CAPITAL GAINS TAXES: ANOTHER REASON VANGUARD DESTROYS MUTUAL FUNDS

CAPITAL GAINS TAXES: ANOTHER REASON VANGUARD DESTROYS MUTUAL FUNDS


One of the best books I’ve read on passive or index investing is The Elements of Investing by Burton Malkiel and Charles Ellis. The book is full of proof that buying mutual funds is a losers game for us, the investors.

One point they discuss that is not widely considered is the significant capital gains taxes that mutual fund investors are responsible for. Mutual fund managers are very active in buying and selling stocks in their fruitless attempt to beat the market.

Every time they sell a stock for a gain, you the investor have to pay tax on that gain. Many mutual funds turn over their stocks 100% in any year; that means the stocks they hold at the beginning of the year are completing different from the ones they hold at the end of the year.

Compare this to index funds which own the whole market. Unless a company declares bankruptcy or is bought by another company, the turnover is very low. This tax efficiency becomes a major advantage of whole market index funds. Mutual funds can create large tax liabilities if you hold them outside your tax-advantaged retirement plans (that’s a fancy word for outside your RRSP or TFSA accounts).

To overcome the drag of high fees and taxes, a mutual fund would have to outperform the market by 4.3 percentage points per year just to break even with whole market index funds.

The odds that you can find an actively managed mutual fund that will perform that much better than an index fund are virtually zero.

How Much Your Need To Save For Retirement

It depends. You want to save enough so you can have a secure retirement but not too much that you deprive yourself during your working years. How much to save depends on a bunch of different things like your yearly family income, are you married or not, do you have children, will you keep working until age 65, and do you own your home.

The common wisdom is you will spend roughly 70% of your yearly income when you retire. For example, if your family income is $100,000 average during your working years, you will need to spend $70,000 a year to maintain your standard of living in retirement.

The problem with this 70% number is it makes it very difficult to save enough while working unless you dramatically cut expenses when you are young. It also doesn’t take into account the fact that you won’t be supporting your children, or have a mortgage in your 60s and 70s.

Actuaries has been studying spending habits as we age for years. Their conclusions are very enlightening and reassuring. Basically, after taking into account the drop in “fixed” expenses like your children and mortgage, the vast majority of people will only need to replace between 40% and 50% of their working income in retirement*. Don’t forget, you will also be entitled to Old Age Security (OAS) and Canada Pension Plan (CPP) in your 60s that will add to your income.

At this level of income, retirees can enjoy the same living standards they had while working. The studies also showed that people did not change their spending habits much after retiring so living the same way you did when you were younger is quite a reasonable expectation. In fact spending actually decreased significantly in later stages of retirement as age and health issues make it harder to spend the same amount of money as you did as a “young” retiree.

What does this all mean for you?

Despite what you might hear in the media, collectively we are not all doomed to a subsistence retirement, as long as you save enough to replace roughly 50% of your income for retirement.

That’s sound better, but how much do you need to save every year while working to reach that 50% target?  In order to have the same lifestyle in retirement as when you were working, you will need to save 6-10% of your yearly income each and every year from age 25 to 65. No excuses.  10% is more conservative and will even allow a cushion for the chance that you are without a job for a short while at some point.

* If you are interested in finding out more about how I reached this 40% to 60% replacement rate, read “The Real Retirement” by Fred Vettese. He goes into wonderful detail about the data and research.

HOW MUCH YOU NEED TO SAVE FOR RETIREMENT

It depends. You want to save enough so you can have a secure retirement but not too much that you deprive yourself during your working years. How much to save depends on a bunch of different things like your yearly family income, are you married or not, do you have children, will you keep working until age 65, and do you own your home.

The common wisdom is you will spend roughly 70% of your yearly income when you retire. For example, if your family income is $100,000 average during your working years, you will need to spend $70,000 a year to maintain your standard of living in retirement.

The problem with this 70% number is it makes it very difficult to save enough while working unless you dramatically cut expenses when you are young. It also doesn’t take into account the fact that you won’t be supporting your children, or have a mortgage in your 60s and 70s.

Actuaries has been studying spending habits as we age for years. Their conclusions are very enlightening and reassuring. Basically, after taking into account the drop in “fixed” expenses like your children and mortgage, the vast majority of people will only need to replace between 40% and 50% of their working income in retirement*. Don’t forget, you will also be entitled to Old Age Security (OAS) and Canada Pension Plan (CPP) in your 60s that will add to your income.

At this level of income, retirees can enjoy the same living standards they had while working. The studies also showed that people did not change their spending habits much after retiring so living the same way you did when you were younger is quite a reasonable expectation. In fact spending actually decreased significantly in later stages of retirement as age and health issues make it harder to spend the same amount of money as you did as a “young” retiree.

