The Market Can Go Down?

February 6th, 2018 by Potato


The US market was down about 4% today, following a ~2% decline on Friday. Everyone on the news and social media and forewords in their books seems to be reminding investors not to panic.

Forget that, let’s PANIC!

Look at your portfolio, and that loss. How many up days did it wipe out?1 Now is this it? Or could we have another week, another month of days like this? Where’s the bottom???

Now, with that fear feeling very real and sitting quite uncomfortably in the pit of your stomach, how comfortable are you with the way your portfolio is? Are you ready to ride out whatever the uncertain future has in store for us?

If you’re not feeling so good after today’s loss, well the reality is that this is what markets do sometimes. This is normal. If you’re having trouble handling this, then a few things may be at play:

  • You could have too much risk in your portfolio. Changing that to something more appropriate for the long term may be a good thing to do when the loss is still minor (just don’t time the market – don’t change it back “when things are more settled” – if you can’t handle risk now, you can’t handle risk).
  • You could be untested. This is your first test, there will be more – start getting used to it. Feel the fear and discomfort, then remind yourself that this is what all those books and articles were talking about, and learn to suppress it.
  • You may be paying too much attention to minor day-to-day moves – when it makes the front page it’s hard to tune out completely, but you may want to stop checking in on your portfolio if there’s nothing to be done.

There are various things you can do to try to handle the uncertainty, which I know is not easy, especially if this is your first real experience with volatility.

  • First, try talking yourself through it. This is normal, it’s happened before, it’ll happen again. Etc.
  • Second, try reminding yourself that stocks going down while you still have money to save and put to work is a good thing for you.
  • Third, try using it as a lesson to check in less often.
  • And finally, go watch Bridge of Spies and ask yourself “would it help?”

gif from the Bridge of Spies – ‘You don’t seem alarmed.’ ‘Would it help?’

So yes, ultimately I’m giving the same “Don’t Panic” message as everyone else, but if you are feeling emotional about the markets then try to use that fear to learn something — either about your risk tolerance, or how to manage fear when markets are erasing years of gains instead of weeks.

1. Not that many, actually – this only took us back to ~mid-Dec.

DIY vs Robo Quick Challenge

January 11th, 2018 by Potato

I was challenged a while ago to figure out if DIY investing is really worth it for regular people when you factor in the value of the time and effort spent — should I even be putting time into things like the book and course to help people learn to invest when robo-advisors are the future?

And of course the first defense is that even if a robo-advisor is doing the work, you still need to do some reading so you’re prepared for the risks and uncertainties inherent in investing, etc. But the point is still there: are the savings of DIY worth the extra time it takes now that robo-advisors exist?

I decided to do a quick back-of-the-envelope comparison. Though there’s no way to know for sure that I didn’t tweak the assumptions to get an answer I liked, I assure you that these are the first reasonable estimates that came to me as I was trying to be fair — we are “doing it live” so to speak.

So do-it-yourself investing requires a bit of time and effort, and the question is how do you value that time and effort to figure out when it makes sense to DIY vs. just pay a robo-advisor? For this I’m going to assume that we’re only talking registered accounts, so no ACB and other tax reporting headaches of a non-registered account (and besides, if the robos aren’t tracking it for you then a more complex robo portfolio may be more work than a simple DIY one).

First, you have to learn about your risk tolerance to make sure you’re ready to invest at all, come up with a rough plan, figure out whether to prioritize your TFSA or RRSP, etc. But that’s a wash as even if a robo-advisor is handling the day-to-day aspects of your investing, you still have to deal with that.

There will be more up-front costs to learn how to invest as a DIY-er. You’ll have a bit more learning to do for DIY investing, like the mechanics of making trades and rebalancing, choosing a model portfolio to follow, as well as some investment in learning to control bad investor behaviour. The Practical Index Investing Course is $299 $169 and a one-stop resource, with another ~15 hr required to work through it — so the total cost depends on what you value your time at. Let’s use $25/hr and call it $544 in up-front investment (more if you’re going to go with the library card and time method – the course will save you lots of research time, which is the point of it /self-promote).

