Book Review: Never Smile at a Crocodile by Paul DioGuardi

This book (available here on Amazon) of several dozen two to four page mini-stories, is a disparate random collection with many messages:

• cautionary tale about the single-minded unforgiving nature of the CRA bureaucracy and the dangers of disobeying tax laws, deliberately or accidentally (as he says, there is "no compassion in a crocodile brain")
• cautionary tale about citizens who don't pay the taxes they should, some of them due to reasons we can be sympathetic to, and others who are just plain cheats - he has met all types
• how the insider game works in politics and business deals where who you know makes a big difference
• self-promotion and self-congratulation of the tax services of the author
• memories of personal holiday and work adventures, (I'd guess all of which were arranged to legitimately be tax-deductible as business expense though he never utters a word about his own tax affairs)
• how sometimes innocent people get caught up in the CRA idiotically and harshly using its power
• how sometimes very guilty people get away with lots of cheating by hiring a good lawyer

There's no specific tax advice, just the general message to pay your taxes on time .. because the crocodile is lying in wait.

It's quick reading, always light and chatty, flows easily, not technical even when discussing specific (all of them non-viable) tax avoidance schemes. One could imagine all these stories being told over a drink in a bar, the reminiscences and tales of an old raconteur, most of it true but some of it probably embellished. Good entertainment value, a few good laughs along the way. 

[There is even a defense in the book of his law firm's current on-going dispute with the Law Society of Upper Canada, reported in the Toronto Star in 2014, about how to hold client retainer money. He makes a pretty good case. He describes himself a number of times in the book as a fighter, not easily deterred. It certainly seems to be so, as he has announced his candidacy for the Law Society Bench in order to shake it up. If the CRA is a crocodile, DioGuardi might be a leopard, which this site says occasionally eats crocodiles. I don't know if he looks soft and fluffy but he certainly seems to have claws.]

Investment Advice Trust Index - A Simplistic but Simple Retail Investor Guide

Whose advice can you trust? It's complex and confusing but you cannot wash your hands of getting an idea of whom to trust because a mistake can be extremely costly, as in having your retirement savings wiped out.

There are titles galore in the financial and investment industry that we individual investors must deal with. Some titles mean something, others are just fluff to impress us.

The key idea is that only a few select people we might deal with are obliged to act first and foremost in our best interest, what is called behaving according to fiduciary duty. Most are held to a much lower standard, such as suitability, for instance in the Mutual Fund Dealers Association Member Regulation Notice on Suitability. That allows the industry professionals to behave with great latitude and often in their own best interest, mostly as salespeople, as long as their "advice" is not outright fraudulent or misleading.

Two documents from official regulatory sources provide a means to narrow things down to a list that has substance:

1) Canadian Securities Administrators Understanding Registration, a one-page list of all the types of people and firms that can sell or offer advice on securities (mutual funds, ETFs, stocks, bonds). Acknowledgement to the Small Investor Protection Association, where I found this link.

2) Canadian Securities Administrators Consultation Paper 33-403, The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided to Retail Clients, a 37-page legalistic, technical document (why is it that such important consumer information is only to be found buried in such a user-unfriendly place?). Page 9 of the pdf contains the following chart; most of the entries in the fiduciary duty columns have a No, few a Yes and several It Depends.

What is your firm's and your personal registration category? This is the first question to ask. Check the registration here. If the answer is "not registered", run for the hills!

Only three categories of individuals matter.

Ninety percent of people who call themselves financial advisor, investment advisor, financial planner, wealth advisor or some variation of such are Dealing Representatives, which as we see from the charts, are actually salespeople selling mutual funds. Caveat emptor! Assume they will not necessarily provide recommendations or plans that are best for you (except in Quebec where they are obliged by law to always act in a client's best interest). 

Advising Representatives and Associate Advising Representatives almost all work for Investment Dealers or Portfolio Managers. If they have explicit authorization to buy and sell in your account i.e. a Discretionary account, they have a clear responsibility to act in your best interest (the Yes entries in the second table). Of course, that does not negate human nature and some bad apples might still do lots of trades to generate extra commission income for themselves.

