Blessed by the Potato

It was 10 years ago that I finished my PhD and started looking for a new place to live. I went deep, deep down the analysis rabbit hole, eventually emerging with my rent-vs-buy spreadsheet. At the time, we decided to rent: the housing market in Toronto was already at a price-to-rent ratio of over 300X, and using a bunch of very reasonable assumptions, renting looked like the much smarter move.

Well, now it’s 10 years later. How’d that all work out?

The housing market (esp. in Toronto) performed very well over the last decade. That was unexpected: the market was already expensive on a price:rent and price:income basis in 2011, and it just simply got more expensive — incomes have not surged ahead in the city, nor have rents. Yet prices have been on an absolute tear, roughly doubling in that decade.

Back then interest rates were at “emergency” lows, and nearly everyone was warning buyers that they would have to be prepared to renew at higher rates. Reality is stranger than we can imagine though, and instead we find ourselves a decade later with rates even lower. If you predicted that, congratulations, you already have your prize. If you used the best information available at the time and decided to rent instead, then you likely have a constant stream of people looking to dunk on you. “How’d that renting thing work out for you anyway?”

While housing is the national obsession, investments had a hell of a decade, too. Remember in the rent-vs-buy analysis we assumed a 7% rate of return for investments? Well in actuality an aggressive diversified portfolio got over 9% because the stock market also blew the lights out.

So how did those two choices shake out with all things considered then? The answer comes down to leverage: if you had a big pile of money and were looking to buy a place outright, you were better off investing it. A $775k (the price of an average detached house back then) investment in a TD e-series portfolio would grow to become $1.9M, while a house of the same value grew to $1.7M. Without leverage, renting and investing was a toss-up versus buying.

If you use the more realistic scenario of starting with a smaller amount to invest and using that as a downpayment (and getting a mortgage for the rest), then buying a house came out better — thanks, leverage!

To look back we can use the same rent-vs-buy calculator and just adjust a few numbers based on how things played out — higher realized returns for both investing and house price appreciation, lower mortgage rates, lower property taxes, as well as lower rent inflation [1].

Saving the extra cashflow from renting plus investing the downpayment would leave the renter with a portfolio of $820k (remember how expensive housing was compared to rents — it took a lot of cashflow to buy!). But that house appreciation (to $1.7M!) leaves the owner with even more equity. Once you sell both (hit the renter’s portfolio with some capital gains taxes, the owner with some sales commission), the owner is better off by $367k.

That’s… not a small difference.

Findependence Proximity

Here’s the strange thing: in reality I chose to rent, so I can see how much more houses in my neighbourhood are than my portfolio. Yet I don’t feel bad about missing the boat. Part of it is not wanting to engage in resulting. I knew what information I had at the time, I know that I put a tonne of effort into my decision-making and analysis, and made the best decision I could with it at the time. Some people were indeed calling for those high growth rates to continue, and we would do the math and laugh.

“You can’t be serious. At that rate, in a decade an already-expensive bog-standard 3-bedroom detached house would be $1.7M! Who would possibly be able to buy that!” Well, here we are, the Darkest Timeline.

With the incredible stock market returns, the renters now have enough to be able to buy in cash — mortgage-free — the house they were previously renting… if it had only appreciated in-line with inflation. But it didn’t, and instead they’re priced out forever (…ever-ever-ever…).

Yet in a way, they’re better off.

I tend to try to put big numbers into context by thinking about FIRE — how much closer to retirement would $367k [2] put me? On the surface, that much money should be a very meaningful difference in outcomes — years knocked off the time in the science mines. But it’s all locked up in real estate equity in the counterfactual. That’s the funny thing: though they can’t buy a house, that stock market performance means that the renter’s investment portfolio is now roughly large enough to pay their rent indefinitely. A few more years of saving and investing to cover their other needs and they’re on track to retire in their 50’s.

The owner still has 15 years of mortgage payments to make, and then still has to save up enough to be able to pay the other costs of the property (tax, insurance, maintenance) and then find a way to pay for food and all the other necessities of life. Their net wealth is significantly higher, and yet their life goals are much further away.

