December 12, 2019

Episode 76: Risk Parity, Rental Properties, and the Smith Maneuver

December 12, 2019

Welcome to another episode of the Rational Reminder Podcast. We kick off the show today with some great listener feedback before diving into the content of a new podcast by Dr. Laurie Santos called The Happiness Lab. In a recent episode of her show, she gets into the idea of human adaptability to fortuitous or catastrophic events. Our capacity to regulate back to a default state has big implications for dreams of greater happiness through wealth acquisition. Next, we move on to three great listener questions, which by the way will be replacing the investment topic segment of the show from now on. We answer questions about the merit of Ray Dalio’s all-weather portfolio, fall back rules for prospective rental property owners, and whether the Smith Manoeuvre is a good move for high-income earners. Next up you’ll hear some fascinating statistics about residential property value in relation to homeownership and income in Canada. Rob Carrick’s article about how tax-free savings accounts are the greatest Canadian financial success story of the century comes under our scrutiny after that. Finally, we end off with our bad advice for the week, in which we discuss the recent protest by investor advocates to speed up the banning process for early withdrawal fee-charging mutual funds. Tune in for your weekly reality check on sensible investing and financial decision-making for Canadians!

Key Points From This Episode:

Three great reviews from our listeners on iTunes. [0:00:15.0]
Human adaptability and how bad we are at predicting our future emotions. [0:03:45.0]
Expected returns concerning risk parity and factor investing approaches. [0:06:32.0]
Cap rates, leverage, and asset-specific risk regarding investing in real estate. [0:14:02.0]
The benefits of the Smith Manoeuvre for those willing to be leveraged investors. [0:20:10.0]
Lifecycle investing and why young people should invest in stocks with leverage. [0:23:59.0]
Homeownership, income, and residential property value statistics in Canada. [0:25:30.0]
Different house prices for middle-income earners across Canada. [0:29:25.0]
Statistics about TSFAs such as who has one versus who has an RRB. [0:30:53.0]
How to use TSFAs in connection with other investments. [0:32:18.0]
Rules and cautions about TSFAs such as why not to pick stocks in one. [0:32:38.0]
Good reasons to use TSFAs such as when one has a low income and is young. [0:32:38.0]
Why not to buy mutual funds that charge investors early withdrawal fees. [0:38:33.0]

Read The Transcript:

Ben Felix: This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making for Canadians. We are hosted by me, Benjamin Felix, and Cameron Passmore.

In our last episode with just Cameron and I, Cameron read some recent iTunes reviews. And after having done that, one of the people who wrote the review that we read emailed us very excited.

Cameron Passmore: I think it's safe to say we don't feel great about doing this, but-

Ben Felix: It feels awkward.

Cameron Passmore: It feels really weird. So it may be the last time we do this, but anyways.

Ben Felix: Maybe not. Depends if we get a good reaction, again, I guess. So anyway, this one person emailed to say that they were really excited to see that we'd read the review out. So we thought we would do the same thing again because we do get frequently new reviews each week.

Millsy322 wrote, "Great podcast. Since the Canadian Couch Potato Podcast stopped releasing new content, I had been searching for something to fill a void. The Rational Reminder Podcast has done this and more with its more advanced content. Thanks, guys." Thank you, Millsy.

Cameron Passmore: And then also Hatted Ken VX, "Amazing podcast. I love listening to it every week and it's helped me be smarter, more informed as an investor. I recommend this podcast to all my friends and everyone I work with. An absolute must for all DIY investors. Great job, guys and thank you."

Ben Felix: Thank you, everyone.

Cameron Passmore: And then also a shout out to ClubRacer6, who left a nice review.

Ben Felix: On the US iTune store.

Cameron Passmore: Correct.

Ben Felix: They said that even though it's for Canadians, they're an American, but they still appreciate the content.

Cameron Passmore: So as many other podcasts are doing, people are starting to do live or recorded questions. So we've set up a system where we're going to welcome your recorded questions. Just record it on your device.

Ben Felix: Like audio recordings.

Cameron Passmore: Audio recordings, yes. So record your question, keep it brief, say your first name and location, record on your device, and email it to Ben at bfelix@pwlcapital.com and then we'll read it out on an upcoming episode.

Ben Felix: Yeah.

Cameron Passmore: Well, play it on an upcoming episode. Not read it out.

Ben Felix: We wouldn't be reading it if it's coming in as a voice recording. We do often answer the listener questions so it would be maybe interesting to play the person's voice for the question.

Cameron Passmore: Yeah.

Ben Felix: That's what other podcasts do, I guess. So we're going to try it out. But you could even just write the question as if you were going to email it and then speak it.

Cameron Passmore: Yeah.

