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Cameron Passmore CIM, FMA, FCSI

Portfolio Manager

Benjamin Felix MBA, CFA, CFP

Associate Portfolio Manager
Contact
  • T613.237.5544 x 313
  • 1.800.230.5544
  • F613.237.5949
  • 265 Carling Avenue,
    8th Floor,
  • Ottawa, Ontario K1S 2E1
November-21-14

Stories over Science – Tony Robbins’ Financial Advice

Tony Robbins’ new book, MONEY Master the Game: 7 Simple Steps to Financial Freedom, is full of great stories, knowledge, and ideas that can help people kick-start their financial future. He discusses disciplined saving, and debunks the financial services industry for the average person. He warns readers about high fees, active management, complex financial instruments, misleading past performance, and conflicts of interest. He even goes into detail about the factors that should be considered when deciding on an asset mix, and the importance of asset allocation. Robbins interviewed fifty of the biggest names in investing to research the content for this book. He has repeated his trusted process of finding the best people in a field, unleashing their secrets, and showing the average person how to use them in an actionable way. Robbins is a genius when it comes to harnessing and channeling human emotions. He has a roster of presidents, billionaires, and star athletes that attribute their success and happiness to the clarity that he is able to bring to their lives, and his ability to evoke feelings of elation and motivation through his text and speech is unparalleled. There are thousands of unread books written about personal finance and investing, but this book is written by one of the most famously trusted people on the planet, and it is currently the bestselling book on Amazon. This is a book that is being read.

Robbins is a master of emotions, but emotions and investment advice do not mix well. In the book, he excels at explaining the importance of an appropriate asset allocation, and then extols one specific asset allocation that has historically “produced extraordinary returns with minimal downside”. Playing into the psychology of an inexperienced investor, Robbins explains that it is smart to “risk a little, make a lot” with things like structured notes (PPNs in Canada), and market-linked CDs (Market linked GICs in Canada), tools that limit downside risk while capping upside potential. He explains, very logically, how an investor should use a mix between a Security bucket and a Growth bucket to match their risk tolerance through time, and then he tells the reader that he has “uncovered the ways in which you can get Growth-like returns with Security Bucket protections”. Robbins does not seem to grasp the idea that market volatility within a well-designed portfolio is not the same the same thing as losing money. He wants investors to seek investments with asymmetric risk/reward, just like the pros do! This theme is present throughout the book to the extent that the focus of an entire chapter is dedicated to “the Holy Grail of portfolio construction,” Ray Dalio’s All Weather Portfolio.

Robbins artfully tells the story of how he finally convinced Ray Dalio to reveal the magic formula for a portfolio that will serve investors well in any market. He tells the story so well that, despite my skepticism, I couldn’t wait to flip the page and learn about it. Robbins’ masterful presentation of Dalio’s All Weather Portfolio is the epitome of emotion-based investment advice – and the epitome of Robbins’ ability to sell. As great as it sounds, this model portfolio, and Robbins’ premise for finding the perfect investment answer, are not based on the science of markets. The idea of getting  advice from one, or fifty, of the best money managers in the world evokes feelings of hope and excitement for investors, but it is a misguided path to a positive investment experience. The indeterminable line between luck and skill makes the investment industry a very difficult arena to use lessons from the past success of individuals as a guide for the future.

Ray Dalio’s All Weather Portfolio is as follows:
 
30% Stocks (S&P 500 index fund)
15% Intermediate bonds (7 to 10 year Treasuries)
40% Long-term bonds (20 to 25 year Treasuries)
7.5% Gold
7.5% Commodities

I modeled this portfolio, and my back-tested results from 1984 - 2014 were very similar to Robbins’ (we might have used different indexes in our models, or different fee levels). My model posted an impressive compound annual return of 9.87%, with a modest standard deviation 7.19%. This all sounds wonderful, but there is an obvious technical flaw in the portfolio that many bloggers have been quick to point out, as Robbins predicted they would; this long-term bond heavy allocation has been back tested through the longest fixed-income bull market in history. With interest rates at an all-time low, it is unlikely that long-term bonds will produce the same magnitude of returns going forward that they have in the past. Robbins explains in the book that the large allocation to bonds is not a bet on bonds alone, but that Dalio has designed the portfolio to spread risk among the four potential economic seasons (rising economic growth, falling economic growth, high inflation, low inflation) using asset classes that will have a low correlation in each possible scenario. This truly is a great story, and it is coming from one of the greatest historical performers in the investment industry – talk about building credibility through social proof.

