Blessed by the Potato

2014 was a busy, busy year. I wrote and released a book, in addition to all the other stuff going on in my life like being a dad, holding down a full-time job, taking on freelance/coaching clients, etc.¹ So I did not have much time left for active investing, and that was one factor in putting in a rather shoddy under-performance of 8.6% vs my benchmark of a 50/50 mix of the Canadian and S&P500 e-series funds which pulled in almost double: 16.7%. Indeed, looking back through my notes from the year, active investing was almost entirely jettisoned from my life when the time crunch got bad. I spent almost as much time doing the bookkeeping and getting ready for tax season for my active portfolio in April as I did on researching new ideas or carefully following the ones I owned through the entire rest of the year. I did not listen to a single conference call all year. For over half of 2014 the time I invested on the active portfolio was precisely zero.

So this gets down to execution risk, another great reason to love simple index investing methods. Even if I did have a workable strategy to beat the index, and the smarts and emotional fortitude to follow through, there are still lots of ways to muck it all up (like not really doing it at all and leaving things on autopilot). That’s an added risk to active investing that we don’t talk about much, and a difficult one to accept: it’s all too easy to say something like “oh, if I had spent more time on it, I would have done better.” But the fact is that I didn’t, and I put myself into a situation where I could under-perform (and also granting that I may have underperformed no matter how much time I put in) by choosing to invest actively. It wasn’t a down year — I still made decent money, which may make it all the easier to fool myself if I wasn’t comparing to a benchmark.

I was overweight oil-related stocks, which hurt this year, but Canexus is a big stand-out mistake. It was a large part of my portfolio (a big part of out-performance in past years), and I just sat on it while it fell 55% in 2014 (and continued to decline in 2015). It’s stunning just how much value was destroyed by their attempt to build an oil-by-rail transloading terminal: over $350M invested, and it sold this year for $75M. Looking back (with the benefit of knowing that there were more declines to come), I should have seen the writing on the wall closer to mid-2014 that this supposed side project was threatening the stable, cash-generating chemicals business that I liked in the first place. That would have been a loss for the year, but not a loss on the position — instead I completely ignored what was happening and lost a lot of money by the time I woke up to how bad things had gotten this year.

I’ve been cutting down the number of positions I hold in the active portfolio and putting more and more towards the passive portfolio, but have not yet gone fully passive — at this rate it will take me several years to wind down to that point. Especially given that I wrote a book on how passive investing works and is so easy to do I should probably just liquidate the active portfolio and go fully passive. As I was putting this post together, Regal (RLC) received a take-over offer, which helps offset some of the other idiot moves I’ve made. The proceeds from selling that have been rolled into the passive portfolio. I also took that opportunity to do a big re-balance: I’ve had a mix of TD e-series and ETFs for a while now, in part because the e-series are easier to buy on autopilot, or in small pieces as the market dips (an idiosyncratic move purely for psychological comfort). I’ve now liquidated the e-series and rolled everything into just four ETFs — and I’ll note for new readers that my passive portfolio is in my TFSA and RRSP so there were no tax consequences to this roll-over, but doing the same thing in a non-registered account would have made me realize (and pay tax on) any capital gains the e-series funds had accumulated. It’s likely I will once again build up some e-series through the next year or two and do another shuffle to roll them into ETFs, or I might finally get into the habit of buying an ETF every few months for the passive portfolio.

This is two years in a row now of under-performance. My cumulative out-performance (“alpha”) is still positive, and by enough still that it raises an interesting conundrum, related to the previous posts on freelancing: in 2014 and the first half of 2015, I’ve ignored managing my active portfolio for the sure thing of freelance work (and the not-so-sure thing of the book). However, if I was able to maintain the 5-year average of out-performance from the years where I was working at it (which conveniently ignores this, my second-worst year relatively speaking), my time would actually be better spent doing investing research than editing/writing/coaching work. Of course, if I were to “risk adjust” that, then I’m back to taking the sure thing of working for a living and indexing my investments.

1. For that matter 2015 has been pretty hectic too, which is why this update on performance is coming 6 months after the fact.
Link to 2013’s update.

I keep thinking that there are a lot of people who really want or need a course on personal finance and investing, and there aren’t many resources for it. There are books of course, but some people just aren’t book learners, or prefer a course for one reason or another. There are some good continuing education courses offered through UofT and a few other universities across the country, but for most people who don’t live close to campus they’re out of luck. So I’ve thought about putting together a full online course on the matter, and while few people think it’s needed, when I actually asked who would sign up for such a beast the response was under-whelming.

