Blessed by the 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).

In a widely seen CBC Marketplace report, the reporters spread the unhelpful tidbit that there’s a magical difference between the spelling of advisor and adviser. They say:

“Advisers” are regulated and have a legal responsibility to act in your best interest. “Advisors” are … not the same.

And since then I’ve seen that “tip” repeated many times when people are looking for advice: “go find an adviser” they may say, not having one themselves. However, it is missing the broader lesson and is unhelpful: job titles are misleading and unhelpful in the financial services industry. More importantly:

Advisor may not be regulated, but adviser is not used.

In what appears to be the original report kicking off the mini-controversy, of 121,932 registrants they looked at, only 17 across the country used the title of “Adviser”. Basically nobody uses that title, so when people repeat the “o” vs “e” issue and suggest that you go find an adviser — such a creature (effectively) does not exist! In an article at advisor.ca they did a check, and of 26 people who did use the term on their LinkedIn profiles, 24 did so in error; others may also use it under the aegis of another licensing body (such as insurance sales).

I’ve seen too many times people repeating the “o” vs “e” spelling difference as though it’s a helpful tip when looking for advice. It’s a distraction, nothing more. The real lesson is that most job titles (whether it’s advisor, vice president, or portfolio doctor) don’t actually tell you anything about whether the person you’re sitting across from is licensed to sell a particular product, experienced enough to provide you advice, or regulated to act only in your best interest. Indeed, some of the least regulated titles (like coach, planner, planning-farmboy, or instructor) may be the best people for you, who would put your needs ahead of any commission (’cause there isn’t one), even if there isn’t a regulatory framework and force of law to make it so.

I recently read Algoirthms to Live By: the Computer Science of Human Decisions and enjoyed it. It takes a few important problems for which algorithms are used in computer science, explains what they do and some of the challenges associated with them, and then relates that back to everyday life.

This is the sort of book where I am clearly the intended audience: the authors do a decent job of making everything understandable and relatable, and there’s some humour… but you’re going to have to have some interest in the foundational problems or you will likely lose interest. That’s not to say that you have to have a math or computer science background, they do explain it all, you should just come to this with some interest and not just my recommendation.

To give you an idea, they spend the first chapter on the Secretary Problem. They explain the problem (you want to hire the best possible secretary, but have to balance that against not wanting to spend forever interviewing; oh, and after you interview and reject someone you can’t go back to them), and how this might crop up in different situations in your life (if you want the best tomatoes at the grocery store might be one example of a secretary-like problem in action). Then some practical insights from the solutions in computer science — in this case, the optimal answer is likely 1/e, or about a third. That is, if you have 100 candidates for your job, you may want to interview the first 30-40 or so with no intention of hiring them just to get an idea of the quality of the field, then after that hire the first one that’s better than any of those previous ones.

A great take-away is from the chapter on caching. In particular, the least recently used (LRU) algorithm is the scientific justification for why your desk is covered in papers where the only organizational principle is that you dropped them there, and the ones you need more are in the pile closer to your keyboard. “What might appear to others to be an unorganized mess is, in fact, a self-organizing mess.”

I also really liked the description of thrashing and context-switching in the discussion on scheduling tasks. This is not unique to this book — lots of time-management books and articles talk about having set times to handle tasks (“interrupt coalescing”), and to turn off your phone and email notifications to handle time-intensive tasks. But for some reason this one resonated a bit more for me — when I read their description of a processor thrashing I was like “this is happening to me right now.” Of course, that’s likely idiosyncratic to me and the fact that at the time I read it, I was struggling with low productivity because I had a large number of small, equally urgent tasks (vs. the usual case of having one big important project on my plate to balance with a few smaller fires) and had to keep dropping something to…

A neat new term I came across in the book to apply to some aspects of the housing bubble is “information cascade.”

“[…] under the right circumstances, this mixing of private and public data can prove toxic.

Imagine the bidders are doubtful about their own estimations of the value of an auction lot—say, the right to drill for oil in some part of the ocean. As University College London game theorist Ken Binmore notes, “the amount of oil in a tract is the same for everybody, but the buyers’ estimates of how much oil is likely to be in a tract will depend on their differing geological surveys. Such surveys aren’t only expensive, but notoriously unreliable.” In such a situation, it seems natural to look closely at your opponents’ bids, to augment your own meager private information with the public information.

