Blessed by the Potato

Just before Blueberry was born, we had a discussion about why we didn’t need life insurance for our situation. I’d like to broaden that discussion a bit, but I have to tread carefully. There are many who are under-insured not because they have decided that insurance isn’t for them, but because they just haven’t gotten around to it yet. I don’t want to encourage further procrastination (well, I do — don’t go off and work, read my blog!), and it can be very important for many people out there. But at the same time the insurance sale may be a bit heavy-handed and the base assumptions seem to increase the apparent need. Part of that may be my perspective: my value system is compatible with the idea that my survivors’ lifestyle shouldn’t be completely untouched (let alone improved) by my passing.

Here is why I’m out of the mainstream:

1. my idea of dependents
2. my idea of lifestyle of survivors
3. my assets/situation

The idea of dependents is a bit of a strange one these days: kids are and always will be, but we are long past the time when the typical family consisted of one breadwinner head-of-household and a stay-at-home spouse (who was typically the female head-of-household). Many families are dual-income now, and even many of the ones that presently aren’t could be (modern stay-at-home mom or dad is likely university educated and had a career before getting hitched at an ever-later age and spawning). So your family would be without your income if you died, but they could still have some income. In our case, Wayfare actually has a much higher earnings potential than I do, and after Blueberry’s in school she could ramp up her hours worked to fully offset any loss of income from my death.

The assumptions of what the needs of survivors will be also seems a little over-the-top to me: some sites suggest full income replacement until you would have retired. But if I’m not there to spend part of that money, it means that my survivors would have an economically better life than if I were still there (except for the dark void in their hearts). Liabilities are also a typical factor in calculators estimating your needs: having enough to instantly pay off the mortgage is common, but seems to imply that they would or should stay in the same house, rather than downsizing, and that the surviving spouse wouldn’t be paying any of that down. For mortgagees, some insurance is a good idea because house prices can go down and transaction costs can be high, and you don’t want your survivors trapped and unable to extract the equity to move on.

The typical assumptions seem to imply that the survivors won’t make any adjustments in their life, work, or spending to compensate for the loss, which can lead to some large insurance needs. Instead, I figure that if I die, Wayfare and Blueberry will be free to move to a smaller, cheaper rental. There will be no need for a place so large with one person down (my whole dual-monitor home office set-up will reduce the room needs by one, and I don’t think Wayfare needs a kitchen half as large as the one I insisted on). And part of the reason for living in the over-crowded fourth circle of hell Toronto is the arcane arithmetic of the two-body problem and large populations; freed of that constraint they could move to a cheaper centre like Hamilton or London. Combined, a smaller place in a less-expensive town (or even less-expensive part of Toronto) could cut rent costs in half. On top of that is the significantly non-zero probability that Wayfare will find a replacement spouse who is gainfully employed.

Having a contingency so that these adjustments don’t have to happen right away makes sense, as does enough coverage for daycare until Blueberry is in full-time school. That’s where our situation also helps with my estimate of minimal insurance needs: we already have over a year’s worth of expenses saved up, and supportive parents who could provide an additional layer of security if we badly screwed up the math. As it turns out, my job came with group benefits for some measure of life and disability insurance (and it is the disability insurance I am more worried about).

Death is tragic, but from a financial perspective it’s not the biggest cause of young families losing an income. Divorce can not only rip daddy away, but cause massive upheaval and lead to a chunk of the “estate” being lost to lawyers. I’m ok with the idea that if I die, even with just 2 years of income for insurance coverage, my family will still be better off than those who started from similar circumstances and got a divorce. But I don’t want to make the delta so large that perverse incentives form.

Back to insurance: I actually found it quite hard to find ballpark quotes on disability insurance outside of my group plan. For life insurance I think it is important to disaster-proof your life, but the actual coverage need might not be quite as high as some calculators suggest, if you’re ok with the idea of your survivors taking basic steps to adjust for the loss.

TLDR: A single, straight-line calculation of invest $X/yr at Y% returns is a little too simplistic for your retirement planning, but a Monte Carlo or exhaustive simulation can be overwhelming. I think a good middle-ground is to find a ballpark number of how much you need to save, and to see where that puts you under good, decent, and relatively poor investment outcomes so you can figure out if you’re in the right ballpark. Download Potato’s Automagical Financial Planning Ballparkinator here.

I think hands-down the most common two questions I get related to finances are “how do I…” (for which I’ve written a whole book and have a course) and “how much do I need to save, anyway?” There are a host of tools available on the internet to try to answer this, but they’re all fairly simplistic — as few as three factors are considered, with many hard-coded variables. If you’re still decades away from retirement then you really just need a ballpark number to get started, and for that those tools are pretty good — heck the “save 10% of your income” rule-of-thumb is not terrible, and it doesn’t even specify whether it refers to pre-tax or after-tax income, or to what age range it applies.

