Blessed by the Potato

This spring looks like real estate prices are coming off the boil. People seem to be wondering if prices could possibly go down despite years of bulls and the FOMO crowd saying that it only ever goes up.

There have also been more people wondering about housing bears. “Remember housing bears? Didn’t they once say that housing could possibly go down in the future? Is this what ‘down’ is?” And of course the big one “So how bad could this get?” As us long-time housing bears come out of hibernation this spring, perhaps it’s worth a long (and snarky) review of the thesis.

A Low Growl

There are lots of ways to determine what a house is “worth” or what it “should” be priced at. You can look at historical relationships between incomes and debt and house prices, but that’s all very high-level stuff, and hard to apply to one specific house that you want to live in. The argument that has always resonated best for me is that a house is primarily a place to live, and shelter is also one of life’s greatest expenses, so it’s worth looking at all your options. Renting your shelter or buying it are the alternatives available.

So we can examine the relative costs between renting and buying, and I made a spreadsheet and a whole series of posts to do that and others made rules-of-thumb and YouTube videos. And basically house prices had gotten so expensive relative to rents that it looked like you were better off renting, and the only way buying would possibly come out ahead is if already-expensive housing became even more expensive at a very high clip and even then you needed cheap leverage.

Well, we got skyrocketing prices and cheap leverage, so people who bought anyway look like they came out ahead (for now). But it didn’t have to turn out that way, and the question is always how much further can those trends go before something breaks? The bigger the price:rent ratio gets, the harder it is to fix it through anything other than a housing crash (assuming of course, that these fundamentals matter at all).

But if doing a price-to-rent comparison is so easy anyone with a physics degree and insomnia can do it, why did prices get so detached from fundamentals in the first place?

Models of the World

The market is far from monolithic: there are many players in it. Not just buyers, sellers, and agents, but buyers with different pricing models at work – people are playing the game with different rules. We can build a thought experiment with different agents (agents in the sense of actors in a model, not the people whose job it is to sling houses) using different strategies and approaches, and how prices might change.

A decade ago we talked about supply and demand, and how speculative demand works: in a textbook economics market, as the price increases, fewer buyers demand the thing the textbook is discussing. Even if they disagree on the assumptions and arrive at different estimates of fair value, people who use a rent-vs-buy framework will, all else being equal, start to drop out of the market as the price gets too high, and choose to rent instead. But with speculative demand, you don’t get that: high prices beget high price expectations, which helps bring in new buyers to replace (or even exceed) those who got priced out.

So that’s one of our groups of buyers and their pricing models: prices going up is good, because they’ll continue to go up, so pay whatever you need to today as you’ll only be richer in the future. This group is what we’ll call the FOMO-MOMO group: fear of missing out/momentum. They expect that as prices go up, they will continue to go up. And the faster they go up and the closer housing gets to completely unaffordable, the more they will pull demand forward and buy more because they are more and more afraid of missing out or getting priced out (e.g., those stories of people buying places for their children). Their pricing model is basically to look at the last comparable price, see how many people show up for the bidding war, and add $10k for every nose on top of the last price.

It can have big positive-feedback cycles, as prices going up makes them feel wealthier, and feel more certain in their worldview, and gives them easier access to credit. A subset of them buy more and more properties: as the first purchase works out and goes up, they build equity, which they can drain with a refinance to buy another place, and another, helping to propel the market upward while adding leverage and fragility to the structure.

The bear case is of course that this is insanity, but we’ll get to that.

The next class of buyers are the ones who just want a place to live, but who skip step zero (i.e., the rent-vs-buy analysis). So they are only looking to buy, and they’re just simply going to go into the market at some pre-determined time point (say on their 30th birthdays for the sake of modelling) and buy as much as they possibly can (AMAP). They don’t care too much about what the price of housing is doing – up, down, or sideways – they just borrow as much as they are able and buy as much house as possible. Their only limit is their ability to service the debt used to finance the purchase and things like a stress test that affect their buying power.

Then you have the “rational” buyers (R): those who may want to buy a house, but want to do so at a “fair” price, and will go rent or GTFO if the prices get too extreme. They may use a price:rent or price:income basis, like dinosaurs, but they’re looking to buy without becoming house poor.