Ben Felix: Maybe that would be a good idea.

Cameron Passmore: Sure.

Ben Felix: On that topic of listener questions, we had three that were quite good this week. They're always good. But there were three that were media enough that we actually replaced the investment topic with the listener questions. Instead of the investment topic, we just had three beefy listener questions.

Cameron Passmore: And then we also have a great story. Rob Kerick talked about the greatest personal finance success story of the century, I think, he called this. So that's one of the stories today as well. Other than that next week or in two weeks, we going to especially year-end show. Again, that's the thing, I guess in the podcast worlds, we're going to take a crack at doing a year-end best hits.

Ben Felix: That's a thing too. I thought that was your idea.

Cameron Passmore: Well, I think it's a thing. Someone must have thought of that. Not like this whole idea of a podcast was an original idea anyways.

Ben Felix: That's true.

Cameron Passmore: Anyways, anything else?

Ben Felix: No, let's go to the episode.

Cameron Passmore: All right, enjoy it.

Ben Felix: Welcome to episode 76 of the Rational Reminder Podcast.

Cameron Passmore: Two weeks ago, before Christmas and here we are. So kick off the top with a recently discovered content that I found. So had some luck sharing the fire movie a couple weeks ago. So this week I've got a podcast that I discovered recently called The Happiness Lab with Dr. Lori Santos. Have you heard this podcast?

Ben Felix: Nope.

Cameron Passmore: So I was listening to Malcolm Gladwell's Revisionist History Podcast. Anyway, she had an episode on that was released September 23rd, called The Unhappy Millionaire. Very sad story. I won't give it away what happens, but the point of this episode is how bad we are as humans at predicting what will make us happy in the future. And so many of us predict we'll be happy if we get more money by all kinds of different means. And it just does not turn out that way very often.

Ben Felix: What's that old saying of money just makes you more of whatever you already were.

Cameron Passmore: Exactly. And we've talked about this in the past with the research from Daniel Conman, talking about how once you get above 70,000 US of income, you don't get a lot happier as you earn more. By the way, that's talked about in Michael Lewis's book called The Undoing Project. Have you read that?

Ben Felix: No.

Cameron Passmore: I'm reading that now, too. What a great book. That might be brought up in a future podcast. Anyways, so Dr. Santos talks about how people always run these simulations in their head about how great or not great things will be. And usually things aren't as great as you expect nor as bad as you expect when things turn out. The bottom line is that as humans we adapt to stuff and we have this hedonic adaptation as we spend more lifestyle increase, and we just keep spending more and we just get into these cycles, but we end up going back to some baseline level of satisfactions. It's a great, great podcast. Great story. Lots of great research.

Ben Felix: That's a concept of human adaptability. Does the podcast talk about... I remember there was some research about people who won the lottery and people who became disabled in a car accident or something like that. And right after each thing happened, the lottery winners felt really happy. And the people who became disabled felt really sad. And then six months later, they were both back to normal.

Cameron Passmore: Exactly. Or people that have, for example, I read in a book once about... I think one of Gladwell's books talking about learning challenges. Dyslexia was the example, I remember in this book and how people saw as terrible that I've got dyslexia. Actually, that's not the case. People with dyslexia end up having this challenge to overcome, which they find more fulfilling, which is interesting. Anyways, great podcast worth listening to. So onto listener questions.

Ben Felix: Yeah. We had a bunch this past week and we picked out three that were, I thought, worth talking about. So the first one I'll read the question out. I've been hearing a lot about Ray Dalio and his All Weather/Risk Parody Strategy. I would be very interested in your take on whether this strategy is valid or if there are some issues with this approach compared to your factor investing approach. It's not our factor investing approach.

Cameron Passmore: The factor investing approach. And this is a question we got a lot of... A couple years ago, I think, when Tony Robbins' book called Money Master The Game came out. Haven't had that question in a while though.

Ben Felix: I still get it quite a bit, actually. Mostly on YouTube comments, "What do you think about Ray Dalio's All Weather Portfolio?" So that portfolio is... It's a risk parity portfolio, which is very different from... And it makes that question of how does this compare to factor investing very relevant. Risk parity and mean-variance optimization are two approaches to portfolio construction. Mean-variance is where I think factor investing would fall into. It's like trying to optimize returns for a given level of risk. So the higher your risk-adjusted returns are or expected returns are, the better the portfolio is. So adding in assets like small stocks and value stocks to a portfolio increases your risk-adjusted returns, which makes everybody have happy in a mean-variance world.

Cameron Passmore: Even those factors on their own are riskier. When added to portfolio, you get better unit of return per unit of risk.