But of course I wanted something a little more detailed with more things to tweak. More importantly, I wanted to put up side-by-side comparisons of some important scenarios so people didn’t have to refresh their web browser a dozen times to get an idea of where to go. May I present Potato’s Automagical Financial Planning Ballparkinator. Available in Excel.

There are many possible shapes to the future, so how much you need to save decades in advance will only ever be a rough estimate. This will help you figure out what the general ballpark estimate of that number should be. It’s based on my retirement planning spreadsheet calculator — I added a more robust tax calculation (including OAS clawbacks), and of course the whole soup-to-nuts saving through retirement component, but have removed some of the finer features (like non-flat budgets and personal inflation rates). It does include a separate field for your investing fees (MERs) so you can see the impact of those without having to directly adjust the returns in the scenarios (and more directly, to put that factor front-of-mind).

It calculates forward based on your current savings rate (and a bunch of other assumptions) to find out how long your money will last under that plan, and also estimates backwards from your budget needs, accumulation years investment returns, and a sustainable withdrawal rate to rough out how much you should be saving (annually). Note that the backwards calculation bundles all account types together for the calculation and does not account for taxes — a much rougher estimate and more similar to the simplistic web-based tools common on many bank websites.

The results are presented in a little table to examine three scenarios for future returns (a base, worst, and best case), which you can of course define yourself, and for four risk profiles/asset allocations: ultra-conservative (all fixed income), balanced (50/50), risk tolerant (mostly stocks), and all stocks. This is important as the rules of thumb like “save 10%” are based on having enough of a balance to get something close to equity-like returns on your savings. If you are like many people today, scarred by 2008 and unable to contemplate anything more volatile than a package of bonds, then you will have to cut your spending budgets and save substantially more every year to make up for that ultra-conservatism in your investments. Similarly, if you don’t start investing until you’re in your 50’s, then you’ll have to put away substantially more than 10% of your income.

Figuring out your future spending needs may be the most difficult part. For your future budget you can start with your current spending needs, and take your best guess as to how they will change in the future. More travel, but less commuting? No more mortgage payments, but added expenses for lawn care & snow removal that you used to handle yourself? The default in the spreadsheet is to take 75% of your current spending budget, but definitely put careful consideration into this figure — and try out a few iterations.

Note that this is not a full financial plan, not by a long shot. There’s nothing here about contingency plans, goals, motivations, asset allocation, rebalancing plans, insurance, emergency contacts¹, taxes and tax shelters, short-term savings goals, or really much of anything else. I’m hoping one day someone will get around to showing us what a good, complete financial plan looks like. Until then: ballpark, get started, evaluate, adjust.

Also, if you need help estimating how much you’ll get from CPP, I have a tool for that here.

1 – no, not poison control. Who will calm you down when markets are roiling? Who will your family call if you’re dead or incapacitated, who has your will?

Update, April 16, 2014: Thanks to Spudd at CMF (no relation) for pointing out that there was a problem with early retirement scenarios and the RRIF table. I’ve provided rough guidance for that going back to age 20 — it might not be the right amount to start withdrawing from an RRSP right away, but it should be reasonably close and at least returns something for early retirement scenarios now. I’ve replaced the sheet on the site, the link remains the same.

Update, July 2017: I’ve fixed the “backwards” calculation with a better approximation, one that uses a few different ranges of sustainable withdrawal rates. There was also a pretty bad bug when RRIF withdrawals satisfied cashflow needs, but money was still being pulled from a TFSA anyway that’s now fixed.

Canadian Capitalist and Squawkfox have created rebalancing spreadsheets to help you when it comes time to rebalance your portfolio. They are somewhat simplistic and hard-coded with the funds — this is a good thing if you’re following the Sleepy Portfolio or one of the Couch portfolios: just enter the current value, the money you have to add, and see how to split your new purchase up.

I wanted one with a bit more flexibility: one that would allow for a few broad categories of investments, with sub-investments. For instance, if I had small bits of cash left over at various points through the year I might throw them into a TD e-series fund, and as long as my overall Canadian/US/International split was ok I wouldn’t worry about rebalancing the e-series versus ETF splits. Or similarly if I had several sub-products to make up one sector, like counting BRK.B and VTI together for US exposure, but not caring too much whether that split was 50/50 or 60/40. Also rather than just entering the current value, the sheet lets you enter the price and the number of units in your various accounts. With the units entered, half the work is done for the next time you want to rebalance (just update the unit prices).

