A Loonie Saved

A Canadian's random thoughts on personal finance

Nov 15, 2011

Occupying Bay Street

You may not know this about me, but I'm an avid lacrosse fan. I have season tickets to the Toronto Rock at the Air Canada Centre on Bay Street. For those unfamiliar with the game, it's a rough, fast-paced game, a lot like hockey, except there's a net on the end of your stick you use to catch the ball, and you're running on turf, so you can turn on a dime. It's higher scoring than hockey, with a typical final score something like 12-8. In fact, the rules on scoring seem designed to make for one highlight-reel goal after another. Oh, and cross-checking is legal. It's pretty cool.

There are times, though, when the refs just seem to like to hear themselves call penalties. Play stops, and a team plays one, sometimes two, players shorthanded. Sometimes there seem to be more players in the box than on the bench (at least Rock players!) and you wish the refs would just lay off and let the players play.

But one thing I never wish for is that the game had no rules. If the rules are fair and balanced and not too onerous, and enforcement is fair and balanced and not too onerous, then you have the ideal situation where two teams of self-interested players compete with each other in a vibrant contest that benefits everyone from the players to the fans to the hot dog vendors.

Another thing I never wish for is that they'd stop keeping score. Sure, it's always disappointing to be on the losing team, but it's equally unfair to refuse to reward those who achieve excellence while playing by the rules, and it would be demeaning to the players to suggest that they can't cope with losing a game or two. Worse, it would undermine the very system that drives them to excel.

Money is also a way to keep score. This is surely not any kind of newsflash to anyone. What is less obvious is why lending money to a friend is so fraught with danger, but I think the reason is clear. When dealing with your circle of friends, you know these people intimately. You know when someone has been good to you and deserves your kindness in return. You know when a friend needs your help, and if they have been a true friend, you offer that help knowing that they would do the same for you. You don't need money for friends.

Money is for keeping score between strangers. In societies as large as ours, we must interact constantly with people we don't know. None of my friends happen to be able to provide me with Cheerios, or coffee beans, or gas for my car, on a regular basis. I get these from strangers, and we use money in an attempt to have everyone contribute their fair share to each other. When you lend money to friends, you are necessarily treating them as strangers, and that's why it feels so strange.

As a system to keep track of the value of the work people do for each other, money is imperfect—otherwise how is it that the best things in life are free?—but it works better than any other system we've tried, and we've tried a lot. Money is not a perfect measure of economic value, but it's not too shabby. However, money is a very poor measure of kindness, or of humour. It is a poor measure of justice. (Should we replace all prison sentences, court injunctions, and restraining orders with fines?)

Capitalism is a good scorekeeping system, but it's a lousy moral philosophy.

The debate over capitalism is confusing because the debaters don't recognize that they are arguing semantics. It's plain to see that a free capitalist economy has demonstrably produced more prosperity for more people than we've ever seen in history. It's also obvious that the profit motive is just greed, and greed is not the moral value upon which we want to pin our hopes for society. I think a lot of the folks arguing over the merits of capitalism might actually be surprised to find they agree with each other once the distinction is made between capitalist system and philosophy.

The true Big-C Capitalists (those who use capitalism as their primary moral compass) argue that there should be no regulation at all. That we should do away with rules and referees, and that profit should be the only motive. This is fine so long as you don't mind our economy being run by the Sean Averys of the world.

I think western society is supported on three great pillars: (1) democratic legislation, giving the people a say in the rules that govern them; (2) capitalist economy, giving the people a means to gauge the equity of their interactions; and (3) public education, giving the people access to the knowledge and skills they need to thrive. At their essence, the Occupy Wall Street protests cover all three of these areas. To the extent that the protestors are standing up against the undermining of these three pillars, I'm behind them.

However, much of the Occupy Wall Street debate seems to argue over more versus less regulation. This is just as absurd as clamoring for more versus fewer rules in lacrosse: if the rules are unfair, it doesn't matter how few there are. If the rules are unbalanced, their quantity doesn't matter: the game won't be worth playing. What matters is not how many rules there are, nor how strict they are, but how equitable they are, how fairly they are enforced, and how effective they are at making the game what we want it to be.

