Well, you read it here first on my Christmas Wish List 2007. Minister Flaherty has delivered on my request to institute a tax-free savings account just like the ISA that exists over here in the UK. Wonderful. These accounts are so simple and straightforward, they achieve much better than RRSPs the goal of getting people to save. There are no books written about ISAs, unlike the tome Preet Banerjee recently put out about RRSPs, because there's so little to write about. The worst thing about the new accounts is their awful acronym - TFSA. How the heck do you pronounce that - TaFSA? Didn't they learn with RRSP, where is the marketing savvy?
The $5,000 annual contribution limit is too low; better would have been double that and even better would have been four times higher, which would start killing off RRSPs. The "if you don't use it, you don't lose it" feature of the annual contribution limit is a great measure for added flexibility since many families with young children might not get the chance to save for a number of years.
I'd expect the new TFSA, as the info sheet suggests, to be heavily used by seniors, for instance for funding inheritances. The money can be put aside, grow tax-free and be non-taxable at death. While it is in the TFSA, it can serve as a safety cushion for unexpected health care costs and if not needed, passed along to the next generation. Increasing life expectancy could allow amassing a tidy sum.
In short, I believe the info sheet blurb is not too far off (except for the niggardly $5k) when it says "It’s the single most important personal savings vehicle since the introduction of the Registered Retirement Savings Plan (RRSP)."
It was nice to see our government paying attention to this humble blogger. I suppose they are waiting for the next budget to put in an annual tax-free capital gains exemption.
Tuesday 26 February 2008
Blogger Identity - Anonymous or Real?
Came across this thought-provoking post at MoneyRelations on whether and why to reveal one's real identity as a blogger. Canadian Dream also talked about this topic here.
A few years ago, I attended a seminar at which health researchers reported on the credibility given by the public to health information found on the web. And do you know what most influenced whether people believed the information they came across? It wasn't the name of the person or the organization, the list of professional qualifications, the quality of the content itself that was most important. Drum roll, please ... it was the photo of the person supposedly giving the advice and the impression that left!! If you looked the part - wearing a white lab coat was good for health people, but a t-shirt killed your credibility - and you had a trustworthy face, then that really boosted your "cred". That's why I have a photo on my website - don't I look authoritative and trustworthy, huh? Please?
As for revealing my real name, it doesn't really matter to me. My friends and family know about my blog and anyone who emails me soon finds out who the person behind the door is. And I assume that no matter what I tried to do, my identity could likely be found out very quickly by anyone or any organization with reasonable smarts. So my policy is to attempt at all times to only write things that are a credit to me. As Mr Cheap of Four-Pillars commented on the Canadian Dream post with a hilarious link, you don't want to post anything your mom would be embarassed to read.
Probably my blog name CanadianFinancialDIY, which was meant to be descriptive (and has turned out not to be very descriptive at that since I write regularly about UK topics), makes me more indistinguishable in the crowd of Canadian bloggers. There are so many Canadian this's and Canadian that's, one has trouble remembering who is who. (Aside: is that the result of a generation of Canadians raised seeing the word Canada in every government department, agency, crown corporation, tribunal and outhouse?) Something weird or random would likely be better - has the name Google ever held that company back?
A few years ago, I attended a seminar at which health researchers reported on the credibility given by the public to health information found on the web. And do you know what most influenced whether people believed the information they came across? It wasn't the name of the person or the organization, the list of professional qualifications, the quality of the content itself that was most important. Drum roll, please ... it was the photo of the person supposedly giving the advice and the impression that left!! If you looked the part - wearing a white lab coat was good for health people, but a t-shirt killed your credibility - and you had a trustworthy face, then that really boosted your "cred". That's why I have a photo on my website - don't I look authoritative and trustworthy, huh? Please?
As for revealing my real name, it doesn't really matter to me. My friends and family know about my blog and anyone who emails me soon finds out who the person behind the door is. And I assume that no matter what I tried to do, my identity could likely be found out very quickly by anyone or any organization with reasonable smarts. So my policy is to attempt at all times to only write things that are a credit to me. As Mr Cheap of Four-Pillars commented on the Canadian Dream post with a hilarious link, you don't want to post anything your mom would be embarassed to read.
Probably my blog name CanadianFinancialDIY, which was meant to be descriptive (and has turned out not to be very descriptive at that since I write regularly about UK topics), makes me more indistinguishable in the crowd of Canadian bloggers. There are so many Canadian this's and Canadian that's, one has trouble remembering who is who. (Aside: is that the result of a generation of Canadians raised seeing the word Canada in every government department, agency, crown corporation, tribunal and outhouse?) Something weird or random would likely be better - has the name Google ever held that company back?
Financial Risks Can Be Health Risks Too
The BBC reports in Bank Crises 'deadly for health' that researchers have determined that financial crises and runs on banks, such as that occurring this past autumn at the Northern Rock, can cause a spike in heart attacks among the population. The article interestingly notes that older people are especially susceptible to heart attacks; perhaps a higher than expected risk aversion amongst older people is an instinctive adjustment for self-preservation? How often does one hear people say, "I don't want the stress of equity investment", or "I cannot take the stress anymore"? Maybe they are reacting to internal health messages from their body?
Another issue is that a proper appreciation of the relative real risk of various assets and holdings is essential. Do people need to be told that even banks are not perfectly safe and that low probability of failure is not equal to zero probability? Various politicians and business leaders who say that things are "perfectly safe" are actually doing everyone a dis-service. It is easier to face a known hazard than to deal with a nasty surprise when it was thought there was no chance of the bad thing happening.
To me this is another reminder that diversification - spreading investments and assets around so that if one fails others prevent calamity - is an essential protection.
Another issue is that a proper appreciation of the relative real risk of various assets and holdings is essential. Do people need to be told that even banks are not perfectly safe and that low probability of failure is not equal to zero probability? Various politicians and business leaders who say that things are "perfectly safe" are actually doing everyone a dis-service. It is easier to face a known hazard than to deal with a nasty surprise when it was thought there was no chance of the bad thing happening.
To me this is another reminder that diversification - spreading investments and assets around so that if one fails others prevent calamity - is an essential protection.
Labels:
disasters,
diversification,
risk
Question on Spread Betting in the UK and Taxes in Canada
A reader sent in this intriguing question: "What are the tax implications for Canadians setting up a spread betting account in the United Kingdom. In the UK and Ireland there is no personal income tax from profits generated by spread betting on such instruments as futures, currency or stocks, as this is considered a form of gambling. My question is would Canadians be exempt from paying tax also."
Spread betting is indeed considered gambling in the UK, despite the similarity to options trading, and not just by the tax folks at HMRC. The financial betting is just another form of betting as is evident in Investopedia's explanation of spread betting.
To guess at an answer since there may not actually be an official one (and I would bet it is a pretty well hopeless exercise to phone the CRA where you would likely spend a long time getting the service rep to actually understand what the heck you were talking about), I refer first to this explanation by accountant Tim Cestnick on the taxation in Canada of pure gambling like poker. The essence of it is that anything, including poker, can be taxable if it is a business. (I especially love the classic extreme example of this in the fact that bank robbers are liable to pay income tax on what they steal).
I suspect the CRA would apply the same principle to any winnings on UK-based spread betting. It notably does not matter that the UK government doesn't consider such winnings taxable. If you are a Canadian resident for tax purposes (and you pretty well have to have left the country and burned all your bridges in Canada to avoid that) then you are subject to pay Canadian tax on your worldwide income. The fact that the UK doesn't tax spread betting makes it simpler in principle for Canada to claim tax since there are no complications from having to avoid double taxation and having to refer to the rules of the Canada-UK Taxation Convention to decide who would get to claim your taxes.
But you have to report the income to the CRA. Making it much more difficult for the CRA to actually track you down should you decide to hide such income, were it actually a business, are some other provisions of the above Convention, which is further charmingly sub-titled "For the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income and Capital Gains". Way down in Article 24, it says in effect, that the tax authorities will exchange what information they normally collect and since the UK HMRC have nothing to do with taxing spread betting, it would be a surprise if they had any data about foreigners doing spread betting to send to the CRA, should they ever even ask HMRC. Nevertheless, it is better to be honest isn't it?btw, if you are able to successfully tell whether the market is going up or down and make any money spread betting, then I would sure like to know what your bets are. ... Naw ... I think I'll just stick with the boring plodding diversified portfolio, which is unfortunately taxable all the time somewhere.