A full course would be something like 12-16 hours of lectures and discussions, which would take hundreds of hours to prepare, practice, and coordinate. It’s madness to put in that kind of work before knowing for sure that there’s actually an audience at the other end. So it’s a bad idea. No one wants it, at least not online.

And yet it’s an idea that won’t die. I’ve kept thinking about how to put it together, how to change and add to the content of the book for a course, and moreover talking myself into thinking that it is needed and maybe the reason for the previous response is that people just don’t want to raise their hands over vague hypothetical options (also, the people who would want a course are likely not on r/PFC or here, excusing the underwhelming response earlier). So I’ve doodled a bit and come up with a preliminary syllabus for such a course.

But it’s still a terrible idea that’s going to take way too much time that I don’t have. Fortunately I’ve heard that Ellen Roseman plans to take one of her UofT courses online next year, and Bridget of Money After Graduation is putting together an online course on investing too. So maybe I can bow out and let them solve the problem.

Here is the preliminary course outline/syllabus, make of it what you will. Maybe it will get you excited and you’ll want to enroll or back a kickstarter-type thing to make it happen. Maybe Ellen and/or Bridgette will liberally borrow for their courses (and the outline is not the hard part of creating a new course so I don’t really mind). Maybe you will tell me that my outline is bad and that I should feel bad.

Planning, Investing, and Other Grown-up Money Concerns
Proposed Course Outline (each unit approx. 45 minutes + time for questions)

• 1. Introduction and Money 101 Review
  a. What you should already know and have mastered.
  b. Budgeting and living within your means.
  c. Saving saving saving
  d. Emergency funds (insurance?)
  e. Credit cards, lattes, etc., etc.
  f. Clever parables, Diderot’s housecoat, Chilton’s four most dangerous words.
  g. Reading list to kick-start the course.
• 2. Free Your Mind and Your Ass Will Follow
  a. The importance of attitude, behaviour, and long-term thinking.
  b. Neat grey matter tricks, including why free makes us stupid.
  c. Social animals and keeping up with the Joneses.
  d. Heuristics and rules-of-thumb (or should this be a whole other class?).
  e. Points-of-view.
  f. On uncertainty, and why a scientist is talking right now.
• 3. Canoeing Down the Spanish River: Goals, Direction, and Having Fun [w/ Sandi Martin]
  a. Sandi’s talk from TPL, expanded a bit.
• 4. Needs, Wants, and Other Sundry Topics
  a. Some concepts, because I had to stick them somewhere (inflation, compound returns, how to read graphs, use a spreadsheet, probably some other stuff).
  b. Needs and wants, and creating your minimum plan and ideal plan.
  c. Other goals and things that will affect your planning.
  d. An aside on the industry, some ranting, why I push the do-it-yourself way.
  e. Sketching out a plan and how to get there.
• 5. Finally, the One in Which He Talks About Investing
  a. Investments help us make our plans a reality.
  b. Types of investments.
  c. Investing in businesses.
  d. Lessons from active investing: intrinsic vs market value, and what it means for long-term investing in a world that survives the coming zombie apocalypse.
  e. Investing in bonds, real estate, commodities, and other stuff.
  f. History and setting reasonable expectations.
• 6. The Quick and Dirty Yet Completely Convincing Explanation of Index Investing
  a. The importance of fees.
  b. For repetition sake, a discussion of how fees matter.
  c. What can be controlled and what cannot be.
  d. Active vs passive – theory and past results.
  e. The added benefit of simplicity.
  f. Other ways of investing, and what they entail.
  g. The importance of “I don’t know”.
• 7. Risk, the Gom Jabbar, and the Unfortunate Gambling Analogy
  a. Risk in everything.
  b. Many definitions of risk, and blending of volatility and uncertainty with risk of lifestyle impairment.
  c. Risk on different timescales.
  d. Risk tolerance.
  e. Enduring a market-crash in real time and Dune’s Gom Jabbar.
• 8. Let’s Do It: Asset Allocation and Your Plan
  a. The canonical portfolio.
  b. How to decide on an allocation that will work for you.
  i. The age-based rule-of-thumb, and the completely arbitrary equity split.
  ii. The classic 60/40 one-size-fits-all portfolio.
  c. Apocrypha.
• 9. How You Actually Do This: Three and a Half Investing Options
  a. Robo-advisors.
  b. Tangerine.
  c. TD e-series.
  d. ETFs.
• 10. How You Actually Do This: Taxes and Tax-Shelters
  a. TFSA.
  b. RRSP.
  c. RESP.
  d. RDSP.
  e. Non-registered: taxes, dividend tax credit, capital gains, ACB.
• 11. How You Actually Do This: Writing Stuff Down and Making Spreadsheets (Or Whatever)
  a. Condensing your goals and direction down into a written plan.
  b. Writing down your asset allocation and a rebalancing plan.
  c. Tracking stuff with spreadsheets (or pieces of paper in a binder, or whatever works for you).
  d. Tools that already exist and can help.
• 12. Where I Talk About Processes and Take a Break to Riff
  a. Processes, lessons from engineering and health care.
  b. Good enough solutions.
  c. Execution risk, and some more talk about the behaviour gap.
  d. Some slack time to review any material from the previous classes that needs further discussion.
• 13. Au Secours, Au Secours!
  a. When to get help.
  b. How to find help.
  c. Getting value-for-money.
  d. What an advisor/coach can do, and what they can’t do.
• 14. The One Where I Reveal My Thoughts on Real Estate and You All Hate Me for It.
  a. The biggest purchase – and biggest expense – in your life, and why it deserves more thought than it gets.
  b. Rent vs buy analysis, and busting myths about renting. The ball pit analogy.
  c. Income suites are not magical.
  d. The housing bubble, and the pernicious myth of the property ladder.
  e. A look back at US housing bubble and why it’s not really different here.
  f. Real estate as an investment, direct and REITs.
• 15. The Hardest Problem in Personal Finance [hopefully w/ secret guest(s)]
  a. The options that open up as you near retirement (annuities).
  b. Government benefits in retirement, CPP.
  c. Sequence-of-returns risk, longevity risk.
  d. Sustainable withdrawal rate, and the various schemes to convert a pile of investments into lifetime income.
  e. Decumulation plans.
• 16. An Hour for Questions, or Lacking Those, Delicious Discussions of Dirty Dealing
  a. Q&A.
  b. Why I hate market-linked GICs and their dirty advertising.
  c. TANSTAAFL in general, being skeptical.

