Short Takes: Forecaster Intervention, the Unexpected, and more
My wife pointed out that some readers of my post on the rout in long-term bonds may not know what “long-term bond” means. Typically, bonds pay interest for some number of years after which you get the money you invested back. So, a $10,000 30-year bond would pay interest on the $10,000 for 30 years, and then the investor would get the $10,000 back at “maturity”. I think of any bond whose maturity is more than 10 years away as a long-term bond, but others may have different cut-offs.
Here are my posts for the past two weeks:
The Rule of 30
The Rout in Long-Term Bonds
Here are some short takes and some weekend reading:
Tom Bradley at Steadyhand has an intervention for stock market forecasters.
Morgan Housel explains that every year, something big and unexpected happens. Housel is always clever, but I find his essays rarely actionable, at least for an index investor like me. This article, however, is actionable. We need more ready cash and other savings than we can justify based on our predictions of the future, because bad things will happen that we couldn’t predict.
Big Cajun Man explains how the RDSP rules change when the beneficiary turns 18. He also has advice on getting school fees treated as a medical expense.
Thanks for the inclusion this week. Found some time to put together some important updates out there.
ReplyDeleteThe following is an anonymous comment made on this post:
ReplyDeleteCash sounds good in theory. But in practice, it can be emotionally painful. The real return of cash in the last year may not make me cry, but I've come close. How much cash should a person have? That's a very personal question. I've reached the stage in my life, where case as a portion of my portfolio can be very small. I still keep about a month's worth of expenses in cash. Why? That's in case the stock market closes for a month. I can't sell stocks to raise cash, if the market is closed. One can make a case for more than 1 month. Can I assume that dividends will be there? Of course, during a bear market, they will go down. But what if dividends are suspended? The risk may be extremely small, but I think it exists. In 2020, British bank dividends were suspended. There will likely be crises greater than 2020 in the future. And in the Canadian stock markets, Canadian bank dividends make up a good portion of stock market dividends. What about margin lending? If the stock market is closed, I'm not certain that borrowing against your stocks will be possible. And even with a open market, margin loans are demand loans. About market closure, dividend suspension and margin loan suspension, they are most likely going to happen when you least want them too. Of course, someone might (correctly?) say that I'm being paranoid. Nevertheless, diversification of sources of possible liquidity makes sense. And the cost of insuring for a short term doomsday scenario may be worth it. As you can't insure against a long term doomsday scenario, it makes sense to keep the insurance short term. That begs the question, as to what is short term? Three months?
I see the holding of cash and cash equivalents as a kind of insurance. I don't focus on the low returns. I like to have a modest amount of physical cash available in case the interbank network goes down for a while or something else that makes it hard or impossible to get at bank accounts. I also make sure I have about 6 months of cash in a savings account. I consider both the physical cash and the savings account cash to be part of my fixed income allocation.
DeleteTo give an example of a stock market closure, the Moscow stock market recently closed for about one month.
DeleteYes, stock market closures are one of a long list of things that are possible and would lead to me being happy to have some ready cash available to live on.
DeletePeople commonly pay considerable amounts of money for disability insurance, life insurance, car insurance, homeowner's insurance, umbrella insurance etc. These insure against unlikely financial risks that are too costly for someone to self insure. But what about risks that you can't buy insurance for? And what about risks that you haven't even thought of? It makes sense to have money in cash equivalents and physicial cash. You'll certainly lose money on a real aftertax basis on that, but that is the cost of this form of self insurance.
ReplyDeleteI agree. I don't lose sleep over the low return I get on the cash I hold. As you say, it's a form of insurance.
DeleteTo manage risk, people pay considerable amounts of money to pay for disability insurance, life insurance, car insurance, homeowner's insurance, umbrella insurance etc. These insure against unlikely material financial risks that are too expensive to self insure against. But what about risks that you can't buy insurance for? And what about risks that you haven't even thought of? Cash equivalents and physicial cash can be used to self insure against those risks. The negative aftertax real return on them is the cost of the insurance.
ReplyDeleteAbout insurance products, the return on them is poor. One estimate that I've heard is that 70% of insurance premiums are paid back to those being insured at best. After all, an insurance company has costs, taxes and profits.
ReplyDeleteAnd that doesn't address the skewed nature of insurance returns. There will be a few people who do very well from insurance. For example, someone buys a disability policy at age 25. Assume that individual becomes completely disabled at 30 and is on disability to 65. Such an individual does well - at least from a financial perspective - from their insurance. But for the good majority, the money spent on insurance has no return. The one exception that I can think of is CPP.
I've never gotten a return so far from the insurance products I own, and the cumulative amount spent on them has been considerable. Yet I feel that the money has been well spent.
So in comparison, the return of cash equivalents as insurance isn't that bad.
And cash equivalents as insurance has attractive properties. You can readily adjust the amount of insurance you have in cash equivalents. You can easily switch "insurance providers"
to those offering a better deal; an example would be switching between HISA providers. The government can backstop your insurance providers, such as CDIC. Cash equivalents as insurance is very flexible, when it comes to risks that it will insure. Also, it's the only way that I can think of to insure against risks that are unknown.
The question is how much insurance do you want in cash equivalents? In one way, it's the opposite of what sees in disability policies. A disability policy will commonly have an initial period of time, where they won't pay out for a person with a disability. For example, this could be anywhere from the first 3-12 months of being disabled, where you self insure. With cash equivalents as insurance, people commonly keep 3-12 months of expenses as self insurance.
Cash equivalents can be insurance and can also be used for known expenses in the near future. Although it may be semantics, I might consider cash equivalents kept for insurance companies separately from my fixed income allocation. Instead, I would group that with my insurance policies. That may be an emotional trick that makes the poor return on cash equivalents more palatable :-).