Spread betting is indeed considered gambling in the UK, despite the similarity to options trading, and not just by the tax folks at HMRC. The financial betting is just another form of betting as is evident in Investopedia's explanation of spread betting.
To guess at an answer since there may not actually be an official one (and I would bet it is a pretty well hopeless exercise to phone the CRA where you would likely spend a long time getting the service rep to actually understand what the heck you were talking about), I refer first to this explanation by accountant Tim Cestnick on the taxation in Canada of pure gambling like poker. The essence of it is that anything, including poker, can be taxable if it is a business. (I especially love the classic extreme example of this in the fact that bank robbers are liable to pay income tax on what they steal).
I suspect the CRA would apply the same principle to any winnings on UK-based spread betting. It notably does not matter that the UK government doesn't consider such winnings taxable. If you are a Canadian resident for tax purposes (and you pretty well have to have left the country and burned all your bridges in Canada to avoid that) then you are subject to pay Canadian tax on your worldwide income. The fact that the UK doesn't tax spread betting makes it simpler in principle for Canada to claim tax since there are no complications from having to avoid double taxation and having to refer to the rules of the Canada-UK Taxation Convention to decide who would get to claim your taxes.
But you have to report the income to the CRA. Making it much more difficult for the CRA to actually track you down should you decide to hide such income, were it actually a business, are some other provisions of the above Convention, which is further charmingly sub-titled "For the Avoidance of Double Taxation and the Prevention of Fiscal Evasion With Respect to Taxes on Income and Capital Gains". Way down in Article 24, it says in effect, that the tax authorities will exchange what information they normally collect and since the UK HMRC have nothing to do with taxing spread betting, it would be a surprise if they had any data about foreigners doing spread betting to send to the CRA, should they ever even ask HMRC. Nevertheless, it is better to be honest isn't it?btw, if you are able to successfully tell whether the market is going up or down and make any money spread betting, then I would sure like to know what your bets are. ... Naw ... I think I'll just stick with the boring plodding diversified portfolio, which is unfortunately taxable all the time somewhere.
Monday 25 February 2008
Book Review: The New Retirement by Sherry Cooper
The New Retirement is part prediction and part advice. It describes the economic and social forces changing retirement and then provides advice to individuals on how to prepare for and cope with those conditions. It is a heads-up for all ages from those just starting their working life to those just at the point of retirement.
Right at the start, there is a useful definition of retirement: "A successful retirement for most people is to be physically and fiscally independent and active with love and purpose in their lives." (p.2) Bonus points for that, since so many discussions of retirement just assume everyone is on the same wavelength.
The kind of forces author Dr. Sherry Cooper examines includes: the baby boom, increasing longevity, physical and mental health, immigration, savings rates, interest rates and inflation, global economic performance in western vs emerging countries, company and government pension plans for both the US and Canada. A modest list, n'est-ce pas!? And all of it fits neatly into 235 pages of compact size pages. Somehow she manages this without leaving the impression that is glossy, surface fluff. How does she accomplish this? It is the art of the author - what you leave out is as important as what you put in, in other words, knowing where to put in the detail and where to write one sentence when a whole book could be written. Most likely this is a demonstration of a principle Cooper notes in the book, "Healthy older brains are better at dealing with complex situations, that you have dealt with for many years, having the benefit of so much experience." (p.208) Despite her eye-catching youthful appearance on the dust cover photo, Cooper has spent a lifetime analyzing and forecasting economic data. Her judgments and predictions merit consideration.
Here is a sample of her observations:
- "Early boomers will get to the financial markets first, before the real onslaught of demand for stocks, bonds and other investment vehicles." (p.25)
- "... low inflation and relatively low interest rates will be sustained for a prolonged period as potential growth slows with the decline in the growth of the labour force in Canada, the United States, Europe, and Japan. On the flip side, developing world growth will continue at a very rapid pace." (p.65)
- "The unsustainable promises made by successive governments, primarily to older Americans, could hobble U.S. foreign policy for decades." (p.96)
- " ... many public sector workers will be assured of gold-plated, fully-indexed pension plans..." (p.143)
- in the past 25 years, "... A portfolio of long-term government and corporate bonds returned to the investor a compounded annualized return of about 12.5 percent, compared to 9.5 percent for the TSX over that period. ... There is zero likelihood that the next 25 years will offer the same return for bond investors. " (p.161)
- in retirement, "... it is essential to hold 45 to 65% of your portfolio in stocks" (p.180)
The book covers other topics than the financial. There are several excellent chapters on being healthy and happy during the years of the "final third of one"s life". The good news is that achieving success is very much influenced by what we do. Eating well, exercising, reading, doing "brain work", being married, having a pet, pro-actively monitoring health to catch treatable disease early and a neutral view of the world, all can contribute to making those years the happiest of all.
The whole book is really an introduction (as noted above, it is short) to the retirement spectrum, but it is an excellent one. I especially like the copious chapter footnotes and 8-page bibliography that allow one to follow up topics of deeper interest.
Now, my quibbles.
- There is little / not enough treatment of planning for one's death and for a legacy, both financial and otherwise. Cooper herself notes that as one gets older one's mindset turns more to others and what one will leave behind.
- There's too much on how much better defined benefit pensions are than defined contribution or private plans like RRSPs and 401ks.
- The many examples in the chapter on "nest egg arithmetic" (the informal term "nest egg" itself starts to get annoying as it is used consistently throughout the book to refer to retirement savings - i.e. call it something else once in a while!) need to be cut down or better organized since the message gets confusing.
- The investment return assumptions, and especially their uncertainty, need to be more explicit and analyzed. For example, if North American economies are to slow in future, will stock market equity returns follow suit, such that future expected returns of the S&P 500 and/or the TSX will be less? There is a fascinating sentence in footnote 2 on page 219: "Greater diversification into such assets as Real Estate Investment Trusts (REITs), Treasury bills, and short-term bonds, commodity futures, and others could well further improve results, but the historical data are not available to prove that point."
- The postwar baby boom also happened in the UK (see here and here), contrary to the statement on page 19.
- The book targets two different audiences (as stated on page 2) - governments and other organizations who must respond to the emerging reality and to individuals planning their own future. Looking at it through individual eyes, I got impatient through especially the early chapters when most of the text would be of note to the former target group. The diffusion of focus and attention takes away from the book.
Despite the quibbles, the book is a valuable and unique, so far as I have seen, addition to the library of those contemplating and planning their own retirement. Its strength is the comprehensiveness of its forward-looking coverage of retirement topics from the standard financial to the physical and mental health aspects as well.
Bottom line, it is well worth a read (and remember, reading is good for your mental health). Four out of five stars. Buy it at Chapters or Amazon.
For those interested, BMO Investorline is hosting a free webcast on retirement by the author, Dr. Sherry Cooper on February 26, 2008. Register here.
Labels:
book review
Friday 22 February 2008
Buying Scottish Cash - Caveat Emptor
Travellers to this lovely part of the world should take heed when buying some cash before departure that Scottish money (cash) costs more than English money despite the fact that both are the same currency - pound sterling!
RampantScotland describes this anomaly and provides other useful money travel advice for Scotland. Is this anomaly due to the fact that Bank of England paper currency notes are accepted everywhere in Scotland but notes issued in Scotland by the three Scottish banks are not commonly accepted in England (even though they are legal tender anywhere in the UK)? The other pages of RampantScotland contain a miscellany of useful and amusing facts about the place, well worth a wee browse.
For trivia buffs, BBC article "Scottish Money Needs Protection" explains how the anomaly came about:
"In 1826, the British parliament passed legislation preventing banks from issuing their own pound notes, a practice which was threatening to get out of hand.
Although RampantScotland says overseas banks issue only Bank of England notes, that is apparently not so in Canada as the the Royal Bank of Canada has two sets of buy/sell rates for cash and indeed you must pay more for Scottish pounds than English pounds. In addition, when you want to sell them back to the bank at the end of your trip, you get less for Scottish pounds. Today, for instance the buy/sell spread for Scots pounds is 7.165% but only 6.893% for the English kind.