The "It Depends" situations are very problematic for the individual investor. You have a Non-Discretionary account and still have final say on buying and selling. But you may be reliant on the advice given, which may mean you can or cannot count on that advice being in your best interest, depending on how the five determining factors (vulnerability, trust, reliance, discretion, professional rules or codes of conduct) cited in the CSA consultation paper pan out. In the case of dispute, usually when it's too late and and bad things have happened to the investor, the only way to find out for sure is to go to court at great cost of money, time and effort. The ambiguity, which usually works to the benefit of exploitative abusive firms and investment professionals, is a big reason for the long-standing but so far unsuccessful push to have a much broader best interest fiduciary standard imposed on the investment management and advice industry. Therefore, as a pre-cautionary rule of thumb, assume the "It Depends" will not necessarily provide recommendations or plans that are best for you.

For all my dislike of the provincially-partitioned investment regulation in this country, I wish the other provinces and the CSA would do what Quebec has done and clear up the ambiguity by statutory imposition of the best interest fiduciary standard.

A source of much un-necessary confusion is the proliferation of so-called financial certifications and designations, some much flimsier than others. Even for the more substantial ones amongst those listed here on the IIROC site, there is a wide range of best-interest related clauses in the codes of ethics or conduct. Trolling through any one of them to know the exact legal ramifications of each code is time-consuming and of uncertain value. Therefore, ignore designations and stick to the above basic approach.

That says who you should be able to trust, legally speaking. But even then, there are a few bad apples, so it is of course necessary to keep a watchful eye and be aware of a gut instinct that says something may be wrong.

As for me, I know where I stand. The Discount brokerage entries show a clear No in both columns. I know I'm on my own. If I mess up my investments, it's all my fault.

More reasons to buy an annuity

Last post, I came to the conclusion that buying an annuity makes sense given a couple of guiding principles and the contrasting alignment of annuities vs my present stock/bond portfolio against key retirement risks and desired features.

That's not quite the whole thinking, however. Some additional motivations are driving me towards annuities.

Not burdening my children or the state - I want make sure I have enough income throughout my life not to oblige my children to pay for my upkeep. Call me old-fashioned but I also don't want to count on the government to bail me out at age 85 either.

Wish and project as we might with the best financial planning, monte carlo software and projections based on historical data, there's always a residual chance that an invested stock/bond portfolio subject to withdrawals might run out except at ridiculously low withdrawal rates or impossibly long planning horizons. But the slower and safer I withdraw, the more chance the money is never withdrawn, so I don't get to enjoy a lot of it. Which complements my next motivation ...

The inheritance I leave will be what's left over, not any specific planned amounts - I (and my wife) have already given the kids a good legacy by supportive parenting and a solid education that seems so far to be enabling them to make their own way.

Tax increase risk diversification - Governments can get into financial trouble and may look to the "wealthy" to impose extra taxes, spurred on by social activist thinking such as at the Broadbent Institute. Turning assets into an income stream today reduces the risk of future rising taxation on either accounts (like TFSAs, which are viewed in some politically-correct quarters as accounts benefiting the rich despite the opposite reality) or dividends and capital gains.

Living a longer and happier life - It is well-known by insurance companies that people who buy annuities live longer than the average population. Now, it is comforting to me to think that because I am intending to buy annuities, I will live longer. But it may not just be accidental, that people who are in good health figure the odds are good. It may be causal i.e. buy an annuity and it will make you live longer! Moshe Milevsky's superb summary of annuities for the CFA Institute quotes the research on page 108: "... he found that veteran pensions reduced mortality for both acute and nonacute causes of death ... [and then Milevsky quotes Jane Austen to put it in plain talk] ... All of these findings echo the famous Jane Austen quote from Sense and Sensibility (published in 1811): “If you observe, people always live forever when there is an annuity to be paid them.”

It's called buying peace of mind. Bill Gates or Warren Buffett don't get disturbed when markets go down because they have far more than they could ever need. But for those of us who have managed a relatively volatile stock-bond portfolio for twenty years and who cannot sustain a prolonged period of poor returns, we can relate to the findings Milevsky quotes.

My Retirement - Should I buy an Annuity?

Should I or should I not buy an annuity? (An annuity is financial product in which an insurance company, in exchange for a lump sum today, pays the investor a pre-determined cash amount for life.)

Why am I even considering this step?
First, I'm in my early 60s and no longer earning appreciable employment income. Yup, I'm retired and I would rather not un-retire if I can avoid it.

