Blessed by the Potato

The Canadian dollar has declined a fair bit over the past few months, making things produced in the US more expensive for us, including books like The Value of Simple. The CAD has dropped over 12% since I set the price of the book, and almost 9% from the release date. I wanted to set the price in CAD because the book is intended for Canadian readers, and I don’t want the price to fluctuate with every little move in the exchange rate — even if I have to absorb those fluctuations from my margin. So ideally this should all be invisible to potential buyers — the price stays at $16.95 until the exchange rate gets so painful that a price increase has to be passed along.

I do not know what happens behind the scenes in the book distribution chain, but Amazon and Indigo have never had quite the right price for the print book, and their price fluctuates over time. Just two weeks ago Amazon had a sale on the book, selling it for less than I do when I sell it at in-person events with no shipping costs. Now this week they have it at $1.50 over the list price (and $4 higher than the sale price). To try to fix this I’ve lowered the (hidden to the public, but existing in the distributor’s catalog) USD price on the book to reflect the new exchange rate, in the hopes that that’s the source of the new, higher price and that the price will get back to where it should be soon.

In the meantime, you can always order directly from me using the online store at the correct price if the Value of Simple is all you’re ordering — if you’re buying more and are eligible for free shipping, then even the erroneous Amazon/Indigo price may work out better for you on the whole (and their shipping with Canad Post is somehow magically faster than my shipments with Canada Post).

Speaking of the direct purchase option, my inventory from the first print run is getting low. In the store software the print book alone and the print and e-book bundle are treated as separate products with their own inventory counts, so I’m trying to balance the remaining units between the two options so you can choose what fits best for you — if one ends up sold out while the other still has stock then it’s quite likely you can order the out-of-stock option and I’ll still be able to fill the order immediately.

Note that I do have direct control over the e-book pricing, even at Amazon and Kobo, so those prices have not fluctuated at all with the exchange rate changes.

It’s buried in the blogroll on the sidebar, but for a few years now I’ve offered consultation services for personal finance/investing matters over at Robertson Investment Services. I mention this now because of this recent article pointing that out, yet people landing here might not see that little wee link and be confused as to how I made it into that list. So hello and welcome — that is a thing that I do.

Deciding what to call my particular services was a bit of a challenge — I’m not a licensed salesperson or CFP, and I don’t really do a whole lot of detailed planning. “Coaching” kind of fits, but I have not aimed to get recurring coaching clients — I’ve specialized in a niche of helping people become do-it-yourself investors. Most of my clients just need one or two sessions to bounce some ideas off someone who’s well-read on the subject, trouble-shoot some nitty-gritty issues, and get over the hurdles of brokerage systems and spreadsheets to fly on their own. Given that I started as I was finishing my doctorate and had a long series of conversations on the meaning of that (to teach), I settled on “educator” and named the business accordingly¹.

After working with a few clients over the years I thought I had figured out some of the most common issues and barriers, and set out to address those in the Value of Simple.

I was conversing with Ellen Roseman about it back in November, and said that I had hopefully made myself obsolete with the book — with only a few exceptions, most of my clients’ concerns have focused on the material in there. Ellen had a great response: “In my view, you never get obsolete if you offer a valuable service people don’t get elsewhere.” I figured I could help more people with a book hitting a wide audience than sitting down with people one at a time — I actually expected client flow to stop after the book came out as it could answer so many of these common issues; instead I’ve had more queries (the rest of you probably saw that coming).

I don’t push the service much — as you may be able to tell by the link being buried below the fold on the sidebar. Somehow enough clients find me to keep me reasonably busy. Of course, I actually have a day job and a family, so an investor education side business that keeps me reasonably busy is not nearly as bustling as for someone who does it full time.

Update: A few years after this post, I launched an online course teaching people how to invest, and have gotten a lot closer to making myself obsolete as an investment educator/coach.

1. “Portfolio Doctor” was an awfully tempting runner-up.