RampantScotland describes this anomaly and provides other useful money travel advice for Scotland. Is this anomaly due to the fact that Bank of England paper currency notes are accepted everywhere in Scotland but notes issued in Scotland by the three Scottish banks are not commonly accepted in England (even though they are legal tender anywhere in the UK)? The other pages of RampantScotland contain a miscellany of useful and amusing facts about the place, well worth a wee browse.
For trivia buffs, BBC article "Scottish Money Needs Protection" explains how the anomaly came about:
"In 1826, the British parliament passed legislation preventing banks from issuing their own pound notes, a practice which was threatening to get out of hand.
But a vigorous campaign in Scotland, which enlisted figures such as the writer Sir Walter Scott, ensured that it was exempted from the new law."
Although RampantScotland says overseas banks issue only Bank of England notes, that is apparently not so in Canada as the the Royal Bank of Canada has two sets of buy/sell rates for cash and indeed you must pay more for Scottish pounds than English pounds. In addition, when you want to sell them back to the bank at the end of your trip, you get less for Scottish pounds. Today, for instance the buy/sell spread for Scots pounds is 7.165% but only 6.893% for the English kind.
Thursday 21 February 2008
Tax Primer for 14 Countries from HSBC
HSBC has a handy primer on matters taxation called the Global Tax Navigator for 14 different countries round the world, including Canada, the USA, the UK, Japan, Australia, Hong Kong, Singapore, India, France and Jersey. It outlines rules for those going to and leaving those countries.
Topics include:
Topics include:
- whether you need a work permit;
- how various types of income are taxed;
- rules for determining whether and how you will be taxed - residency, domicile or other;
- tax rates for different types of income;
- ways of filing returns;
- existence of tax treaties with other countries;
- doing returns with a spouse;
- whether inheritance, estate or other important taxes apply
Labels:
Canada,
international,
taxes,
UK,
USA
Expat or Immigrant? You are not alone
Whether you call yourself an immigrant seeking to establish a new permanent life in a country or an expat temporarily living away from home or you cannot make up your mind, there are lots of us around the globe as the article "Migration strains rich and poor" from the BBC shows.
The UK leads the pack amongst OECD countries with no less than 3.2 million citizens living abroad, a good number having headed to warmer retirement in Spain. Australia is a popular destination too (and I hear about it a lot here in Scotland), perhaps partly accounting for its world leading 22% of the population which is foreign born. The UK is an immigration magnet as well, with some 8% of the population foreign-born ... though I'm not sure how recent or accurate those numbers might be since that would put the absolute number around 5 million (8% x 61 million) and there has been a huge influx of folks from new EU countries, especially Poland, which one estimate says has 1.5 million citizens in the UK.
Canada, as usual, cannot decide whether it is coming or going. It has a large number of expats - around 1 million (of which I would guess the vast majority are in the USA) - combined with a high proportion of the population (looks like 18-19% on the BBC graph) being immigrants. The 1 million Canadian expats represents about 3% of the population. It is astounding that expat Canadians outnumber US expats, since the US has a population about 10 times that of Canada - 300 million vs 33 million as of 2007.
The UK leads the pack amongst OECD countries with no less than 3.2 million citizens living abroad, a good number having headed to warmer retirement in Spain. Australia is a popular destination too (and I hear about it a lot here in Scotland), perhaps partly accounting for its world leading 22% of the population which is foreign born. The UK is an immigration magnet as well, with some 8% of the population foreign-born ... though I'm not sure how recent or accurate those numbers might be since that would put the absolute number around 5 million (8% x 61 million) and there has been a huge influx of folks from new EU countries, especially Poland, which one estimate says has 1.5 million citizens in the UK.
Canada, as usual, cannot decide whether it is coming or going. It has a large number of expats - around 1 million (of which I would guess the vast majority are in the USA) - combined with a high proportion of the population (looks like 18-19% on the BBC graph) being immigrants. The 1 million Canadian expats represents about 3% of the population. It is astounding that expat Canadians outnumber US expats, since the US has a population about 10 times that of Canada - 300 million vs 33 million as of 2007.
Labels:
Canada,
international,
UK,
USA
Monday 18 February 2008
Expat Canadians Investing While Abroad
What happens to investment accounts at Canadian brokerages when a Canadian goes out of the country to work or live? Would you want to be forced to transfer your investment accounts to another country for a few years in order to manage them or be obliged to leave them inactive?
For self-directed, self-managed investors, such a prospect can be particularly frustrating since technology enables Internet or telephone access to accounts from virtually anywhere. Unfortunately, the WWB (World Wide Bureaucracy) has complex rules that may bring a full stop to such activities. If you are not leaving permanently with your money/investments and you wish to keep your accounts open and available for trading, you need to be careful.
The issue arises from this fact taken from the Ontario Securities Commission note on Cross Border Trading:
So where are you considered to be "resident"? It all hinges on the meaning of that word resident, which is defined in different ways by different authorities, or even not at all explicitly, leaving the matter to the varying interpretation of court cases, to the utter frustration and dismay of us poor schmucks who have to figure it out.
Here is part of the OSC's response to my enquiry on the issue:
"The term "residency" is not defined in Ontario securities law. Where questions of jurisdiction are to be determined, it must be done on the basis of specific facts and not hypothetically. The basis of jurisdiction may be differently interpreted and applied in different jurisdictions. We cannot give you an opinion or interpretation of Ontario securities law, nor of any other jurisdiction."
The oft-quoted principle that being 183 days or more (i.e. more than half the year) in a place makes you a resident may not apply. A few years ago, Canadian snowbirds with RRSPS and RRIFs found that Canadian brokers refused to allow them to trade in those accounts. As a result of many protests, the US federal regulator, the Securities and Exchange Commission, made a special ruling outlined in the note Canadian Tax-Deferred Retirement Savings Accounts that exempts those type of accounts and allows Canadians to continue trading in them while in the US. It also contains this ominous statement,
"... federal securities laws generally require that securities transactions made for U.S. residents-even those in the U.S. for only a brief period of time-and brokers who sell those securities be registered with the SEC". What the "brief period of time" might be I do not know.
The SEC exemption that removed the restriction on trading in RRSPs and RRIFs did so only for those type of accounts. Regular taxable trading accounts are being blocked. I'm not 100% sure but I believe the reason Canadian brokerages have not fixed the problem simply by registering in both Canada and the USA is that the securities being traded must also be registered in the proper jurisdictions. In the case of the USA, the individual States also have registration requirements as the afore-mentioned SEC note says. Our cherished OSC sums it up nicely: "Due to the complexity of regulations and the confusion as to which states have accepted or partially accepted the SEC process, many compliance departments of Ontario registered brokers have decided that their firms will NOT transact any business from those customers while they are on US soil." Welcome to the WWB!
All this is supposedly motivated by a desire to protect the investor from fraud as paragraph 1.1(a) of the Ontario Securities Act says and this document Investing and the Internet by the OSC suggests. In the case of the USA, there are evidently other motives too, namely to protect the business of US investment firms - see III - Cost Benefit Analysis in the explanation of the ruling where it says the ruling will not significantly harm US brokers by taking away the potential business of Canadians forced to move their accounts to the US.
The brokers are the ones we must deal with and it is their interpretation and application of the law and regulation that counts in the end. Part of the OSC's response to me included this: "Dealers and advisers in Ontario have developed compliance policies to ensure they do not risk breaching the laws of foreign jurisdictions. These policies are not specifically prescribed by Ontario securities law and may vary from firm to firm."
One should therefore not expect that they will all do it the same but I was puzzled and amused by the discussion by several Canadians living in Japan on a Financial Webring thread describing their investing activities despite living outside Canada for many years. One broker evidently is deducting taxes at the rate for non-residents while continuing to allow trading. I am not familiar with securities regulation in Japan but perhaps trading is allowed to continue because there are no restrictions in Japan that Canadian brokers would violate and the broker knows that the Canadian regulator will in fact do nothing about it (the OSC's response to my enquiry left me the strong impression that the OSC would not care - they only mention the foreign jurisdiction problems). Or maybe different parts of the brokerage business don't communicate well enough to catch it. Or maybe the brokerage applies what the OSC also said in their response to my enquiry: "The citizenship and tax status of the investor is generally not relevant in applying Ontario securities law."