Ben Felix: Even on their own, value stocks have a better risk-adjusted return than the market, which is why they were an anomaly at one point. In a risk parity world, you don't think about expected returns at all, which itself is interesting. We'll talk more about that in a second. It's really more about allocating to assets based on their individual level of riskiness. So for example, a 50% stock, 50% bond portfolio is obviously half stocks and half bonds, but in terms of the amount of risk contribution from each asset class, stocks completely dominate bonds. So in a risk parody world, you would have less stocks in the portfolio. But then the other implication is that you start looking for other assets that are going to be hopefully diversifying assets and then allocating to them based on their level of riskiness.

Cameron Passmore: So you're saying that risk parody, you're trying to have the same amount of risk in each of those buckets?

Ben Felix: Based on the allocation, yeah. A riskier thing would get less allocation in the portfolio because you want each thing to have an equal risk contribution.

Cameron Passmore: So each thing being, not just stocks and bonds, but other asset classes as well?

Ben Felix: These are looking for other asset classes.

Cameron Passmore: Okay.

Ben Felix: And you want uncorrelated asset classes too. So you see in the Dalio All Weather Portfolio example, the one that Robbins had in his book was 30% stocks, 15% intermediate bonds, 40% long-term bonds, 7.5% gold, and 7.5% commodities.

Cameron Passmore: So in risk parity, each one of those buckets should have the same level of...

Ben Felix: It should contribute the same amount of risk to the portfolio.

Cameron Passmore: Fascinating.

Ben Felix: The problem, I think, is that we're, by definition, in a risk parity world. We're ignoring expected returns.

Cameron Passmore: Right.

Ben Felix: We don't care about that. If we're making a risk parity portfolio construction and correlation. We want assets that have low correlation with each other or no correlation.

Cameron Passmore: So which gold and commodities do have low correlation, but likewise have low expected returns.

Ben Felix: So this is the problem from my perspective. I mean, we think about things through the mean-variance world. And I mean, who's to say what's right and what's wrong. But I think with stocks and with different types of stocks, like stocks with higher expected returns that we often talk about, there's a good theoretical basis to have a positive return expectation. But you start getting into stuff like gold and commodities, they look really good in a backtest, in risk parity portfolio construction, they can look really good, but there's no reason to expect a positive long-term outcome. Now, people who are taking a risk parity approach to portfolio construction would say, "Well, Ben, you have no idea what future returns are going to be. How can you have an expectation?" And I mean, on some level, I get that. But at the same time, when there's a good theoretical reason to believe certain types of assets will have positive expected returns, completely ignoring that seems irresponsible.

Cameron Passmore: And what do you think about the heavy weighting to long bonds? There's 40% in 20 to 25-year treasuries.

Ben Felix: I think this gets tricky when we start talking about the whole risk parity concept, is that a lot of it we're betting on... I mean, you can say mean variants we're betting on future returns, but in risk parity, we're betting on future volatility. And you look at long bonds, in the example, they've been not crazy volatile over the history that we have available to us. And they've actually had really good returns and low correlation. It looks fantastic in a backtest, but should you expect the same characteristics going forward?

Cameron Passmore: Well, we've had decades of falling interest rates, which is very good for long bonds.

Ben Felix: I think this is the challenge. In a risk parody framework, you can build a portfolio that looks really, really good on a backtest, but what's the basis for your expectation that it's going to do well in the future. And I mean, people got excited or still get excited about the Dalio All Weather Portfolio, because it looks really good in a backtest. It beats a 60/40 portfolio and with less volatility, but we're isolating a period of time, particularly. I mean, 40% in long-term bonds. Of course, it's going to look good with that asset class.

Cameron Passmore: Tough to replicate those returns though.

Ben Felix: You even see it in model ETF portfolios, like a 60/40 ETF portfolio in the historical data with an allocation to aggregate bonds might be the 90% equity portfolio for the last 20 years. But does that mean we should put all of our money in the 60/40 portfolio because it has better risk-adjusted returns? I don't think so because you're giving up your equity exposure in favor of bond exposure, which historically looked really good. But again, we come back to that theoretical basis. Is there any reason to believe long bonds or aggregate bonds are going to have the same returns over the next 20 years that they had over the last 20 years? Probably not because we've had this unprecedented fall in interest rates. But I think this thing that I'm saying now with bonds ties right back into the whole concept of risk parody, you find an asset with low correlation in pretty good risk-adjusted returns historically. But if there's no basis for that to occur in the future, I mean, it's tough.

Cameron Passmore: That's the key. Keys have a robust theoretical basis for the expected returns.