Preet at WhereDoesAllMyMoneyGo recently posted a video of Peter Schiff discussing economics with the Occupy Wall Street protesters. Take a look if you want to watch a debate that goes nowhere because the opposing sides don't recognize that they are not making opposing arguments.

Aug 6, 2011

Orders of wealth magnitude

Born Rich is a 2003 documentary by Jamie Johnson, heir to the Johnson & Johnson fortune. In it, he interviews a number of other wealthy young people, and explores their taboos against discussions of money by doing the exact opposite: exposing intimate details of wealth in a documentary film. Ironically, he never gets a straight answer from anyone as to just why money is not to be discussed.

I think I've figured part of it out.

It came to me watching another of Johnson's documentaries, The One Percent. In one segment, Johnson talks to the director of an exclusive wealth management conference. The conference director estimates the average wealth of attendees at around $400M, with some in the billions.

Watching this scene, the thought occurred to me: what if you were a 400-millionaire at one of these conferences, sitting next to a family worth $10 billion? If this family invested their fortune conservatively in a broad basket of stocks and bonds, and followed the 4% rule, their investments would earn your entire life savings each year.

Imagine: would you really feel wealthy sitting next to someone who passively rakes in the fruits of your lifetime of business achievement plus inherited wealth every year with no effort? Such a person would belong to a whole different class of wealth, if such things were discussed in the open.

Being a big fan of logarithms, this led me to a rather novel notion: to use decibels to measure wealth. On this scale, a difference of ten decibels represents a ten-fold increase in wealth. Twenty decibels would then represent two ten-fold increases in wealth, for a total 100-fold increase. (If you're familiar with decibels from engineering applications, you'll also recognize that this means three decibels represents a doubling of wealth.)

Of particular interest to us is what happens at the 14-decibel mark. This represents a 25-fold increase in wealth. If your wealth is 14 decibels larger than mine, you are in the lucky position that you could invest your wealth very conservatively and spin off my entire life savings each year using the 4% rule.

To set the zero-point of the decibel scale, I wanted someone at zero decibels to be "just barely wealthy" in some sense. I chose $500k for this. At this level, the 4% rule provides for $20k each year, which corresponds to Canada's "Low-Income Cut-Off" for one person living in an urban center. (Statscan goes to great lengths to point out that the LICO is not a poverty line, but I'm going to use it as such anyway. So sue me.) Below zero decibels, attempting to live on your wealth alone would mean living in poverty, and therefore you don't quality as wealthy (barring Early Retirement Extreme, of course). Above zero decibels, your wealth passively spins off enough income to keep you out of poverty.

Between the Forbes Billionaires list and the highly scientific and authoritative Celebrity Net Worth web site, I cobbled together a list of some notable people (mostly Canadian) and plotted their wealth in decibels:



The vertical lines every 14 decibels divide these people into orders of "wealth magnitude", so you can tell at a glance that, for example, Warren Buffet's wealth could passively earn the entire fortune of Jim Balsillie each year. I think Isadore Sharp is pretty rich, but his entire fortune could be earned passively by David Thomson each year. And imagine Jim Carrey sitting down to have a chat with Stephen Harper, knowing that he passively earns Harper's total personal fortune each year.

This, I think, may be one of the reasons that the rich don't discuss their wealth, and it's a problem that middle-class peer groups never experience, because if one person's fortune can passively earn another's fortune each year, then at least one of those people is not in the middle class.

P.S. One other remarkable thing to note is that, by my definition of "wealthy", simply selling the average Vancouver house makes you instantly (barely) wealthy. The passive income from the price of a Vancouver house would be enough to keep you out of poverty without ever working again. This is what you give up to own a house in Vancouver. Houses in other large Canadian cities are just a few decibels behind.

Apr 23, 2011

The incredible benefits of house ownership

The financial media, as always, are exuberant over the prospects of higher housing prices—an attitude I've never quite understood.