So if we have a group of price-insensitive buyers, and even a small supply/demand imbalance, the FOMO-MOMO and AMAP crowd can rapidly drive prices to crazy levels, and drive the R’s completely out of the market – the demand is strongly inelastic from those buyers. In addition to all the speculation about how this was working in Toronto and Vancouver’s run-ups, we saw more natural experiments with this in the pandemic: prices in many small exurb towns doubled with very small increases in the number of price-insensitive buyers hitting the region.

These pricing models used by the currently dominant agents lead to a powerful positive-feedback loop. But what happens when the market finally changes?

Eschatology

As soon as prices stop going up, the momentum buyers may hit pause, creating a reinforcing cycle in the other direction: fewer buyers, putting fear into others, as fewer and fewer believe it’s a dip and start to fear prices won’t be up so much in five years’ time that any price today can be justified. Plus, how do you even set a price if your model is to multiply X by the number of noses in the bidding war and nobody else shows up to bid?

If the FOMO-MOMO crowd disappears, the next marginal buyer is the AMAP, who simply will borrow as much as they can for a house and pay that. With interest rates rising, their ability to borrow is more limited, so prices will have to come down a bit to match their maximum affordability.

So our mental model suggests that the first new equilibrium point would be wherever the new constraint on buying power puts prices.

Take a house that’s currently selling for say $1.5M in Toronto. An AMAP buyer that could afford that place at 2.5% (a mortgage payment of ~$5400/mo) may only be able to pay $1.3M at 4%, or $1.2M at 5%. Not a huge difference, which is what a lot of people are saying now – a slowdown or correction is in the works from interest rate increases, but far from the crash the bears have been crying about that would be needed to restore actual affordability. We’re still in the post-pandemic bump there, and not even negative year-over-year thanks to that massive run-up at the end of 2021/start of 2022.

The true bear case is if the fomo momo crowd steps back, and there aren’t enough price-insensitive AMAP buyers (or their purchasing power is significantly impaired, which may happen for example if they need a down payment from the bank of mom and dad, which is also facing higher financing costs on their HELOC, or interest rates rise even more, or inflation hits all the other line items in the GDS calculation at the same time that interest rates rise) to move the needle. The next marginal buyer is then the “rational” buyer.

And the problem is that the price that the “rational” buyer or investor buyer steps in is far, far below the current prices. That $1.5M (peak) house might rent for $3200/mo, a price:rent of 469X. To get back to say 250X, the price has to come down to $800k – a big air gap below current prices.

So that’s how a crash could play out from too-high prices and a shock that breaks the momentum and psychology. It’s certainly plausible, but is it at all likely?

And that’s the problem with this mental model: it produces some narratives to help explain how we got here, and some potential future paths, and where some reasonable stopping points for bottoms might be (when the monthly payment for AMAPs balances out, when the price:rent gets back to historic norms, etc.). But it doesn’t make any actual predictions about what will happen – there isn’t survey data out there about how many AMAPs are left, for example.

The Turn

Though the market does seems to be turning now, with rising interest rates putting fear into the hearts of the fomo momo crowd, and reducing how much “as much as possible” is for the AMAP crowd – the “every 50 bp reduces the maximum amount you can borrow by X,” etc. articles that you’ve no doubt seen all over.

But wait, there’s more! In the calculation for the debt service ratios is also a line for heating costs. And natural gas has roughly tripled in price over the last few months, which will take another decent chunk ($100/mo or so?) out of the maximum borrowing capacity of buyers.

So in that example of a $1.5M house that an AMAP could reach for at 2.5% going to $1.2M at 5%, add in an extra $100/mo hit on heating costs and now their maximum serviceable price is hit by another $20k.

I see lots of people still saying that there’s no way it could crash though, and there’s a lot of good reason to think that way. The government explicitly said they wouldn’t allow even a 10% correction to happen, and they’ve made plenty of (deliberate?) policy errors to get us into this over-priced mess in the first place. And the market has gone straight up in the face of bear logic for so long that people believe that there must have been a mistake in the logic somewhere. Every time we’ve had a good reason to think a correction was at hand (2012, 2017, 2020), the market has given bears a thrashing and gone right back to resuming its lunar trajectory.

And maybe they’re right. The fundamentals have gotten worse (better if you want high prices): we do also have a supply problem now on top of the demand surge, and we can see it in rents that have gone up above the rate of inflation (esp. for product that makes for a good [illegal] AirBnB). However, the increase in rents isn’t even in the same solar system as the increase in prices. So the floor has been raised… but it’s still a long way down.