Ben Felix: As opposed to betting on correlations and volatilities being telling of the future. Now, Larry Swagger's done a lot of work on this recently. None of it that we're implementing in portfolios, but it is still interesting. I should have looked it up. I can't remember the asset classes he's been looking at, but I think reinsurance is one and there might be a couple of others, but there are these other asset classes that Larry is saying, based on their research, do have positive expected returns and they can be used in a risk parity framework. And that maybe starts to become more interesting. Gold, commodities. I don't know.

Cameron Passmore: Maybe a topic for another show.

Ben Felix: Maybe get Larry on to talk about it, i'm sure he'd love to.

Cameron Passmore: Next question.

Ben Felix: You read this one.

Cameron Passmore: Just like your 5% rule with renting versus owning. Is there a rule or math that people that want to own properties as rentals can fall back to? For example, if I have $350,000 for down payment and buy $900,000 property that has 60,000 of yearly rental income, would that be a good investment?

Ben Felix: So I don't have a hard and fast rule for this one, but I think that when you are investing in real estate, you're looking at the cap rate, how much yield are you getting for the asset? And you might demand a different cap rate or hope for a different cap rate. Maybe you'll be willing to pay the price for the property based on the cap rate, depending on how risky you think it is. If you're certain that you're going to get a good capital return and perfect tenants, you might be willing to accept a lower cap rate. That ends up being very geographically dependent and even investor dependent. The example I just gave. If you're certain about a good outcome for a property, you might be willing to accept lower rents. And I think that's actually something that we're seeing in the marketplace now where I read an article maybe a year ago or a couple of years ago, about how a lot of landlords are buying properties and renting them out at a loss after costs.

Cameron Passmore: Just to get the capital appreciation.

Ben Felix: Because they're betting on the capital appreciation. So again, that's why I say that there can't be a rule in this case because some investors are willing to accept a negative cap rate after costs.

Cameron Passmore: As for my question to you was, if it makes sense to rent as opposed to buy if the cost of renting is less than 5% of the value, is the opposite also true. If the rental yield is above 5%, does that then make the property a good investment? Forgetting about cost of friction trading and whatnot, selling and buying.

Ben Felix: So I think in that 5% rule framework, that was based on property taxes, maintenance costs, and the opportunity cost of equity. So this is not including any leverage, which we're going to have to talk about in the context of rental properties for sure. Let's say you pay cash for a property. You've got 1%, roughly, property tax, 1%, roughly, maintenance costs. And then between the expected capital appreciation on the property and the expected return on stocks, you've at 3%. So that's where 5% comes from.

So to your point, if you can, as a landlord, get more than 5% then the expectation would be that you're getting a better outcome than investing in stocks. But the challenge is, I think, having expectations about... If you find a property, say it meets that test. Great, but there's a big difference between buying one property and having an expectation and buying all the stocks in the world and having an expectation. Now, we just talked about risk parody. Some people say you can't have an expectation in either case, but it comes back to expected returns. I think the expected returns on stocks are reliably higher. Expected, who knows what's going to happen, but expected.

Cameron Passmore: And much less dramatic downside risk. Things can go very bad with a single property. Yes, things can go bad temporarily in the market.

Ben Felix: That's important too, is that real estate as an asset class, even if it's not... It has had really good risk-adjusted returns. If it's not a volatile asset class, that does not mean that your real estate investment is not going to be a volatile asset because you can have all sorts of assets specific things go wrong, like things in the specific area. I know you heard a crazy story recently about a house close to an Airbnb that was causing problems in the neighborhood. Stuff like that, that's asset-specific risk that can drive down property values.

Cameron Passmore: Others had soil contamination they didn't know about when they bought it.

Ben Felix: When we're talking about real estate investing, and again, we've talked about this in the podcast in the past, it's really hard to diversify. If you can globally diversify with hard asset real estate, you might get a good outcome, but then you start getting into the realities of managing multiple properties in one city. But how about multiple properties around the world? It's not feasible for most people. Now, the thing that we haven't talked about yet, which is very important when we're talking about investing in real estate as leverage. You can borrow money to invest in a property. And that can be really attractive because if it goes well, it goes really well, but It can work against you.

Cameron Passmore: It can go very bad as well.

Ben Felix: Yep. I have a good friend who, for a while, was a professional real estate investor. Now, he's a real estate agent. He's a mortgage broker and now he's actually working for another company doing similar real estate analysis and acquisition type work. But he was explaining to me that you can make good money in real estate. And I believe that because I don't think the market is as efficient as the stock market, but the guy that I'm using as the example, he's a CFA charter holder, he's a real estate analyst, so he knows exactly how to look at properties. And while he was doing the real estate investing on his own, this was the only thing that he was doing. If you don't have the knowledge. And in his case, the infrastructure because he was able to do his own real estate deals as the agent and the mortgage broker and the time, he said there's no way you're going to be successful.