Housing is a basic human need. If the cost of bread were to rise 8.9% year-over-year, would the media proclaim a "bread boom" and paint a glowing picture of the strong bread market? If people viewed the cost of housing as they view the cost of gas, we'd all be talking about how we're being ripped off, and there would be calls for the government to intervene to keep prices lower. I've always found it rather puzzling that houses are given this special treatment.

Thankfully, a pamphlet from the National Association of Realtors arrived in my mailbox to explain the pro-side of house ownership. This is a document I must share with you. I found it very entertaining, and even enlightening (though probably not in the way the authors intended).

The first thing I learn from this pamphlet is that homeownership provides 5, count 'em 5, "substantial social benefits for families, communities, and the country as a whole":
  1. Higher Academic Achievement
  2. More Cohesive Communities
  3. Better Connected Families
  4. Improved Health and Safety
  5. Stronger Economy
Under section 1, Higher Academic Achievement, they reference a number of rather esoteric statistical studies that I'm not capable of criticizing, though if I trust their motives and methods, their conclusions do seem to support a causal relationship between owning one's home and higher academic achievement for children. All I can say here is that in my own community of rented townhouses, we have about 30 school-aged children. In that population, one would expect to find 0.6 children in the 98th percentile, yet there are actually three children in the gifted program. It's hard to draw a conclusion from this one data point, but it's safe to say not all communities of renters are populated by academic underachievers.

However, my favourite part of section is the following chart:


As you can see by the axis labels, this chart clearly shows that the more Renter you are, the more Homeowner you are too!

Sections 2 and 3 describe More Cohesive Communities and Better Connected Families, using statistics from Cincinnati telling us that homeowners are "9% more likely to know who their school board representatives are" or "are less likely to have alcohol and substance abuse problems". These are clearly confusing correlation for causation, and so they'd bear no more thought if they weren't so entertainingly ironic or irrelevant in my particular situation.

For example, apparently homeowners are "28% more likely to repair or improve their home". I can tell you my odds of repairing my home are zero, because all I do is walk to the management office and fill out a work order, and the repair is done for me, for free. Likewise, they are "1.3 times more likely to read newspapers". I guess rentership explains why I never read newspapers. I suppose if I bought a house, I'd be more likely to stop getting my news online and order a subscription for a daily dead tree.

Homeowners are also "16% more likely to belong to parent-teacher organizations, book clubs, etc." My wife belonged to a book club at one time; I guess renting made her quit? And both my wife and I have belonged to our school council (which I currently co-chair) since the first year our older son started kindergarten, which doesn't particularly prove anything except that participation in such things is an individual choice.

The sizable Muslim population in our area may be alarmed to find that homeowners are "10% more likely to attend church". There's a rather narrow-minded implication there that we're all Christians, but homeowners are better Christians than renters.

My personal favourite is that homeowners are "59% more likely to own a home within 10 years of moving from parents [sic] household". Beyond the obvious reversal of causality in this statement, there's also an insidious circular argument that homeowners are better because they're homeowners. I've heard this a number of times in arguments such as "I don't want my kids growing up around renters", and I just don't know how to respond to that kind of statement.

Section 4, Improved Health and Safety describes how renters who buy a house suddenly experience higher self-esteem and perceived control over their lives. I'm sure taking up cigarette smoking would have a similar effect, but surely that doesn't make for a strong argument.

The pamphlet saves the best for last:


It's nice to think that the economy benefits from $60k out of my pocket when I buy a house, but it does tend to contradict the statistic in that green bubble that "a home owner's net worth is 45.9 times that of a renter's [sic]". Apparently, buying a house will reduce my net worth by $60k initially, and it will do very little (aside from forced saving) to help me recover that amount.

All in all, if I were a member of the National Association of Realtors, I'd be pretty embarrassed that this document is being used to represent the argument in favour of house ownership.