Unless, of course, they’re willing to sell and realize those gains. But at what point do you do that? If you looked at the market in 2011 and decided to buy anyway, when do you switch tracks and get out? What do you do with all that housing wealth if you don’t sell?

The market has seriously warped the notion of wealth. Ten years ago I was aiming for an early retirement (not extreme FIRE, something like early-to-mid 50’s). Round numbers, $1.5M invested would have been in the ballpark for me to comfortably quit my job and either fully retire or go freelance part-time. Yet these days, that doesn’t even buy a house here.

Resulting and the Next Timestep of the Simulation

Was it a “bad decision” to rent 10 years ago? I don’t think so — based on the information available at the time, it was the right move under most expected future scenarios. The future as it turned out happened to be the darkest timeline: rather than correcting the 300X price:rent, it simply went to an even crazier 470X through massive appreciation. If in 2011 you told me the high rate of growth would continue for another decade, I’d say that seemed laughable, and do the math for you — wouldn’t the average house becoming $1.7M in 2021 seem like a ridiculous outcome? …yet here we are. So no, I don’t think it was a bad decision, just a bad outcome.

Likewise, continuing to rent from here: there is nothing in the short-term data that suggests this market is about to crash. The bulls are firmly in control and the government has explicitly said it’s not going to do anything that might bring prices down. But it doesn’t have to crash for renting to come out ahead — it just has to stop growing at such a ridiculous rate. The price:rent is even more insane, so even with lowered expectations about future stock returns, renting looks like it should come out ahead if the housing market also settles down to inflation-plus-a-bit returns. And maybe in 10 years we’ll laugh at how people thought a two-and-a-half decade bull market would continue into a third and fourth decade, and that an average house would somehow be trading at $4M by 2031. Or maybe we’ll see that become the price and the class divide will be complete.

Now, if you gave me a time machine and said what would be the best move to make in 2011, then sure, buying might be the way to go… but that would be a terrible waste of a time machine. As Ben Felix said it would be even better to use that time machine to go back and rent and then invest the difference + downpayment into Bitcoin.

1. There’s a big suburbia/downtown split here — AirBNB really threw a wrench in the rental market. If your condo approximately resembled a hotel room, the rent went up by more than the 2% assumed inflation, then crashed in 2020, while rents out here in commuterville have gone up less than 2%/yr yet held up through the pandemic.
2. Or whatever scaled but not so very different amount for my actual situation vs. the average house retrospective/counterfactual numbers here.

It’s been a hard slog for mental health this last year. Tough on physical health, too.

Err… year and a half. Damn.

Anyway, it just never seems to end.

There are some things we can do to help cope better, of course. They’re not panaceas, but they can help at least a little. The thing is, I have never managed to internalize those lessons.

Some pretty basic things can help with mood and energy levels: if I do some exercise, if I eat some fresh fruit, and I do it consistently, I’ll start to feel a little better in about 2 weeks. I’ve done enough tests with getting into a depressive funk where I don’t do those things and then forcing myself to do them again and it helps (not a full cure, but helpful).

So I try, every day, to at least go for a walk and it’s such an easy sounding thing to do and yet so hard. The eating is even harder — pandemic baking and potato chips have done a real number on my diet, but I consciously work in at least one piece of fresh fruit.

Then someone posted this meme of a determined/upset-looking bald eagle and that has become my new slogan. “I’m going on a stupid walk for my stupid mental and physical health. See you in an hour.” and I repeat it each night.

It’s still not a habit, and it’s still not an internalized lesson — I very much consciously get up and go for that walk (and repeat my refrain about my stupid mental and physical health). Maybe one day I’ll be one of those people who jumps out of bed and then exercises before staring the day, though that has always sounded just terrible to me. I also have to try to remember the gremlin rule: no snacking after midnight (I mean, no snacking ever would be even more effective but it’s not as cute and super-hard).

Am I feeling better now that it’s been a few months of semi-consistent bare minimum self-care? I don’t know, I guess, a little.