In the UK, so far as I could determine from two separate calls to the regulator, the Financial Services Authority, there is no legal restriction for UK brokers to deal with non-residents ... though phone calls to a couple of UK brokers also revealed that they will not open an account unless you are a UK resident. Maybe it's only the US that is an issue because only the US will punish the brokers.
Out of curiosity, I called BMO Investorline to ask how they deal with this stuff. According to the telephone rep I spoke to (who knows if it could be different in practise or with a different person), they rely on the investor to inform them through an address change notice, though they also suspend an account if signs show a person is gone or mail is returned. When pressed about when a person becomes a non-resident, they said they use the 183 days+ absence rule but they have no way of knowing the length of absences.
What to Do to Keep A Canadian Brokerage Account Happily Active.
Let us call this the benign neglect or the "See No Evil, Hear No Evil" approach. Ultimately it doesn't economic make sense for brokers to stop their clients trading - that's how they make their profits. So don't provoke them or force the issue.
1) Decide for yourself whether you are a Canadian resident for brokerage purposes (which is not the same as for tax purposes). If your answer is yes, Keep a Canadian Street Address to receive mailed statements and have an official location within Canada, not just a post office box, and if you need to inform the broker about a new address prior to leaving, make sure it is a province where the broker is registered
2) Do your trading online; it's cheaper and faster anyway
For self-directed, self-managed investors, such a prospect can be particularly frustrating since technology enables Internet or telephone access to accounts from virtually anywhere. Unfortunately, the WWB (World Wide Bureaucracy) has complex rules that may bring a full stop to such activities. If you are not leaving permanently with your money/investments and you wish to keep your accounts open and available for trading, you need to be careful.
The issue arises from this fact taken from the Ontario Securities Commission note on Cross Border Trading:
"As a fundamental principle in securities regulation, for a securities broker to deal with a client, the broker needs to be registered with the securities authority in the jurisdiction where the client is resident. This applies in the individual states in the U.S. and in the provinces and territories of Canada."
So where are you considered to be "resident"? It all hinges on the meaning of that word resident, which is defined in different ways by different authorities, or even not at all explicitly, leaving the matter to the varying interpretation of court cases, to the utter frustration and dismay of us poor schmucks who have to figure it out.
Here is part of the OSC's response to my enquiry on the issue:
"The term "residency" is not defined in Ontario securities law. Where questions of jurisdiction are to be determined, it must be done on the basis of specific facts and not hypothetically. The basis of jurisdiction may be differently interpreted and applied in different jurisdictions. We cannot give you an opinion or interpretation of Ontario securities law, nor of any other jurisdiction."
The oft-quoted principle that being 183 days or more (i.e. more than half the year) in a place makes you a resident may not apply. A few years ago, Canadian snowbirds with RRSPS and RRIFs found that Canadian brokers refused to allow them to trade in those accounts. As a result of many protests, the US federal regulator, the Securities and Exchange Commission, made a special ruling outlined in the note Canadian Tax-Deferred Retirement Savings Accounts that exempts those type of accounts and allows Canadians to continue trading in them while in the US. It also contains this ominous statement,
"... federal securities laws generally require that securities transactions made for U.S. residents-even those in the U.S. for only a brief period of time-and brokers who sell those securities be registered with the SEC". What the "brief period of time" might be I do not know.
The SEC exemption that removed the restriction on trading in RRSPs and RRIFs did so only for those type of accounts. Regular taxable trading accounts are being blocked. I'm not 100% sure but I believe the reason Canadian brokerages have not fixed the problem simply by registering in both Canada and the USA is that the securities being traded must also be registered in the proper jurisdictions. In the case of the USA, the individual States also have registration requirements as the afore-mentioned SEC note says. Our cherished OSC sums it up nicely: "Due to the complexity of regulations and the confusion as to which states have accepted or partially accepted the SEC process, many compliance departments of Ontario registered brokers have decided that their firms will NOT transact any business from those customers while they are on US soil." Welcome to the WWB!
All this is supposedly motivated by a desire to protect the investor from fraud as paragraph 1.1(a) of the Ontario Securities Act says and this document Investing and the Internet by the OSC suggests. In the case of the USA, there are evidently other motives too, namely to protect the business of US investment firms - see III - Cost Benefit Analysis in the explanation of the ruling where it says the ruling will not significantly harm US brokers by taking away the potential business of Canadians forced to move their accounts to the US.
The brokers are the ones we must deal with and it is their interpretation and application of the law and regulation that counts in the end. Part of the OSC's response to me included this: "Dealers and advisers in Ontario have developed compliance policies to ensure they do not risk breaching the laws of foreign jurisdictions. These policies are not specifically prescribed by Ontario securities law and may vary from firm to firm."
One should therefore not expect that they will all do it the same but I was puzzled and amused by the discussion by several Canadians living in Japan on a Financial Webring thread describing their investing activities despite living outside Canada for many years. One broker evidently is deducting taxes at the rate for non-residents while continuing to allow trading. I am not familiar with securities regulation in Japan but perhaps trading is allowed to continue because there are no restrictions in Japan that Canadian brokers would violate and the broker knows that the Canadian regulator will in fact do nothing about it (the OSC's response to my enquiry left me the strong impression that the OSC would not care - they only mention the foreign jurisdiction problems). Or maybe different parts of the brokerage business don't communicate well enough to catch it. Or maybe the brokerage applies what the OSC also said in their response to my enquiry: "The citizenship and tax status of the investor is generally not relevant in applying Ontario securities law."
In the UK, so far as I could determine from two separate calls to the regulator, the Financial Services Authority, there is no legal restriction for UK brokers to deal with non-residents ... though phone calls to a couple of UK brokers also revealed that they will not open an account unless you are a UK resident. Maybe it's only the US that is an issue because only the US will punish the brokers.
Out of curiosity, I called BMO Investorline to ask how they deal with this stuff. According to the telephone rep I spoke to (who knows if it could be different in practise or with a different person), they rely on the investor to inform them through an address change notice, though they also suspend an account if signs show a person is gone or mail is returned. When pressed about when a person becomes a non-resident, they said they use the 183 days+ absence rule but they have no way of knowing the length of absences.
What to Do to Keep A Canadian Brokerage Account Happily Active.
Let us call this the benign neglect or the "See No Evil, Hear No Evil" approach. Ultimately it doesn't economic make sense for brokers to stop their clients trading - that's how they make their profits. So don't provoke them or force the issue.
1) Decide for yourself whether you are a Canadian resident for brokerage purposes (which is not the same as for tax purposes). If your answer is yes, Keep a Canadian Street Address to receive mailed statements and have an official location within Canada, not just a post office box, and if you need to inform the broker about a new address prior to leaving, make sure it is a province where the broker is registered
2) Do your trading online; it's cheaper and faster anyway
Labels:
BMO Investorline,
discount brokers,
international,
UK,
USA
Free Seminar on Personal Debt Management with Gail Vaz-Oxlade
Monty Loree over at Canadian-Money-Advisor.ca is hosting a free teleseminar with author and TV show debt advisor Gail Vaz-Oxlade on March 4th, 8PM EST. This is your chance to get answers to your questions on the subject as the show will include audience interaction. Gail has her own website so you can check out her bona fides. From what I can tell, her viewpoint is sensible so I am happy to promote this event.
Monty is donating some extra seats to the event, so if you are interested in attending for free, leave a comment on this blog entry by the end of this week, 5pm on Friday, February 22nd. I will pick someone randomly (fortunately don't need to use the Monte Carlo simulator for this) and announce the winner through posting a comment here at which point I would need to get in touch by email (don't worry I won't sell your name to the devil or anyone else). On your comment, should you feel inspired, tell me the difference between good debt and bad debt.
Canadian-Money-Advisor is also running its own free-seat giveaway at this page. The site also warns " Each winner will call the teleseminar number given at their own expense. Long distance charges may apply."
Monty is donating some extra seats to the event, so if you are interested in attending for free, leave a comment on this blog entry by the end of this week, 5pm on Friday, February 22nd. I will pick someone randomly (fortunately don't need to use the Monte Carlo simulator for this) and announce the winner through posting a comment here at which point I would need to get in touch by email (don't worry I won't sell your name to the devil or anyone else). On your comment, should you feel inspired, tell me the difference between good debt and bad debt.