The sheet calculates and displays the variances (how much you are off by), and then also calculates how many units of each fund you need to buy to get back into balance. Note that you should generally round down so that you don’t over-spend the funds in your brokerage account. In the top row you can enter how much new cash you have to invest, or enter a negative value to withdraw cash from your portfolio.

The spreadsheet is available here in Excel, or through Google Docs* here. Enjoy!

* – Google can try to call it Drive, but Docs has stuck with me.

In the comments to the first post on regulating financial advisors someone brought up the issue of regulatory burden: the extra paperwork and delays imposed on businesses. Nicole went so far as to call it “onerous” and “strangling” — and that’s just for the regulation already in place, which we’ve criticized as not providing enough protection.

There are lots of examples of regulatory burden out there, for many stakeholders. I regularly suggest that people go with TD Waterhouse to be able to invest in e-series funds over TD Mutual Funds because of the extra steps and forms needed to fill out and mail in to convert an account and the possible limitations of the KYC forms. I never got my CFP/CSC because it’s just not worth my time to take the courses and exam for what the designations would bring me; if something like that were to be a mandatory requirement to talk to clients about investing and their financial plans that would keep me and several other part-time educators/planners/coaches/DIY-support people out of business.

But a certain amount of form-filling, records-keeping, and education overhead should be expected in any business. The correct amount of regulatory burden is highly unlikely to be zero, and if it brings important consumer protections then that’s a good thing.

However, the way regulations and reporting are structured can have huge impacts on the eventual regulatory burden. Consider for example something I have some experience with: applying for a grant to do some medical research. You could apply to the US National Institutes of Health (NIH) and or to the Canadian Institutes of Health Research (CIHR). In both cases the basic document outlining the experiment you’re looking to fund would be say 13 pages. On top of that you’d have a detailed 5-year budget and a justification for the funds you were seeking, a half-page lay summary for the funding agencies to release to the press or the elected government representatives, and some kind of CV to demonstrate that you had the experience and ability to carry out the research you proposed.

Now both funding agencies take very seriously the protection of research participants and have fairly similar rules and regulations in place for that protection, but the implementation and regulatory burden is night and day in my mind. In Canada, your grant would now basically be complete: CIHR’s protection of research subjects rules are separate from the grant process, and all institutions sign on to it before they can enter a competition. They know that any research is going to be reviewed by a research ethics board that meets their standards, and will get a copy of the approval before releasing funds (if you’re successful in the first place). If the experiment calls for anything terribly out of the ordinary, then it’ll have to be explained in the proposal anyway. Compare this to the US, where the proposal part of the grant submission is almost like an afterthought to the stacks of appendices and tables that have to be filled out — including some that no one really seems to understand (including the NIH help staff I’ve spoken to), where you have to predict the racial breakdown for any proposed study (how many whites, blacks, asians, etc. will you recruit), but then also the “latino/non-latino ethnic breakdown” (how many latino asians vs non-latino asians will you include in your study??). It’s stressful and confusing (Spain and Portugal aren’t included in the countries of origin for people considered hispanic?) and totally bizarre (why do they care about this stuff? Will they really reject my grant over this?). For basically the same mandate and ultimate protection of research subjects, the regulatory burden is quite different between the agencies because of how they approach the problem and where they place the reporting requirements. By having so much paperwork up at the application stage it creates a lot of work for the ~80% of NIH applicants who will not get their grants funded because the scientific component wasn’t competitive enough for the severely limited funds.

Also, some protection comes with virtually no on-going regulatory burden. The Residential Tenancies Act sets out many protections for tenants, but aside from modifying what you can put into a lease there is no paperwork for landlords or tenants to fill out in the regular course of business beyond what you’d need anyway. Indeed, you get some of that for better than free: by standardizing certain terms, responsibilities, and practices they don’t have to be separately negotiated and drawn up in a lease. Everything is handled on an enforcement basis: only after a problem arises does someone end up having paperwork to fill out. Now at that point it can be very onerous (dealing with the LTB is no picnic, especially for landlords), mostly due to the delays involved. But for most people most of the time, it’s reasonably strong regulation with little overhead cost.

So I think that implementing a better model for financial advice and regulation thereof can be done in a way that minimizes the regulatory burden. It’s something that can and should be kept in mind as a new regulatory framework is thought out (especially the implementation aspect), and kept in balance with the benefits.

In the last post we talked about the importance of regulation: to create an environment where a non-expert, without the ability to independently evaluate an expert, can come to trust a complete stranger because of the regulations and mechanisms in place to create and maintain quality and ethics. There are lots of examples of industries and professions with varying degrees of regulation that we can learn from.