I think there was also something about sleep? Crap, forgot about that one.

Anyway, I think because the effects are so delayed I never learn that lesson. I don’t often feel energized after exercising, I feel tired and sweaty — but after a few weeks of doing it every day, I do feel more energized. But such a long stimulus-response delay keeps me from internalizing that message, and without that constant conscious effort, I quickly slip back into slothful inaction.

I can of course relate that back to investing: there are lots of lessons that aren’t easily internalized and we have to keep reminding ourselves of. Market timing and adding complexity are two that immediately spring to mind, especially in the current age of meme stonks and bubble warnings.

I have so much to say about the last crazy, lunatic, unprecedented year, and not sure how to say any of it — my own thoughts are still all muddled. Covid was just a part of that for me — we’re also coming up on a year since my dad died. I haven’t properly eulogized him, or told his story Speaker for the Dead style, and don’t know if I will ever be able to.

This may be a personal blog, but a big focus is on finances so let’s stick to that aspect. It’s easier to talk about, at any rate.

Doing taxes was painful this year, for lots of reasons. I had to prepare the final return for him, as well as a T3 return for the estate, which had quite the learning curve and lots of weird CRA idiosyncrasies. Some examples to delay us before getting to the meat of the post? Sure, why not. Let’s start with where to simply mail the form. It wasn’t a simple Ontario and East send it here, Manitoba and West, send it there — Ontario was spit up with some cities sending it to one tax centre, others to another. Why does that matter? It’s not on its own a complex thing to figure out, but it’s one more step of complexity in what was already a hard process, and one that most people only face under hard circumstances. And it seems like the sort of thing that makes no damned difference so why is the CRA making it needlessly harder? Oh, and there was also one page that got sent on its own to another tax centre in Quebec. Why? Who knows.

It was painful because it was the “final” return and well, that’s a reminder that he’s dead, that’s it. Things are final now, and there are feelings there.

But the other reason tax season was painful was that I had to go over all the financial losses from 2020 to report capital losses. For most people, 2020 wasn’t such a big deal, investing-wise — scary for a brief while, insanely bubbly in a few pockets of the market, but a buy-and-hold index investor ended the year in the positive. Not so for us.

I’ve said many times before that my dad was a good investor. He got me into investing at a young age, etc. etc. That was an understatement: he was a great investor. He didn’t want to be famous, but would give his head a little shake whenever someone else tried to proclaim themselves “Canada’s Warren Buffett”. He was Canada’s Warren Buffett, or at least it seemed that way for a long time.

But as Buffett said, a long string of impressive numbers multiplied by a single zero is still a zero. In the end my dad wasn’t Canada’s Warren Buffett: he was Canada’s Bill Miller or Hwang.

The problem was that he was so good for so long that he got over-confident. He was not afraid of leverage — indeed, he used a lot of it.

On an episode of Because Money (I can’t remember which one to link it now), I shared the tale of how he was in the hospital, sick from his cancer, and needed to check in on the market — because a drop of 5% would be enough to trigger a margin call.

We argued a lot about leverage after that.

I tried to tell him that he was taking too much risk — risk he didn’t even need to take. He tried to convince me that if I ever wanted to be rich, to do more than just get by on my public sector salary (which he also argued I could do much better if I just switched careers), I needed to use leverage.

So he gave me a two-part gift: the first was an amount of money, which here we’ll just call X, a large amount that was roughly a year’s salary for me. The second half of the gift was that he would manage it for me, including by using margin. When I was young he had taught me to invest, but he never really taught me how to invest, at least not like he did. Dad was not the teaching type — he had no patience for it. So this was a chance to finally pass along that knowledge, as I could see what he did in an account in my name almost in real time.

X went into a brokerage account, and he borrowed another 2.48X against it. All it would take would be a 28% market correction to completely wipe me out, which was terrifying. “Relax,” he said, “you need to get used to this. If I do lose you your money, I’ll just write you another cheque. But it won’t happen, and this is something you have to learn.”

