middleton, and special guest Noel D’Souza.

1- actually the quality standard itself is important too — it should serve the right people (i.e. the public rather than the banks), have associated metrics, be achievable, consider structural issues and conflicts-of-interest, etc.