Mar 9, 2011

How to buy a car

A recent post from Michael James reminded me of the car I just bought in August. The way we bought the car eliminated the problem he mentions and many others. I heartily recommend it.

Back in 2007, we decided we wanted a Honda Fit. We have no intention of ever buying a new car, but we went into a dealership anyway to test drive one, and the salesman worked out the numbers for us. The quote came out to $23k.

Instead of signing on the dotted line, we started pretending we had car payments, and setting aside the amount. (Yes, this early blog post of mine was nonfiction.)

I figured if I waited three years, we'd save about $6k in depreciation, and because we wouldn't be paying interest on a car loan, we'd save another $3k in interest, so we'd be spending $14k. So once we had saved up $14k, we just waited until the car we wanted reached that price.

That happened this past August: we saw a listing online for a 2007 Fit with low mileage for $14k. That week I went to the dealership and told the salesman that I wanted that car, and if he could make it work for $14k all-in, he had a deal.

Well, he made it work, so I bought the car.

The process was pretty much stress free for me. I got the car I wanted at the price I wanted, without any negotiation. Ok, it's true that the salesman might have shaved off a couple hundred bucks if I had negotiated harder, but in the big scheme of things, I saved $9k by waiting a few years, so I'm not going to try to stiff this guy for a couple hundred more bucks. In the end, we were both happy with the deal, so as far as I'm concerned, that makes it a good deal.

The most striking part for me was when it came time to sign the contract. He was explaining all the extra charges like taxes and whatever else. I can't even remember what the charges were because, well, I just didn't care. I had negotiated the bottom-line price, so in effect he was paying all these other charges, including the taxes.

And to top it all off, I didn't have to worry about financing rates, and I didn't even have to give the dealer my car insurance info. He didn't care because he had cash in his hands.

The only painful part was writing that bank draft for $14k. Man, that's a lot of zeros for a cheapskate.

Update: My wife would like me to point out that, while I may not be a world-class negotiator, I didn't just walk in and pay the sticker price on the car. They were asking $13,999 plus taxes, plus plus plus... We paid $14k all-in, which works out to almost 20% off the sticker price.

Feb 27, 2011

The market is over-valued

I usually don't try to make predictions about the stock market, but a rather complacent post by Potato has led me to end my 6-month blog drought to explain why I think the market is over-valued, and why I'm not selling anyway.

I want to start by drawing your attention to this chart:


This chart, stolen from Wikipedia, is based on data from Robert Shiller, and shows the relationship between the P/E ratio of stocks (using the average earnings of the previous 10 years) and their performance over the subsequent 20 years.

The relationship is striking. The higher the P/E, the lower the returns over the subsequent two decades. This makes P/E the only reliable indicator I'm aware of for predicting future stock performance.

As I write this, the P/E of the S&P500 is 24. Based on the above chart, if historical trends hold, that means from this moment forward we can expect a 20-year return of approximately 0%. (In the market, historical trends seldom hold, but it's food for thought.)

Even if we we set aside Shiller's musings, and focus only on what the P/E ratio tells us directly, P/E=24 means annual earnings are just 1/24 = 4.2% of invested capital. This, plus earnings growth, is what we can expect to earn from the market whenever P/E=24.

(How much is earnings growth? Well, the nominal earnings of the S&P500 have roughly doubled every 30 years for the past century, which comes out to something like 2.3% per year, but with enormous error bars.)

4.2% nominal return is not an exciting number. The iShares Bond Index Fund XBB is paying 4% right now. The extra risk you're taking in the market rewards you to the tune of just 0.2% (plus earnings growth).

And if that's not bad enough, multpl.com has a chart showing the current P/E in relation to the historical values. Looking at the current value of 24, you'll notice the market has never had a P/E this high without crashing shortly afterward.

So... I find this is a scary time to hold stocks. As a net purchaser of stocks over the coming decades, I'm disappointed that the prices are so high, and if I were a market forecaster, I might even venture to guess that a correction is coming soon.