Well, Covid-19 hit. I bought some puts on the S&P500 in the early days as a hedge — I briefly felt like a market genius when the virus escaped Wuhan and the market started to wake up to the risk. I sold those for a small profit as things got volatile and it reduced the margin a tad. But the market kept going down, violently. The overall markets were down about 30% by the end, but the highly concentrated active portfolio he was in was down even more, despite appearing more conservative. But all those staid dividend-payers suddenly looked like broken businesses in the wake of shutdowns, and the overall indexes were buoyed by tech stocks that we didn’t own. I threw more money from my savings at the account to try to stave off a margin call, but finally got margin called on March 22, and became a forced seller just a day before the bottom was in.

In the end, X became 0.1X — my inheritance was essentially gone. The market recovered over the rest of 2020, but I did not leverage back up, and even if I wanted to there are limits to how much I could have added.

That’s the real danger of leverage: even if you have the psychological risk tolerance to ride out a volatile period in the market, a big enough dip can cause a permanent loss of capital as you’re forced to sell at the bottom to cover the loan. I should perhaps interject that while that non-registered account was actively managed, I do have registered accounts that are invested in passive index funds, which fared much better though the market crash and recovery, and which is my general recommendation for people — obviously active investing entails various risks, doing so with leverage even moreso.

The story sadly doesn’t have a silver lining, as I also didn’t learn much about his style of active investing — the cancer made him tired, and a little extra motivation to teach didn’t magically imbue him with the patience for it. “So tell me son, why did I do that trade?”
“I don’t know.”
“Well if you’re too fucking stupid to see it then I guess this family is doomed.”
“Thanks, Dad.”

He wanted to spend what little energy he had left on trading, not teaching.

In addition to learning a lot about leverage — or rather, strongly reinforcing my previous view — I also got an object lesson in risk correlation. Because part of this whole experiment was a compromise that stemmed from those arguments on leverage: I would have an account with more leverage to get used to it and see first-hand its power, and he would in turn take down the level of leverage on his own portfolio. Because even setting aside how nuts it was to run so close to the red-line that a 5% correction would make you start blocking the margin clerk’s number in good times, it was not good times. He had by that point had several run-ins with the hospital system for his cancer, and many more days where he didn’t want to get out of bed to trade. So he agreed that he was going to reduce his own leverage, begrudgingly. But “reduce” didn’t mean “eliminate,” and he too was margin called, almost every damned day through March, 2020.

The ability of an insurer to pay out insurance that was also tied to that very risk — risk correlation is not a good scene. So very understandably, Dad had to renege on his promise to insulate me from losses related to the leverage. In hindsight that was a completely obvious outcome, but it somehow never occurred to me when I let him go nuts with margin loans in my account.

That whole year was crazy in so many ways, and I want to try to be clear (I know I’m not, but I’ll try) that the human losses were the real tragedy… but those are hard to talk about, and this is in many ways a personal finance blog, and there are financial aspects to talk about.

Another aspect of the whole affair was a huge whipsaw in my own financial planning.

Back before we found out my Dad had cancer, before we found out it had returned and spread, before we knew that it was terminal, we did a Because Money episode on expecting vs *expecting* an inheritance. Basically, I never factored in receiving an inheritance into my own financial plans, at least not in a major way. My parents were definitely better-off than I was, so my standard-of-living in part is facilitated by gifts from them. While they don’t pay my rent or anything quite that co-dependent, a lot of my luxuries have come from gifts: plane tickets for vacations, curling equipment, or new video game systems. A good portion of my clothes I didn’t buy myself. So of course I was leaning on them in some ways (hashtag privilege?) but I also wasn’t factoring an inheritance into my long-term plans.

Suddenly that was changing. I was getting a rather large gift up front, and dad was dying — the prospect of an inheritance was becoming very real and updating my planning to take it into account seemed like the next step. In-between arguments over leverage and trading strategies, we also argued about frugality. I’m a pretty frugal person by nature, and over 8 years of grad school only reinforced that. I save a decent portion of my earnings, and have nearly zero affinity for conspicuous consumption. Dad tried to convince me to spend more, and live more in the moment. He didn’t want me to save that gift for the future — he wanted to grow it briefly, then have me plan to spend the dividends on the extra gas and insurance for a new showy gas guzzler to replace my Prius. He wanted me to spend 100% of my income — I already had enough saved up for the first few years of retirement, and I could count on an inheritance after that.