But this public information might not be nearly as informative as it seems. You don’t actually get to know the other bidders’ beliefs — only their actions. And it is entirely possible that their behavior is based on your own, just as your behavior is being influenced by theirs. […]

Just as with the tragedy of the commons, this failure is not necessarily the players’ fault. An enormously influential paper by the economists Sushil Bikhchandani, David Hirshleifer, and Ivo Welch has demonstrated that under the right circumstances, a group of agents who are all behaving perfectly rationally and perfectly appropriately can nonetheless fall prey to what is effectively infinite misinformation. This has come to be known as an “information cascade.”

[…] imagine there are ten companies that might bid on the rights for a given tract. One of them has a geological survey suggesting the tract is rich with oil; another’s survey is inconclusive; the reconnaissance of the other eight suggests it’s barren. But being competitors, of course, the companies do not share their survey results with each other, and instead can only watch each other’s actions. When the auction begins, the first company, with the promising report, makes a high initial bid. The second company, encouraged by this bid to take an optimistic view of their own ambiguous survey, bids even higher. The third company has a weak survey but now doesn’t trust it in light of what they take to be two independent surveys that suggest it’s a gold mine, so they make a new high bid. The fourth company, which also has a lackluster survey, is now even more strongly inclined to disregard it, as it seems like three of their competitors all think it’s a winner. So they bid too. The “consensus” unglues from reality. A cascade has formed.

No single bidder has acted irrationally, yet the net result is catastrophe.”

This immediately reminded me of bidding wars in Toronto, where a common algorithm is to count the number of noses at the table and multiply by some constant, say $10,000, and add that to the phony asking price. An extra bidder (or 10) should not in any way affect your perception of value for the house, yet there are many instances where this sort of bidding strategy is reported.

The quotation above also shows the one caveat — it is a slightly academic style, with references and names dropped throughout (though quite readable despite that). This is great for being authoritative, but can slow the read down.

So this is going to be a review of Burn Your Mortgage, and TLDR, it’s mostly going to be me ranting and nitpicking so if you don’t want to get into that, just know that most of it is fine but there are some particular issues. This image sums it up:

Before getting to the book itself, some quick background on the tale. Sean is famous for buying a place, living in the basement, renting out the rest, and working super-hard to pay off the mortgage before he turned 31. The Sean Cooper Story boils down to: guy makes $150-200k/yr, lives cheaply in a basement apartment, saves up $500k over 7 years. Yawn. Oh wait, he didn’t just save and invest that money: he bought a house and then burned the mortgage. Now that’s a marketable story!

The biggest problem with Cooper’s story is that it happened at all. In the book and several articles, Sean has said that the reason he was so motivated to burn his mortgage was because of his mother and how she struggled to pay off the mortgage. He had a nearly irrational fear and distaste for debt.

So what should a debt-averse single person who is frugal and content living in a basement apartment do? Rent, of course! No, wait, I meant buy a house you don’t need! Then you can rent out the top floor while you live in the basement apartment, adding risk, losing your principal residence exemption, stressing about the mortgage and pouring everything into paying it off. I have referred to this as Cooper’s Folly.

Indeed, back when Sean first set off on the journey I pointed out that renting out the top floor of his house wasn’t as good a deal as he made it out to be — he was effectively paying something in the neighbourhood of $800-900/mo to live in a basement apartment based on the numbers he was publishing, which is what basement apartments cost anyway. In hindsight, the Toronto real estate market has been on fire, but because he didn’t stay crazy levered, he actually would have been wealthier if he had just rented a basement apartment, saved himself some stress and worry over debt and space heaters, and invested in a diversified portfolio (thanks to the markets also having a great 5-year run — over 12% annualized for an aggressive e-series portfolio vs ~9%/yr for Toronto real estate).

Anyway, this is just the background to the book: Sean bought a house, rented most of it out, lived frugally, worked an insane amount, and paid off the mortgage in 3 years (or, because the downpayment was also significant, the alternative title might be “local man works three jobs, lives in basement, saves $500k over 7 years.”).

The first chapter relates that story, and talks generally about buying a house, while barely even analyzing whether anyone should be buying a house or if renting might be better in their situation. Where it does touch on the topic, it does an egregiously bad job of it, so if you happen to know something about how to compare the options it comes across as extremely biased towards buying. The figure above says volumes about the dismissive tone towards renting and investing. He takes a dig at bears (throwing shade at Garth Turner in particular), but then sets up a strawman version of the rent-and-invest thesis to then make a show of toppling. Sean ignores interest in the rent-vs-buy comparison (implying it’s insignificant), then on the same page says that mortgage interest is a compelling reason to pay down your mortgage (implying it’s an important factor). Within a few pages he talks about the power of leverage as a reason to buy over renting (indeed, 2 of his 8 pros to buying relate to leverage)… then excoriates the reader to not use leverage and burn the mortgage.