And the demand is still high: for all the demand that has been pulled forward, there are plenty of Canadians and newcomers who want to own, they’re simply priced out. Maybe there are hordes of would-be buyers on the sidelines who will come rushing in to buy on any weakness, and this will only be a gully, not a crash. But at what price can those priced-out hordes come in? If they are themselves AMAPs who were priced out, then prices need to drop enough that even with higher rates and heating costs that they can service the debt again (I am very carefully avoiding the word “afford”), so we’d need to see prices fall by at least 25-30%.

Six Impossible Things Before Breakfast

Through the years, many people have acknowledged how expensive Canada’s housing markets have become, but say that a crash is impossible for reasons.

Back in the day when Alberta was even bubblier than Toronto, people said Toronto could crash, but no way Calgary would because its house prices were supported by the oil industry, and demand for oil wasn’t going anywhere. Just a few years later, the price of oil crashed, though miraculously Alberta experienced a soft landing rather than a crash. Record-low interest rates (which drove Vancouver and Toronto to new heights as they stabilized Alberta) likely helped a lot with that feat.

In Toronto, interest rates have been one of the key impossible things supporting the market: people can afford the payments to keep the market elevated as long as interest rates stay low. And far past the crisis days of 2008, emergency rates stayed with us, and even went lower and lower. It didn’t seem like the BoC was ever going to raise rates, and there are only so many years financial pundits can warn people that rates will eventually go back up before buyers tune the warning out and just go hog wild on debt. Even as inflation started to rage at the end of 2021 and beginning of 2022, the BoC stood its cowardly ground, and bulls became even more emboldened in their call that rates would never go up.

And besides, the argument went, “they” couldn’t raise rates: we’re too indebted as a society, higher rates would crash prices and cause a recession, and they would never do anything to endanger house prices.

Well, it looks like we’re in for some rising rates. [Ed. note: since the first draft of this post and the enormous amount of time it took me to hit publish, the BoC has raised rates 100 bp in two 50-bp steps after the first cowardly 25 bp hike in March] And if the argument was that rates couldn’t rise because house prices would fall… I guess house prices are going to fall then?

When markets get badly distorted, but the most obvious corrective force is “impossible”, well, impossible things seem to happen all the time to break theses in nasty ways. Many people seem to be learning the hard way that real estate prices can go down, and rates can go up.

The Big Misunderstanding

One other common sentiment out there is that “bears were wrong and so will always be wrong. Even with rising rates and a correction, house prices will never go back to 2011 levels so bears have lost! Don’t listen to bears!” And this sentiment is either an attempt to show a brave face as a bull, or a deep misunderstanding of the rent-vs-buy math that we’ve been talking about for that decade.

If you were in Toronto in 2011 and decided to rent when the price:rent was 300X, the bulls were (so far), right post hoc and had a faster increase in net worth… if they were sufficiently levered (and sell and go rent now to lock in that gain). But check that spreadsheet again: the base case for renting was that you would be ~$100k ahead (back then six figures was a lot of money and not just a kicker to win a bidding war) assuming historical ~3% increases in real estate. Bears don’t need prices to go back down to nominally what they were (though we do need a correction to pull ahead < a href="http://www.holypotato.net/?p=2516">post-hoc), as the difference in monthly cashflows and investments can close the gap. Indeed, at various points along the way the price:rent got so disjointed that you needed a 6%/yr increase in house prices forever just to keep pace with the renter. The last decade saw closer to 7%/yr in Toronto, so those who bought have done well for themselves… but how much longer can that rate of appreciation keep up?

Someone who passed on a $700k house in Toronto to rent and invest the difference does not need house prices to crash below $700k to come out ahead – they just need prices to come back to ~$1.2M by 2024 to win in the post hoc comparison. Yes, that will still require a correction from here, but the delta is not nearly as big as those who just want to say being early is the same as being wrong want to paint it as. If you did make the “disastrous” choice to rent, you’re not nearly as far behind as all that.

How Far Down?

A common question I see directed at bears now that people remember that we exist is how far would it have to drop before you’d buy? I’ve been quite happy renting here, and the LL doesn’t seem to be in any hurry to throw us out. Even though it would only take a ~30% correction from the peak to end up ahead (and prices are already down ~10%), I’m not sure that I would be buying there – the price:rent would still be pretty elevated at that point, and we have to be forward-looking with our decisions.