I wasn’t willing to go that far (I mean, I love my Prius), but hey, I can get greedy too. I was off work to take care of him, but was already imagining what it would be like to spend a few extra thousand per year once I had a paycheque again. I had started *expecting* an inheritance.

Then Covid hit and we got to be on a first-name basis with the margin clerk and it all went to hell. Whipsaw: back to planning to save the normal way.

Just a quick note that Nest Wealth has changed their fees. There are now 4 flat-rate tiers (vs. 3 before). At the low end, this makes them a little more cost competitive. At the high end though, they lose their cost dominance until a much higher portfolio size — from roughly a quarter of a million to roughly half a million now.

And of course there may be reasons you prefer one firm over another even if the costs are a bit higher one way or the other.

With passive index investing, there’s a bit of a concern from some corners that if too many people become indexers, then there won’t be anyone to do security analysis. The market will stop being efficient, and the free ride that passive investors enjoy will be over. While it’s a “paradox” in that passive investing only works if there are active investors to make the market efficient, in practice, most of us aren’t too worried about it — there will always be some active investors to help determine prices.

I’ve seen the argument (not that I can find it now to link to it) that the weakest active managers will be forced out first (the ones who were basically closet indexers but charging 2.4% for the privilege). The remaining good managers may make some pre-fee alpha, and help keep prices rational for the passive investors. So as active managers continue to broadly under-perform index funds net of fees, and more investors move to passive funds, the ones who were least able to generate alpha will be the ones forced out of the industry.

But watching the chaos of the markets over the last little while, I also remembered the Dunning-Kruger effect: those who are least skilled are also not generally able to accurately assess their skill. So as passive continues to prove to be a good strategy, the ones who don’t switch are not just the most skilled (still generating alpha) but also the least (who may not know the risks they take or that they’re not generating alpha). And professional managers are not the only ones in the market — there are a lot of retail traders out there. On the whole they’re dwarfed by institutional money, but they can certainly move a few sectors and specific names. And so they have.

And social media in some ways fuels it — most people would never trade on a tip made in a video, tweet, or forum post. But the world’s a big place, and there are lots of people who do. And the algorithms are good at serving up more and more of that if you engage with it.

The last little while has seen some market moves that are just plain hard to call “efficient”. The weak-form efficient market hypothesis still applies — no matter how crazy it is, it’s still unpredictable enough that you can’t reliably profit from it, so just stick with index funds. Looking at the Gamestonk run-up and crash, calling the top never looked like a sure enough bet that I wanted to do it. Tesla, a niche, money-losing maker of electric vehicles (with a money-losing solar panel division that’s shrunk significantly since its related-party bailout, I should add, before the comments section fills with wails that it is also “an energy company”) somehow became the world’s most valuable automaker. And if you tried to short it at the point that it passed Toyota, you got destroyed as it continued to go straight up and become the most valuable automaker by such a margin that it’s worth more than all the global brands you recognize combined.

But even then, you just have to look around and shake your head at the stuff people are buying. An electric — no, hydrogen! — truck company with no working trucks, no plan to make any, and an executive chairman who left in disgrace is worth $9B, with $500M in shares traded on a given day. Weed companies went up and up and up ahead of legalization in Canada, even as the sector became way bigger than the most optimistic projections of post-legalization market size, and you could not escape the hype. Space is a cool idea, but is Virgin Galactic really worth $13B (and 3X what it was a year ago?).

I’ve read a lot of stuff on active investing, and many articles make points about second-order, third-order thinking — how will the market react, what’s already priced in, etc. Lately it seems like that stuff will get you killed. There seems to be a lot of people in the meme trades, but there’s no way to go and become an active investor and profit from it: all I can do is rant on my blog about how crazy some of this stuff seems.