Putting money into your tax-sheltered accounts (RRSP, TFSA) is great: not only are the gains on your investments not taxed, tracking the gains and distributions becomes totally optional because the CRA does it for you (or more properly doesn’t care, and treats it like a black box where only what goes in and comes out matters).

While using your TFSA right away can be a good move for almost everyone, the RRSP can be trickier: if you’re young and not making much now, you may want to wait until you are closer to your peak earnings (or at least a few tax brackets higher) before you start contributing and taking the deductions. You can of course hold on to your contribution room — it will carry forward until you’re ready to use it.

However, a neat feature is that the contribution and taking the deduction are separate steps: you can contribute to your RRSP to get tax-free compounding and a freedom from paperwork and hold on to the tax deduction until a higher-income year. I did this towards the end of grad school, maxing out my meager RRSP room while deferring the deduction until last year when I was working full time. Indeed, this is one of the classic examples of where such a move is the way to go. Another case where you may want to defer taking your deduction is when you have a new job or big raise that starts partway through the year, and won’t hit that next tax bracket until the year after.

When should you consider deferring the deduction? [edit: please see the next post for when deferring might make sense.] I don’t have a precise formula or spreadsheet ready for you. You do need to consider the time value of money: a tax deduction (refund) now will be more valuable than one a few years from now. There should be a reasonable chance of getting to a higher bracket soon — and the bigger the projected shift the more you may be willing to wait. Waiting 3-4 years to move from a 20% tax bracket to a 31% one was a no-brainer for me — the tax refund was worth 50% more in just a few years. Deferring for a decade in the hope you’ll move from 31% to 33% or 35% may not make sense for you. If you still have TFSA room, use that first — you can always pull from your TFSA to contribute to an RRSP later. But if your TFSA is full and you’re starting to build non-registered investments while you wait for your salary to increase to use your RRSP room, then contributing and deferring may make sense.

I’ll just note that some cases make sense for deferral (like mine in grad school), but for many people out there in the middle class, the climb through the tax brackets is gradual enough that it usually will not make sense to defer taking the deductions — if you’re not sure, you’re probably one of the many who will be just as well off taking the deduction immediately.

How do you engage in this magical deferral? The contribution step is the same as always: move money into your RRSP (and once it’s in there, invest in something). You’ll get a contribution receipt, which you will report on your taxes — even if you plan to defer taking the deduction you must report the contribution, and you must have enough RRSP contribution room for it. Your tax software will likely then try to automatically use all of your contributions for deductions right away to maximize your current refund. If instead you want to defer them, search for a form called Schedule 7. If you follow along in the PDF/paper version of the form, it’s divided into parts:

Part A — Contributions
Part B — Repayments under the HBP and the LLP
Part C — RRSP/PRPP deduction
Part D — RRSP/PRPP unused contributions available to carry forward

Part C is where the magic happens: you just tell the CRA how much of your contributions you want to use for a deduction this year. If you contributed $5000, but want to carry-forward that whole amount, just override line 13 with $0 (you want to use none now). Or you can enter a partial amount if you want to use some now and some later (useful if you’re just over a marginal tax bracket break).

To do this in TurboTax, click on the forms button at the bottom of the screen, and then the “form lookup” option. Start typing “schedule 7” and you’ll see it pop up. Once you open it, it will look almost identical to the CRA form above. If you try to change line 13, it will take you to a special TurboTax “worksheet” where you can enter the amount you want to carry-forward, which saves you a step of subtraction. Note that you can also go directly to the worksheet from form lookup (just look for “RRSP”), but it makes more sense to me to look for schedule 7 than some special TurboTax thing.

In StudioTax, you can adjust this right from the initial wizard when you’re entering your RRSP contribution information: uncheck the “maximize RRSP claim” option. I’m a little less familiar with Studiotax, but it appears that if you want to defer your deduction after you’re past this wizard step, you have to click on “forms” at the top to ensure Schedule 7 is in the “added forms” category, then click on “federal forms” at the bottom of the screen. Double-clicking on line 13 will bring the wizard screen below back up so you can adjust how much you want to claim this year.