Then on-going effort is small but not nil. For the TD e-series route you may have to spend 2 hours/year or so on tweaking your automatic contributions and rebalancing; for ETFs it might be more like 4 hours/year. Plus the ongoing MERs of the funds (and the robo-advisor’s fee for that option).

Element DIY e-series DIY ETFs Robo-advisor
Time: learning about risk tolerance, planning Same – this is table stakes for investing Same – this is table stakes for investing Same – this is table stakes for investing
Learning how to trade and manage portfolio $544 (one-time) $544 (one-time) 0
Annual cost of funds 0.45% 0.2% ~0.7%
Annual effort to maintain $50 $200 0
Total cost for $10,000 for 5 years $1,019 $1,644 $355 (*)
Total cost for $100,000 for 5 years $3,044 $2,544 $3,275 (*)

* – includes “first $5k managed free for a year” offer calculated with real all-in costs.

Now I am a fan of robo-advisors and they do have their place — lots of people will be well-served by going to one and not everyone wants to be a DIY investor. That’s important so I’ll repeat it: regardless of the potential savings of DIY, not everyone will want to (or should) do it all on their own. Plus there are other potential benefits, for instance a robo-advisor may help prevent bad investor behaviour (and read Michael James’ comment to further reinforce that — any savings can be swamped by bad investor behaviour).

But it looks like even if you give a decent value to your time ($25/hr here) and assume that there’s a big up-front commitment required to learn it, that DIYing can still make sense and be worth the time and effort for moderate-sized portfolios. I picked 5 years out of the air as a reasonable amount of time to amortize those up-front costs — the longer you think that’s good for, the more DIY will pull ahead (at least where the portfolio is large enough to make sense in the first place). For smaller portfolios, the time might not be wisely spent on DIY efforts, though small portfolios do grow into large ones and there is some value to just sticking with one method.

Note that putting a value to your time also reinforces the traditional wisdom that you need a ~5-figure portfolio for ETFs to make sense over TD e-series — even with commission-free purchases, the MER savings may not outweigh the effort with smaller portfolios.

FLM and the Wonder Bread Abomination

November 1st, 2017 by Potato

Financial literacy month is upon us, and I have another stretched metaphor for you.

Bitches Get Riches had this post in the summer on learning to cook for yourself, which will help kick this off. Even if you don’t become good at cooking or build a large repertoire, out of necessity most people are going to learn to cook a few things at some point in their lives. Parents will teach kids what is and is is not food – often one of the first things they teach them after “hey, I’m Daddy. Say ‘Daddy’.”

So then you’re well prepared for when this horrific ad appears in your feed:

An ad for Wonder Bread suggesting the reader put pizza sauce (or ketchup) on a piece of bread, lay down strips of -- quote unquote -- white cheese, and toast until barely melted to make what they term is a Mummy pizza.

You’ll just know, because you have some measure of food literacy, that this is not a recipe you should attempt. And that any smiles you’ll be enjoying will be at your own expense for attempting to pass this off as food. Or you’d just know that if, for shits and giggles, you did make it to throw up on your Instagram, that you’d never give it to a kid as “food” and never, ever, ever give it to a kid calling it “pizza”. That ketchup and barely melted cheese on a piece of bread is an abomination and is in no way a pizza, let alone one deserving of a made up -acular adjective, and that even if you used pizza sauce a) you wouldn’t put it on a piece of wonder bread and b) you’d at least leave it in there long enough for the cheese to bubble you monster. (Wayfare notes that ketchup and cheese is kind of like a grilled cheese sandwich and this might not be so horrific if they passed if off as that instead of pizza, which I would still not eat)

Anyway, this is pretty clearly the sort of ad you would instantly know is just a bad idea because of food literacy. If you never really bothered to learn about what makes food good (or what makes pizza the High Food of the Special Day rather than something other than a slice of bread with sauce and barely melted “white cheese”), you might get taken in by this perfectly legal ad. And indeed, though all would instantly recognize the moral repugnancy of the act, there is no actual law against calling a piece of bread with ketchup on it “pizza”. Though perhaps there should be, consumers are completely unprotected against predatory recipes such as this, and attempting to protect them would be a big regulatory hassle1

And of course, so it is for financial matters. Except that’s not something we all learn proficiency with. If you saw an ad for a monstrous mash-up product like a market-linked GIC, it might look neat, the ad copy might even sway you into putting some of that in your children’s portfolios. And you might even call it a “good investment”, never knowing what true pizza, I mean investments, taste like without developing your financial literacy.

