The Canadian Money Roadmap
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The Canadian Money Roadmap
Inefficiency is your friend...sometimes.
Could the financial strategies that appear flawless on paper be leading us astray in the real world? We're peeling back the layers of investment principles to reveal why some inefficiencies might just be your portfolio's best friends. Taking a page from Morgan Housel's "Same as Ever: A Guide to What Never Changes," we delve into the unexpected virtues of financial buffers and the fallacy that cost always equates to value. Discover how the pandemic's strain on just-in-time manufacturing shines a light on the need for slack in our systems, and why the presence of an emergency fund during economic highs could save you during the lows. Plus, we discuss the underrated advantages of investment advisors, challenging the penny-pinching mindset to embrace quality that pays off in the long run.
Then, we shift gears to a provocative study that upends conventional retirement planning wisdom—should you stockpile equities all the way to your golden years? We dissect the enticing, yet nerve-wracking notion of an all-equity portfolio and confront the harsh truths about our own risk tolerances and financial aspirations. It's not just about the potential gains; it's the psychological rollercoaster and the necessity for a tailored asset mix that fits like a glove. As I advocate for a well-rounded investment strategy, consider this your invitation to explore how aligning your portfolio with your personal narrative could be the smartest financial move you make. Join us as we navigate through the complexities of balancing risk and reward, and crafting a financial future that doesn't just look good on paper, but feels right in your gut.
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Hello and welcome back to the Canadian Money Roadmap podcast. I'm your host, evan Neufeld. On today's episode, we're going to be talking about efficiency in your portfolio and why sometimes inefficiency can actually be your friend. A lot of times online you'll see people talk about wanting an efficient portfolio or trying to maximize returns or tax efficient withdrawals all these things about maximizing efficiency, optimization, all these things like that. So today I'm going to talk about the little things that can appear to be inefficiencies but actually could make you better off.
Speaker 1:It's a little bit counterintuitive, I know, but a lot of people seem to stress about the potential inefficiencies in their investing or their financial life, and so I was reading a book recently from Morgan Housel. The book is called Same as Ever A Guide to what Never Changes, and he's got a great chapter called the Casualties of Perfection, and I'm going to read a little section here that inspired today's episode. So this part comes directly from the book. He's talking about manufacturing. He says just in time, manufacturing where companies don't stock the parts they need to build products, relying instead on last minuteminute shipments of components, was the epitome of efficient operations over the last 20 years. Then COVID-19 hit, supply chains broke and virtually every manufacturer found itself dreadfully short of what it needed. The irony is deep In 2022, during one of the biggest consumer spending booms in history, car companies had to shut down factories because they're short on chips, brakes and paint. They had no room for error. A business's goal is no room for error and it completely backfired. A little inefficiency across the whole supply chain would have been the sweet spot. Room for error is often viewed as a cost, an anchor and inefficiency, but in the long run, it can have some of the highest payoffs imaginable. Same in investing Cash is an inefficient drag during bull markets and as valuable as oxygen during bear markets. Leverage is the most efficient way to maximize your balance sheet and the easiest way to lose everything. Concentration is the best way to maximize returns, but diversification is the best way to increase your odds of owning a company capable of delivering returns on and on.
Speaker 1:All right. So that's a great little clip there, and maybe that should be the whole podcast, because that kind of covers up the bulk of it, but I was going to go into a few more specifics here about how it relates to you as an investor and some things that you probably don't need to waste a whole lot of time on, necessarily. So first thing to understand is that no one exists as a spreadsheet. Anyways, no one will be perfectly efficient because of our behavior. Laziness, incomplete knowledge, limited access to investment products, time constraints, opportunity costs, et cetera All of these things are inefficiencies that show up despite what our best intentions are. So give yourself a break a little bit. So today I'm going to talk about three things that you probably don't have to spend a ton of time worrying about, if they're applicable to you and how you've been thinking, or perhaps stressing about your money. So first one is the lowest cost doesn't mean the best result, and the first caveat here doesn't mean that the opposite is true where the highest doesn't mean the best result, and the first caveat here doesn't mean that the opposite is true where the highest cost does mean the best result. No, low costs are very important, but paying for an advisor or some specific advice is kind of where I'm going with this one.
Speaker 1:Let's think about an example here. Say you're buying a house or you're building a deck. The cheapest way to do either of these major construction projects would be to do it yourself. You can do it yourself. I know people that have done it themselves. Every city has a number of hardware stores where you can buy materials and tools All the selection you could ever want. Youtube is full of videos teaching people how to do things like this Different construction projects, different techniques, all sorts of things but have you done it before? Are you going to ever do it again? How long is it going to take you to learn how to do everything and then implement it, and is it actually going to be better? What about the variables that the YouTube videos didn't cover? The slope of your land, how moist your soil is, dealing with contractors, all of these other things, right? So sometimes hiring a builder who's built houses in different conditions and different shapes and sizes can help you build a higher quality house and one that you can be confident in. It might not be the cheapest. It definitely actually. It won't be the cheapest upfront, but it'll save you in time, stress and potentially repairs.