Once you’ve deferred your deduction, you’ll see it show up on your notice of assessment. If you use the same tax software year to year, it will pull that deferral forward for you next year; if not, you’ll have to enter it from your notice of assessment, and you’ll see it show up in the very first line of Schedule 7 as unused RRSP contributions. Every year your tax software will try to automatically use your deferred contributions and any new contributions for you, so if you’re trying to defer for more than a year then you’ll have to make the adjustment to line 13 each year until you’re ready to take it.

“I love deadlines. I love the whooshing noise they make as they fly by.”

February is usually better known as “RRSP season” as the deadline approaches — this year that deadline is March 2, 2015.

But a deadline for what, exactly?

The deadline for RRSP contributions to count against the previous years’ taxes — due to a quirk in the rules, contributions made the first 60(ish) days of the the year can count to the current year or the previous one — so this is a last chance to make a contribution and reduce your 2014 taxes owing.

Yes, there is time value to money, and you don’t want to go a lifetime without contributing to your RRSP, but this is the least important deadline there is. If you don’t log in to your online banking to make a contribution until March 3rd this year, it just means you have to wait a year and two months for your refund instead of just two months. When you’re 75 and spending that money you’ll care whether it’s there at all far more than whether the tax deduction was taken a year later. Plus for many people, the TFSA is a better choice to prioritize anyway, so this RRSP and refund stuff is just noise. Oh, and implicit there is another fact about the deadline: you can contribute at any point during the year, not just during this special “RRSP season.”

But no, you will not lose your contribution room — you carry it forward and accumulate it until you’re ready for it. The consequences of missing the deadline are very minor, so if you’ve procrastinated this long on putting together a financial plan and starting to invest, another few weeks or months is not going to kill you — though please do commit to getting it done sometime this year.

Indeed, you don’t have to contribute in a lump sum right at the end and can ignore the deadline by starting a regular contribution plan now, and even fill out a form get your employer to stop taking the tax off at the source so you get the money working for you right away (and then you don’t get a refund in the spring — which also takes away the temptation to spend it). So despite the media and advertising blitz that happens every February, RRSP “season” isn’t really a big deal.

So, let’s not stress out over this deadline: if you miss it, the consequences are pretty minor. The last few weeks of February are the worst time to try to go to a bank to open an account or meet with your planner. But if you do want to get your contribution in before the deadline you can do so and let it sit in cash (or a money market fund — the equivalent for a mutual funds account), as Sandi points out in this post, and make a plan at your leisure, and invest it when you’re more prepared (though seriously, it only takes one weekend to burn through the Value of Simple).

In the first post I discussed some of the philosophy underlying the Canonical Portfolio, and of course laid out the basic asset classes and default allocation suggestion. Remember that all asset classes with an ETF to make them investable have a compelling elevator pitch for why an investor should add them to their portfolio — if they didn’t, the ETF wouldn’t exist. So many other authors who pick these non-canonical classes for their suggested asset mixes tend to explain in those terms why they made it in… but that’s not quite enough for me. There are practical implementation issues to adding and rebalancing these different asset classes, in addition to explaining when and why someone would want or need them. Some are difficult to find, with only one or two illiquid or high-cost funds to choose from, others get such low recommended weightings even from their proponents that they’re not worth the effort of discussing, and there’s always the basic increase in complexity from adding more funds to the mix.

That said, it’s your portfolio and you can make it as complex as you like. Just remember that there is very little precision in investing, so just as I couldn’t come up with strong reasons for including these various alternatives, there isn’t really a strong reason why you shouldn’t. It’s not worth running into analysis paralysis over a few percentage points allocated to these more esoteric funds — go ahead if for whatever reason it really speaks to you, or you fell in love with the author of a particular alternative model portfolio — or just stick to the basics and be done with it.