Car salesmen are regulated (OMVIC in Ontario). The regulations set some minimum standards for disclosure and how prices can be advertised: it’s not especially strong legislation (for instance, the dealer does not have an obligation to work in the best interest of the customer), but then the general public understands explicitly that the car salesperson sitting across the desk from them is in a sales role. They don’t couch themselves as “transportation advisors”, and if you went to one you would know that they would try to sell you a car (and you would not walk away with a recommendation for a bicycle and transit pass even if those might suit your situation better). They might be able to help you pick a particular car that’s suitable: compact over a truck, but even then you know that if you walk into a Chrysler dealership with a need for something fuel efficient you won’t be driving out in a Prius or Leaf: the best they could do is a 4-cylinder gasser that their dealership sells. To my mind, this is most analogous to the current MFDA designation in the financial sphere, but without the universal, mutual understanding of the sales and commission-driven nature of the role.

Some trade organizations exist more to protect their members and a monopoly than to protect consumers and build trust with the public. Since it’s been a while since I’ve done so, let’s pick on realtors: there are minimal barriers to entry, and no formalized processes to manage conflicts-of-interest (except for those set up at individual brokerage offices). There is a dispute mechanism, but from casually looking at cases and allegations, they seem to take realtor-on-realtor aggro way more seriously than allegations of misleading or mistreating the lay public. In other words, CREA/TREB is not a model I would want to copy: the initial quality standard is not rigourous, there’s no continuous improvement, there’s next to no policing or efforts to maintain the public trust: it appears to be a trade organization out to serve its own interests.

In cases where the decisions are literally life-or-death the regulatory body tends to take a more active role. Medical physicists for instance are responsible for calculating radiation doses in cancer therapy and ensuring that the machines are accurately delivering the doses prescribed. Over-dosing can kill through radiation effects, underdosing can allow cancer to proliferate. The Canadian College of Physicists in Medicine requires a graduate degree in one of several related fields, a fellowship program (education), examination, continuing education, periodic re-certification, and practice reviews.

Banking, at least the deposit-taking part, is a highly regulated industry. Not just anyone can rent out a space with marble pillars and a vault and call themselves a bank. Because trust is essential to preventing a run on the banks, a government-backed insurance scheme (CDIC) is in place to guarantee that if all of the regulations and oversight somehow still manages to fail, depositors will get their money back (up to a limit of $100,000 per account). Now, that’s not to say that a bank won’t ding you with service charges or sell you services you don’t need — they walk a fine but well-defined line of trust and conflicting interests for sales.

Franchises are not something handed down by the government or enshrined in law, yet by building strong brands people know that stopping at McDonald’s or Subway for a meal will provide a fairly uniform meal experience — they can trust that even in a strange city far from home that they’re going to get what they expect. It’s a way of accomplishing the end goal of letting someone with no easy way of independently evaluating quality to walk in off the street and know that they’ll be in good hands.

So what would I like to see? I think good regulation will be stronger and faster* than building up a brand/franchise, though the end result might be better that way as an organization shooting for excellence doesn’t have to play to the lowest common denominator. Either way, I think getting rid of embedded commissions and their inherent conflicts-of-interest and obfuscation is the first step: it’s an uphill battle for education and standards if that basic component of the business model isn’t fixed first. We could follow the UK and Australia in that direction, and it will be interesting to see how their experience plays out over the next few years.

Either way, training and examination requirements at the start, including an ability to explain how fees work, the impact of fees, cash flow planning, and managing behavioural issues. Explaining risk at some level is necessary but is tough because even experts have trouble defining it precisely — perhaps just understanding that there are aspects of risk. Levels or specializations of certification, and an understanding that some situations should be kicked up the chain. Re-examination, auditing of practices, and other systems to keep quality high. And a correction mechanism: some way to feed back new or unresolved problems back through continuing education, to arbitrate disputes, and compensate customers who were wronged.

The regulatory body should ideally be separated from the body that looks to maintain a monopoly or promote the profession so that it can be client-serving and not self-serving. Because it can be confusing as to what the responsibilities of the advisor are (especially if a term like “advisor” is used), someone (who?) should make it clear to the public what the relationship is, possibly disclosed up front (“Hi, I’m a salesperson and I do not have a responsibility to do what’s best for you, just to make my commission and not recommend something egregiously bad. Let’s look at a 7-seater, shall we?”).

Unfortunately I still haven’t had a chance to read the private member’s bill in Ontario so this might all be covered already.

* – from implementation to helping people. It will likely be slower to be crafted and passed in the first place.