Canadian-Money-Advisor is also running its own free-seat giveaway at this page. The site also warns " Each winner will call the teleseminar number given at their own expense. Long distance charges may apply."
Friday 15 February 2008
UK and Australian Active Fund Manager Performance
The poor investment performance of actively managed mutual funds in Canada and the US is becoming a reasonably well-known fact, with mainstream media increasingly picking up the message. Less well-known is that the same phenomenon exists in the UK. A 2000 study in 2000 by Garrett Quigley and Ray Sinquefield "Performance of UK equity unit trusts" shows the same disappointing results as in North America.
Some choice quotes:
"UK money managers are unable to outperform markets in any meaningful sense, that is, once we take into account their exposure to market, value and size risk."
"Does performance persist? Yes, but only poor performance. As others find for US mutual funds, so we find in the UK. Losers repeat, winners do not."
There is no exception to this trend in Australia either as this Abstract of a journal article by David R. Gallagher and Elvis Jarnecic titled " International equity funds, performance, and investor flows: Australian evidence" confirms: "... active management does not provide investors with superior returns to passive indices."
Some choice quotes:
"UK money managers are unable to outperform markets in any meaningful sense, that is, once we take into account their exposure to market, value and size risk."
"Does performance persist? Yes, but only poor performance. As others find for US mutual funds, so we find in the UK. Losers repeat, winners do not."
There is no exception to this trend in Australia either as this Abstract of a journal article by David R. Gallagher and Elvis Jarnecic titled " International equity funds, performance, and investor flows: Australian evidence" confirms: "... active management does not provide investors with superior returns to passive indices."
Labels:
international,
mutual funds,
UK
Wednesday 13 February 2008
The Necessity of Monte Carlo for Financial Planning
On Monday in my review of Preet Banerjee's book RRSPs, I praised his use of Monte Carlo simulation to project investment returns. Below is a simple illustration of why this is so important in financial planning. There is growing use of Monte Carlo in retirement planning but it should apply equally in the accumulation phase since you may not end up where you thought you might after 30, 40 or 50 years of saving unless you take this into account and implement some appropriate measures in your investing strategy. Using a straight 8% annual growth rate to project your investments may be grossly misleading!
Monte Carlo simulation more closely models the way the stock market actually works, where each year's return is different from the last and where some years are negative while most are positive. For a clearly written introduction to Monte Carlo, read this series of inter-linked articles on Investopedia. This where I got the basic example, which I have expanded a bit.
Click on the spreadsheet extract above and follow along. The examples all show investing for five years using different rates of investment return, either with an initial amount of $100 left alone for the five years, or with yearly contributions of $20.
In the upper left is Case 1, the Base Case. The left hand column of returns vary each year, more like the stock market, going up and down, while the simple case of the same return every year (here 10%) is to the right. Note first that for an initial investment of $100 left alone for five years, even when the arithmetic average of returns (simply adding up each year's return and dividing by five) is the same 10%, the fact that returns go up and down through the five years means the end result is quiet different - $161.05 for the constant growth rate and a lesser $157.32 for the varying returns. The real compounded rate of return (CAGR), which is the relevant return, is obviously less than 10%, it is actually 9.49%.
Cases 2 and 3 down the left side show that when the exact same set of yearly returns occurs in a different order (in fact it is only the minus 5% year in the red box that I have moved around), the average is of course still the same 10%. An initial investment of $100 always comes out the same at $157.32. In other words, the compounded return is still the same too. The pattern doesn't matter in these instances, though the amount in each year along the way is not the same in each case.
In Case 4 at the bottom I kept the CAGR/final amount constant (an investor of $100 at the start would still end up with $157.32) but made the yearly swings more pronounced. The arithmetic average for the years now goes up to 10.2778%. So much for the helpfulness of "average rates of return".
Things become more interesting when a more realistic investing pattern is added, in these examples the $20 per year. In all cases five years of investing $20 (total $100) begets less, much less, than $100 salted away at the beginning, no matter what the sequence of returns (well, it could be more if every year was negative). This another illustration of the oft-noted powerful effects of compounded returns. The same CAGR of 9.49% every year produces only $132.34 (table in the right-most column) after five years of investing $20 per year.
Isn't it interesting how the application of the varying pattern of returns to the $20/year contributions in case 1 produces more than the CAGR rate, namely $132.98, reversing the results for the same sequence of returns applied to the single initial investment? Modeling the real way that investment returns occur begins to acquire some importance.
Now comes the really fun part. Note how Cases 2 to 4 of the $20 contributions produce markedly different end total values. Cases 2 and 3 use the exact same set of yearly returns, only in different sequences. In Case 2, when the negative year of minus 5% happens earlier, the total value is appreciably higher. in Case 3, where it happens later than in the Base, the net is much lower. When you are investing on a regular basis the pattern of returns matters and it matters a lot!
In Case 4, the very same CAGR of 9.49% ($157.32) for an initial investment but with a broader range of yearly returns (I changed the last year to minus 10% then fiddled with the preceeding year till is gave me the same CAGR) creates an even lower value of $123.75. Wider market swings can be bad for your financial health. If on the other hand, the minus 10 occurred early in the sequence, the positive end result would be greater than any of the other. Bigger year to year swings magnify the possible end results up or down. They do not necessarily cancel each other out.
Crestmont Research has published a table and graph of the Dow Jones Industrial Average called Distorted Averages that illustrates the above principle with real data. Between 1900 and 2008 the DJIA had an average annual return of 7.0% but the compounded return was only 4.6%.
Since most people would say that an unexpectedly lower net result after a lifetime of saving in the accumulation phase or many years in retirement in the drawdown phase - think of it, would you rather be forced back to work at age 80 because you have run out of money or chance the pleasure of a round the world cruise at that age? - my suggestion is that big swings are more bad than good.
What can be done about it? Certainly one cannot control the market swings, the yearly returns. But one can control and reduce volatility to a fairly significant degree by diversification, that is picking a set investments that do not move in perfect unison - that are non-correlated, or better, negatively correlated. So, to the TSX or the S&P 500 equities we add things in a portfolio like international equities, bonds, real estate/REITs, and commodities. Take a look at my model portfolio at the bottom of this blog. Most holdings have gone down but my commodity DJP and international equity VWO are up a bit, while bonds in AGG are close to breakeven (it's only because of the rising C$ and the not-shown cash distributions I have received that they are not) and my Canadian bond ladder is up considerably.
Effective diversification may reduce returns by a little but it will cut volatility/risk by a lot. Check out this chart at IFA Canada to see how their portfolio approach creates the desired effect.
Another lesson from this simple example is that to the extent one can control retirement date, it is best not to do it in the middle of a big market downswing when investment net holdings could be driven down by a lot. Turning investments into annuities at that moment could lock in 30 years of retirement at a much lower income level.
Monte Carlo in actual financial investment planning use does not give a single deterministic answer of how much your portfolio will be worth after five or fifty years. Rather, it gives a picture of a whole series of possible outcomes, depending on which of many possible sequences of returns happen in the market or in your portfolio. Varying the assumptions about the expected return and the volatility produces ranges of possible outcomes, as shown in the graphs on this post on RRSP vs Mortgage in WhereDoesAllMyMoneyGo. You don't get certainty, you get realism with Monte Carlo.
Is Monte Carlo beginning to sound useful?
Two excellent articles with examples and explanation of the reasoning behind Monte Carlo simulation can be found at William Bernstein's The Retirement Calculator from Hell and William Sharpe's Financial Planning in Fantasyland. I found the links to these articles on the MoneyChimp site, always an excellent resource for learning about investing principles.
Monte Carlo simulation more closely models the way the stock market actually works, where each year's return is different from the last and where some years are negative while most are positive. For a clearly written introduction to Monte Carlo, read this series of inter-linked articles on Investopedia. This where I got the basic example, which I have expanded a bit.
Click on the spreadsheet extract above and follow along. The examples all show investing for five years using different rates of investment return, either with an initial amount of $100 left alone for the five years, or with yearly contributions of $20.
In the upper left is Case 1, the Base Case. The left hand column of returns vary each year, more like the stock market, going up and down, while the simple case of the same return every year (here 10%) is to the right. Note first that for an initial investment of $100 left alone for five years, even when the arithmetic average of returns (simply adding up each year's return and dividing by five) is the same 10%, the fact that returns go up and down through the five years means the end result is quiet different - $161.05 for the constant growth rate and a lesser $157.32 for the varying returns. The real compounded rate of return (CAGR), which is the relevant return, is obviously less than 10%, it is actually 9.49%.