Second, I'm getting CPP but OAS is a few years off. I do not have any defined benefit pension so my investments in various registered plans, a TFSA and a non-registered account are the only possible sources of living expenses for the rest of my life, though at some point I am likely to receive a lump sum inheritance. Probably I am fairly typical of a growing number of Canadians, for whom the comfort of DB pensions providing assured lifetime income is no longer a possibility.

Third, I aim to follow a couple of simple financial management principles that make intuitive sense:

• Guiding principle #1 - Match spending liabilities with income assets.

To the extent possible I want my various spending needs for food, housing, recreation, health to align with income sources in terms of timing, amounts, regularity and certainty aka riskiness. Grocery money, electricity and property taxes are essentials and must be matched by equally reliable income. On the other hand, I can put off or reduce travel.

This means matching the characteristics of income-producing assets with retirement financial risks and desired benefits, many of which are unique or especially important to the withdrawal phase of investing and to later life. The following chart summarizes the nature of the two main categories of financial products - i) stock & bond portfolios in the various types of investment accounts like RRSPs, RRIFs, LIFs, LIRAs, LRIFs and Defined Contribution pension savings plans and ii) annuities, CPP & OAS and Defined Benefit pensions.

(click on image to enlarge)

The striking feature of the chart is how well the two categories complement each other. Neither ticks a Yes in every box but where one category falls short with a No, the other in almost every case has a Yes. The two exceptions are inflation protection and tax minimization, where each category can only offer partial protection.

The obvious conclusion is that every retiree needs to have some of both types of products, except perhaps for those lucky or wise few whose 70% of final salary fully CPI-indexed DB pensions are more than adequate and who are net savers in retirement.

• Guiding principle #2 - Take only as much risk as necessary.

Given that my objective is to maintain the lifestyle I have been happy with through the pre-retirement part of my life, if I can see that risk-free income sources will suffice to fund that lifestyle, why should I take any more risk?

Since my present CPP and even including my eventual OAS fall far short of my essential needs, the above considerations naturally lead me to plan for an annuity.

The next steps, for future posts to explore, is to decide:

• how much to annuitize
• when - now or later, when I'm 65, 70 or later, or whether to buy today a deferred annuity that only starts paying (how many?) years hence
• which bells and whistles to buy, like guaranteed minimum payout periods, annual payout increases, death benefits
• whether to use money from a registered account, which offers a higher payout, or a non-reg / TFSA account, where a prescribed annuity offers a tax advantage

Size doesn't matter (in investing)

Small-cap stocks no better than large caps - It is a waste of time to add a separate small-cap ETF or "tilt" to a portfolio since the extra return from small cap stocks can no longer be observed in the USA where it was first named, nor in any other market around the world, as Vitali Kalesnik and Noah Beck write in Busting the Myth about Size.

Worth a tilt - The tried- and still-true sources of equity premiums are market (the basic one that we get when we buy a total market ETF), value, momentum and low volatility, which Jason Hsu and Vitali Kalesnik conclude in Finding Smart Beta in the Factor Zoo. One interesting note they make is that while value and low volatility are amenable to low cost, transparent, rules-based, low turnover investing (such as in ETFs), capturing the momentum factor is best done through active alpha managers.

Avoiding back-tested data mining - There is also a sensible-looking list of criteria for deciding whether some return-enhancing rule discovered in past data is actually an equity premium source / risk factor or just a data mining artifact that will almost surely not work in future:
"

1.    The factor was discovered many decades ago; it has survived numerous database revisions as well as extensive out-of-sample data.

2.    The factor has been vetted, replicated, and debated in top academic journals over decades.

3.    The factor works in non-U.S. countries and regions.

4.    The factor premium does not change materially due to minor variations in the factor definition/construction.

5.    The factor has a credible reason to offer a persistent premium

a.    It is related to a macro risk exposure, or

b.    It is related to a deep-rooted behavioral bias that is present in a meaningful fraction of investors, or

c.    It is related to an institutional feature that cannot be easily changed.

6.     The factor exceeds a more stringent t-stat threshold of 3.5 (preferably 4.0) instead of 2.0 to adjust for data-snooping and other biases evidenced by the recent explosion in factor proliferation."