After that, the rest of the first section is generic advice on frugality, with a lot of lists… Most of it is fine, but parts of it read weirdly. To take one particular example, he suggests that you could save $500/yr on gas by planning your trips better and driving more efficiently. I spent $400 total on gas last year. Yes, I don’t drive much and have a pretty efficient car, but even with a normal car getting 10 L/100 km, that would take about 4500 km/yr of “extra trips” to get that kind of savings — it really just isn’t realistic. Similarly, who spends $1000/yr on taxis (actually, more than that, if they can save $1000/yr by cutting back or splitting with friends)? A lot of what he talks about in the frugality tips are outside his expertise and it shows.

Weirdly enough, there’s only ~4 pages on work ethic and time management. This really could have been almost the whole book, as the side hustle thing is a huge part of how Sean did what he did and is within his circle of competence to talk about. In some of his better times, Sean made more in a month (on top of his regular job!) than I made in a year as a grad student.

Let’s not understate this: he’s a very hard-working guy. He worked 80+ hr weeks for years at a time — not just a few months holding the world together while his wife was sick or ahead of a major deadline. And he kept that grind up without burning out.

Part of why I didn’t like the book is because of the massive missed opportunity there — I kept expecting to hear how I could also burn my hypothetical mortgage by hustling to earn more than my day job income, and how to fit all those hours in a day and avoid burning out. But the formula for success remains a secret. There is a side hustle appendix at the end, but it’s almost an insult, full of vacuous tips like “Childcare: Look after other people’s kids.” Yes, that is seriously the entire tip. He also suggests donating plasma for money, but there are only two clinics in Canada that do that (Moncton and Saskatoon), and Canadian Blood Services does not and will not pay for donations (though Wayfare is only alive because of the work of ~200 blood/plasma donors, so please do that one anyway). The rest of the list serves similarly as a brainstorming session with no regard to practicality — and clearly isn’t the way that he did it.

Anyway, from the generic middle we come to the FOMO section:

“Although foreign buyers help prop up the economy, many locals are finding themselves being priced out of the market. It’s probably wise, if you’re in the financial position to do so, to buy now while you can still afford to.”

Yep. He also suggests turning to the bank of Mom & Dad, so they can tap a HELOC on their house to help you buy one. Or buy with a friend (“great way to build equity and get your foot in the door” — BTW there will not be a giveaway as I threw up on my copy).

Only late in the chapter, after fanning the FOMO, does he include a note of temperance: “Buying a home is a good long-term investment — most of the time. But it doesn’t always make good sense. (With a book title like Burn Your Mortgage, I bet you weren’t expecting me to say that.) In fact, you may jeopardize your financial freedom if you buy a home before you’re ready and end up selling it within a year, say.” I for one, could have done with a lot more temperance.

The book pays a fair bit of lip service to buying what you can afford and staying within your budget, so it seems like a huge gaping hole that it’s not until much later that he does actually provide a rule-of-thumb on what affordable means. Though that gets immediately undercut because after introducing the figure for affordable, he says to spend more in a pricey market (no justification on how that’s still affordable, or why you couldn’t spend more of your income in a less hot market).

There’s actually a lot of detailed information after that on buying a house, features of a mortgage, and getting wills and insurance, and there’s a lot of promise here… except the FOMO stuff makes it hard to recommend. Not just on getting in before being priced out, but things that are very Toronto/Vancouver red-hot market centric like going in with a “clean” offer, or a bully offer for good measure.

Here’s where I want to take a bit of a side-bar discussion: this is a dumb thing to do. If you actually need financing to close, then you have to including a financing condition, because if for whatever reason you can’t get a loan (which could be due to an unforeseeable event like changes to mortgage regulations or a weak appraisal), you can’t close and are liable for damages that can be costly without that condition as an out.

Realtors put a positive spin on this and call it a “clean” offer, but you might as well call it a “naked” one (and that gets into another sidebar about the incentive to make a deal happen vs. protect a client). Now, in a flaming hot real estate market (such as Toronto has seen up until recently), those are the lengths buyers have been driven to. So if you want to give advice to people that helps them “win” a bidding war and get a house, you have to be pragmatic with the prevailing conditions and suggest they put in a naked offer. And that’s one approach and I get that and it’s fine — but it should also come with the appropriate warning label, and at the very least acknowledge that most readers in the country are not facing such dire competition and can proceed with more sense.