Cameron Passmore: I'm also assuming he's adding value to the properties?

Ben Felix: Yeah, that's-

Cameron Passmore: So it's like a business?

Ben Felix: That's part of it too. But his comment to me, we chatted about this for a while. It's actually the guy that I was on the East Coast trail with, we talked about it then. So he thinks he's been able to generate alpha, but it's because of the specific skillset and setup that he had. But for an individual person doing this as part of their investment portfolio while they've got another full-time job, he says the outcome's going to be driven by luck. We didn't give a rule for investing in real estate, but-

Cameron Passmore: Gave insights.

Ben Felix: We give context, I guess.

Cameron Passmore: All right, so here's the next one. I'm curious to know your opinion on the Smith Maneuver for high-income professionals. Is it too good to be true?

Ben Felix: It's not too good to be true. It's turning yourself into a leveraged investor, basically.

Cameron Passmore: You better explain what it is. A lot of people might not know what the Smith Maneuver is.

Ben Felix: So the Smith Maneuver was pioneered by a guy named Fraser Smith. And interestingly actually have his son Robinson Smith coming on the podcast in March 2020. So they've got a consulting business. I'll have to prepare for the interview. I don't really know him. They do something related to educating advisors and individuals about the Smith Maneuver. So, anyway, it's the process of paying down your mortgage and then immediately reborrowing against the equity in your home to invest. So instead of paying down your mortgage over time, you're changing your mortgage loan into a line of credit, and you're using that line of credit to invest in a portfolio in a taxable investment account. And the reason that you would do this is to build wealth, I guess. It's making the decision to be a leveraged investor. You had to mortgage anyway, so you're not taking on more debt. But what you are doing is each time you pay down some of the mortgage debt, you are readvancing it.

Cameron Passmore: So you pay down one side, borrow on the other side?

Ben Felix: Right. You use what's called a readvanceable mortgage, which is a traditional mortgage that also has a line of credit. So every time that you make a principle repayment on the traditional mortgage side, you readvance that debt on the line of credit side. Your level of debt is remaining constant over time. The difference is that the debt that you are taking back out from the line of credit and then investing the interest is tax-deductible because you're taking a loan to invest with the intention of earning income. So, I mean, it's a way to turn your mortgage over time into tax-deductible debt. And it's a way to build up a portfolio more quickly than you would've done otherwise. But you're doing that by borrowing money. It is making the decision to be a leveraged investor, and not pay down your mortgage.

Cameron Passmore: Because your mortgage affectively is not going away. It's just shifting from being attached to your house to being attached to your portfolio.

Ben Felix: Correct. So your level of debt is staying the same. I think people have the idea that this is a way to pay down your mortgage, but also build a portfolio, but you're maintaining your level of debt.

Cameron Passmore: The big issue is if the market collapses, how are you going to behave now you've got that debt. So to me, it's a largely behavioral question.

Ben Felix: Oh, it's 100% behavioral.

Cameron Passmore: And perhaps as you get older you might want less debt, but for someone starting out, high income.

Ben Felix: I think on the topic of this being an aggressive strategy, like on the behavioral topic, one of the other pieces is that if you're borrowing to invest, you probably don't want to borrow to invest in bonds. So you borrow to invest in stocks. That behavioral factor is really being tested. If you're comfortable being a 100% equity investor, great. But are you comfortable being a leveraged 100% equity investor?

Cameron Passmore: Remembering that the past 11 years have been good to equity investors.

Ben Felix: I think for a lot of people, the answer to that question is no. It is an interesting approach for sure. And it's not too good to be true, given that you're comfortable being a leveraged investor. And on the topic of being a leveraged investor, I was doing some research over the weekend for another discussion, but there's a paper that came out in 2008 by a couple of Yale professors. And they wrote a book about it in 2010. It's called Lifecycle Investing. There's another component of the title. I can't remember what it is. They're actually arguing that young people should invest in stocks with leverage. It's based on Paul Samuelson's and Robert Merton's lifecycle investing research, which said something along the lines of you should hold a constant proportion of the present value of your future wealth in stocks. And these Yale professors, they're basically arguing that because young people don't have enough capital to maintain that proportion in stocks.

They should borrow as much as they reasonably can to increase their equity exposure while they're young. And they call this intertemporal diversification. It's time diversification for equity ownership, which makes sense. Because you think about a normal investing life cycle, you have very little in stocks, even if you're 100% equity, you have very little in stocks in dollar terms when you're young. And then even if you make your portfolio more conservative later on in life, the magnitude of your equities in dollar terms is much higher. And so they're arguing that you should try and increase your equity exposure as much as possible when you're younger, so that you're diversified across more time periods.