This is an excerpt from my book The Value of Simple. It has been edited to stand alone as a post.

In the short term the market as a whole (or an index representing it) can go down 50% or more. As you give the market more and more time to work out the short-term fluctuations stocks become less risky¹. For some history, there have been quite a number of market crashes where stocks declined. The worst was the 1929 crash that marked the beginning of the Great Depression. Stocks fell some 90% and took about 25 years to recover. But recover they did, and if you would allow yourself to mark that experience down as a one-off, never-to-be-repeated event, then the worst market crashes involve stocks declining by about 50% (including the recent 2008-2009 market crash). Though those events can be quite painful for investors at the time, they do pass and the markets go on to set new highs. If you held on after any given crash the prices recovered within a few years – that’s long enough that in your day-to-day life you’d wonder if the prices would ever recover, but short enough that it would happen soon enough to matter.

When deciding whether to invest in equities, and how much you can allocate to them, on top of your time horizon is the matter of risk tolerance: your ability to receive a statement from your financial institution showing that the value of your investments had been cut in half, and to not panic or lose sleep at night – or worse yet, log in to your account and sell all of your holdings out of fear or disgust. If you’re the type of person who would panic in the midst of prices falling, seeing everyone else selling and decide that you would join the pack, you would take a “paper loss” that might recover (and given the historical record, would in all likelihood do so) and transform it into a permanent loss. Better in that case to stick to safer investments right from the beginning. Better still though to separate emotions from your investing, and keep a coldly rational long-term perspective.

You need to sort out your risk tolerance in advance: the midst of a market panic and sell-off is not the time to discover your risk tolerance isn’t what you thought and to try to change your plan when it is most expensive to do so. Indeed, that is the time to pull out your planning binder and remind yourself of the long-term plan and what you decided you should do in a market downturn when you were in a calm and rational state.