Cases 2 and 3 down the left side show that when the exact same set of yearly returns occurs in a different order (in fact it is only the minus 5% year in the red box that I have moved around), the average is of course still the same 10%. An initial investment of $100 always comes out the same at $157.32. In other words, the compounded return is still the same too. The pattern doesn't matter in these instances, though the amount in each year along the way is not the same in each case.
In Case 4 at the bottom I kept the CAGR/final amount constant (an investor of $100 at the start would still end up with $157.32) but made the yearly swings more pronounced. The arithmetic average for the years now goes up to 10.2778%. So much for the helpfulness of "average rates of return".
Things become more interesting when a more realistic investing pattern is added, in these examples the $20 per year. In all cases five years of investing $20 (total $100) begets less, much less, than $100 salted away at the beginning, no matter what the sequence of returns (well, it could be more if every year was negative). This another illustration of the oft-noted powerful effects of compounded returns. The same CAGR of 9.49% every year produces only $132.34 (table in the right-most column) after five years of investing $20 per year.
Isn't it interesting how the application of the varying pattern of returns to the $20/year contributions in case 1 produces more than the CAGR rate, namely $132.98, reversing the results for the same sequence of returns applied to the single initial investment? Modeling the real way that investment returns occur begins to acquire some importance.
Now comes the really fun part. Note how Cases 2 to 4 of the $20 contributions produce markedly different end total values. Cases 2 and 3 use the exact same set of yearly returns, only in different sequences. In Case 2, when the negative year of minus 5% happens earlier, the total value is appreciably higher. in Case 3, where it happens later than in the Base, the net is much lower. When you are investing on a regular basis the pattern of returns matters and it matters a lot!
In Case 4, the very same CAGR of 9.49% ($157.32) for an initial investment but with a broader range of yearly returns (I changed the last year to minus 10% then fiddled with the preceeding year till is gave me the same CAGR) creates an even lower value of $123.75. Wider market swings can be bad for your financial health. If on the other hand, the minus 10 occurred early in the sequence, the positive end result would be greater than any of the other. Bigger year to year swings magnify the possible end results up or down. They do not necessarily cancel each other out.
Crestmont Research has published a table and graph of the Dow Jones Industrial Average called Distorted Averages that illustrates the above principle with real data. Between 1900 and 2008 the DJIA had an average annual return of 7.0% but the compounded return was only 4.6%.
Since most people would say that an unexpectedly lower net result after a lifetime of saving in the accumulation phase or many years in retirement in the drawdown phase - think of it, would you rather be forced back to work at age 80 because you have run out of money or chance the pleasure of a round the world cruise at that age? - my suggestion is that big swings are more bad than good.
What can be done about it? Certainly one cannot control the market swings, the yearly returns. But one can control and reduce volatility to a fairly significant degree by diversification, that is picking a set investments that do not move in perfect unison - that are non-correlated, or better, negatively correlated. So, to the TSX or the S&P 500 equities we add things in a portfolio like international equities, bonds, real estate/REITs, and commodities. Take a look at my model portfolio at the bottom of this blog. Most holdings have gone down but my commodity DJP and international equity VWO are up a bit, while bonds in AGG are close to breakeven (it's only because of the rising C$ and the not-shown cash distributions I have received that they are not) and my Canadian bond ladder is up considerably.
Effective diversification may reduce returns by a little but it will cut volatility/risk by a lot. Check out this chart at IFA Canada to see how their portfolio approach creates the desired effect.
Another lesson from this simple example is that to the extent one can control retirement date, it is best not to do it in the middle of a big market downswing when investment net holdings could be driven down by a lot. Turning investments into annuities at that moment could lock in 30 years of retirement at a much lower income level.
Monte Carlo in actual financial investment planning use does not give a single deterministic answer of how much your portfolio will be worth after five or fifty years. Rather, it gives a picture of a whole series of possible outcomes, depending on which of many possible sequences of returns happen in the market or in your portfolio. Varying the assumptions about the expected return and the volatility produces ranges of possible outcomes, as shown in the graphs on this post on RRSP vs Mortgage in WhereDoesAllMyMoneyGo. You don't get certainty, you get realism with Monte Carlo.
Is Monte Carlo beginning to sound useful?
Two excellent articles with examples and explanation of the reasoning behind Monte Carlo simulation can be found at William Bernstein's The Retirement Calculator from Hell and William Sharpe's Financial Planning in Fantasyland. I found the links to these articles on the MoneyChimp site, always an excellent resource for learning about investing principles.
Labels:
diversification,
financial planning,
Monte Carlo,
portfolio,
retirement
Tuesday 12 February 2008
Another Advocate of Infrequent Portfolio Rebalancing
For those who believe in an asset allocation investment approach with periodic rebalancing back to target percentages, here's more evidence that less often, specifically only every four years or so, is better. I've discovered that financial planner and author Jim Otar had independently reached the same conclusion as academic researchers David Smith and William Desormeau, whose findings I had written about in December in My Rebalancing Policy Refined. Otar used US data and found that rebalancing every four years produced better results in a retirement portfolio - see his paper Optimizing Rebalancing in Retirement Portfolios. Otar found that rebalancing only every four years, as opposed to once a year, was especially important in secular bull or bear markets, in either maximizing the upward benefit of multiple years of good returns, or in minimizing the downward losses in the other directions. The latter effect was critical in helping to avoid what retirees fear most - running out of money before death.
Otar based his four-year cycle on the US Presidential cycle, doing the rebalancing at the completion of each cycle. The Smith and Desormeau article did not study the US Presidential cycle but it did look at the Federal Reserve Monetary Policy as reflective of expansion and contraction of the business cycle and found that coordinating rebalancing with changes in Fed policy (i.e. whether it goes from rate hikes to cuts or vice versa) produced the best results. Do Fed policy changes correspond to the US Presidential cycle and therefore the two sets of research are just expressing the same forces at work? Whatever that answer, both researchers say four-year long waits between rebalancing is better and it appears the reason is that one is therefore able to take advantage of multi-year bull markets or minimize the damage of bear markets.
Otar based his four-year cycle on the US Presidential cycle, doing the rebalancing at the completion of each cycle. The Smith and Desormeau article did not study the US Presidential cycle but it did look at the Federal Reserve Monetary Policy as reflective of expansion and contraction of the business cycle and found that coordinating rebalancing with changes in Fed policy (i.e. whether it goes from rate hikes to cuts or vice versa) produced the best results. Do Fed policy changes correspond to the US Presidential cycle and therefore the two sets of research are just expressing the same forces at work? Whatever that answer, both researchers say four-year long waits between rebalancing is better and it appears the reason is that one is therefore able to take advantage of multi-year bull markets or minimize the damage of bear markets.
Labels:
portfolio,
rebalancing,
retirement
Monday 11 February 2008
Book Review: RRSPs by Preet Banerjee
This book is written by Preet Banerjee, a financial advisor by day and a dedicated blogger at WhereDoesAllMyMoneyGo by night. The subject - Registered Retirement Savings Plans - is near and dear to all Canadians' hearts, especially at this time of year, when all the banks and mutual fund companies are exhorting everyone to invest for their retirement before the end of February, the deadline for contributions to apply to the 2007 tax year.
The book is thus a timely contribution and a very useful one at that. It is divided into three sections. The first section explains the basic rules about RRSPs and how they fit into the Canadian tax system. The second section is the guts of the content with a series of 41 chapters on a wide variety of topics involving RRSPs in one way or another, ranging from simple tips, rules subtleties to complicated investment strategies. Due to the nature of this content, it is not necessary to read the book from one end to the other. The strategies are stand-alone. The third section is a brief appendix with other sources of information, notably including blogs that Preet has found useful. It is flattering to find my own blog listed among those he finds to be useful - how could I disagree! His description of me as a "very detail oriented writer" is accurate and for me, at least, a compliment - I've found that paying close attention to details is necessary to avoid unpleasant 'gotchas'. This book is not an exhaustive, definitive guide and reference source. Its aim is to provide inventive ways of effectively using RRSPs.