Cameron Passmore: Interesting.

Ben Felix: So being a leveraged investor, maybe, isn't so bad. Well, behaviorally it is, but-

Cameron Passmore: You have to make sure you know what you're getting into.

Ben Felix: Yeah.

Cameron Passmore: Okay. Current topic number two. This is a paper that you put on our feed for us to look at. Paper from Stats Canada released December 5th. So it's called Home Ownership Income and Residential Property Values. What they did in this paper is, they analyzed income characteristic of residential property owners in three provinces, BC, Ontario, and Nova Scotia. I don't know how they chose those three provinces. I couldn't see, but this is 2018 data. And what it does, it gives insights into First-time Home Buyers'. So those people who either did or did not use the home buyers plan and the relationship between the owner's income and the property values, then looked at the distribution of income levels in those three provinces for those two categories. So some of the findings are pretty interesting. Owners earned on average two times more than those who did not own homes, overall. Buyers who use the First-time Home Buyers' Plan earned higher income, but owned lower value properties than all others in Ontario and BC. The median property value to income ratio was highest in Vancouver at nine times.

Ben Felix: Makes sense.

Cameron Passmore: You expect that. So your property is nine times your income property value, but the bottom 20% of income earners in Vancouver get this, had a property value to income ratio of 32 times, or it could be people that have owned it for a long time.

Ben Felix: Wow. Yeah. True.

Cameron Passmore: Not necessarily first-time home buyers. Properties owned by the lowest income earners were more likely to be co-owned by non-residents of Canada. And these properties had higher valued income ratios than properties owned by residents. Here's some other neat facts that came out of this study. Housing prices are growing faster than household incomes. So the Teranet-National Bank House Price Index shows that house prices have increased 69%, the decade ending 2017, but income has increased 27%. In Q1 2019, Canada's housing price to income ratio was the highest across OECD member nations.

Ben Felix: We talked about This in the podcast a while ago. You remember that?

Cameron Passmore: Yeah. Overall, the owner's median age is 55. Non-owners are 37. 75% of homeowners are married. For first-time homeowners in Ontario and BC, the first-time home buyers who use the Home Buyers' Plan, purchased houses that were significantly cheaper than those who did not claim the Home Buyers' Plan. So I guess from a policy standpoint, that-

Ben Felix: Is this Home Buyers' Plan or that new program that helps to increase the-

Cameron Passmore: It's that, yes. They use that plan. So does this mean that that program is working, getting people that may not have the assets but have the cash use in the market? The mean age of those claimants was age 32. More than 20 years younger than the median homeowner. Here's some other observations that comes from StatCan, which is why it's full of stats here. The interesting observations of value to income of owners. So Vancouver of the highest ratio of 9.1, so 9.1 times income, whereas in West Van, it was over 20. Toronto was 5.7 times.

Ben Felix: Wow. I wonder if that speaks to just higher incomes in Toronto?

Cameron Passmore: No.

Ben Felix: Prices are that much higher.

Cameron Passmore: The next one does, Ottawa, where we are, is 3.1 times. And it's really low due to the highest median income level owners. I was really surprised at that.

Ben Felix: That is surprising.

Cameron Passmore: And Nova Scotia is 2.1. So one thing I did look up because they break down income levels by Quintiles. So I looked at if you're in the middle quintile in these three areas, so the third quintile of family income. So if you're in the Vancouver census metropolitan area, the middle quintile of income is 75,000 to 111,000 of income. The ratio for the home valued income was 8.6. So just doing some very simple math. That means if you're in that middle-income and you're a first-time home buyer, you're buying a house around 800,000. In Toronto, that income level for the middle quintile, between 81 and 118,000, the ratio is 5.5. It's a simple math 547,000. I'm just guesstimating that just to get a sense of what the middle-income earner is paying for a place in these three cities.

Ben Felix: Intuitively, the numbers seem reasonable though.

Cameron Passmore: I guess it's pulled down because of condos. You know, people buying houses in Toronto, they're paying a lot more, but perhaps the condos is a bit cheaper and at Halifax, income level is very similar, between 83 and 113, but the ratio was 2.3. So again puts you about $225,000 a house.

Ben Felix: It's crazy. When you look at other cities even because Ottawa is not cheap either to buy a place, you start looking at other cities, you can buy nice houses for what in Ottawa would get you a teardown or a condo.

Cameron Passmore: Yeah. Let alone Toronto or Vancouver.

Ben Felix: Yeah, that's right.

Cameron Passmore: There you go. Just some interesting data points. Okay. So you good to move on to the next topic?

Ben Felix: I'm good.

