Episode 12: Doug McKenzie: Living through the financial crisis

September 28, 2018 Benjamin Felix

Key Points From This Episode:

Attacking a retirement goal [0:01:58]
Managing expenses before retirement [0:02:50]
Toronto real estate in a retirement plan [0:04:55]
Living (and working through) the financial crisis [0:07:48]
The Investor’s Group Dividend Fund [0:11:30]
Income investing [0:15:41]
Robo advisors [0:16:55]
Using prepaid credit cards for budgeting [0:17:30]
CCP vs. CPM vs. DFA [0:18:51]
Running regressions [0:21:24]
Data sources [0:21:38]
Come From Away [0:22:00]
The value of knowledge and advice [0:23:16]

Read The Transcript:

So a couple of weeks ago we had Carson join us in our weekly discussion and shared his thoughts on long-term planning. With Doug in town today from Toronto, I thought it'd be great opportunity for you to share your story because I find your story fascinating, how you decided seven years ago to really hone in and focus on your ability to retire and to be able to be financially independent.

And you came at it from two ways. So why don't you just tell us the story because I think you came at it from making sure you had enough saved up, but also you went up the expense side of the equation so well.

That's right. Exactly. Yeah. Seven years ago, we were coming into the retirement horizon, with 10 years to go, if you're considering the traditional 65 stop point. And we knew we were doing well, but we didn't know how well we were doing. And we were also working fairly hard at tracking our expenses, but not getting the perfect results that we wanted. So just wanted to have a second opinion, if you will, on the whole thing.

So that's where our focus started and we were doing what a lot of people do. We had spreadsheets going and doing some couch potato stuff and different things. We got into focus at that point in time and we really got serious about it.

And you actually cut expenses, right?

We did cut expenses. We discovered little things, whether it was as small as buying coffee every day to trimming down and researching our insurance costs across the board. We were able to lower those. Actually, just did that again, six months ago, re-instituted that project and made some more savings there. The way we shopped, all sorts of different things. There was no one great single expense reduction, but everything cumulatively really helped out.

So one of the things that you mentioned is doing some couch potato stuff, which I find really interesting because you're someone who works on base rate for a big financial institution.

It probably seems counter-intuitive. You're right, but my side is on the corporate and commercial side. My personal financial expertise was okay at best, but as we came into the focus zone, knowing that there is about 10 years to go, and kids were just finishing university and different horizons were changing. That's when we really wanted to get a focus and make sure we were doing it the right way.

Right. Do you think your investment approach changed as you approached the retirement date?

I would say yes. We were always fairly conservative, to start with. We always look for value as opposed to the quick hit. So just preservation of capital was certainly at least the back of mind, not necessarily the forefront, but just being careful and smart about the whole thing.

So you own Toronto real estate.

I do.

What are your feelings or how do you think about that market right now?

For us, where we live, it's been a bit of a lottery that none of us could ever have known. But the way it factored into our plan, my wife doesn't want to leave the house or until the absolute last possible moment. So the house was left on the outside of the planning. We wanted to get there with our own monies. And what happens now, the house, it's been paid off for quite a while, so that's helpful. But it's kind of the insurance program now, at the end. If we reach a point down the road in retirement that we need to sell it, we can do that.

Must be amazing to think there's that many people coming up behind you that can afford these houses?

Yeah. We marvel at that. We look at our neighborhood and wonder how these kids are doing it. They're kind of in their early to mid 30s. They have massive mortgages, is the only thing I can assume, or a strong parental support as well.

So as people's grow, we notice that people become gun shy making trades, kind of the fear factor kicks in. So you've seen your portfolio progress along. Can you talk about the kinds of worries that you have when you think about your portfolio? Or do you worry?

A little bit, from the standpoint of preservation of capital, again, and given that we are getting closer and closer to the retirement side. We were never aggressive investors to start with. And certainly, one of the things about working with you guys and going through dimensional is just we see value in it. I've always kind of been a value investor and that really fits for us.

So this must be so contrary to, I'm only assuming, right, that between you and your colleagues on Bay Street, like this is not how a typical person on Bay Street thinks about investments. Is that safe to say?

That would be true. I talked to various people and we're very much different than a lot of them are. A lot of them are banking on big bonuses coming down for the next few years. A lot of them are banking on cashing the house out when the time comes. But to me, there doesn't seem to be a lot of long range planning to the whole thing.

What do you think was different for you? How do you think you ended up thinking about it differently from your colleagues?

We just wanted to make sure that we could preserve our quality of life all the way through that. That was really the key driver to it.