Chasing high returns with low volatility is an idealistic and emotion-based approach to financial markets. Removing emotion from the equation, and looking to the evidence from the history of markets rather than to sensationalized stories about past success yields much more logical investment advice. Stocks have outperformed bonds. Small stocks have outperformed large stocks. Value stocks have outperformed growth stocks. These are not magical formulas or stories about low correlations that guarantee downside protection, they are reflections of the higher expected returns associated with making investments in riskier asset classes. Risk and return will always be related, and there is no magical formula to get around that. Rather than listening to stories about low-risk high-return portfolios, smart investors follow the science of markets and build an asset mix to harness the risks that have higher expected returns (equity, size, and value) while managing volatility with fixed income securities.

Robbins’ heart seems to be in the right place, and he does give a lot of very useful financial advice that is not heard often enough, but his emotion-based approach to investing falls short of what people need to hear.

By: Ben Felix | 0 comments
November-18-14

The RDSP after age 19

RDSP accounts are eligible to receive funds from the Government of Canada to assist disabled persons in long-term saving. Both a contribution matching grant and an income tested bond can be paid to an RDSP, based on the beneficiary’s family income. If a beneficiary’s family income is over $87,123, they will be eligible for $1 of grant for every $1 of contributions to the account up to an annual maximum of $1,000; if the family income is below $87,123, the beneficiary will be eligible for $3 of grant for each $1 of contributions up to $500 per year, and $2 of grant for each $1 of contributions on the next $1,000 per year. The $1,000 bond is paid in full when the beneficiary’s family income is less than $25,356, paid partially (based on the formula in the Canada Disability Savings Act) if the family income is between $25,356 and $43,561, and the bond is not paid at all when the family income is over $43,561. Knowing these rules, the definition of family income becomes very important.

The income of the account holder of an RDSP does not affect the beneficiary’s eligibility for grant and bond payments. Up until the year that the beneficiary turns 18, their family income is the same family income that determines the Canadian child care tax benefit; this is the income of the minor child’s legal guardians. In the year that the beneficiary turns 19, their family income is based on their own income and their spouse’s income, but to earn the maximum grant and qualify for the bond based on their own income, the beneficiary must have filed at least two prior years of income tax returns. When this requirement is met, the RDSP benefits shift from being based on the guardians’ to the beneficiary’s income. For a beneficiary that is not able to work and has a very low income, the result of this shift in income testing can be a significant increase in grant and bond eligibility.

If two years of tax returns have not been filed in the year that the beneficiary turns 19, unused grant and bond entitlements can be carried forward for 10 years, starting after 2007. This means that if the beneficiary does not have two years of tax returns filed in the year that they turn 19 and do not receive their full grant and bond entitlement in that year, they will be able to claim the unused amounts in a future year. To maximize the amount of time that the full grant and bond entitlement can be invested and grow tax-free, it is best to have two prior years of tax returns filed in the year that the beneficiary turns 19. This is a small step that can yield large gains for the long-term growth of an RDSP account.The RDSP after age 19

By: Ben Felix | 0 comments
November-13-14

Managing risk in retirement income

With the ever-declining number of defined benefit pension plans in North America, the ultimate goal for most investors is a well funded retirement. The idea that a lifetime of disciplined saving and investing leads to a comfortable retirement is generally accepted, and the accumulation of a significant nest-egg should be viewed as an achievement. However, the goal of a fully funded retirement won’t have been surely achieved until death. In an ideal world, each investor would use their known annual rate of return and life expectancy to draw down their pool of retirement assets to zero (or some other amount that they wish to leave as a legacy) on their last day.  In reality, nobody can predict what the market will do tomorrow, let alone how long a person will naturally live; these two variables become two of the greatest challenges in planning for, and achieving, a fully funded retirement.

Market risk, the risk that equity markets as a whole could decline, has obvious effects on a portfolio’s ability to maintain sufficient levels of capital through the drawdown period. Investors are not able to control or predict market movements, but market risk can be managed to a certain degree by adjusting the mix between stocks and bonds – a portfolio with less exposure to stocks will not decline in lock step with the market, but it will also have a lower expected return. In some cases, the higher expected returns associated with equities are necessary for investors to match their portfolio’s longevity with their own lifespan and income needs.

Longevity risk, the risk of outliving an investment portfolio, is much more difficult to manage than market risk. There are benefits to living a long and healthy life, but unlike market risk there is no expected financial return associated with human longevity. People find ways to maintain a healthy body and mind with advancing age, but there is no sure-fire way to influence the natural expiry date. Planning around this is extremely difficult, and it makes drawing down a retirement portfolio a dynamic task. In some cases annuities can be introduced to the overall asset mix to take some longevity risk off the table, but annuities also decrease overall flexibility and can reduce expected returns.

Market risk and longevity risk work together to make the transition from a pool of capital to a stable long-term retirement income a challenge. These risks can be managed through the thoughtful development of a mix between stocks, bonds, and insurance products, and a carefully planned and monitored withdrawal rate. In any case, the drawdown process should be approached with care.

By: Ben Felix | 0 comments