Preet's writing style is informal and free-flowing, very readable and natural. He does a good job explaining terms and technical details, a real bonus for those just getting into RRSPs.
Preet's day job as an advisor shows through in the realism of the examples he chooses and the comments he makes. Key choices that most people must make are analyzed - e.g. pay down the mortgage or contribute to the RRSP, since most people don't earn enough to do both simultaneously. And he does the analysis with numbers, which is far more believable. He also comments on the psychological challenges that often prevent people from gaining the benefit of a strategy, such as the temptation to spend the tax refund from an RRSP contribution instead of investing it somehow or the panic that causes a sell-off at precisely the wrong time when using leverage.
The introduction of Monte Carlo simulation of investment returns in the analysis of various scenarios such as RRSP vs mortgage and RRSP vs non-registered account is a major improvement over traditional modeling, which usually assumes some constant rate of increase. Monte Carlo is vastly more realistic. It gives a much better sense of the risk involved in investing when returns swing amongst a range of positive and negative results from year to year. The fact that an 8% average growth rate with different patterns of positive and negative years can result in vastly different total wealth / retirement incomes will probably be a revelation to many. The book is well worth it for that analysis alone.
There could be a simplified presentation of the long analytical chapters 26, "RRSP vs Mortgage" and 28, "RRSP vs non-Registered Account". So far as I can tell, some factors and information are irrelevant to the conclusions, like the inflation rate, the value of the house and its rate of value gain and how long the investor lives. Though this extra data was likely added to present a believable scenario, it makes no difference to the choice of which is better to do. Another quibble is the conversion of the net savings/wealth to retirement income. We are never told specifically how that happens, though I assume again, if it is done consistently, it makes no difference. The possible confusion is that all the charts show wealth on the Y-axis not income. Some of the charts appear to show unsuccessful outcomes with higher net wealth than successful ones, a puzzle for sure. Could this just be a problem with graphics?
One part of the RRSP vs mortgage analysis that I question concerns the assumed contribution of the $2009 monthly mortgage payment to the RRSP in various scenarios after the mortgage is paid off. At $60k salary, the contribution limit is 18% times $60k or $10,800 yet the analysis posits contributions of 12x$2,009 or $24,108 per year plus an amount of $3,000 already being contributed that grows with salary. Since the investor's salary and contributions are assumed to grow at 4%, in 25 years here is what I calculate: salary $153,798, new RRSP limit $27,684, existing $3k contribution up to $7,690 plus $24,108 equals $31,798, or $4,114 too much. This especially affects scenarios B and D where the investor is assumed to pay off the mortgage early then contribute the mortgage payment amount to the RRSP. I wonder how the conclusion would differ taking that lower RRSP contribution room into account? Would scenario D still beat C?
At the end of the many pages on RRSP vs mortgage, the summary table on page 125 is the key. The basic answer is that when the rate of return of the RRSP exceeds the mortgage rate, the RRSP is better and vice versa. Moshe Milevsky had already shown and explained that in his book Money Logic so it's good that they arrive at the same conclusion. Beyond that, the relative certainty of the mortgage rate against the uncertain, variable investment return is a major consideration that Preet examines at length.
It is surprising to see that the book does not present a case or scenario in chapter 28 on the RRSP vs non-Registered account comparison that shows one of the core supposed benefits of the RRSP - namely, that when one gets deductions at a higher tax rate when working and a lower tax rate on withdrawal when retired, one is much better off saving in an RRSP. The scenario of Anna in the book appears to show that she ends up in the same tax bracket, though that is not explicitly stated. However, it is significant that the non-Registered account strategy only beats the RRSP when the on-going investment taxes of the non-Reg account are paid with other funds. Such an approach does not compare apples with apples, as Preet himself says on page 148.
There are several spots where the author says that a number of other factors could affect the conclusion (e.g. page 155 regarding the RRSP meltdown strategy) but he neglects to explain even the nature of the effects. That's frustrating for the reader.
I notice that some of the book's content seems also to be on the author's WhereDoesAllMyMoneyGo blogsite so interested readers can get a sense of the book for themselves there.
All in all, the book could be better but it still quite useful; it only takes one good idea to be worth the money.
My rating: 3.5 out of 5.
The book can be purchased at the RRSP Book website,
Labels:
book review,
retirement,
RRSP
Wednesday 6 February 2008
Figuring Out When You Are Going To Die: Life Expectancy
One of the biggest challenges of retirement planning and figuring out how much money will be needed, how much you need to save, is deciding for how many years you will need income, in other words, estimating when you will die.
This somewhat macabre exercise has become necessary with rising life expectancy and the decline in defined benefit pensions. The success of medicine, public health and improved nutrition in the 20th century is reflected in the vastly increased life expectancy of people in all developed countries like Canada, the USA and the UK. As Sherry Cooper outlines in her new book, The New Retirement (which I will review soon), when the retirement age of 65 was first introduced few people died much older than that. Even as recently as 1951 (for people my age that's recent!), this Maclean's article What's the Magic in 65? says that average life expectancy was 67 for men and 71 for women.
Those figures are far higher today and they are still climbing as the table below from the Statistics Canada website shows. Baby boys born in Canada in 2005 could expect to live to age 78, while baby girls would get to 82.7 on average. It is amazing to me that in a mere five years from the year 2000 to 2005, life expectancy would rise by 1.4 years for males. More pertinent for retirement planning, is that those men age 65 in 2005 could expect to live another 17.9 years, i.e. to age 82.9, while women would get to 86.1.
Three important points come out of this for retirement planning:
Point two surprised me. The older you are, the longer you can expect to live. It goes up steadily as this other table from Stats Can shows.
Since I am around 55 and if I retire I would need to plan for at least 25 years of income as a start. When I first did my retirement planning at my birth around about 1951, per the Macleans figures, I only needed to consider living to 67, or 12 years. This suggests a need to regularly re-evaluate retirement income plans upwards as one gets older. If you have died along the way that isn't necessary!
The story doesn't end there, however. Those averages can be refined. If you take care of yourself in various ways (being fit, not fat, drinking less, not smoking, eating food not processed junk, having a pet, mental stimulation, a neutral worldview, friends, cuddles for the women and sex for the guys) you will live even longer. The Sherry Cooper book recounts that taking care of yourself is especially effective in prolonging life expectancy when you get older.
How much longer you ask? What I could find on-line is sketchy and incomplete. Here is a UK report from Channel 4 that discusses the factors and provides some estimates of their impact. Then there is this life expectancy calculator from the University of Pennsylvania where you select your own circumstances from drop down boxes to get a prediction of your own life expectancy. You can use it to do trade-off analysis - if you like driving fast, how much is it worth in years to keep to speed limits? Should you bother sleeping more if that means missing that great late night poker show on TV? Trade-off pleasure for years ... shades of Dorian Gray! Another simpler calculator is at Death Timer. The Northwestern Mutual longevity calculator, based on US data, has a 12 question amusing quiz that shows how each factor adds or subtracts years as you answer each question. The Foundation for Infinite Survival (ambitious goal, huh?) has a lengthy and seemingly actuarily-founded life expectancy calculator too. Canadian Business' MoneySense offers this calculator for Canadians. Finally, you could simply predict your own death; if I understand this academic gobledygook by Siegel, Bradley and Kassel at Gerontology, it seems to say that people are pretty accurate in predicting when they will die.
What is needed:
Since the only way to know for absolute certain when one is to die is not palatable, something better is needed. As Moshe Milevsky pointed out in his book Insurance Logic, the financial challenge is to not run out of money, to mitigate the so-called longevity risk. I wish the discount brokerages or maybe our governments would put up a proper death calculator on the web to develop good individual estimates. This should include what is missing from all the above - confidence intervals, such as, "if your are 65 and you have the following charactersitics and lifestyle, your life expectancy is 81 years; there is 99% probability you will die by 87 years, a 95% probability of dying by age 85" and so on. Then we could plan effectively.
Alas, we cannot follow W. Somerset Maughan's admonition on WisdomQuotes: "Dying is a very dull, dreary affair. And my advice to you is to have nothing whatever to do with it."
