Tuesday 7 September 2021

GICs and Savings Accounts - Which Best Combat Inflation?

Guaranteed Investment Certificates (GICs) and Savings accounts at banks offer a person in Canada the safest possible place to invest money. Both are backed 100% against any loss up to $100,000 by the Canada Deposit Insurance Corporation, an arm of the federal government. That's as safe as it gets.

Safety against outright loss isn't enough for the investor. There is inflation to consider. Annual inflation - targeted by official Bank of Canada policy at 2% - eats away the purchasing power of our cash unless the interest rate on the GICs and savings accounts exceed inflation. If inflation is 2% and your interest received is 0.5%, you've lost 1.5% in real purchasing power.

Unfortunately, the tale told by the numbers is discouraging. The chart below traces the deteriorating trend over time. Data is from the Bank of Canada. Inflation is the CPI (Consumer Price Index) All Items, shown by the red line.


Back in 1981, all was wonderful. Savings accounts, 5-year and 1-year GICs issued by the major Canadian banks all paid interest rates comfortably in excess of inflation. 

Suddenly, in 1994 savings account rates dropped substantially to derisory amounts, well below inflation, and they have never risen within shouting distance since. 

1-year GICs held out till 2002, when they more or less matched inflation till 2009. Ever since 2010, they have paid appreciably less than inflation.

5-year GICs have resisted the best, staying consistently above inflation till 2010. It has been a cat-and-mouse close call since then. The 5-year GIC is really the only option left that more or less provides both rock-solid safety and reasonable inflation protection.One way to invest is to build a ladder of 5-year GICs. Every year, when there is cash to invest, buy only a 5-year GIC. Discount brokers offer a selection of GICs that pay higher interest than the major bank GICs while benefiting from the essential CDIC guarantee. The downside is that your money is locked-in for five years, though there are cashable versions ... but then you get a lower rate and pay a big interest rate penalty if you do cash early, which negates the whole advantage of the five year rate. After five years, the oldest GIC will mature and it can then be spent, such as a retired investor like me might do, or re-invested for the next five years.

Tuesday 8 May 2018

Vulnerable Investors / Elder Abuse report proposes Walrus Should Help the Oysters

FAIR and the Canadian Centre for Elder Law should have taken the advice of the eldest oyster in the Walrus and the Carpenter poem from Lewis Carroll's timeless classic book Alice In Wonderland. Instead of listening to elders however, they have adopted the role of busybodies delivering investors further into the hands of the main perpetrators of elder abuse, the financial "advisor" industry.

Why is their report on Vulnerable Investors so problematic? What could be bad about asking securities regulators to force the investment industry to prevent abuse of "vulnerable" investors?

#1 Absence of fiduciary duty by financial advisors - For the vast majority of investors (the exception being the minority who have turned over discretionary trading power to Portfolio Managers), financial advisors do not have to put the interests of investors only and strictly above their own interests. Almost all financial advisors are in effect salespeople who only have to abide by the weak suitability standard. Why would we want to trust them to suddenly begin acting for the best interest of investors who in addition happen to be vulnerable? It's a bit like being worried about foxes (untrustworthy family members or false friends) abusing the chickens and asking the wolves (financial advisors) to do the protecting. Is it not the case that there are far more instances of investors being hard done by the investment industry than by family members abusing their Power of Attorney (who do have a fiduciary duty)?

#2 Can of worms definitions for "vulnerable", "exploitation", "diminished capacity", "undue influence" and "abuse" - Beauty is in the eye of the beholder, goes the expression and what these terms will mean in practice will depend on the interest and intent of those taking action, in this case investment firms. Regardless of whether this motivation is well-meaning or not, instituting powers recommended in the report will launch a whole new legal cottage industry of interpreting those terms. First the lawyers create a problem, then they solve it.

Take the word vulnerable, for instance. It isn't being pedantic to say that everyone truly is vulnerable at all times regarding investments. Despite my years of financial blogging, my formal education in finance, my considerable (my wife probably would say excessive) interest  in investing and my decades of experience self-managing my own portfolio, I am keenly aware of holes in my knowledge and weaknesses in my character that have the potential to cause me considerable financial harm. Others in my family, intelligent people and quite competent in their occupation, are consciously completely ignorant of the most fundamental aspects of investing. They are highly vulnerable to financial foxes and wolves.

Investing is complicated enough already. Why then make it even more so by adding a whole new domain of legal considerations, nominally well-intentioned though they may be? The clearest kinds of abuse such as stealing or fraud are already covered by laws that apply to everybody, vulnerable or not. The financial industry is already free to report suspected cases to police. The police are also more likely neutral than the conflicted broker industry. It is disingenuous to say that the police are poorly-equipped or under-resourced to deal with abuse cases and that therefore there should be a big additional resourcing effort in the investment industry. Keep it simple - put the resources and the task on the police who people know are supposed to stop or catch the bad guys.