But the fact that it was within reach is what must be really motivating for you.

Right.

At that time, you would say we kind of pin this down. I mean, we reviewed your plan here this morning, and it's solid. So to know that you were that close to having everything buttoned down must have been a pretty good feeling.

It was. Yeah. And it was, I mean, PWL put the confidence or the final level of confidence back into it.

Cool. So one of the things that we've been seeing a lot about online recently is that this month marks the 10 year anniversary of the start of the financial crisis. So Lehman brothers collapsed under 600 billion of debt. You were not at Lehman, but you were right in there. What was that like?

It was scary times, being in the industry I'm in. Funding went away almost overnight. And a lot of people were wondering where's it all going to go? Can business continue? No one knew what the depth of it would be at the end of the day. Some emergency funding was done in my industry to put the stuff together that was backed by the government. In the end, it wasn't really tapped into all that much.

But I can remember being at a conference this time 10 years ago when the markets just crashed on the one day. And it just, the long faces around this conference were just mind boggling.

Wow. And funding dried up?

Funding totally dried up. We were fine where I was, but for a lot of secondary players or level two players, funding was virtually gone overnight.

So having been through that and knowing what you know now, do you worry that something like that could happen again?

I guess it could always happen again. I just feel that, personally, I'm insulated from it now, if it does go. A lot of people look at the administration south of the border and worry that something close to cataclysmic could happen again. No one knows for sure. But we're long in the cycle right now. You get lots of people talking about the bear coming back. So.

There must be a lot more protections put in place in your industry though?

There are. The capital requirements that you have to have the type of products, the regulatory environment. Having said that, before, everybody was getting intoxicated, particularly south of the border, on what could be done. And a lot of people had some culpability in it along the way. But yeah, a dose of reality set in.

I think the movie The Big Short did a really good job showing that the whole thing was perpetuated by people operating in silos, where there was no malicious intent. It was just a lot of people who knew they were making money, taking certain actions.

Doing that, and also believing what they wanted to believe. Certainly, you could accuse some of the rating agencies of that.

They were giving AAA ratings to things that were nowhere close to that. And investors relying on those, those ratings, to go ahead and keep going.

And even at the ground level, Barry Ritholtz posted an article this morning on it, that was in the Denver Post. A great story by this attorney that spent the last decade interviewing people who made fraudulent mortgage applications. Unbelievable story. When you think back to that time, people with no income getting two, three, four mortgages and they figured they'd never have to make a payment, that it would go up so fast and based on leverage, you'd flip out in three or four months and make all this money. And people lying about all kinds of different pieces of information. And that was the root of what caused these fraudulent mortgages to go through the system and then be wrapped up into other products with high ratings from the agency.

Exactly. The thing I find fascinating and going back to people believing in what they want to believe, even down to that person or family buying a house and believing that it's going to go up 20%, 30% inside of 12 months and keep borrowing and keep going on. My own personal psyche couldn't deal with that.

Cameron Passmore: So last week, I don't know if you listened to it, Doug, or not, but we got Ben pretty fired up talking about the province of Ontario's decision to support the continuation of the deferred sales charge. So we had a lot of feedback from people that they liked hearing Ben riled up a little bit, and it got me to remembering an argument we used to make about how costs matter. And this is an article that I saw re-posted on a blog site this week, talking about the investors dividend funds. You know investors group, of course. Something like Power Corp. They manage $130 billion, I believe. And their granddaddy fund is the investor's dividend fund. And it's around a $14 billion fund with an expense ratio in the 2.4% range, I believe.

It's been around a long time. But I remember we used to make this argument about fees. So you take $14 billion, even at just over 2%, that's going to be a lot of money. So half of that revenue roughly goes to advisors for advisors compensation. But still, the amount of money left in the kitty for the company to manage the money comes up to just under $200 million or so, which basically, has to be, at that size, closet index fund. Right?

Ben Felix: Well, that's the whole issue of closet index funds. Sure.

Cameron Passmore: But can you imagine that amount of money being charged to run that kind of fund, when you can get index funds at a fraction of that price? So of course, Ben being who he is, went back and nerded out and ran a regression on the fund. So what did you find out?

Ben Felix: We found kind of what you'd expect with the value fund is that it had statistically significant positive loadings to the value and quality factors. And it also had a negative alpha, which you'd expect from a high fee. And also, ...

Cameron Passmore: What does that mean?

Ben Felix: Alpha is value added in excessive risk taking.

Cameron Passmore: So they took away value?

