Here are my posts for this week: Leverage Quiz When Genius Failed Here are some short takes and some weekend reading: Jason Zweig gives a clear explanation of why fund managers tend to make their portfolios match the index fairly closely even if their investors would prefer bolder moves. Potato reviews several rent vs. buy calculators. He takes a much deeper look than writers of most such review posts and actually explains what’s wrong with some of them. Tim Stobbs explains his approach to early retirement in an interesting interview. His approach sounds very sensible. The one thing that concerns me in declaring my own financial independence is the possibility that when my health eventually declines somewhat, my expenses will rise. I might need to pay someone to mow my lawn, shovel snow, or clean eavestroughs. I may have more direct expenses such as physiotherapy. For this reason, I think early retirement enthusiasts should add a buffer to their current spending to...

What happens when smart guys including some Nobel Prize winners borrow $125 billion to invest with huge leverage, gain further leverage from derivative contracts, and rely on markets remaining rational and investments remaining mostly uncorrelated to avoid blowing up? This is the story of the hedge fund Long-Term Capital Management (LTCM). Spoiler alert: they blew up. Roger Lowenstein’s book When Genius Failed is an interesting account of LTCM’s seeming wild success starting in 1994 followed by its spectacular failure that threatened to take down the U.S. banking system in 1998. Apparently, “long term” is 4 years. Lowenstein does a good job of blending financial events with the personal interactions that were important to this story. In its first four years, LTCM total returns were a staggering 311%! Even after deducting stiff management fees, investors were up 185%. Unfortunately, when trades started going against LTCM’s huge leveraged portfolio, it took only 5 months to er...

When you borrow to invest, it is called using leverage. I’ll explain the basics of leverage and then hit you with a one-question quiz to see how well you understand its effects. If you have $100,000 and borrow $100,000 more so you can invest a total of $200,000, it’s called using 2:1 leverage. If you borrowed $200,000 to invest a total of $300,000, that’s 3:1 leverage. Once you’ve leveraged your portfolio, there are two ways basic approaches to maintaining that leverage. One is to rebalance periodically so that you maintain the same level of leverage. This means that if you’re leveraged 2:1 and stocks go up, you borrow to buy more shares to maintain the 2:1 leverage. If stocks go down, you sell shares and pay off some debt to get back down to 2:1. The other basic approach is to treat the debt and investments separately, just paying the loan interest. Your leverage ratio goes up and down as your investments go down and up. If you had invested in the exchange-traded fund of ...

Here are my posts for this week: TFSA Penalties Poised to Rise Test Driving Financial Rules of Thumb Here are some short takes and some weekend reading: Dan Hallett uses his expertise to pick apart the misleading aspects of a few ads for investments. The rule seems to be “if it’s misleading but legal, run it.” Eric Reguly does a great job of explaining executive pay abuses. Stock options do a terrible job of aligning the interests of shareholders and company executives. Tom Bradley at Steadyhand is advising retired clients to rebalance by topping up their cash reserves. He says “the general range used by our clients is 12 to 24 months” worth of spending in cash reserves. When I started looking at retirement income strategies , I chose 5 years of spending as a cash buffer. I think the difference is that Steadyhand’s client’s portfolios generally contain a significant allocation to bonds that reduces risk. My strategy was based on the cash buffer being the only safe ...

Taking a close look at some financial rules of thumb began with a post at Brighter Life and jumped to My Own Advisor . Here I give my take on some very common rules of thumb. Your retirement income needs to be 70% of your working income. This is obviously just an average or typical case. You should really look at your spending needs, including saving up for bigger items like replacing a car, windows, furnace, flooring, or roof. My family’s spending is currently about 40% of the combined take-home pay for my wife and me. It makes no sense for us to target a retirement income almost double what we need right now. Retirement needs are driven by your spending, not your income. Keep an emergency fund equal to six months’ income. I’m a big believer in liquidity. Access to credit may seem like adequate protection, but lenders may take away access to credit in tough financial times. If you lose your job when the biggest employer in town goes bankrupt, banks may not be in a hurr...

While the number of people mistakenly over-contributing to their TFSAs has been declining each year, the size of individual penalties is likely to grow. This is a consequence of a common type of mistake and growing TFSA balances. To illustrate the problem, consider our hypothetical hero Joe who dutifully fills up his TFSA every January. Like many Canadians, Joe doesn’t realize that his TFSA can be more than just a savings account collecting modest interest. It’s now January 2020, and after filling up his TFSA yet again he now has $75,000 saved. Then Joe sees an ad at another bank offering TFSA rates a half percent higher than he’s getting now. That would pay him an extra $375 per year. He decides to take action and withdraws the whole $75,000 and deposits it into a TFSA at the new bank. Unfortunately, Joe does not do a “qualifying transfer,” which is when the TFSA contents are transferred directly from one TFSA to another without Joe ever handling the money. He just does t...