#3 Nefariously under-mining individual responsibility and expanding the culture of victimhood - The whole philosophy of labelling elders as weak, fragile people that the nanny state must step in to protect insidiously undermines the message that every adult must take prime responsibility for his or her life. That includes planning ahead for potential incapacity e.g. i) by re-structuring investments to be ultra simple or by setting up automatic annuities for income in place of investments, and ii) by putting in place powers of attorney in the hands of individuals who are both competent and trustworthy. It means cultivating family and friend relationships so that someone is actually willing to take on a job that is often onerous and time-consuming (sometimes the real elder abuse is the elder doing the abuse of younger people making unreasonable difficult demands - one of my relatives comes to mind, someone who refused for over fifteen years to accept sound financial advice, spent all of her liquid investments to fund her chosen lifestyle and then went to the bank for a loan - really! in terms of her best financial interests this was clearly abusive for a woman over 90 - and then refused to grant power of attorney to anyone while still mentally competent but now is incompetent, complicating things for my sister who is trying to help her, while being accused of stealing things by my aunt!).

A person must take time out from planning the next holiday or researching the best car to buy to think of the future. Understanding that if you do not plan ahead bad things are likely to happen. In that regard, several of the case studies of abuse in the report display elements of people failing to mind their future when they were of sound mind and had the chance. Other examples smack of people being stupid and wasting their money .... but everyone has the right to spend their money wastefully, no? Who is to say whether it is wasteful, anyway?

Being now officially a senior, allow me to repeat, the eldest oyster's comment (sourced on the Alice in Wonderland wiki),
"The eldest Oyster winked his eye,
And shook his heavy head--
Meaning to say he did not choose
To leave the oyster-bed."

Friday 13 April 2018

IIROC - Shafting Self-Directed Investors by Fixing What Ain't Broke at Discount Brokers

Grrr! IIROC, please leave us alone! With friends like you, self-directed investors don't need enemies. Despite receiving many objections and warnings from both investors and discount brokers (such a convergence of views sure doesn't happen often!) against measures that will make the discount broker business more complicated and costly to the detriment of investors, the regulator IIROC is ploughing ahead with a revised Guidance.

What kind of bad things for investors are likely?
  • disappearance and future restriction of many useful useful tools like model portfolios under the pretext that this is making recommendations aka providing advice, which the discount brokers are not allowed to provide; I would dearly like to see a (good) risk assessment module attached to the model portfolio selection tools but this probably won't happen now
  • rising fees or commissions charged to investors as the brokers are obliged to provide more complicated vetting procedures to ensure investors are only allowed to open "appropriate" accounts
As I said in my own comments to IIROC over a year ago, the history of the discount brokers over the two decades during which I have been an active investor with a bunch of them (BMO InvestorLine, TD Direct Investing, Questrade, RBC Direct Investing) has been pleasingly positive - low trading and administration costs, broad and steadily expanding product availability and services, responsive people when when a few administrative issues arose, impressive and widening range of useful tools, reports and educational material. In all those years I have been a client, the worst negatives have been the too-high rates charged for foreign exchange conversions to invest to or from US markets; the not-great pricing, and inventory at some brokers, of bonds; the restricted choice resulting in the not-best-in-market rates on high interest savings accounts for idle cash and; for those who unlike me bought certain classes of mutual funds, the embedded fees for advice collected by the brokers despite not providing any advice.

Overall, the discount broker business has been a shining bright spot for individual investors unlike too many other sectors of retail financial services where high costs and abusive business practices have severely gouged into the savings and investments of ordinary Canadians.

The treatment of investors by discount brokers (termed Order Entry Only / OEO by IIROC) is not broken. It is very suspicious to say the least that IIROC has steadfastly refused to release its own research of 2013 (yes, they have taken that long to look at this) and 2015 into the investor experience with discount brokers. Where's the abuse, where's the damage to investors? So why try to fix them? One wonders what is going here - bureaucratic empire-building within IIROC with un-necessary make-work regulation based on a theoretical issue that is not one in practice? a put-up by costlier advice-based services to cut out a very competitive channel and drive investors back to the fold? I don't know but the purported investor-protection motivation doesn't wash.