What does this all mean for you?

Despite what you might hear in the media, collectively we are not all doomed to a subsistence retirement, as long as you save enough to replace roughly 50% of your income for retirement.

That’s sound better, but how much do you need to save every year while working to reach that 50% target?  In order to have the same lifestyle in retirement as when you were working, you will need to save 6-10% of your yearly income each and every year from age 25 to 65. No excuses.  10% is more conservative and will even allow a cushion for the chance that you are without a job for a short while at some point.



* If you are interested in finding out more about how I reached this 40% to 60% replacement rate, read “The Real Retirement” by Fred Vettese. He goes into wonderful detail about the data and research.

It Doesn't Really Matter

My second ever rock concert was to watch the 80’s glam band Platinum Blond. Their big hit was called “It Doesn’t Really Matter”.  I find myself repeating that line in my mind when I’ve been asked some financial questions over the years.  The most common questions I get from students, former students, colleagues, family and friends that make me think “Platinum Blonde” include:

Which Canadian etf should I buy – XIC, XIU and VCN (all Canadian low cost etfs)?
How much should I save for retirement – 6%,10%, 15% or some other amount?
How often should I rebalance my etfs- twice a year, once a year, or longer?
When should I buy the etfs – all at once, or little bit throughout the year?
Do I need to buy European, Japanese and emerging market etfs?
Which discount broker should I use – big bank broker (eg. Scotia Itrade), or independent broker (Questrade)?

In my mind I’m thinking that these people asking these questions are already winning the investing game.  They’ve decided to take the time to learn how to DIY Invest.  They have decided not to become the suckers that the big banks, mutual fund companies and even financial advisors rely on to pay for their lifestyles.

If you are one of these folks, congratulations!!  The fact you are asking very specific questions on the nuts and bolts of DIY Investing means you are already 95% of the way there to retiring comfortably.
These questions listed here are the other 5% and that is why the answer to these questions typically is

“It doesn’t  really matter”; just do what is easier for you and what improves the chances that you will continue to save 6-15% of your income in low cost etfs until you reach retirement age.
In any case, here are how I’d answer the questions:

The difference between XIC, XIU, VCN is insignificant.  Buy one and stick with it.

Save between 6% and 15% depending on your chicken index.

Try to rebalance once per year, but if you forget, do it when you remember to.

I’d buy my Canadian etf first when I have the money, then I’d buy my International etf when I have the next block of money, and then finally my Canadian bond etf.   3 purchases during the year; that’s it, no more trading.

If you are more comfortable sticking only to Canadian and US stocks, that’s okay. I’ve seen analysis that adding non North American stocks to your portfolio has not significantly boosted returns since 1970.   Remember Warren Buffett will put all his money in the US broad market when he can no longer invest for himself.

If you like the convenience of setting up a brokerage account with your personal bank, then do that.  You pay a little more each time to buy an etf, but since you won’t be trading and will make few purchases, the extra cost is not significant.

IT DOESN’T REALLY MATTER

IT DOESN’T REALLY MATTER

My second ever rock concert was to watch the 80’s glam band Platinum Blonde perform at the Fire Fighters Club in Markham. Their big hit was called “It Doesn’t Really Matter”.  I find myself repeating that line in my mind when I’ve been asked some financial questions over the years.  The most common questions I get from students, former students, colleagues, family and friends that make me think “Platinum Blonde” include:

Which Canadian etf should I buy – XIC, XIU and VCN (all Canadian low cost etfs)?
How much should I save for retirement – 6%,10%, 15% or some other amount?
How often should I rebalance my etfs- twice a year, once a year, or longer?
When should I buy the etfs – all at once, or little bit throughout the year?
Do I need to buy European, Japanese and emerging market etfs?
Which discount broker should I use – big bank broker (eg. Scotia Itrade), or independent broker (Questrade)?

In my mind I’m thinking that these people asking these questions are already winning the investing game.  They’ve decided to take the time to learn how to DIY Invest.  They have decided not to become the suckers that the big banks, mutual fund companies and even financial advisors rely on to pay for their lifestyles.

If you are one of these folks, congratulations!!  The fact you are asking very specific questions on the nuts and bolts of DIY Investing means you are already 95% of the way there to retiring comfortably.
These questions listed here are the other 5% and that is why the answer to these questions typically is

“It doesn’t  really matter”; just do what is easier for you and what improves the chances that you will continue to save 6-15% of your income in low cost etfs until you reach retirement age.
In any case, here are how I’d answer the questions:

The difference between XIC, XIU, VCN is insignificant.  Buy one and stick with it.

Save between 6% and 15% depending on your chicken index.