Cameron Passmore: So this one's planning topic of the week. I just thought we'd throw it a quick refresher on tax-free savings account, the TFSA, and lo and behold, the next day Rob Kerick puts an article in the Global Mail in December 5th, calling the TFSA the greatest Canadian personal finance success story of this century so far. So that was a pretty big buildup. Currently, there's 19 a half-million TFSA set up in Canada worth 277 billion at the end of 2017 up 19% year over year and 14 million Canadians have a TFSA right now. And did you know that more Canadians have a TFSA than an RSP? 57% of the population versus 52% having an RSP that's according to the 2019 iteration of RBCs financial independence, retirement poll conducted by IPSOS. The average TFSA balance is $42,000. The average RRSP balance is $96,000. Nearly half of Canadians, 43%, believe that TFSAs are good for saving money, but not growing it.

Ben Felix: That's a big insight.

Cameron Passmore: I remember when it came out, a lot of people complained about the name Tax-Free Savings Account. A lot of people thought it was just for saving, not for investing and the most common holding in TFSA's, get this, is cash short term savings in GICs, 57% of the holdings are in that.

Ben Felix: Crazy. So that speaks to the last point. But I guess something that this doesn't capture is that a lot of those people putting the savings in the TFSA might not have other investments.

Cameron Passmore: Quite possible.

Ben Felix: And if that's true, then sure use the TFSA to shelter your interest. But ideally all of your less tax-efficient long-term investments, like stocks and bonds are going to go on the TFSA.

Cameron Passmore: So basic rules after-tax money goes in, grows tax-free, comes out tax-free. Any money you pull out of the TFSA can be replaced. That limit gets added back to your limit the next year.

Ben Felix: Replace the following year.

Cameron Passmore: The following year. So make sure you follow your limits closely because the penalties can be brutal. Can name a beneficiary except in Quebec, including a contingent beneficiary. So it continues on to the surviving spouse.

Ben Felix: Plus successor holder.

Cameron Passmore: Holder. Yes.

Ben Felix: That's an important distinction because if you name a spouse as a beneficiary-

Cameron Passmore: They get the money.

Ben Felix: They get the money.

Cameron Passmore: Not the tax-free benefit, correct.

Ben Felix: You name them the successor holder. So if anyone has a TFSA, if you have a spouse, it's important to make sure they're coded as successor holder and not beneficiary.

Cameron Passmore: Not beneficiary. They just announced a limit for 2020s, an additional six thousand. That puts a lifetime limit at $69,500. Only 10% of TSA holders have maximized their limits.

Ben Felix: I believe that.

Cameron Passmore: The average amount of unused TFSA room is 31,000. Things to watch for. Make sure you watch for any over-contributions. The penalty is 1% per month of the over contribution. Also watch if you're contributing an investment that has a capital loss. If you contribute that security to the TFSA in kind, the loss is denied.

Ben Felix: Superficial loss.

Cameron Passmore: A lot of people don't know that, but if you trigger capital gain, the gain is triggered on that contribution.

Ben Felix: I think a big one in terms of what to watch out for with the TFSA. And one of my earlier YouTube videos was on this topic, is that if you're going to pick stocks, fine, don't pick them in your TFSA. And the reason is one. We know the data on individuals securities is not very good. You're far more likely to lose money than make money. And you have a pretty significant chance of a permanent substantial loss. I can't remember the exact data points, but some large proportion of securities historically had, I think, it was a 60% loss that they never recovered from. I can't remember what percentage of securities, though, but it was a big number. If that happens inside of your TFSA, so say in the example, what was the total room? 60...

Cameron Passmore: 69.5.

Ben Felix: So say you put $69,500 into your TFSA, first contribution ever. And you invested in a stock and that stock goes to zero. What's your TFSA room now? Zero, because there's nothing in the account and you've got thing to withdraw. Room's gone. And then the other thing is that you don't get to claim the capital loss. So if you're going to pick stocks, you're probably going to lose money. You may as well do it in your taxable account where you can at least claim the loss when you do lose money. I think people think about the big gains they are going to make tax-free in the TFSA.

Cameron Passmore: And I know some listeners have had that experience. We know a few.

Ben Felix: Don't pick stocks in your TFSA. If you must pick stocks, pick them in your taxable account.

Cameron Passmore: Lots of good reasons to use a TFSA. I mean basic rules of thumb, all things being equal once your RSP is fully contributed.

Ben Felix: That's a tricky one though, right?

Cameron Passmore: For most people.

Ben Felix: If you have a higher income, the order of use would be RSP first. If you have kids maybe RESP second and then TFSA would be last. But we talked about this on the podcast. Alexandra McQueen tweeted about this a while ago. I think we talked about it on the podcast. If you have a low income, you probably don't want to use the RSP at all.