The nub of the issue is simple: due to the transparent fundamental relationship established at the outset that discount brokers do NOT provide advice (which is manifestly clear in the term Order Entry Only), anything that they provide is to be considered marketing or sales promotion. Some of it is junk but much of it is useful and we are all free to take or leave what we want. The notion of IIROC trying to protect me when there is not a problem is patently ridiculous and worse, likely harmful to me as it pressures discount brokers to restrict future services and to charge me more. I'm just fine, so get lost, IIROC!

Sunday 26 February 2017

Book Review: The Essential Retirement Guide by Frederick Vettese

This book (available here on Amazon) makes a valuable contribution to the individual investor's bookshelf. It has some unique content on some extremely important topics like the frequency of health problems and their potential costs during retirement. It also provides a lot of common sense on the issues of how and how much to save for retirement, including the old bugbear rule of thumb on what percentage of working age income one should aim to replace in retirement.

The "Contrarian Perspective" in the book's subtitle is not explicitly stated but I would presume arises from key points that depart from the mainstream of advice, namely:
  • the 70% income replacement target is far too high for most people, especially the middle income earners who are constantly being hectored to save more to stave off retirement disaster; author Vettese makes a pretty good case too, showing with examples how major portions of pre-retirement expenses usually go away, such as mortgage payments, child raising expenses and retirement saving itself; instead he says, reasonable targets that maintain lifestyle are often closer to 50%; he usefully provides enough detail to allow readers to figure in variations for their own circumstances.
  • retiree spending declines with age, and at an accelerating pace, after age 70 or so, such that maintaining an inflation-adjusted constant real return overdoes the need; furthermore, he cites sources explaining that this decline is due to falling interest and capability to spend; thus, he believes that inflation at the government's 2% target rate is not as serious an issue as commonly stated.
  • buying an annuity, which only a tiny minority of retirees actually do, is a wise move to counter the risk of out-living your money if you do not have a defined benefit pension plan, which fewer and fewer people do.
The above is good stuff that has been said elsewhere, but the best content in this book is a topic of huge worry to retirees that I have never before seen treated in any kind of depth - the material on retirement health patterns and the costs thereof. It's a top of mind topic for all retirees but how significant is it in fact? I have been trying with great difficulty for some time to dig out hard facts about this and I can say that the book is worth buying just for the 40 pages devoted to health. The key health issues are addressed:
  • How long will you live and how much of that will you likely be healthy?
  • What are the most threatening health problems or diseases during retirement and how likely is it you will need to go into Long Term Care (LTC)?
  • What is the cost of LTC and what are the odds for average years in LTC and worst case?
  • Is it worth buying LTC insurance and might you be ineligible anyway? (which I discovered is my situation so I don't even need to fuss about LTC insurance)
Ironically, given the fact that Vettese is an actuary, the weak part of the book is the treatment of investing leading to and during retirement. Probably this is the result of the book's aim to address both Canadian and US audiences. There is mention of, but no in-depth discussion of types of accounts like RRSPs, TFSAs or the appropriate types of investments for each account and how this should change after retirement except the sound, but general, advice to buy annuities. Chapter 17 confusingly misconstrues the 4% withdrawal rule, ignoring the original formulation by William Bengen as a constant real (inflation-adjusted) annual withdrawal based on the portfolio value at retirement. Vettese instead states it as 4% of the remaining annual balance. The effect of Vettese's version of the rule is of course that you will never run out of money. Mathematically, taking any percentage less than 100% out of a portfolio will always leave something though at higher percentages the remainder gets awfully small. Even at lower percentages like 4, 5, 6% you will face quite significant reductions in spending in larger down market years, which goes against the objective to maintain lifestyle spending.

There is also no discussion of the dangers of poor investment returns early in retirement, termed sequence of returns risk. This is a critical risk (see this simplified example of how much sequence of returns can influence outcomes), one that finance professor and pensions expert Moshe Milevsky has found (in his book Are You a Stock or a Bond?) to be more important than inflation or longevity as a threat to successfully living off a portfolio during retirement.

Bottom line: This book is not the complete answer but it is well worth buying. Four out of five stars.

Monday 16 January 2017

Suitability of Investments: Why it's so complicated but doesn't need to be

There is much on-going controversy in the financial advice industry amongst regulators, so-called and real advisors and their firms and consumer advocates about the current suitability standard for recommending investments versus a possible best interests standard.