Unfortunately, there isn’t much of a substitute for that real-world experience of living through a market crash. In Frank Herbert’s science fiction masterpiece Dune, a young Paul Atreides had to endure a test of his humanity called the Gom Jabbar, wherein a magical box simulated the experience of excruciating pain (but left no lasting tissue damage); he had to display the ability to withstand short-term pain and resist his animal instincts in the interest of his long-term future by holding his hand in the box and enduring it by sheer force of will. There are times I wish a similar test existed for investors to accurately gauge their risk tolerance before a market crash, a way to harmlessly experience the pain and roller-coaster of emotions that accompany living through a market crash. Instead you will just have to make the most honest assessment of yourself that you can, and attempt to prepare yourself for what may come — bearing in mind that years-long market crashes and corrections that look like blips on long-term stock charts really consist of day upon day of uncertainty and fear-mongering news reports.

When considering your ability to take risk remember that risk tolerance can also include things like your job or life situation: if you’re in a field that is very boom-and-bust, then you may not want to invest as much in stocks which can also be boom-and-bust-like, because you may find yourself unemployed at the same time that the investments you’ll need to live off of are selling for less. If you’re younger, you have more time to wait for a market recovery or adjust your savings plan than if you are close to retirement. The young can also be more certain of their continued ability to work and save, whereas when you get older your chance of having your investment timeline cut short by a chronic disease increase.

Risk tolerance also touches on your financial ability to suffer losses without destroying your life. If you have a large financial cushion or flexibility in your financial needs you may have a higher risk tolerance. For example, if you were planning on buying a car in four years that would generally be considered too short a time-frame to risk putting the money you have saved up in equities. Yet if you had the flexibility to buy a cheaper car if you did suffer a loss, or to delay your purchase by a few years, it might not be such a black-and-white situation as the timeline alone suggests.

Though I have attempted to put you into the proper mindset with all the warnings of the riskiness of stocks, the simple fact is that investing in stocks is the only easily accessible way to get such high expected returns, with so little effort and expertise required. The warnings are to prepare you for the inevitable rough ride in investing, and not to scare you off of investing entirely. Indeed, including at least some exposure to stocks is critical to reducing your overall risk of running out of money in retirement.

Keep in mind that the volatility of the stock market is very attention-grabbing; market crashes are stressful times and stories of hardship and loss can get passed down through the generations. However, the hidden risks of paying too much in fees or starting too late can be just as costly over the long run – and you cannot recover from those by waiting.

And though I would caution against trying to “time the market”, better returns come from buying when the market is low (remember the aphorism “buy low, sell high”). That will bring us to rebalancing later [in the book], but it’s important to remember that when you’re in the phase of your life when you’re saving money (i.e. when you’re young), you want to be buying stocks when they’re cheaper. So if (when) a market crash comes along, that’s not the time to wring your hands, lament your losses, and consider selling and getting out of the crazy world of investing. Instead it’s the time to cheer the bargains, to buy more, to take advantage of the temporary insanity of the traders to set yourself up for later. Market crashes, as much as they are feared and vilified in the media, usually end up being good for a young investor, and conversely, people do not make money by “waiting for things to settle down.” As long as you have faith that in the long term businesses will continue to be profitable and grow, then eventually your diversified investments should perform for you.

Understanding your risk tolerance in advance is critical for investing success and your ability to stick to your plan through future volatility. Risk tolerance has many components, including details of your situation as well as your psychology.
In the short term, equities can have large losses and high volatility. But history shows that patient investors have been well rewarded over the long term.

1. If you have a definition of risk that is not simply volatility.

I have re-created the Money 201 session from our Toronto Public Library talk in February, and put it up on YouTube for your enjoyment and/or education and/or ridicule:

Now, here’s my crazy idea: wouldn’t it be great if there was a full online course along these lines? A full course would be about 12-24 hours of material, and would be designed to have some coherency and flow. So would you be interested in something like that? Doing something like that would take hundreds of hours of time to plan, draft, record, and upload: would you be willing to pay for it (either to pay for an online course with group hangout sessions/webinars, or to sponsor a video series through something like KickStarter)? If it was say $200 for an online course?

As cool as it sounds, it’s not like an online course is the only way to learn this stuff: there are plenty of books and blog posts, there are even some videos out there on individual components of personal finance/investing/planning if you look hard enough. But other than the odd book it’s very haphazard. If you’re coming in with no background, a blog is a terrible thing to encounter as the information is scattered all over chronologically, and often blog posts are focused on debating little technical issues which are not so helpful for a first-timer looking to learn.