Cameron Passmore: No, they would do a TFSA and that could help you preserve your GIS.

Ben Felix: If you have low income now, you put money in the RSP, you don't get much benefit from any tax savings. And then the future, when you withdraw it, it increases your taxable income, which like you said, can eliminate GIS.

Cameron Passmore: And once you're 18, you start creating rooms. So I know I told my kids, "Maximize." They're both over 18 and if you keep maximizing based on that limit, if you can, I appreciate if you can, but it's a good limit to strive for, the $6,000 per year.

Ben Felix: We've had a few clients send their kids once they turn 18 to come and see us and open up a TFSA and kind of get started getting their feet wet with investing.

Cameron Passmore: Yep, 84% of TFSA holders, age 18 or 19 have maximized.

Ben Felix: Well, they've got no room. Come on. That's easy.

Cameron Passmore: Well, still you're 18 years old, six grand. That's $500 a month.

Ben Felix: That's impressive.

Cameron Passmore: It's impressive. But it's a good limit to encourage them to follow. Anything else you want to add to TFSA's

Ben Felix: Well. You had a couple other things in your notes, I think, on asset location. Do you want to talk about that for TFSA's

Cameron Passmore: I think we've talked to asset location enough, but-

Ben Felix: What were you thinking?

Cameron Passmore: Just in general, but asset location...

Ben Felix: I think the big one with the TFSA's is that you can get caught on is a double withholding tax. If you're holding a Canadian listed ETF that owns a US-listed ETF of international stocks, you're going to get hit with two levels of the holding tax that think you're losing about 70 basis points. So in the TFSA, if you're going to hold international stocks, you're going to want to hold a Canadian listed ETF that holds the stocks directly. Still, even withholding tax but it's only one level instead of two. We don't want to go back into the bigger picture of asset location discussion.

Cameron Passmore: No.

Ben Felix: Okay. You shouldn't have written asset location.

Cameron Passmore: I know. I'll make that... These are my rough notes here. Anyways. It's a great program. I agree with Rob Carrick.

Ben Felix: TFSA's awesome. If you gift assets to a spouse and they invest them in their TFSA, there's no attribution. In a taxable account, if you give assets to a spouse and they invest, the income's attributed back to you, not true in a TFSA. So if you have a spouse, if one person has a high income and a spouse that isn't working or is a lower income, you can give them money to match up their TFSA.

Cameron Passmore: Okay. Bad advice of the week from the global mail article entitled, Investor Advocates Inpatient With Lack Of Reform On Mutual Fund Sales Charges. This is the story that never goes away. So it's about deferred sales charges. Those are the funds that pay larger commission upfront and then charge you if you happen to leave in the five or seven years. It's the usual schedule. And the commenting on how slow the regulators are to ban them. So you remember last year, almost a year ago, "After a six-year review, the Canadian Securities Administrators proposed a prohibition on DSC's backend lows." On the same day, the Ontario government releases statement opposing the ban. And they also propose that discount brokerages not collect trailer fees and the Ontario government killed that proposal as well.

Ben Felix: I didn't know that one was killed.

Cameron Passmore: Yeah.

Ben Felix: Oh, I didn't know that.

Cameron Passmore: That's what the article says. So the question is where is this issue now? And the article quotes that the OSC is still reviewing its next moves. "We are taking our time and we know that our decision is going to be a very important decision for investors in the market," said the Director of the Investment Funds Product Branch at the Ontario Securities Commission. So of course, investor advocates are, to say the least, not very happy as this process has been underway for six years. And there's been so much debating. DSE debate goes back, I think, 20 years. So Ken Kavenco, who'd be a great guest on the podcast sometime, who is an active investor advocate suggested that if there is no outright ban at least DSC should be banned in riff accounts and perhaps reduce a backend scheduled to three years.

Ben Felix: For sure. We still see, like I know Investors Group got out of the DSC game, what last year, but we still see. And when we're onboarding new clients, it's still probably 10 or 15% of the time they're coming in with a whole bunch of recently DSC.

Cameron Passmore: Oh, it's the recent ones. In today's day and age there's really no need. I was astonished when the Ontario government was against the ban.

Ben Felix: I was talking to somebody earlier today and they said that they figured that the market for financial advice is probably somewhat efficient. Meaning if you're not paying explicitly for advice, you're probably still paying about the same amount as you would pay a fee on the planner in implicit costs like DSC fees.

Cameron Passmore: No doubt.

Ben Felix: I thought that was an interesting comment.

Cameron Passmore: Anything else?

Ben Felix: I think that's good.

Cameron Passmore: Great. Thanks for listening.