Looking for a place to start? I’ve got a reading list here.

1. And even then, you might end up with protections such as nutrition labels and ingredient lists that help protect against some form of abuses but will not solve all the problems and sometimes require their own, different form of literacy to parse.

Early Withdrawal from RRSP for Low Income Year?

October 9th, 2017 by Potato

A common myth is that you can’t withdraw from your RRSP until retirement (except for programs like the HBP or LLP). There’s actually no such restriction: you can withdraw at any time, but the withdrawal will get added to your income for the year, and you will lose that room. Now, most of the time that means you’re going to want to wait until retirement before withdrawing anyway.

But what if you’re in a period of your life where your income is temporarily low? Mat/pat leave, or a job loss, for example? It may make sense then to pull some of your money or investments out of the tax shelter when you can do so at a lower tax rate.

Reminder: The RRSP is beneficial in two basic ways: it provides tax-free compounding of your investments, and lets you contribute with pre-tax money, so you can engage in tax arbitrage by deferring the tax until later, when you might be in a lower tax bracket. Much of the time the tax arbitrage is not much of a benefit, as clawbacks of various programs can make your effective tax rate in retirement higher than raw income might suggest. But, if you have a year with minimal income (because of job loss, mat leave, etc.) then you may find yourself in the lowest possible tax bracket — lower than when you contributed the money — so there’s an advantage to withdrawing then. But you’ll be trading away the one benefit for the other. Is it worth it?

There are a few basic scenarios to consider, and your own different tax rates and rates of return will play a role, too.

The biggest question to start with is whether or not you have excess RRSP room. For many younger people who start saving early, getting 18% of your pay in RRSP room and a chunk of TFSA room (~10% of the YMPE) means that you’ll have more tax shelter space than you will fill. In that case, burning some of it up to withdraw in a low-income year is an easier decision: you pay tax at a lower rate, then put it back in when you’re in a higher bracket. The benefit from tax-arbitrage just between the bottom rate of 20% and a middling ~30% is a one-time gain of ~10%, which is going to far exceed one or two years of tax on investment growth (assuming you don’t actually need the money to pay for your expenses while out of the workforce).

If you have excess RRSP room, it’s a pretty easy choice to withdraw during a lower-earning year. You can even plan in advance for this where possible. For instance, you may ordinarily use your TFSA for long-term savings, but if you’re pregnant and expecting to be off work the following year, you might choose instead to use your RRSP (or even withdraw some funds from your TFSA to contribute to your RRSP), then withdraw those funds when your earnings are lower the next year.

We’re not all in that boat though — if you started building up a non-registered account before the TFSA was introduced, or if your RRSP room is used up by a pension, or if you have earnings that don’t generate RRSP space (like grad school stipends or dividends from your small business), or if you just simply have a high savings rate (which may be needed for early retirement plans or because you wasted your 20s in grad school and have to play catch-up or because you’re renting-and-investing-the-difference), then you might not have any available RRSP contribution room to put back what you take out in a low-income year. In that case, you’ll want to be more careful and certain that a withdrawal in a low-income year will really help you before you go through with it and burn the space.

Now it’s harder. You could get the one-time benefit of pulling money out at a low rate, but then you’re going to have non-registered investments that grow more slowly due to the tax drag than registered ones — and if you expect to be in a low bracket at retirement anyway (or for several more years as your disability takes time to resolve), then taking the money out early is of no real benefit to you.

There are going to be a number of factors at play: you’ll have a higher rate of compounding on your RRSP investments than non-registered ones (made even more complicated by the fact that some capital gains can be deferred a long time even in a non-registered account). The length of time to consider will matter, too: if you’ll have to pull the money out in a few years anyway, then it may make sense to withdraw early, as the difference in growth rates may not add up to much compared to the difference in effective tax rates of the withdrawal. If it would be a few decades before you would otherwise take money out of your maxed-out RRSP, then even a modest tax drag can add up to a large effect and you’d be better off just leaving things alone in your off year.