Emerging markets are often included in the international diversification piece, and have been a bit of a hot topic with cutesy acronyms like BRICto describe them. Emerging markets add a lot of risk to a portfolio (both in the sense of volatility and chance of loss of capital). Yes, exposure to rapidly growing economies is sexy, but to some extent the profits from that growth will be captured by the multinationals already owned in the US and developed international indexes, and I am personally highly suspicious of some of them as long-term investments. My own feelings aside though, is it an asset class that should be included in the Canonical portfolio? My answer is no: even model portfolios that do like emerging markets only put a small allocation towards them — if it’s only worth 4–6% is it really worth the complication? If you want more risk, you could just turn up the knob on your existing three equity classes (indeed, this is partially done already through the age-10 guide). No, that would not be the same as getting broader diversification to these other markets, but emerging markets are not part of the TD e-series or Tangerine portfolios (though high-MER versions can be purchased at TD).

This last concern is very important for a book or resource laying out the Canonical Portfolio, because it creates pressure on a reader who might otherwise lean towards the simpler e-series or Tangerine choices: are these mutual fund options lesser or weaker because they lack these exotic asset classes? Does that mean the reader should push towards a more complete ETF portfolio¹ with all these little slivers of allocation? And honestly, my answer was no, those are full and sufficient portfolios as they are. And if Tangerine is a satisfactory portfolio, then why should I add the complication of these other funds just because they’re available in ETF form? Especially when I could not come up with a guideline or simple rule on when someone might or might not need or want exposure to these alternative asset classes.

Here is a list of some of the other asset classes or ETFs that might be worth considering, but did not make my cut for inclusion in the book (or Tangerine’s cut for their funds, for that matter).

Preferred shares: these look like a blending of bonds and stocks, providing a higher, more tax-efficient return than bonds while being more stable than (common) stocks — and also sitting halfway between the two in the capital structure of a company. Able to provide a relatively high dividend even in a sideways market, preferred shares can be a nice addition and some people suggest adding them by chipping away a little bit of each of the stock and bond allocations. Indeed, Garth Turner is such a fan that he prioritizes preferred shares over international equities for an investor whose portfolio was on the smaller side, and in his more generic portfolio has a high allocation — as much as any other equity slice. But they suffer from a lack of sector diversification that’s even worse than the Canadian market in general. For those with really large fixed income accounts (e.g. those entering retirement), I think it can make sense to start to slice and dice that into regular bonds, real return bonds, and preferred shares… but ultimately I think it’s just not worth the complication for an interesting share class coming from a narrow slice of the economy.

Real return bonds: tied to measures of inflation, real return bonds have protection against one of the big risks to regular bonds. They’re also not highly correlated to stocks or regular bonds, which can be desirable in building a portfolio. However, their expected return is terrible (in part because they are so safe in other aspects); while the lack of correlation to the other “eigenvectors” is nifty, that argument absent some kind of expected return didn’t have much sway for gold, either. The main issue though is the practical reality that there is only one ETF in Canada offering real return bonds that I could offer up as a recommendation, and its MER is rather high at 0.39% (the iShares XRB — Vanguard does not have a real return bond offering, and while BMO does have ZRR in its library, with a market cap of just $37M it raises serious liquidity concerns for me so I wouldn’t include it in the book). Again, I don’t think the other bond funds are seriously deficient because they lack real return bonds, and while it’s not quite such a direct, perfect hedge, the big equity slice of the portfolio has the job of beating inflation. If equities are failing at that, a 5-10% allocation to real return bonds would help the stinging, but only so much.

Real estate investment trusts: this is the one that nearly got me. REITs are a particular weakness of mine in my active portfolio, and while they are not nearly the same thing as individual real estate holdings, I did have a simple justification for when you might want them (if you are a renter). They are nearly as common a selection as the major equity indexes and emerging markets, particularly for Canadian authors. But, like other sector-specific funds, the MERs are getting a touch high, and the diversification is not great (though there are many more quality REITs than there are banks). Though in some ways they look like fixed income or preferred shares, where most of the expected return will come from the steady payout and with some close relationships to interest rates, they are volatile and in terms of capital structure for the companies count as equity — thus if you do include them, you should be looking to count them as part of the equity portion.

