Blessed by the Potato

A little while ago I was approached with a unique opportunity: to actively manage an investment portfolio for someone else, which we named the Blueberry Portfolio. For this, I’ve been writing monthly letters about what has been happening in the portfolio, which gives me a bit of pre-written content to post here when I get busy in RL. At first the letters will be coming in with a 7-8 month lag, but I anticipate I’ll post them more than once a month, letting you catch up to near-real-time.

At the time I started, it was my understanding that this investor had a balanced and well-diversified portfolio, and that the Blueberry portfolio was free to invest somewhat aggressively without paying much heed to diversification. The goal was to use a value style with a fair bit of concentration. My idea going in was to have about 5 “core” positions with weightings of about 10% each, and another 10-15 smaller positions.

In the way of fees, I was to share in the profits (after trading fees) in a manner that can only be described as generous, with no fees for under-performance [it is at this point that you probably realize the owner of the Blueberry portfolio is a relation, and the fee structure is a convoluted gift]. The initial benchmark was absolute – comparing performance to a HISA, but at my suggestion we also compared relative performance to the Canadian Index ETF XIU (since that’s where this money would have gone otherwise).

The initial core positions identified were Berkshire Hathaway, Capital Power Income Fund, Chemtrade Income Fund, Daylight Energy, and Google. Almost immediately, I ran into an embarrassing problem: I couldn’t figure out how to execute trades on US securities in the portfolio. So the portfolio became Canadian-only; Canexus was bumped up to “core” weighting, and only 4 stocks had that high a weighting. The smaller positions were built as opportunities presented themselves — which didn’t take long in the summer of 2011.

Hopefully you’ll find these letters worth your time: they’re not Buffett partnership quality, but they will give you some insight into my thought processes, and allow you to follow along (with a time lag) with actual portfolio performance.

There is no special significance to seeing the digits roll over and all those zeroes line up on a milestone post like this one, number 1000 here at BbtP. It’s particularly meaningless because the URL doesn’t even have 1000 in it: it’s up there as 1125 — an artifact of having 125 posts/pages that didn’t become part of the post timeline. And the starting point isn’t the starting point of the website, just the point in 2005 when I switched over to WordPress.

But we’re (mostly) humans: we’re not strictly rational, and we do like to take time to reflect.

So woo-hoo, post #1000!

When I first got the idea for this site, I was a sleep-deprived high school student. When a less-awesome and significantly less-popular version than I had in my mind’s eye first launched, I was a sleep-deprived undergrad. When I switched over to WordPress and a more codified blog format (and “blog” became a word), I was a sleep-deprived master’s student. Now look at me: a sleep-deprived dad!

I’ve blogged about whatever happened to be on my mind, with primary focuses shifting over the years from video games to the environment, internet throttling to hybrid cars, and my now most-popular category: personal finance.

I’ve never pretended to have a schedule, so the frequency of blog posts has waxed and waned, anywhere from several long ones in a row as I pounded on the keyboard, to periods of relative quiet (like now — one of the few times I’ve posted less than once a week). I’ve had some good feedback to be sure, which is to be expected with such high-quality readership, but less back-and-forth in the comments than I expected: most posts have zero comments, and over-all I have more posts than comments from people who are not me. I can only assume that it implies that my posts and logic are perfect, since the primary function of comment sections is to point out errors and disagreements.

There’s no telling what the next thousand posts will bring. Likely more stories of my daughter, since that’s new. Maybe I’ll continue to average just one post a week vs. the three per week I was running at for much of the last 6 years. Or maybe having a hellishly long commute will lead to a lot of time to write — though likely with pen & paper or on my blackberry rather than on a computer.

I have no idea what will be coming down life’s road, but odds are good I’ll be writing and ranting about it here, and I hope you follow along with me.

Good news: I got a job offer this week!

The offer was laid out a little differently than I was expecting in that it comes with a defined benefit pension! These days a DB pension is a rare, nearly mythological thing, and it definitely adds value to the offer, possibly even more than a higher up-front salary. Being well, me, I decided to try to use a bit of spreadsheeting to come up with an approximation of how valuable that DB pension is to me. There are doubtless actual actuaries out there who would laugh at my attempts to do this from first principles, but if they do decide to correct my methods, I will welcome the learning opportunity :)

So without getting too far up into my business, let’s use some nice round fabricated numbers and suppose for the sake of argument here that I had a competing job offer with no pension but a $5k higher salary, and wanted to try to value the pension to compare (as much as is possible) the two offers. The DB pension involves taking some percentage of my salary from me to invest in the plan, and that is matched by contributions from my employer. Let’s say that my employer’s contributions would amount to $3.5k/year. That might be one quick way to value the DB: the amount of the bonus contributions from my employer. However, a pension is a little more complicated than that: I can’t actually use that money the way I would want to (whether for investing or spending), yet it’s also less risky than investing on my own in stocks/ETFs/e-series index funds would be.

If I go to the pension calculator provided on the website of the pension fund, I can see that with certain assumptions (namely that I’d continue to work for the same employer until age 60) that the pension would provide a stream of income in retirement, let’s say $26k/year here. A pension is a bit different than having a pool of investable assets in that it provides protection against longevity: no matter how old I manage to live to, the pension will continue to pay without running out. On the other hand, there’s less flexibility and no inheritance to leave behind if I do die early. Let’s be somewhat fair to the pension and assume I’ll live to a nice ripe old age of 89 (a few years longer than the actuarial tables might otherwise suggest).