There is a kernel of truth to all that stuff people say about not perfectly timing the market and all that, so I wouldn’t be trying to pick the bottom once we get back into range of some semblance of a fair value. But even at 30% off, unless rents also spike, we’re still talking about very elevated price:rent levels around here. There’s no way to know if the R’s in our mental model will ever become the marginal buyer again, but for doomcasting, that would mean prices dropping something like 45% from the spring 2022 peak.

Oil prices have gone through the roof with the war in Ukraine, but even before that, gas prices in Toronto were about 25% higher than pre-pandemic. Despite that, gasoline consumption appeared to be hitting new highs in the fall of 2021. New cars are hard to come by, and the prices of used ones are up a lot following the pandemic for other reasons (supply chains, etc.), but still I was not seeing the interest in hybrids that we saw the last time gas prices spiked.

I was staring to think that maybe people forgot that it’s one of those things I spent way too much time learning way too much about, or maybe instead of accosting random Prius drivers in parking lots people had learned to research things on the internet themselves. I was starting to think that the price of gas didn’t matter.

Then gas prices hit ~$1.75 and it was like a tsunami of hybrid interest hit me. And it wasn’t just me and BbtP: Google trends shows that searches for Prius doubled from baseline in March of 2022, and those for PHEVs tripled. So there was a point where gas would get expensive enough that more people would get interested in burning less of it. I also noticed more people on the 404 and 400 driving the speed limit — slowing down is a good way to burn less gas (and much more immediate).

While I was expecting more to happen at $1.30 or $1.40/L, people did seem to get to a point where there was interest in change. It’s just that people seem to be able to tolerate much bigger changes in prices before getting to the point of demand destruction than we ever would have guessed before.

Which brings us around to the idea of the carbon tax. A carbon tax is an attractive idea for reducing GHG emissions: give carbon a price, and let the free market figure out solutions to reduce consumption. While I still think the approach is a good idea, after seeing how resilient demand can be in the face of sharp price increases, I think we need to increase it by about an order of magnitude a factor of ~3 to have any effect — the ~11 cents/L carbon tax is not moving the needle at all on people’s driving habits and consumer choices.

It may also be a good idea to re-think how we apply carbon taxes in a market with rapid swings in natural pricing: rather than a static carbon price, would it be better to set floor and quasi-ceiling amounts for gasoline directly? When the market is already setting a price that’s high enough for demand destruction, does an additional tax help further drive behaviour, or would it be better to cut it back as gas approaches $2/L to provide a modicum of relief? And vice versa, if gas prices start going back under $1.50/L, should a new responsive carbon tax make up the difference to keep the price high enough to maintain that reduction in use and behaviour change, or do we really think a $0.11/L carbon tax will do anything if the oil market corrects and gas drops back under $1/L?

Budget 2022 proposes to introduce the Tax-Free First Home Savings Account that would give prospective first-time home buyers the ability to save up to $40,000. Like an RRSP, contributions would be tax-deductible, and withdrawals to purchase a first home—including investment income— would be non-taxable, like a TFSA. Tax-free in, tax-free out.

The new Tax-Free First Home Savings Account (FHSA) is pitched as a way to save up for your first home. It’s like a super-charged RRSP: you get to put pre-tax money in, and in one specific circumstance (buying a home), you can take it out tax-free. And if you don’t buy, you can roll it into an RRIF like a regular RRSP.

There’s lots to nit-pick with this idea: the $40k lifetime limit doesn’t make it much more effective for saving for a home than the old HBP option did. And while this is even better as you don’t have to pay it back and get to keep that tax savings, that’s a benefit you only see in later years vs the HBP — the $35k HBP was already letting you put that much pre-tax money to work for the purchase itself. On top of that, the $8k yearly limit means it will take 5 years to max out (and 4 to match what you could do in 90 days with the HBP and a regular RRSP). So at least it will push demand out if some people want to max it out before buying.

It’s a bit regressive, in that people in the highest tax brackets will see the biggest advantage from using the FHSA.

However, ignore all of the talk about using it for a downpayment. The fact that they took out the age limit and let you roll it into an RRIF mean that the FHSA serves another purpose: it helps renters shelter more investment income, functioning basically as more (and with an embedded option!) RRSP room. Someone who buys a place gets any increase in equity as a tax-free gain thanks to the principal residence exemption. That’s been a huge windfall in recent years, and can push people toward buying in an environment where prices are going up double-digits every year. That tax advantage also makes it even harder for those who don’t own to keep up. Someone can choose to rent instead and save the difference in monthly cashflows, but may soon run out of TFSA and RRSP room. An extra $8k/yr will help them shelter more of those gains.