Ben Felix: They subtracted value.

Cameron Passmore: Just to be clear.

Ben Felix: Which is what you'd expect with high fees, if you're not actually outperforming the market. So we looked, this data's from back to 2004. And the reason I went back to then is because that's when the DFA Canadian Corp Equity Fund was launched. The A class and B class of the IG Dividend Fund were launched in 2003. They did have a class of the fund going back to 1962. But anyway, comparing to 2004 lets us compare it to DFA Canadian Corp.

So Canadian Corp had an alpha of zero, which is interesting because it does also have a fee. That means [inaudible 00:13:57] adding enough value to cover their fee behind the scenes on this fund. They don't always have a zero. Sometimes they're negative two because of fees. But anyway, this one's zero.

Similarly value loaded, so almost the same coefficient in terms of value loading. The DFA Fund did not have a quality loading, which the IG Dividend Fund did. The reason being, I think, DFA didn't start using the profitability screen, which is similar to quality until 2014. So I didn't run a regression from 2014 on, but if I had, I would have expected to see some loading to quality. Anyway.

So similar value loading, similar loading all around actually. Dividend Fund had a lower market beta. The DFA Canadian Corp since July, 2004, its inception, has returned 7.34% versus 4.98% for the IG Fund. So I mean, obviously, the factor loadings explain it, and the alpha explains it, but kind of what you'd expect.

So I guess to summarize all of that is that the returns of the IAG fund are, well, they're underperforming the market. And they're also explained by factor exposure, which is obviously what you'd expect.

I think this gets back to, Doug, your comment earlier about having confidence in this philosophy. So this isn't necessarily a dimensional story. It's about getting exposure to the factors that you want and then paying a competitive price to get those factors. That's the name of the game, right? In this case, you're getting factors. You may not want that kind of mix, but you're paying a hefty price for those factors.

Yeah. I think, quite frankly, a lot of people just don't understand what's happening, at the individual level. And if they fully understood it, they'd be stepping back and asking questions.

Do you see your colleagues, coming back to that conversation, do you see your colleagues talking about things like income investing and seeking dividends and all that kind of stuff?

A couple, yes. And other ones, not so much.

Okay. Interesting. Couple more data points on the Investors Group Fund. To be fair to the fund, it did only drop, well, only. It dropped 26% in the financial crisis, while the DFA Canadian Corp dropped almost 39%. So there was some insulation from, I guess, what you'd call downside risk there. But if we look out 10 years, the worst 10 year return for Canadian Corp was positive 2.89%, while it was 2.65% for the IG dividend. So even with the Investors Group Fund, sure, you got some insulation from the downturn, but over the long-term.

And to their credit, they've done away with the DSC at Investors Group.

Yeah. To their credit, I mean, they did it right before CRM disclosure started.

And if people see value in the service, that's fine. Everyone can pay what they want. If you prefer to pay higher fees, our only point is just be aware of the fee that you're paying and make sure you understand the factor.

And what you're paying for.

Yeah. But if you like paying that much, that's fine.

Right. Also interesting to note that they own, so Investors Groups is owned by Power Corp, which owns Wealthsimple, which is a leader in the robo space. I don't know if you hear much talk about robo-advisors in Toronto these days.

Definitely. Yep.

Oh, yeah? What kind of stuff do you hear?

Just it's becoming more and more prevalent amongst the youth. My 24 year old kids talk about that sort of stuff all the time. Although they prefer to do their own online investing.

Right.

But it's out here in the market, that's for sure.

Are your kid's couch potato investors too?

I would describe them as that. Yep.

And another one that we know, getting back to Doug talking about cutting expenses. We know Ben's been talking about this KOHO credit card that he uses to cut and manage his expenses and then just poking around on the weekend, I discovered that Power Corp owns that too. So it's kind of like all across the spectrum, Power Corp is there. It's a preloaded credit card. So you define how much you're going to spend on discretionary items. When you started cutting expenses, did you guys use any specific tools to do that?

One of the ones, we changed our credit cards to cash back cards. Started one with a fee and one without a fee. And now a couple of them do have fees, but we are far exceeding the money we're getting back just on normal, regular spending, nothing outside of, nothing towards the extravagant side. These things are more than paying for themselves. So that made a lot of sense.

Ben Felix: So we had two good questions come in. On the last episode, I believe, I mentioned that the Dan [inaudible] Canadian couch potato model portfolios are not perfect in some ways, even though they're pretty good. Like, I mean, I think they're great. But the question came in and I was kind of wondering if it would come in. What did I mean?