What pool of capital would I need to provide that $26k yearly income? Assuming a conservative 2% real return, that would be roughly $594k saved at age 60. To get to that point, I’d have to save a fair bit every year between now and then. Using a slightly higher rate of return during the saving years (3% real) and assuming that the contributions increase at 1% per year (in-line with the raises I used in the pension calculator), that would be a hefty savings of almost $13k per year.

In other words, the DB pension could be worth a lot more than just the employer match being put up every year.

There are a few wrinkles though: the rate of return might be too conservative. I’m not too concerned on that point, since even if I use a more aggressive rate of return (3% in retirement, 5% in the savings years) the value of the DB plan still seems to be greater than the up-front salary of the hypothetical competing offer: I’d have to save $8.6k/yr on my own under those assumptions, which is still $5.1k more than the amount being taken off for the pension. Even if they gave me an additional $5k up front that I saved on my own, I might prefer the pension due to lower market and longevity risks (plus I’d lose out to taxes if I ran out of RRSP contribution room).

The other big wrinkle is that this is all assuming that I stay in the job (and that the pension plan doesn’t get significantly modified) until I turn 60. What seems to be weird about the pension calculation (which may be an artifact of the web calculator but I believe is actually in the payout calculation) is that there’s no time value to contributions: all that seems to matter is years of service. If I work from 33-36, that’s 3 years of service and seems to be worth the same as if I worked from 57-60. Yet clearly money saved while in my thirties should be able to compound and provide more monthly income in retirement than money contributed in my fifties. If I end up moving to a different job in the next few years, then my pension contributions won’t be compounding in the same way as if I had saved some money and invested it in an RRSP. That gets complicated though, since there is the option to cash out the commuted value to a LIRA, and I can’t find any way of estimating that. If I choose to leave the pension alone, then it looks like it’s still about as good as the amount I’m contributing and the employer match growing at 5% (then 2% during the payout years).

Though it’s tough to decide how valuable a DB pension is, it looks like it’s worth at least as much as the employer match, and possibly triple that. The older one is (and the longer one stays on the job), the more valuable the DB pension benefit becomes.

A reader asks whether or not he should start taking CPP early. There are hundreds of articles out there asking this very question, but that’s not going to stop me from giving you my take on it, too! [Edit: can’t believe I forgot to link to Michael James’ post on the matter, which has a graph!]

For those who are unaware, CPP stands for Canada Pension Plan: you pay into the plan in your working years, and in return in your sunset years the plan pays you a small pension. The normal age for that to happen is 65, but you can start taking payments as early as 60 if you like, or put off withdrawing until age 70. Taking it early incurs a penalty (you get 36% less if you start at 60), while you get a bonus to your payments if you defer taking it. My impression from reading all the articles along the way was that the system was set up to be pretty close to break-even, so you should just start taking payments early if you needed them, and defer if you didn’t (e.g., if you were still working at age 60).

But the question has been posed, so let’s answer it!

First up, the very simple case of not giving any value to having the payments early (i.e.: not investing). In that case there’s a break-even point around age 74 in terms of how much total money you can pull from the plan: if you die before age 74, you’ll have squeezed the most out of the plan by taking CPP right at 60. If you live longer, you’ll be glad for having put off withdrawing until age 65 to get that bigger benefit, and it’ll add up to getting more out of the plan in the end. This agrees with most of the articles I’ve found.

If you invest the money you start taking right away (or equivalently, keep more money in your investments because you’re spending the CPP money), then that gives more benefit to having money early on (it compounds). With a 3% real return, that pushes the break-even point back to age 76, and with a 6% return, it pushes the break-even back to age 80.

One non-financial reason for taking it early was given somewhere (and unfortunately I’ve closed the tab, or I’d give credit): even if you get less total payout, you should still take it early because you’ll enjoy a bit of money more at age 60 than you will more money at age 70. Your lifestyle expenses may be higher when you’re a young retiree in good health than when you’re older, so even a reduced pension will be put to better use. On the flip side, your medical bills may be higher in later life, and the higher payout of a deferred CPP payment may come in handy then.

Update: years after this, I’ve had more time to think about this, and the case for deferring is much stronger. That’s because I wasn’t properly considering the importance of longevity insurance — it’s not just about some break-even age. If you can defer, then defer — if you have no savings, then you may have no choice but to take it as soon as you stop working. As for the last point about enjoying it more when you’re younger, when you factor it all in that’s rubbish too — if you have the savings, then you can spend your savings while you’re younger to enjoy the spending at a younger age, which you can do with confidence because the higher CPP payments later in life will be guaranteed and inflation-adjusted. If you want to instead take CPP early to spend when you’ll enjoy it, you’ll end up having to hold back more of your own savings, as you have to be more conservative with your longevity and return assumptions. It feels different to spend the government cheque than your own savings, but you can safely spend more earlier in retirement (out of your own savings) by deferring!

So my final answer is a little wishy-washy: most people will expect to live beyond the break-even point, so waiting until the “normal” age of 65 to take CPP should make sense. However, it’s not by a huge margin, so if you need the money starting at age 60, then take it starting at that point.