And of course, provide that option to take the whole FHSA out at some point in the future to buy, tax-free.

Imagine a world where the cap and 15-year lifespan were removed and renters continued to get $8k/yr in room until they bought or turned 71 (and rolled it into a RRIF). Someone renting in a big, unaffordable city like Toronto could prioritize their FHSA, knowing that it would make it that much more possible to eventually buy when their indentured servitude in the city was over. $8k/yr at a 5% return would leave someone with nearly $400k after 25 years*. You could make a solid plan to do your time, renting happily along the way, and know that you could — tax-free — have nearly enough to buy a place in the boonies outright when your commuting days were done. Or, have more in your RRSP to support the costs of lifelong renting in retirement if you stayed in the city.

So while I don’t think this was a necessary thing to create (indeed it adds more complication to our tax and savings account system, and yet another financial literacy hurdle), and don’t think it’s going to do a damned thing for housing affordability… I welcome the FHSA. For many people, it will be the obvious first account to fill (even edging out a TFSA for those who plan to buy eventually). However, to be truly great and to help incentivize more people to rent and invest the difference and keep open the option to buy in the future, they’ll have to remove the fairly low lifetime contribution cap.

Indeed, I’m not sure many brokerages will bother to offer registered accounts that can only ever accept $40k, and are only available to the subset of renters who save money to invest — see how few bother to offer RDSPs.

* – remember that this is a hypothetical where they remove the cap and time limit. As it stands, the 2022 Federal Budget proposes a $40k lifetime cap and a 15 year maximum term to either buy a home or roll it into a RRSP/RRIF.

Perhaps Commissions Aren’t So Bad

Dan Ariely talks about the difference between free and nearly free. Nearly free and free have basically the same effect on your overall net wealth: whether you pay 14 cents in ECN fees every month or zero as you accumulate your investments is going to have no measurable impact on your ability to retire. But the difference between a few cents and free on your trading behaviour is huge — people will trade a lot more when it’s free. Plus the sales commission on the selling side for Questrade is good for investor behaviour: not high enough to actually be a real barrier to selling, but puts just that little bit of psychological stop in before selling and prevents dabbling in day-trading.

So I’m worried these days that so many people don’t ask “what’s a good brokerage to use?” but “which investing app should I use? Is Robinhood in Canada?”

And as much as lower fees are better, perhaps there’s a behavioural benefit to paying a little bit of commission and we shouldn’t encourage zero-fee platforms. Plus these companies make money somehow, which may include providing worse fills (though that doesn’t seem to be allowed in Canada).

Smartphone Addiction

Your smartphone is an ingenious device, carrying more power than the desktop computer I had in university, and able to carry out many very useful functions. It’s no wonder many of us have them practically welded to us. But they are an insidious thing: they short-circuit our brains in some of the worst ways.

Paying by mobile phone reduces the pain of paying even beyond that of using a credit card, so it’s all too easy to impulse buy something and not even notice how much you spent with that tap. And so many apps are addictive (sometimes purposefully so) that just touching your mobile phone short-circuits all of your careful reasoning faculties. [only a modest exaggeration on my part]

Do. Not. Trade. On. Your. Phone.

Investing Apps

Long before there was daytrading involved, WealthSimple bragged about how a third of their users checked in with the app daily. Daily! For a robo-advisor. There’s nothing to do! The whole point is to have a long-term investment plan that you don’t have to babysit!

From their point of view it was great: more mindshare, better odds that someone is checking on their phone and a friend goes “oh hey what’s that.” So of course they loved it. But I was horrified. Setting aside the unhealthy relationship people had with their phone and this app, it was setting investors up for loss-aversion disappointment (or panic): the more often you check in on your portfolio, the more likely you are to catch a downturn and see that you’ve lost some money.

So mobile phone investing apps had a horrifying relationship to engagement and addiction before they threw day-trading into the mix.

Do. Not. Trade. On. Your. Phone.

Dark Patterns, Advertising, and Active Investing

The trailblazer in no-commission app-based trading, the brand that has become synonymous with the product itself, is Robinhood in the US. And Robinhood has been criticized for its dark patterns, gamifying parts of the user experience to encourage people to trade more often and make more speculative bets. For example, they’d flash digital confetti up on the screen as a kind of reward/congratulations for placing a trade, and list trendy stocks.