Speaker 1:So this kind of relates to how I think about working with an advisor. No, not everybody has to do it, but there can be a lot of value in working with someone who has seen a number of other financial situations outside of your own and what you read about on the internet. So I've talked about this on the podcast before. I'm not going to harp on this one too much, so I'll link an old episode in the comments about some of our experience working with clients. My colleague, stephen Gunther, joined me for that one. I think it was a great episode. So, like I said, not everybody needs to work with an advisor, but every single week that I do this job I'm blown away at the opportunities to add value for somebody far and away above the fees that we end up charging to either do a plan or manage an investment portfolio for somebody else. So this perhaps could be viewed as an inefficiency of your money. However, in our experience we've seen significant efficiencies with the types of clients that we end up working with, far and away above the cost that we end up charging. Number two not every dollar needs to be earning a meaningful return.
Speaker 1:One of the comments that I get all the time especially when bull markets are going on meaning when the stock market is particularly positive A lot of people say, oh, I've got all this money in a savings account, maybe it's an emergency fund, maybe they got a bonus or something like that, and I don't want my money just sitting there not making anything. Funny how I don't get these comments or have these conversations with people when the stock market is down 30%. So this speaks to what Morgan said specifically in his section there, where cash is inefficient, drag during bull markets and as valuable as oxygen during bear markets. Right, so you never want cash when the market is going up, but that's the only thing you want when it goes down. The way that I think about this is specifically about you and your situation, because if you've got cash on the sideline and you need that money or it's already spoken for, like think about, for taxes or a known expense in the future you can't have that money invested because we never know what tomorrow is going to bring. Every year there's significant drawdowns, even when the market is very positive at the end of the year. So, especially if you know that that money is already spoken for, don't worry about every dollar needing to earn a return.
Speaker 1:Having some cash not invested can help you feel better when the market goes down, when you have expenses that come up, or if your financial life doesn't pan out exactly how you thought it would. This can take the form of an emergency fund for someone who's still in the accumulation phase of their life, but also for retirees, using something like the cash wedge portfolio strategy. These have been shown to be inefficient in terms of maximizing your returns, maximizing your net worth or anything like that, but it does increase your ability to be flexible. It decreases volatility and in my experience, it has helped people make better decisions with their money because they don't feel so overwhelmed when the stock market goes down. So from my perspective, a little inefficiency can be helpful by having a little bit of cash on the sidelines, especially if you know that money's already spoken for for things like taxes or known expenses in the future.
Speaker 1:Third, one is similar but a little bit different. It's about asset allocation. So there's a professor at the University of Arizona named Scott Sederberg and he wrote a paper recently that got a little bit of traction and it's very interesting to go through. The guys from the Rational Reminder podcast had him on the podcast back in fall. I think to go through the results of the paper. If you are a finance dork like me and you find academic studies on this kind of stuff interesting, go and listen to that. I'll summarize it as succinctly as I can here for the average person.
Speaker 1:But the paper found that, despite a commonly held belief that you should have a more conservative portfolio as you age, their research found across significant timelines I think they went back to the late 1800s and many countries around the world, not just US, not just Canada, not just Europe. It was a very comprehensive study and they found that an all equity portfolio of 50% domestic and 50% international stocks have been the optimal portfolio for people throughout their life cycle. So even for retirees, maintaining an all equity portfolio was optimal. However, this is just in a academic study and not with real people. So in their own conclusion they wrote here despite the dominance of stocks and achieving retirement outcomes, investors and regulators may be uncomfortable with the tendency for larger intermediate drawdowns using the all equity strategy. Drawdowns inflict psychological pain and some investors may abandon their investments rather than stay the course. We are sympathetic to the discomfort and real costs of these bouts of poor short run performance and they go on to say however, it is worth considering to take a look at an all equity strategy because of how significantly better it came out for investors. In their study they go on to say we call for alternative approaches to mitigate the cost of short-term losses, such as financial education on staying the course.
Speaker 1:That's what I'm doing here on the podcast, hopefully retirement account reporting standards that emphasize long-term performance I would agree that would be awesome and regulations that assist retirement savers with maintaining a long-term focus. Not sure how that would actually play out. I'm sure other people have more ideas than I do there, but even though the research shows that having all stocks in your portfolio in a specific blend of domestic and international that can be optimal for maximizing wealth and maximizing spending, having some bonds in your portfolio can decrease that short-term volatility. Because from someone like myself and anybody else who listens that works with real people in their portfolios and their retirements, they know that sometimes when the market goes down, people start panicking and they want to make decisions that we know will negatively impact them in the short term and the long term. So having bonds in your portfolio I often describe it as like the airbag on your portfolio.