Here are my posts for this week: Why Market Timing Fails Loan Pushers Too Big to Fail Here are some short takes and some weekend reading: David Chilton (the Wealthy Barber) explains in this video clip the secret to a happy financial life. Saving isn’t just about making a better future; it’s about making life simpler and better right now. His remarks at the end about math knowledge are interesting. I’ve definitely noticed that people with strong math skills tend to earn more money than the general population. Whether they’re better at handling and investing that money is another question. Canadian Couch Potato shows how to reduce transaction costs and optimize asset location by treating all family investment accounts as a single big portfolio. Doug Runchey explains how working past age 60 affects CPP benefits in a number of example cases. Dan Hallett takes a look at a market-linked GIC that seems good on the surface but wilts under Hallett’s scrutiny. Big Cajun...

I wouldn’t have thought it possible to turn an account of the 2008 financial crisis into a story as compelling as a novel, but Andrew Ross Sorkin did it with his book Too Big to Fail . Sorkin gives an inside account of the actions of Wall Street executives and government officials that captures their panic, greed, loyalty, and in some cases patriotism. One theme in the early part of the book is the power play that exists at the top of large corporations. In one example, an executive forcing another out of a company is just a routine “disposal of a potential rival.” In another example, one executive is pushed out but not a second because the second “appeared nonthreatening.” This is a peculiar world where competence is valued, but too much competence is threatening. Another theme is executives making themselves rich at the expense of their own firms. Even when the market for Collateralized Debt Obligations (CDOs) “was perceptibly unraveling,” Merrill Lynch kept churning them ou...

I was out for a walk at lunchtime one day and saw a huge billboard for a payday loan company. The huge font read $100 LOAN FOR $1 Presumably this means that you’d pay only $1 in interest on a loan of $100. This is cheaper than the usual rates for payday loans, so I suspected a catch. Then I noticed a smudge to the right of the large font. I had to cross the street to read the fine print written sideways: ON FIRST LOAN The font for the fine print was so much smaller that all three words together sideways were the same height as each large character in the main message. So, the offer is a lower cost entry to a cycle of debt and despair. It all reminds me of the techniques used by drug pushers when I was young. The first joint or little baggy is free, but you’ll have to pay when you come back for more.

In a recent study , market timing based on Robert Shiller’s well-known Cyclically Adjusted Price-to-Earnings ( CAPE ) ratio failed to produce market-beating returns. Here I offer an explanation of why this doesn’t work. Shiller’s CAPE is one way to try to measure whether stocks are currently over- or under-valued. If CAPE gives correct results, you might think it’s self-evident that getting out of the market when stocks are overvalued would be a good idea. Based on this reasoning, the study results seem to imply that CAPE is not a good valuation measure, but this isn’t necessarily correct. Even if CAPE is completely accurate, it still isn’t necessarily useful for market timing. The problem is that it takes time for stock prices to readjust. Suppose that CAPE says prices are 10% too high. If the market reacted quickly, then next year’s returns would be 10% lower than normal. But prices don’t react this quickly. Suppose that it takes 10 years for stock prices to adjust and b...

I wrote one post this week replying to email I usually ignore: Replying to More Email Here are some short takes and some weekend reading: Potato has some thoughtful arguments for why his family don’t need much life insurance on his life. Insurance brokers are likely to disagree strongly with him. He makes some interesting points, but it’s hard to decide to what degree I agree or disagree without some numbers. Canadian Couch Potato reviews the book Clash of the Financial Pundits: How the Media Influences Your Investment Decisions for Better or Worse . Sounds like an interesting read. Million Dollar Journey updates his Smith Manoeuvre (leveraged) portfolio. In my opinion, very few people are well-suited to leveraging a portfolio. Frugal Trader says “If you can’t stomach losing 20-30% in the portfolio in any given year, then your risk tolerance isn’t suited for leveraged investing.” My Own Advisor reviews Larry Swedroe’s book The Quest for Alpha which makes a strong c...

I get a lot of great feedback from my readers. I get other email as well. Here is another installment of replies to emails that I usually ignore (see the first one here ). Dear Julia, Thank you for the opportunity to profit from writing a post that directs my readers to your forex broker. Forex trading has all the advantages of trading against extremely highly skilled opponents without the built-in tendency for prices to rise that we see with stocks. If I ever lose my empathy for fellow human beings, I’ll take you up on your offer. Sincerely, Michael -------------------- Dear Blair, Forgive me if I’m a little skeptical of your claimed ability to offer unbiased financial advice to Canadian seniors. What threw me off was the phrase “Gold Price” in your organization’s name and the reference to “proprietary trading algorithms.” When you say that current seniors are the wealthiest generation ever, is it your mission to cure them of this affliction? Sincerely, Michael

I wrote one post this week about how I can feel myself getting complacent about stock market risk: Stock Markets Only Go Up? Here are some short takes and some weekend reading: Million Dollar Journey has an excellent list of key philosophies for long-term investing success. Beginning investors and old hands would do well to read it. John Heinzl does a great job of explaining the problems with covered-call ETFs. Canadian Couch Potato says that if you started investing in stocks in the past 5 years, you don’t really know your tolerance for risk yet. However, older investors who suffered through 2008-2009 had their nerves tested. My Own Advisor gives the results of a Sun Life survey on the difference in attitudes toward retirement between men and women. Big Cajun Man explores a market timing strategy. It might be more believable if he included references to “Dementia 5”.