The other approach is to try to give people unpopular advice to protect them, in which case you can acknowledge that the stupid thing is happening, and tell people not to do it. It’s a small risk, sure: most deals close and the buyer finds a way to finance; most pre-construction purchases end with the market flat or higher and a buyer is able to get a mortgage and close. But in a book that also suggests buying life insurance for young healthy people, this is a comparable risk and deserves similar discussion. As a bestseller, it could have helped turn the tide on foolishness. Besides, in markets where you “have” to go in with a naked offer and completely expose yourself to the risks of not being able to close, the price-to-rent might favour renting anyway.

Conclusion

Burn Your Mortgage is mostly harmless. The lead-in ignores the alternatives and serious risks involved in buying, it has a strong pro-buying bias throughout, and there are better sources to go to for frugality hacks, budgeting advice, and side hustle tips. But if you’re going to buy a house anyway, the middle section does have a fair bit of handy information on what’s involved in the purchase and financing process. To be fair I’ve focused on nit-picking the other sections, so the truly helpful middle chunk is not reviewed in detail.

Footnote:

And just as this post was being put up, this from the Star: “Others, who bought unconditionally, have discovered they can’t get the financing to meet their purchase obligation. In some cases, the bank appraisal has come in at a value below what a purchaser agreed to pay, leaving the buyer scrambling to make up the difference.”

In some markets there’s a difference in the cash flow between buying and renting. Particularly in Toronto and Vancouver, it can cost a lot less each month to rent a house than to buy the same place (this is why there’s commentary about these cities being in a bubble). You can (should!) save up that difference and invest it, and come out much better as a renter than a buyer.

I’ve been banging that drum for a while. I made a rent-vs-buy calculator to help you estimate how much better off you might be.

But a very important point is that you don’t have to save the difference. It’s not just about how much money you have at the end (though that’s important), but the options you have along the way. You can spend the savings on increased lifestyle if you want — living in a bigger/better house than you could otherwise afford, travelling more, eating out more, whatever it is that you want to trade money for to improve your life. Or have Plan A be save and invest the difference.

When the shit hits the fan, you can use the difference as an important safety buffer on your budget. You may “build equity” with each mortgage payment, but you can’t eat equity, and in the meantime you have to keep paying your mortgage.

So when Wayfare was in the hospital and then continued being sick so we’re down to basically one income, we were (and still are) able to stay in our house. Firstly, because we had an emergency fund. Secondly, because we have awesome parents who can help pick up Blueberry so I could keep that one job (and who gave us the confidence that there was another backstop behind our emergency fund if needed). But also because, as expensive as Toronto rents are, we’re actually able to (almost) afford to live here on (almost) one salary.

Let’s do a quick comparison (not our personal numbers, but taken from real GTA listings of similar houses on the same street, and the ratios would be the same):

(All else equal, see notes, * – maintenance can be deferred/ignored temporarily in a crisis, but not long-term).

When cut down to a single salary of ~$4,350/mo after-tax and CPP/EI ($70k/yr pre-tax), a family in the rental house still has $2,110/mo to spend on food, transportation, utilities, phones, summer camp, and other necessities, so the emergency fund doesn’t get drained too fast with one person out of work. It’s likely a tighter budget than they had before, but they can manage for a fairly long time if needed.

In the owning situation, there’s only $767 left over — not nearly enough to get by on, and then only if they ignore maintenance. The house is eating through the emergency fund, and with nothing being set aside for maintenance they’re one poorly timed major repair away from catastrophe. Unlike the renters, the owners have to worry about a possible forced move on top of the immediate medical crisis.

Having a few years of that kind of cash flow difference with two incomes (and saving the difference) also meant that the renters also go into their medical crisis with a good-sized emergency fund saved up, and instead of being used up in the purchase, the sizeable downpayment is spinning off dividends to help with cash flow. So even if they fell short or lost both jobs, they could manage for a while.

This is why the rent-vs-buy debate matters. In exchange for a little less security of tenancy, the renters gain a massive increase in resiliency and flexibility.

Notes: This is the edge of affordability for a 2-income household where each head makes $70k/yr pre-tax (and on a side note, I had to go north of the 407 to find a matched pair of 3-bdrms to fit that kind of budget, but the price:rent holds in North York). The maintenance amount is a rough estimate and can be deferred/ignored in a crisis for a while. This simple cashflow analysis ignores factors like investment returns/opportunity costs, transaction fees, etc., that would be captured in a full rent-vs-buy calculator. While not our specific numbers, the ratio of the owning cashflow to renting cashflow requirements is still very close to the choice we faced when we moved here.