There are in-person courses around: Ellen Roseman and Gail Bebee both offer courses on investing, with the added bonus of the reputational backing of the continuing education arms of UofT and Ryerson (at $245 for ~12 hours of class time). Plus there are plenty of free Toronto Public Library talks on the matter. Of course, you have to live in (or haul your butt to) Toronto for those classes, and I don’t think the rest of the country is as well supplied, so an internet option may be needed. So comment, email, or Tweet if you want to see something like this (especially if you would want to support it and make it happen).

Update: I am working on a course along these lines. I’ve streamlined the draft syllabus from what I linked to above, and am looking into using Thinkific to deliver the course. However, it’s a lot of work to get it right so expect many months yet (I don’t want to put a date to that after already blowing through one planned launch date).

I’ve started to give the idea some thought, and even thought about who I might pull in for guest lectures (some of whom are game if I can raise some money), but this is something that will only come together if there’s a real demand in the community for it — and the demand might be for someone other than me to do it. And just because I was crazy enough to think it was feasible doesn’t mean I’m the one who has to do it: if you think Ellen or someone else should make an online course then mention that in the comments too, and I’ll give them a poke.

“Have I told you about my latest crazy idea?”
“You have lots of crazy ideas, it’s hard to tell which one is the latest.”

Note: the self-publishing series will return at the end of the week.

A reader writes in, asking about a particular mutual fund manager. They’ve read The Value of Simple, but aren’t sure if they should switch to DIY index investing considering their particular funds have outperformed net of fees the past few years, and have won Lipper and Morningstar awards.

This was an interesting email to receive. The reader had four different ways of saying that past performance for the particular fund was good.

The Lipper and Morningstar awards are basically useless as indicators of a fund’s ability to out-perform their fees in the future. The Lipper awards in particular are completely focused on past performance, so winning one doesn’t tell you anything a screen of past performance wouldn’t already. The Morningstar award includes “style consistency” and “tax efficiency” as other criteria, but is again basically just a metric of past performance.

There are studies that show that past performance is not a criteria for finding winning mutual funds, so by extension, the Morningstar and Lipper awards shouldn’t have any bearing, either. Indeed, I went back and spot-checked the 2010 Lipper winner, and they badly under-performed in the subsequent ~5 years. Their 10-year average (including the out-performance that won them the award and subsequent under-performance) is now equal to the index. I then quickly checked all the 3-year winners in the Canadian equity category from 2007-2014 (the range data is available from Lipper), and all but one of them went on to under-perform the index. (I didn’t check all of the winners in all categories because they have dozens and dozens of categories to try to spread the love around)

So why is past performance not a good indicator of future performance, when it is for say, job performance for an engineer or a sales associate? There’s always a combination of luck and skill in performance and outcomes, but the proportions change for different tasks. The engineer’s outcomes might be mostly skill and a bit of luck, so a good one in 2010 will probably still be good in 2015. A sales associate might have an equal mix of factors affecting their past performance — finding the skill may not be too hard, but it may not be immediately apparent in past results. But for mutual funds the skill can be completely swamped by luck, so it’s quite hard to find, especially from the customer’s chair.

I’m not dogmatic about indexing and active management, but pragmatic: I think some people can out-perform due to skill, maybe even enough to beat their fees if they do it professionally. However, identifying that small percentage of managers is a task that’s comparable in difficulty to just being an out-performing active investor yourself, and that is very difficult in my mind. You have to have a good understanding of what skill looks like to be able to spot it amongst all the luck and marketing. And the MER acts as a huge hurdle: these guys might be very skilled, but out-performing by even 2% every year is quite an achievement, and that would be needed just get you back to even. In my opinion, going with indexing is the better bet.

Another consideration is what value you get for the MER paid. A big issue in the industry is that typical big bank/big firm advisors just sell funds and don’t provide the detailed plans, hand-holding, tax advice, or other services they claim in newspaper articles are reasons to avoid DIY investing. If you’re getting good service, then you have to decide whether it’s worth 2% — or whatever the fee difference is — to keep getting that level of service, or if you’d rather do it yourself and save on the fees and avoid the risk of their performance streak ending. If you’re not getting good service for what you pay, then paying the higher MER is purely a bet on their ability to out-perform, and historically that has not been a good bet to take. Demand better service to get your money’s worth, or take matters into your own hands (which may include paying fee-for-service for the expertise you need to supplement your own efforts in indexing).