To help look at a few scenarios, I’ve put together a spreadsheet available here. You can play around with it to see which is better, and also how much you’d be off by in different scenarios if your assumptions are wrong.

For example, we can run a scenario where Wayfare is 37 and would be in the 20% tax bracket this year, but in a few years is able to return to work and get back to the 30% tax bracket, and then will stay in that bracket until the money is needed in 18 years (retirement at 55). Let’s assume her investments grow at 7% inside the RRSP, and at 6.5% outside. In that case, she is a bit better off to withdraw early (~$122 extra in the future for $1000 withdrawn today). If instead the disability is permanent, and the later withdrawal would also be at 20%, then she would have been better off leaving the money in her RRSP. The optimism costs ~$193 (in lost growth in future dollars) for $1000 withdrawn today (about 8% of her future investment value). If her non-registered investments are less tax-efficient and only grow at 5.9% (because her earnings power returns, for example), it’s an even worse deal to withdraw early.

It’s a tough call — you have to know the future to say for sure how much (if any) you’ll save.

And for the case of someone with no spare RRSP room and non-registered investments, there’s a similar dilemma of whether to realize the gains now in a low bracket, paying tax now so you have less to continue investing, but resetting your cost basis higher for the future. The second tab of that spreadsheet looks at some cases for that decision.

Of course, we’re actually facing these decisions. While going in I thought it would make sense to take advantage of a low-income year, after looking at a few scenarios we’re not going to burn any RRSP room as long as there’s still non-registered investments standing behind the emergency fund.


August 24th, 2017 by Potato

The Ontario Municipal Employees Retirement System (OMERS) is one of those big pension funds you hear about, providing sweet defined benefit pensions to government workers, and buying up companies and assets to help fund those pensions.

A reader asks:

Because I participate in an OMERS’ pension fund at work, I have the opportunity to invest in Additional Voluntary Contribution (AVC) within the same fund. This fund has been doing quite well so should I consider this?

The AVC is a neat option at OMERS: you can treat them like a mutual fund or ETF and invest in the same investment portfolio they’re using to try to meet their members’ pension obligations, on top of what they’re investing for you for your pension. It’s widely diversified with reasonably low overhead/MER-equivalent (~0.6%), and you can set it up to automatically take contributions straight from your paycheque. As a one-fund solution, you don’t have to see the performance of individual asset classes or worry about diversification and rebalancing decisions, you’ll just see the smoothed over-all performance.

I should note that this is not buying additional service or pension credits — it’s an investment managed by them, with no guarantees about what the funds will pay for in retirement (unlike the DB pension itself). The fact sheet also mentions limitations to the timing of withdrawals that limit the liquidity, which appears to limit you to only withdrawing in a 2-month window in the year, and then only 20% of what you have invested, which can really limit flexibility if these funds are for anything other than retirement.

Now, if anyone could waltz in and sign up to invest in the OMERS AVC, this would be a really interesting option to present alongside Tangerine, robo-advisors, and TD e-series. However, only people who are already OMERS members can do it. And that’s where my natural paranoia suggests this is not the way to go. OMERS has a great management team, the portfolio is diversified, and has competitive past performance relative to a passive index fund portfolio… but you’re already depending on them to come through for your DB pension, which is likely a big part of any member’s retirement plans. And as great a basket as it may be, you’ve already got a lot of eggs in that OMERS basket. In the unlikely event that they fall on their faces and have to trim DB benefits, you wouldn’t want the rest of your investment portfolio with them, too. And it adds one more thing to transfer (or think about transferring) if you get another job.

What do you think, would giving the AVC a pass be prudence or overly paranoid?

Edited to add: Over on Twitter, Sandi adds this:

I’d want to know what % future income relies on OMERS before cautioning against. (“It depends!!”)

And of course, that’s a good extra factor to consider. If you have 30 years of service with OMERS, your basket with them is going to be much bigger (and the over-exposure may be more of a concern) than if you have 5, and most of your retirement needs are funded elsewhere (where doubling up for some additional investments may not be a big concern).