Cameron Passmore: So what did you mean?

Ben Felix: Well, so Dan has these three ETF portfolios, which are great in terms of simplicity. But even when you look at Justin Bender's Canadian portfolio manager, blog model portfolios, he cuts them up further into more ETFs, which gives you a couple of things. It gives you flexibility to hold IS listed ETFs in your RSP account, where it makes sense, to reduce withholding tax or eliminate withholding tax in some cases. And it also gives you slightly lower MERs.

So with Dan's super simple portfolios, you're getting simplicity, obviously, which is fantastic and probably the most important thing for most people, but you're giving up or you're paying slightly higher fees and you're giving up some flexibility in terms of tax location. And then, so that's kind of Dan's model portfolios versus what you could do with ETFs. And then the next step, I think, is we use the DFA, the DFA products extensively, which obviously have the small cap and the value and the efficient trading and all of the benefits on implementation of those portfolios.

So the coach data portfolio doesn't have that at all. That's actually maybe a good question for you too, Doug. When you transitioned from couch potato to DFA, what were your thoughts around that? Or how did you feel about that transition?

I felt confidence, certainly, and it was just sort of a justification of the project that we undertook to go after the proper retirement horizon. So it made a lot of sense to us.

Ben Felix: Right. Really interesting. So anyway, that's what I was talking about, that you give up some flexibility for simplicity and then you also give up the, well, it's the same thing. You give up the tilts. So some cost efficiency, some tax efficiency, some factor exposure you're missing out on.

Now, Dan's clearly aware of this. His model portfolios used to have small cap and value funds across the board in all of his geographic allocations. And I believe in 2015, when he updated his model portfolios, he completely stripped all of that out. I think he used to have his Uber tuber, which was 12 or 13 ETFs. And he wrote a post when he updated his model portfolios, basically saying that based on his experience with the blog, he doesn't think that individual investors can handle a portfolio with that much complexity. So he's saying you're better off with something super simple.

Which an extreme case of is the Vanguard, the new Vanguard all in one portfolio. So again, you're paying slightly higher fees. You can't do tax location, but you place one trade and you don't have to rebalance.

And then the other question you got is you talk about regressions a lot. How do you run them?

Yeah. So we do talk about progressions a lot, because it's all about the factors, as everyone knows. We just use Excel. It's not very exciting. Ken French has a data library of global factors. And then EQR also has a data library that includes Canada specific factors. So we use those for data sources and then we do have access to Morningstar Direct to get a fund return data, to actually pull the fund returns and then we just run the regression in Excel, using the data analysis tool pack. Nothing fancy.

So something else for Doug on the fund side of things. So last time you and I had breakfast in Toronto at our favorite place, you mentioned that we should get to Toronto to see the play, is it Come From Away?

Come From Away. Fabulous play. Seen it twice. Would be happy to see it two more times.

So what's it about?

Canadiana. It's about September 11th and all the aircraft that had to land in Gander, Newfoundland, and how that town rallied to support basically almost doubling the population of the town with 37 planes that landed that day. It's a fascinating story. I don't know if you saw last week, but the US ambassador to Canada, Kelly Clark, on the anniversary of September 11th, was in Gander and described Gander as what the relationship between Canada and the US really is.

Oh, wow. Amazing. Hard to get tickets?

You have to get them in advance, but they're still there. They've extended it again, actually.

Terrific. Well, we're going to try to make it down in November, December if we can. So I was going to say do you still play guitar very much?

I do.

Did you get a band going?

The house band with the two kids. So our next gig will be the Christmas party.

I've got one more question for Doug before we wrap up. So you've made some very deliberate decisions in terms of saving, spending, retirement goals, how you're investing. If you could give advice to other people out there who maybe have not pulled the trigger on making those decisions yet, what would it be?

Don't believe that you know it all, because you don't and don't be afraid to reach out for professional help and don't let fees deter you from doing that. Knowledge has value and is worth paying for.

Wow. That was unscripted. That's awesome. Anything else you want to add, Doug?

No, just thanks for having me. I really enjoyed it.

Links From Today’s Episode:

Rational Reminder on iTunes — https://itunes.apple.com/ca/podcast/the-rational-reminder-podcast/id1426530582.
Rational Reminder Website — https://rationalreminder.ca/

Shop Merch — https://shop.rationalreminder.ca/

Join the Community — https://community.rationalreminder.ca/

Benjamin on Twitter — https://twitter.com/benjaminwfelix

Cameron on Twitter — https://twitter.com/CameronPassmore