Now WSTrade looks to be copying some (but thankfully nowhere near all) parts of the playbook, with a mobile-only [update: mobile-first, as I took forever to publish this and got scooped in some ways and they now have a desktop web version] app, offering zero commissions and fractional shares. And they’ll give you a free stock, to really drive home that idea of trading individual stocks, with a lottery-like component (will your sign-up bonus be a penny stock or a really valuable share?).

They also moved beyond stocks into an even more speculative space with crypto trading. And while not a dark pattern within the app itself, their ads are highlighting all the new speculative investments you can trade with them (rather than focusing on the good parts, like that you can do long-term investing in an all-in-one ETF with no commissions — in fact I can’t say that I’ve seen a single ad along those lines).

In the US case at least, there are plenty of stories of people getting caught in things they don’t understand and losing lots of money — whether through mistakes, or through functionally a fully enabled gambling addiction. Thankfully, here in Canada investing apps don’t push users toward derivatives to add risk on top of daytrading, though they are moving toward “instant deposits” to wipe out any chance for cooling off periods and do include crypto. And the “first stock” promotion of “up to $4,500!” reinforces the gambling aspect of investing, and fractional share ownership promotes speculating in individual securities long before a user is ready for that.

And that’s not to mention fat-finger trades — how many typos have you made texting on that device?

Do. Not. Trade. On. Your. Phone.

Academic Research Backs Me Up

Two recent papers back up my instinctive refrain that you should not be trading on your phone.

First, Does Gamified Trading Stimulate Risk Taking? looks at the gamification aspect:

“We find that gamification “nudges” participants to take on more risk, particularly when trading high-volatility assets. The effect is stronger for inexperienced traders with lower financial literacy.”

You can read a more lay-friendly version here.

Their finding on the moderating influence of financial literacy gives me some hope. However, it also worries me, as people with low financial literacy are the ones now searching for “investing apps” rather than “best brokerage” – the term brokerage is almost entirely missing from new discussions on Reddit, for example, so the people using these apps are much more likely to be the low-finlit ones most susceptible to the gamification, gambling, ads, and dark patterns.

Next, Smart(Phone) Investing? A within Investor-Time Analysis of New Technologies and Trading Behavior looks at people’s behaviour when trading on their phone.

“we find that smartphones increase the purchase of riskier, lottery-type, non-diversifying assets, and of past winners and losers. […] following the launch of smartphone apps, investors are—if anything—more likely to purchase risky, lottery-type, and non-diversifying assets as well as chase winners and losers on non-smartphone platforms. […] We find evidence against investors offsetting these trades on other platforms and against digital nudges mechanically driving our results. Smartphone effects are neither transitory nor innocuous: assets purchased via smartphones deliver lower Sharpe ratios. Our findings caution against the indiscriminate use of smartphones as the key technology to increase access to financial markets.” [emphasis mine]

That reinforces my more instinctive view that even touching your phone short-circuits your self control thought: simply trading on your phone increases the likelihood of buying riskier things, and it infects your trading even off your phone. They also include a reference to another study on purchases, supporting the idea that smartphones reinforce system 1 thinking, where people ordered more unhealthy food on their mobile devices.

Conclusion

If you’re looking to start investing, do not look for a zero-commission “app”. Start by reading, and then open a brokerage account and only use your desktop/laptop to trade. Even if the brokerage you ultimately choose has a mobile app, don’t use it, as even occasional usage may change your appetite for lottery-like stocks. Controlling costs is important and a virtue, but zero costs changes our behaviour in ways that may be counter-productive. A few dollars here and there (or even $10 big bank commissions) are not going to derail your long-term plan, but may keep you from trading more than necessary. And finally:

Do. Not. Trade. On. Your. Phone.

I wasn’t sure how I would react to Reboot Your Portfolio: 9 Steps to Successful Investing with ETFs by Dan Bortolotti after his announcement post, which said “What was needed, I recognized, was a step-by-step guide to designing, building, and maintaining a portfolio of ETFs over the long-term.” My Dude, I thought, that book already exists and it is called the Value of Simple.

But that’s the reaction of someone who spent too long in Science, where you have to cite prior work and it’s hard to publish replication studies. In art there’s all kinds of room for cover songs, and RYP actually has a really nice harmony with VoS.

Preaching to the Choir

RYP fully assumes that this is not your first book on investing, and so doesn’t spend much time on the basics like “what’s a stock?”. It dives right into “stop trying to beat the market!” Which I suppose fits very well with the title: you must first have a portfolio to reboot it.