There are three main issues:
1) suitability definitions (e.g. IIROC Rules or Ontario Securities Commission requirements) for investment industry salespeople are meant to stop abusive practices. Most often this involves putting clients into highly risky, high cost securities. This issue accounts for 99% of the whole suitability vs best interests debate.
2) suitability for someone like me, a reasonably informed self-directed investor (who thereby has no ethical conflicts), equates to the best interest standard. The only thing that's suitable for me is what's best for me. ... But it still leaves a very wide possible variation of investments. I could probably ask three highly experienced, completely ethical true financial advisers to tell me what investments to make and I could probably get three very different answers. This reality shows up in the definitions - beyond the words about Know Your Client and Know Your Product, the regulatory definition of suitability is still either circular where the word suitable itself is repeated, or it says something vague like "must apply sound professional judgement". That's because there is no single correct best answer even when you take into account risk tolerance and risk capacity, short and long term objectives, complete financial circumstances, including taxes and so on. The world, and life, is too uncertain to be sure you have what will turn out to be the best answer. I can say that things get even more complicated in retirement when additional factors become as or more important than the investment portfolio, such as future inflation, unknown longevity, other products like annuities, unknown health, mental decline, account choice for holdings and withdrawals (TFSA, RRSP, RLIF, regular), CPP and OAS changes by the government. If you don't believe me, peruse the writings of Wade Pfau whose research seems not to (yet?) have uncovered, after probing many suggested approaches, a right answer on how to organize the investment side alone. For example, see this discussion of three ways to incorporate bonds in a retirement portfolio about which he notes "Scholars and practitioners have numerous disagreements about the best way to incorporate bonds into a real-world retirement income plan."
3) suitability can and should also apply at the portfolio level, not just individual securities, funds or ETFs. Asset allocation is a powerful risk mitigation tool that works at the portfolio level. Thus, robo services that propose and actually implement collections of ETFs with rebalancing rules should not have to apply a suitability judgment against individual ETFs - a more volatile emerging markets ETF as a minor portfolio component with USA equity and a bond fund can reduce overall volatility and that would make it ok even for a conservative investor. On its own, it would probably not be ok however.

When all is said and done, I believe, for example, that a low fee balanced equity - fixed income fund (such as Larry Macdonald's One Minute Portfolio or our similar Reluctant Investor's Lifelong Portfolio) is suitable for everyone and anyone, of whatever age or financial circumstances. Why? simply because it is not unsuitable. The anti-definition is best >> What is suitable? = Anything that is clearly not unsuitable. 

Eliminating the Unsuitable by avoiding dangers
In practical terms, a default automatic suitability pass could consist of individual securities, mutual funds, ETFs or portfolios with all of:
  • no leverage 
  • no use of derivatives
  • low fees, for example under 0.75% MER
  • diversification, such as individual mutual funds or ETFs with holdings of 50 or more individual securities
  • avoid over-concentration by holding less than 10% of total portfolio value in individual securities, which also must be listed in the TSX Composite index, or S&P 500
  • fixed income (individual) with ratings of investment grade or funds with no less than 70% investment grade holdings
  • portfolios (such as robo advisors provide) of equity combined with fixed income where each of the two is limited to 30% to 70% of the total value
  • minimum liquidity characteristics, an exact number for which I cannot suggest but would be based on trading volumes in a public market
It's quite possible that other securities could pass the suitability test - indeed one of my favourite and highly suitable funds is BMO's Low Volatility Canadian Equity ETF with only 46 holdings. Such alternatives would need to have more justification as to why they are suitable e.g. low volatility is very beneficial for a retired investor to reduce sequence of returns risk (a large market drop early in retirement combined with portfolio withdrawal causing an irretrievable reduction in the portfolio) while retaining the equity exposure.
Such a restrictive approach to suitability as the above makes investing simpler and allows the focus to shift to the other elements of financial management for individuals, which is where it should be.

Wednesday 26 October 2016

Work for your passion or for money?

Recommended reading: "Don't do what you love for a career - do what makes you money" by Catherine Baab-Muguira.

It's a timely rebuttal to the rose-coloured glasses view that you should follow your passion and only work at something that you love. Baab-Muguira is right with respect to 99% of the population. No job is perfect and no job is without considerable hassles. Very often one discovers that the "passion" fades. Circumstances can and do change. Let's face it, humans are built to be adaptable. Almost all of us are not so gifted at anything that our legacy to the world and our happiness is uniquely tied to one job, occupation or career.

My wife is a perfect example of what can happen when you start a job for money. While in secondary school she wanted to study languages and possibly be a translator. The family situation did not permit this and she was obliged to go into something practical, which would help support the family (this being the bygone era when kids were expected to contribute financially as soon as they could work). That undesired, unsought occupation was teaching. Guess what, by determination and hard work (e.g. taking extra courses necessary for advancement while having two children) she got really good at her job. So much so that she rose to become principal of a primary school. She also learned to love the job. So much so that she worked on for a year and half beyond the age at which she could retire with full pension. And the languages since she retired? Nope, she has not gone and done it. She's more interested in our grand-children.