The question naturally arises, then: should I sell my stocks? Well, don't think I didn't consider it. However, I'm planning to hang on to my stocks for now for just one reason:

This is exactly the roller-coaster I signed up for.

I invest money I don't need soon, so I am largely indifferent toward fluctuations. Because I'm only interested in the highest expected returns, I stay invested in stocks.

I don't have the skill to time the market, nor to outsmart it. Yes, there's a good chance my stocks will some day be worth less than they are now, but that does not necessarily mean I should sell now. For example, if the 10% drop I fear were to be preceded by a 15% increase, on the whole I would regret selling now. And if I do sell now, there's a guy on the other side of that transaction buying my stocks, and who's to say he's the one who's wrong?

So, in the end, while I'm worried that my stocks will drop in value, I'm not going to start basing my investment choices on gut feelings. I must say, though, that as a net buyer of stocks over the next couple of decades, I do wish prices would drop to a more reasonable level!

And if the P/E rises another few points, I may be back here re-evaluating my position on this.

Sep 13, 2010

There's no such thing as marriage insurance

Frank at Bad Money Advice has an article on marriage insurance. In this article, he goes to some lengths to determine whether marriage insurance is worthwhile. He does this by calculating the odds off a payoff and comparing with the amount of the payoff.

I think this analysis is misguided. I have a simpler one.

To begin with, you need to understand this: you never ever buy insurance on the hope that it will pay off. If you ever find yourself doing that, you've made a mistake, because then you're not buying insurance; you're making a wager, pure and simple. When you buy insurance, you should always be hoping it will never pay off. You should be hoping that your money will be wasted. When insurance pays off, it's because you rolled snake-eyes in the game of life and you could end up being ruined financially.

Insurance is meant to eliminate that risk of financial ruin. However, for this marriage insurance, the 1.63x payoff relative to the premiums makes this impossible. I can't think of anyone who can afford to pay $X for nothing, yet would be financially ruined by having to pay $1.63X during a divorce.

Therefore, this marriage "insurance" product is not insurance. It is gambling.

Jun 5, 2010

The penalty for saving

Thicken My Wallet has a post on how the tax system discourages saving. In it, he mentions progressive taxes, the estate tax, and the high taxation of interest income among the reasons for this.

With all due respect, this seems to be a somewhat naive treatment of tax policy.
  • The estate tax prevents a hereditary aristocracy from forming. In Canada, death triggers a "disposition" which leads to capital gains tax, having a similar effect.
  • Dividend tax cuts take into account that the dividend-paying company has already paid some tax.
  • The flat tax is promoted as a way to simplify taxes, but in reality it's just a tax break for the rich. In Canada, our system's complexity doesn't come from its progressive nature, but from the multitude of obscure rules and deductions.
To me, what really penalizes saving is inflation. For some very loosely justified reasons, the central banks of the US and Canada aim for a 2% inflation rate. Deflation is deeply feared as some sort of bogeyman with scant explanation using terrifying terms such as "deflationary spiral" that call to mind the end of the financial system as we know it.

The fact is, before about 1900, deflation was commonplace in North America. Currency kept its average value over long periods because inflation and deflation alternated.

Targeting 2% inflation is just a 2% asset tax. It is analogous to a property tax, which would be fine, except for two very large problems:
  1. Inflation doesn't just decrease assets by 2%; it also reduces debts by the same amount. Therefore, part of this "asset tax" is paid to debtors. The fairness and wisdom of this is debatable.
  2. The beneficiaries of inflation are those who create new money. In our system of banking and fractional reserve, the money goes not primarily to the government, but rather the banks.
If you want to encourage saving, how about a prolonged period of gradual deflation?

The problem, of course, is that there's no way for the government to achieve this. Our government lost control of the money supply in 1935 with the creation of the Bank Of Canada, at which point monetary policy could be relied upon to favour the banks. Banks love debt; inflation favours debt; hence we have nothing but inflation after 1935:

(Source: Bank of Canada web site.)

To really encourage saving over borrowing, the government would need to take back control of the money supply from the banks. Well, good luck with that.