Dan clearly and convincingly makes the case for why you shouldn’t try to beat the market, and why indexing (and specifically market cap weighted indexes) are the way to go. There’s a good section on factor/smart beta and why he doesn’t go for it.

He also has much more on building your plan before you invest, and how that influences your choice of investments and your ability to stick with them. Importantly, the planning section includes some key questions you should ask yourself as you’re building your plan.

RYP includes much more detail on how ETFs are built and the alternatives (e.g. smart beta), currency implications, etc. The book spends a bit of time digging into tracking error and transaction costs: the more advanced stuff that VoS doesn’t touch — again, a great complement. He also addresses head-on the common misconception about ETFs that track similar indexes having different prices: one is not “cheaper” or “a better value” just because the price per unit is lower. The price per unit is fairly arbitrary.

He also has a section on cutting ties with your advisor, to prepare you for the common arguments they might make. One addition I like a lot is his point that “You don’t need to change each other’s minds.” “There’s no point engaging in an argument with an advisor you’re planning to fire. He or she may be using fear tactics to encourage you to stay, which is unprofessional and provides another reason for you to cut ties.”

Then he has guidelines for how to buy your ETFs. He doesn’t go into quite the screenshot-level detail of VoS (which will also save him from having to release a new edition every 3 years — smart compromise), but hits all the main generalizable points, including using limit orders and rounding down your number of units.

Nitpicks

It wouldn’t be a BbtP review without nitpicking, but I have basically none. {gasps from the crowd}

The one thing that got me was my own bugbear (which is admittedly being pedantic on one page): in the TFSA-vs-RRSP bit, his RRSP description is missing the pre-tax nature of RRSP contributions. You should not pick an RRSP over a TFSA because it gives you a tax refund — you should be re-investing that refund anyway (or getting it back after grossing up or whatever). Yet Dan says “And if your income is significantly higher–once you’re in the six figures, you’re being taxed at more than 43%–then prioritizing the RRSP is almost a no-brainer, because that tax deduction is so valuable.” [Emphasis mine] This is the thinking that gets people to not add more to their RRSP to account for that gross-up/pre-tax bit, and then complain when they hit retirement that they have to pay tax on their RRIF withdrawals.

If you’re in a high tax bracket the RRSP is usually the better choice because there’s a higher chance you’ll be in a lower tax bracket later. The current tax deduction has nothing to do with it. If you have say $5k to save today and are debating between putting $5k in your TFSA or RRSP, putting $5k in your RRSP and enjoying a tax refund means you’ve really only saved $2850 — you had to contribute $8.77k to your RRSP [at that 43% tax rate] to have an equivalent situation to $5k in your TFSA (and then your tax deduction just brought you back to the same state as the TFSA, it was not valuable on its own).

I will note that he got it right immediately before that: “if you were in the same tax bracket for your whole life, the TFSA and RRSP would be essentially the same… an RRSP is particularly useful if you make contributions when your tax rate is high, and then make withdrawals when it’s low.” And to be fair, that this is something tonnes of otherwise careful experts get wrong (sometimes on purpose — people are irrationally motivated by tax returns, so selling them on saving and investing in their RRSP to get one works to get them to save and invest something much more so than a long, carefully worded explanation about pre-tax amounts — investing the same amount in a TFSA may be better, but that’s not always the counterfactual).

So Which One Should I Get?

As much as I have a conflict of interest, get both Reboot Your Portfolio and The Value of Simple. The lessons are important and it’s good to reinforce it, and now you’ll get it from two different voices from different angles to really help drive it home.

VoS is very purposefully designed for people who are not (yet!) DIY investors. It’s main criticisms have been that it is too simple, which I eat up. So if you’ve never made a trade on your own before (or are shopping for a friend or relative in that situation), I would suggest that you start with VoS, and then read RYP to reinforce the take-home messages of indexing and the value of all-in-one funds, and get those extra details on why you should pick certain index funds.

If you are already an investor, and are confused by all the different strategies out there (growth? dividends? crypto? meme… stonks?) then get RYP. VoS has more detail on what happens next for beginners (how do you read a statement, what are taxes and what do I have to do) if you’re confused on that after reading RYP, but if you’ve already opened a brokerage account and know how to use it, and are mostly stuck on convincing yourself to go with a simple index ETF route, BYP will probably be better at convincing you of that and will likely be all you need.