Speaker 1:More often than not, bonds act as a opportunity to decrease volatility compared to stocks alone. So if the stock market is down 20% and your portfolio that includes some bonds is down 15%, that might help you feel a little bit better and keep you from panicking. My perspective, panic selling is worse than a lower average return, because bonds typically don't increase your expected returns. They'll decrease your returns, but it decreases your volatility as well. Panic selling can often guarantee your losses because you're selling after it's already gone down. So if you're someone who has made bad decisions, like selling long-term assets when the stock market is down, you need to be honest with yourself and decide whether a stock-only portfolio is actually appropriate for you. This is why we can't just blanketly say, okay, this is optimal, this is what everybody should have. No, because we're people and we're not spreadsheets and we're not robots, and some people can't handle it. Also, some people don't want to make the pile bigger.
Speaker 1:I often put people in two camps. If they have enough money to sustain their spending throughout the rest of their natural life, if they have additional money from there say from an inheritance, sold their house, whatever now you have a decision to make Should you invest that money or should you spend it, give it away, whatever you want to do? And so people fall on two ends of the spectrum where they say, okay, well, I don't need to make more money, I don't need to have more money, so why wouldn't I take some risk and see how much I could make from it. It's not going to blow me up. If it goes completely sideways, let's give it a try. And the other people say, well, I don't need to make more money, so why would I bother taking any risk? Very few people exist in the middle of that spectrum, in that situation where they are confident in their financial plan enough to know that they don't need more return. And so these people I find that most of the clients that I work with anyways they're in the camp of well, if I don't need it, I prefer not to take any more risk than I really have to. So these are the people that don't feel they need to make the pile bigger.
Speaker 1:Optimization through asset allocation often leads to making piles bigger, and to me that isn't a goal that is meaningfully worth pursuing. Just as a rule, I believe to set your asset allocation based on taking as much risk as necessary to achieve your goals is more of a prudent approach. But these people that don't really want to make the pile bigger just for the sake of making the pile bigger is they've made all they need and they have the luxury of maintaining a more conservative asset allocation, and that is fine. It's inefficient from every definition, but it's fine, you don't have to. You can do whatever you want.
Speaker 1:If you're someone that doesn't have any sort of savings discipline, you've got a pile of debt. You haven't built a portfolio large enough. Being a conservative investor in that case will probably leave you a little bit short. So, for the sake of feeling good and not taking more risk than you want to, a bit of inefficiency is okay. In my books. Not every investor is an optimizer and that's okay. So that's my little rant on that. If you want to be an all equity investor and you can actually stomach it and that's something that you want to prioritize, totally fine. If you want to be an all equity investor and you can actually stomach it, and that's something that you want to prioritize, totally fine. If you're someone that gets nervous about the volatility in your portfolio and you don't actually want to take on any more risk, especially in your elderly years, great. If that works with your financial plan, don't worry about it. So this is a challenge, right?
Speaker 1:So this optimization, or total efficiency focus, is a challenge for us as financial planners, because there's the technical knowledge of the job and we know all the tactics that you can use to create optimal results for people, but more often than not, these optimizations come at the cost of something else. If something related to your money is going to stress you out or create fear in your life, you need to evaluate, perhaps with the assistance of a professional, whether you could add a little room for a bit of inefficiency in your life in the terms of a little bit of cash on hand, maybe paying for an advisor, maybe adding a little bit of bonds or something else to your asset allocation. That takes the edge off a bit. So perhaps you could add a little inefficiency in your life. That could end up being the best type of efficiency for you. Everything is situational. Everything is unique to you as an individual. There's cookie cutter knowledge out there, there's good rules of thumb to know, but when it's all said and done, your situation is unique to you, and the priorities that you have for your financial life will govern how you invest, how you spend and how you give to the next generation or to the charities of your choice.
Speaker 1:So let me know what you think of this episode. Shoot me an email over at hello at evanneufeldcom. I'd love to hear from you If you've listened to the podcast for a while. I'd love to get a review on Apple Podcasts. I haven't got one of those in a while, but I have many kind reviews on there already.
Speaker 1:Leaving a review helps other people know that this podcast is worth listening, so if you believe it is, then let people know by leaving me a review on Apple Podcast. There's a rating system on Spotify and a few other apps as well. Those are always welcome and very much appreciated. Thank you so much for listening to this episode and we'll catch you next week. Thanks for listening to this episode of the Canadian Money Roadmap Podcast. Any rates of return or investments discussed are historical or hypothetical and are intended to be used for educational purposes only. You should always consult with your financial, legal and tax advisors before making changes to your financial plan. Evan Neufeld is a certified financial planner and registered investment fund advisor. Mutual funds and ETFs are provided by Sterling Mutuals Inc.