Retirement is no uninterrupted orgy of selfish passionate pursuits either. The phase of not being able to do whatever the heck you like never arrives, not even in retirement. You can do more of what you want to do and less of what others want you to do with financial independence, but as long as there are other people around, starting with family, and extending to whatever groups you belong to, the mix of good and bad, success and disappointments, is always there to contend with.

Saturday 21 May 2016

Fraser Institute Trying to Damn the CPP with Faint Praise

The Canada Pension Plan will generate only a 2.1% real rate of return for Canadian workers starting out today, concludes Rates of Return for the Canada Pension Plan (May 2016) by Jason Clemens and Joel Emes of the Fraser Institute. Therefore, we Canadians seem to be invited to further conclude (given the Fraser Institute's past attacks on the idea of expanding the CPP), that's a very poor investment and therefore a good reason for Canadians not to support expansion of the CPP.

Telling half the story truthfully is a sly way to debate an issue. Clemens and Emes appear to have crunched the numbers properly. Here's what they forgot or neglected to say.

2.1% compared to what? - For CPP to be judged as poor, it needs to be compared against a realistic alternative that covers both the savings phase and the retirement phase of life, such as an RRSP and a life annuity. I calculated and posted such a review in 2015 and found that the relative attractiveness of the CPP varied enormously according to whether the person is a man or woman, single or married, and self-employed or an employee. Married women employees benefit most from the CPP, enjoying the equivalent of a prospective lifetime guaranteed real return of 5.1%, while single self-employed men would get only about 1.1% return. The biggest difference arises from the fact that employers pay half the contribution on behalf of employees while self-employed pay the full shot.

Managing investments yourself vs Total auto-pilot of CPP - It's easy to say you can beat 1.1%  or even 2.1% real return investing money in an RRSP yourself without breaking a sweat but consider:
  • Will you with absolute regularity for 39 years without fail save out of your income to accumulate investment funds like the CPP imposes automatically, or will you like most people find a more pressing use for your pay, especially early on in life, and only start to save seriously when the reality of retirement stares you in the face? Starting to invest late means needing to achieve much higher returns since you miss out on the power of long term compounding.
  • Will you then invest wisely, maintaining a sensible strategy of diversified low cost funds, or instead like most individual investors, buy return-sapping high-cost funds that are offered by salespeople disguised as advisors, or chase returns and hot ideas that only occasionally pay off? Will you properly compare the riskiness of your portfolio, probably containing a lot of riskier equities, to the lowest risk triple A guarantee of the Government of Canada? To be comparable risk, you would need to invest in Government of Canada bonds, which currently yield a nominal max of 2% (on long term bonds), or about 0.3% after the latest 1.7% inflation. And how much is your time and effort worth to do all this in comparison the fully automatic zero effort required by you for the CPP?
CPP extras that are difficult to price but very valuable - As my above-linked post mentioned, CPP also has bundled into it disability benefits, survivor children's benefits, survivor spouse benefits, a death benefit.

True inflation protection - Only the CPP offers true inflation protection, i.e. CPI-linked increases. The best fudge available in the annuity market are annuities that ratchet up by a pre-set amount you choose, like 1.0, 1.5 or 2.0%. You have to guess at what future inflation will be. Guess too high and you over-pay un-necessarily, or guess too low and you still lose to inflation. Either way the uncertainty about inflation is not removed and your retirement annuity income does not keep in step with inflation, drifting further and further apart as years roll on and the differences compound.

Hilarious irrelevant comparisons - The Clemens/Emes report also details some laughable calculations about how people who started receiving CPP back in the 60s and 70s have been getting phenomenally high returns, mainly because they did not contribute long but get full benefits. As if that should make present-day contributors jealous and angry to not want to pay any more - i.e. not support an expanded CPP because they would be handing even more money to retired rich so and so's. Well, we should first note that anyone retiring at 65 in 1969 on CPP launch would now be 112. They're all dead. The ranks are pretty thin at the older higher return end. There's only one living 111 year old Canadian and one of 110. Besides, what happened is done, We must look forward. And, individuals can do much worse or better than the average - die soon after after retirement and get a tiny of your money back, live long beyond the average life expectancy and your rate of return rises to very high amounts. If the report authors are inferring inter-generational inequity needs to be fixed, then the payouts to past retirees needs to be reduced. It is not by stopping CPP expansion.

Most proposals for CPP expansion are that higher benefits come only when they have been earned through higher contributions. That would be fair. You get back for what you put in and you are not paying extra for someone else already a recipient to receive more.

When the full context is given and the whole story told, the CPP sure looks a lot more reasonable than a single low return number seems to imply.

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