Try to rebalance once per year, but if you forget, do it when you remember to.

I’d buy my Canadian etf first when I have the money, then I’d buy my International etf when I have the next block of money, and then finally my Canadian bond etf.   3 purchases during the year; that’s it, no more trading.

If you are more comfortable sticking only to Canadian and US stocks, that’s okay. I’ve seen analysis that adding non North American stocks to your portfolio has not significantly boosted returns since 1970.   Remember Warren Buffett will put all his money in the US broad market when he can no longer invest for himself.

If you like the convenience of setting up a brokerage account with your personal bank, then do that.  You pay a little more each time to buy an etf, but since you won’t be trading and will make few purchases, the extra cost is not significant.

Yale University Investing Advice

David Swensen is an investing superstar.  He manages Yale University’s endowment which is valued at over $22 billion.  Over the past two decades, Yale’s endowment has grown an average of 16.8 percent a year, more than any university, foundation or pension fund.  Here is some of his advice for individual investors to D.I.Y. invest.

Paying for Advice :

“Paying up to 1.25 percent of the total investment. That means an investor with a half-million dollars invested in a retirement 401K would end up paying about $6,250 a year in fees.

Over 20 years, that person is losing hundreds of thousands of dollars because of fees. Of course, that’s better than not investing at all, and a lot of people want an adviser to help them.  Most of these investment services provide pretty mediocre advice, and it’s just not worth giving them a percentage of your life savings.

That’s the wrong path and the reason it’s the wrong path is it’s a very, very expensive path.”

What to Invest in:

“Fees are also the big reason you should buy index funds instead of classic mutual funds. Index funds, which track market segments like the S&P 500, are a lot cheaper. The vast majority of professional mutual fund managers fail to beat those indexes.

When you look at the results on an after-fee, after-tax basis over reasonably long periods of time, there’s almost no chance that you end up beating an index fund the odds are 100 to 1.

Don’t try to pick individual stocks, instead pick nonprofit funds like Vanguard”

YALE UNIVERSITY INVESTING ADVICE

YALE UNIVERSITY INVESTING ADVICE



David Swensen is an investing superstar.  He manages Yale University’s endowment which is valued at over $22 billion.  Over the past two decades, Yale’s endowment has grown an average of 16.8 percent a year, more than any university, foundation or pension fund.  Here is some of his advice for individual investors to D.I.Y. invest.

Paying for Advice :

“Paying up to 1.25 percent of the total investment. That means an investor with a half-million dollars invested in a retirement 401K would end up paying about $6,250 a year in fees.

Over 20 years, that person is losing hundreds of thousands of dollars because of fees. Of course, that’s better than not investing at all, and a lot of people want an adviser to help them.  Most of these investment services provide pretty mediocre advice, and it’s just not worth giving them a percentage of your life savings.

That’s the wrong path and the reason it’s the wrong path is it’s a very, very expensive path.”

What to Invest in:

“Fees are also the big reason you should buy index funds instead of classic mutual funds. Index funds, which track market segments like the S&P 500, are a lot cheaper. The vast majority of professional mutual fund managers fail to beat those indexes.

When you look at the results on an after-fee, after-tax basis over reasonably long periods of time, there’s almost no chance that you end up beating an index fund the odds are 100 to 1.

Don’t try to pick individual stocks, instead pick nonprofit funds like Vanguard”

The Most Important Advice from Warren Buffett's 2017 Annual Letter to Shareholders

Mr. Buffett, as usual, has lots of useful advice to help ordinary investors improve their investing skill and increase the odds of success in achieving investment goals.

From this year’s letter, he addressed the fact that stocks will go down from time to time and instead of panicking, we should follow Rudyard Kipling’s advice.

“When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If:

If you can keep your head when all about you are losing theirs . . .
If you can wait and not be tired by waiting . . .
If you can think – and not make thoughts your aim . . .
If you can trust yourself when all men doubt you
Yours is the Earth and everything that’s in it.”

The Most Important Advice from Warren Buffett's 2017 Annual Letter to Shareholders

Mr. Buffett, as usual, has lots of useful advice to help ordinary investors improve their investing skill and increase the odds of success in achieving investment goals.

From this year's letter, he addressed the fact that stocks will go down from time to time and instead of panicking, we should follow Rudyard Kipling's advice.

"When major declines occur, however, they offer extraordinary opportunities to those who are not handicapped by debt. That’s the time to heed these lines from Kipling’s If:

If you can keep your head when all about you are losing theirs . . .
If you can wait and not be tired by waiting . . .
If you can think – and not make thoughts your aim . . .
If you can trust yourself when all men doubt you
Yours is the Earth and everything that’s in it.”