This somewhat macabre exercise has become necessary with rising life expectancy and the decline in defined benefit pensions. The success of medicine, public health and improved nutrition in the 20th century is reflected in the vastly increased life expectancy of people in all developed countries like Canada, the USA and the UK. As Sherry Cooper outlines in her new book, The New Retirement (which I will review soon), when the retirement age of 65 was first introduced few people died much older than that. Even as recently as 1951 (for people my age that's recent!), this Maclean's article What's the Magic in 65? says that average life expectancy was 67 for men and 71 for women.
Those figures are far higher today and they are still climbing as the table below from the Statistics Canada website shows. Baby boys born in Canada in 2005 could expect to live to age 78, while baby girls would get to 82.7 on average. It is amazing to me that in a mere five years from the year 2000 to 2005, life expectancy would rise by 1.4 years for males. More pertinent for retirement planning, is that those men age 65 in 2005 could expect to live another 17.9 years, i.e. to age 82.9, while women would get to 86.1.
Three important points come out of this for retirement planning:
- you can live many years in retirement - 20 or more years; and remember that's only the average so about half will live longer (? not sure how close the average age is to the median, which is the true dividing line in terms of half the number of people above and half below)
- if you get to 65, there are more years left than you might have thought (most of the weak, the foolish and the unlucky have disappeared from the statistics)
- the number of years you will live is still creeping steadily upwards, though there must be a limit somewhere we don't seem to have reached it yet
Point two surprised me. The older you are, the longer you can expect to live. It goes up steadily as this other table from Stats Can shows.
Since I am around 55 and if I retire I would need to plan for at least 25 years of income as a start. When I first did my retirement planning at my birth around about 1951, per the Macleans figures, I only needed to consider living to 67, or 12 years. This suggests a need to regularly re-evaluate retirement income plans upwards as one gets older. If you have died along the way that isn't necessary!
The story doesn't end there, however. Those averages can be refined. If you take care of yourself in various ways (being fit, not fat, drinking less, not smoking, eating food not processed junk, having a pet, mental stimulation, a neutral worldview, friends, cuddles for the women and sex for the guys) you will live even longer. The Sherry Cooper book recounts that taking care of yourself is especially effective in prolonging life expectancy when you get older.
How much longer you ask? What I could find on-line is sketchy and incomplete. Here is a UK report from Channel 4 that discusses the factors and provides some estimates of their impact. Then there is this life expectancy calculator from the University of Pennsylvania where you select your own circumstances from drop down boxes to get a prediction of your own life expectancy. You can use it to do trade-off analysis - if you like driving fast, how much is it worth in years to keep to speed limits? Should you bother sleeping more if that means missing that great late night poker show on TV? Trade-off pleasure for years ... shades of Dorian Gray! Another simpler calculator is at Death Timer. The Northwestern Mutual longevity calculator, based on US data, has a 12 question amusing quiz that shows how each factor adds or subtracts years as you answer each question. The Foundation for Infinite Survival (ambitious goal, huh?) has a lengthy and seemingly actuarily-founded life expectancy calculator too. Canadian Business' MoneySense offers this calculator for Canadians. Finally, you could simply predict your own death; if I understand this academic gobledygook by Siegel, Bradley and Kassel at Gerontology, it seems to say that people are pretty accurate in predicting when they will die.
What is needed:
Since the only way to know for absolute certain when one is to die is not palatable, something better is needed. As Moshe Milevsky pointed out in his book Insurance Logic, the financial challenge is to not run out of money, to mitigate the so-called longevity risk. I wish the discount brokerages or maybe our governments would put up a proper death calculator on the web to develop good individual estimates. This should include what is missing from all the above - confidence intervals, such as, "if your are 65 and you have the following charactersitics and lifestyle, your life expectancy is 81 years; there is 99% probability you will die by 87 years, a 95% probability of dying by age 85" and so on. Then we could plan effectively.
Alas, we cannot follow W. Somerset Maughan's admonition on WisdomQuotes: "Dying is a very dull, dreary affair. And my advice to you is to have nothing whatever to do with it."
Labels:
financial planning,
retirement
Friday 1 February 2008
Equity-only or Bond with Equities: Objection and Nuances
Yesterday's post Why Not All Equities attracted a valuable comment by blogger Michael James to the effect that the math alone indicates it is highly unlikely that bonds could actually increase returns (see his comment for details) in a portfolio with equities.
I think the point about rebalancing made by another commentor John accounts for part of the shortfall and thanks to John for saying that since I did not mention it in the original post. Gibson's modeling rebalanced the portfolios annually, which in effect implements an automatic program of "sell the asset when high and buy the other which is low". This boost returns. But that only accounts for part of the return gap noted by Michael.
So, Ok, Michael, let me back off a little. First, the portfolios modeled by Gibson consist of various non-bond combinations. The other asset classes of international equities, commodities and real estate returns have been close enough to that of an all-equity S&P 500 portfolio to do exactly what was stated - higher returns at lower volatility. But with respect to bonds, Gibson himself states that when fixed income is mixed with equity in a portfolio ... "the large difference between the returns of fixed-income and those of equity investments obscures the increase in portfolio return attributable to the diversification effect." In other words, you are strictly correct: with bonds it is unlikely that portfolio returns will actually increase in a combined portfolio. However, there will be a large decrease in volatility/risk that more than compensates for the slightly lower return. The common way of expressing this is the Sharpe ratio, which divides the equity return (net of the risk-free T-bill rate) by the standard deviation (i.e. volatility). I daresay you will never find a study/data in which a portfolio of bonds plus equities has a lower Sharpe ratio than an equity-only portfolio.
I found this interesting article "Do You Need Bonds?" by Duncan Hood in Canadian Business. Apart from the "can-you-stick-with-it-when times-get-tough" argument, he outlines differences in returns using an example of the TSX over 30 years and indeed the portfolio with bonds does have a slightly lower return of 11.5% annually vs 12.1% for one of TSX index-equity only. The annual return ups and downs are much less for the combo portfolio.
The additional element introduced by the article is taxes, which can result in net returns being higher with equities plus bonds when the money is in an RRSP or with equities only in a taxable account for long holding periods due to the differences in taxes on bond interest income, on RRSP withdrawals (taxed as income) and on capital gains and dividends from equities (lower rates).
Thanks to Michael for his sharp eyes and brain. To quote Keynes again, "There is no harm in being sometimes wrong — especially if one is promptly found out."
I think the point about rebalancing made by another commentor John accounts for part of the shortfall and thanks to John for saying that since I did not mention it in the original post. Gibson's modeling rebalanced the portfolios annually, which in effect implements an automatic program of "sell the asset when high and buy the other which is low". This boost returns. But that only accounts for part of the return gap noted by Michael.
So, Ok, Michael, let me back off a little. First, the portfolios modeled by Gibson consist of various non-bond combinations. The other asset classes of international equities, commodities and real estate returns have been close enough to that of an all-equity S&P 500 portfolio to do exactly what was stated - higher returns at lower volatility. But with respect to bonds, Gibson himself states that when fixed income is mixed with equity in a portfolio ... "the large difference between the returns of fixed-income and those of equity investments obscures the increase in portfolio return attributable to the diversification effect." In other words, you are strictly correct: with bonds it is unlikely that portfolio returns will actually increase in a combined portfolio. However, there will be a large decrease in volatility/risk that more than compensates for the slightly lower return. The common way of expressing this is the Sharpe ratio, which divides the equity return (net of the risk-free T-bill rate) by the standard deviation (i.e. volatility). I daresay you will never find a study/data in which a portfolio of bonds plus equities has a lower Sharpe ratio than an equity-only portfolio.
I found this interesting article "Do You Need Bonds?" by Duncan Hood in Canadian Business. Apart from the "can-you-stick-with-it-when times-get-tough" argument, he outlines differences in returns using an example of the TSX over 30 years and indeed the portfolio with bonds does have a slightly lower return of 11.5% annually vs 12.1% for one of TSX index-equity only. The annual return ups and downs are much less for the combo portfolio.
The additional element introduced by the article is taxes, which can result in net returns being higher with equities plus bonds when the money is in an RRSP or with equities only in a taxable account for long holding periods due to the differences in taxes on bond interest income, on RRSP withdrawals (taxed as income) and on capital gains and dividends from equities (lower rates).
Thanks to Michael for his sharp eyes and brain. To quote Keynes again, "There is no harm in being sometimes wrong — especially if one is promptly found out."
Labels:
diversification,
portfolio,
taxes
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