Small cap tilts: I did prefer Vanguard’s total index to the S&P500 and the TSX Composite to the TSX60 for the added diversification, but did not mention getting small cap or value-tilted funds to increase this weighting. There are several to choose from for US and International, if you’re willing to go to a US exchange — but that’s a tough thing to recommend for the base Canonical portfolio (I’ve already received some flak over including Norbert’s gambit as an optional thing for getting VTI in RRSPs). The Canadian small-cap ETF from iShares has a relatively hefty MER of 0.6% and a really high weighting to the volatile junior materials sector.

Dow and NASDAQ: the Dow Jones Industrial Average is a collection of 30 companies that is popular largely for historical reasons — nonetheless, there are many funds available to invest in it if one wanted to (including e-series versions). Similarly, the NASDAQ has its own index that is quite technology-heavy. However, the main Dow and NASDAQ companies are also in the S&P500 (or VTI), so there’s no reason to slice-and-dice US exposure to include these other indexes.

Fundamental indexing: as an alternative to traditional market-cap-weighted indexes, FTSE has created indexes that weight companies on various characteristics of the investment. This is a really neat idea in theory, but the costs of implementing it are pretty close to the expected out-performance such an approach should bring — and in Canada they’re even less diversified than the already-tilted TSX Composite. Here’s a post from Y&T that Kyle put up after a short discussion with yours truly on the matter.

Bond fanciness: maybe it’s my bias towards a focus on equities, but I just did not want to get into the options for slicing and dicing the bond exposure into short term and long-term, government, corporate investment-grade, high-yield paper, real-return, or international bonds. In addition to the implementation problems facing the real return bonds, it could almost become a whole book on its own to discuss how and why someone would want to tilt their allocation — bond funds can be surprisingly complex.

Dividend and income funds: the dividend growth community loves dividends, and looking backwards dividend stocks do seem to be highly competitive with the broader markets. There are also many funds appealing to “yield-hungry investors” full of former income trusts — but when should someone be “yield hungry”? Focusing on payout also cuts out large swathes of the market.

Sector funds: whether it’s energy, biotech, utilities and infrastructure, or precious metals, many investors can’t help but have a preference for a particular sector, no matter how much they may otherwise believe in broadly diversifying and keeping things simple. These can then show up in their model portfolios, but then there is very little concordance between them — if you read enough they almost cancel each other out to form the broader indexes!

Berkshire Hathaway: though technically an individual stock and not an index fund at all, BRK does have some of the good properties an index investor would be looking for: they hold a diversified portfolio of businesses, keep turnover to a minimum, are tax-efficient, are highly liquid, and have effective management fees that are quite low. Michael James and Financial Uproar have written more about Berskhire Hathaway as an index-like investment, and in full disclosure, I personally hold some in my RRSP and count it as part of my passive portfolio. But it once again requires buying on a US exchange, so not appropriate for the book.

To sum up, there are lots of ways to build an index portfolio that is reasonably simple and stays true to the philosophy of diversifying and minimizing costs. As Michael James said in that last link “Most proponents of indexing strategies don’t quite manage to implement a pure index approach. They often come close to pure indexing, but they can’t resist adding some sort of twist,” and there are lots of possible twists. I’ve worked with people getting started with DIY investing, and seen the confusion that having multiple portfolio options out there can cause, especially when there is no clear reason for choosing one model over another. Hopefully the consensus that is the Canonical Portfolio will help — and that’s what I was aiming for in The Value of Simple — a good-enough portfolio that you can run out and get started with right away.

1. Indeed, this has been a major concern for people who come out confused by the MSGttPP — they see the cutesy name of “Uber Tuber” and worry that the “Complete” portfolio is a misnomer.