Behavioural Finance – Doug Carroll

To sleep, to wake, to make better financial decisions

Here’s one of those Running Thoughts … Despite (because of?) the pandemic, I’ve been making a point to get out for a run whenever the weather even closely accommodates, and otherwise I’ve been keeping up with my indoor workouts. Either way, the earphones are in, so I’m getting in more audiobooks and podcasts.

I just got through a rather lengthy book this afternoon, Why we sleep from Matthew Walker. This link takes you to Walker’s author page, where you’ll find a link over to Amazon if you want to buy the book – OR, you can do as I did, and borrow it from your local library. In my case, I listened to it on cloudLibrary.

While I didn’t think I was all alone in having occasional sleep challenges, Walker provides an eye-opening view (sorry … typed that before I realized how cheesy, but I’m leaving it) of just how prevalent and problematic sleep challenges can be. He reinforces over and over how drowsiness is worse than drunk driving (in terms of its statistical frequency, not morally speaking).

My own sleep challenges

As a young(er) adult, like many I thought I was almost immune to sleep problems. Once our babies were on the bottle, I was the primary night-feeding designate, as I could be done and back to sleep almost immediately, often 2 or 3 times on a given night. My belief was bolstered (to my detriment) by the ease with which I could rise early for flights, adapt to time zone changes and hotel beds, and fall asleep right after coming back in the door. (Hmm, those regular absences might also explain why I was on tap for baby bottles when I was home.)

Things changed in recent years, with changing job responsibilities, changing jobs altogether, and just changes in me due to age (this last one not boding well, given that I’m not yet at the age when this is more commonly a concern).

Thoughts on sleep and personal finance?

Your ability to focus is significantly impaired if you are not getting 7-9 hours of sleep consistently. Despite the bravado claims of people who burn the candle at both ends, they are paying for that now, and will pay for it in future in terms of weakened health, frayed relationships and reduced life expectancy.

The simplest application of this material is that one should be careful to be well-rested before making any significant financial decision.

And as financial decisions go, a house purchase is the biggest for most of us. If you have been going through bidding wars, you can literally be losing sleep for weeks on end. Walker’s research shows that your cognitive ability declines in a measurable way when this happens. With the very personal nature of a home purchase, there’s a danger that your emotional drive could overtake your logical side. With so much on the line, it’s important to stay alert so you can keep those two influences in balance.

Walker explains how you can’t catch up on lost sleep one night by simply adding the same amount the next. He emphasizes that it doesn’t fit the analogy of accumulating credits that you cash in later.

Looking now at real credit and debt management, that’s the classic situation where people may lose sleep. Your ability to appreciate, analyze and manage your debt will be compromised if you can’t bring your best brain to bear. Staying awake at night (possibly intentionally) could take you down a spiral that causes large and long-term harm. That’s not to suggest that it will automatically be easy with a good night’s sleep, but if you are able to get that sleep then you give yourself much more of a fighting chance.

Walker’s recommendations for good sleep health

Walker has 12 recommendations, and I’m noting here the key points that stood out for me. You can check out the book yourself for the full list:

Have a regular sleep time. This is #1 for a reason! In fact it’s even more important to have an alarm that tells you when to go to sleep than one that tells you when to get up.
Go to bed only when you’re sleepy, and avoid sleeping on the couch
Avoid daytime napping if you’re having trouble sleeping at night. And if you are a napper, don’t do it after 3pm.
Again if you’re having problems, don’t lie in bed more than 20 minutes dwelling on getting to sleep. Get up and do something relaxing until the urge to sleep returns.
Remove anxiety producing worries by learning to decelerate before going to bed.
Understand how the chemical attributes of nicotine, caffeine and alcohol affect sleep, and how they affect your own sleep.

And one last thing … exercise can contribute to greater sleep consistency. Be sure though to finish 2-3 hours before bedtime so that your body is sufficiently cooled down.

The case for CPP at 70

Why and how advisors can help

_{[A version of this article appeared in Advocis Forum February 2021]}

While playing charades over the holidays, my youngest son stumbled with “a bird in the hand is worth two in the bush”. Eventually we guessed it, and I explained to him that it means accepting a sure thing now rather than holding out for something potentially bigger later.

Coincidentally, that adage also featured prominently in an item on my holiday reading list. It’s a research paper^[1] about delaying Canada Pension Plan retirement benefits, released in late 2020 by the National Institute on Ageing and the FP Canada Foundation.

My long-held opinion has been to take at 65, unless there are compelling reasons to start earlier. After reading this paper, I’m now leaning toward 70 as the default position.

When we’re starting CPP, and why

The majority of Canadians – 7 out of 10 – take their CPP retirement pension at either 60 or 65. Less than 5% take after age 65, and only 1% wait until 70. The study’s author, Bonnie-Jeanne MacDonald, attributes this pattern of early uptake to a combination of lack of advice, bad advice and ‘bad “good” advice’.

The bad advice includes the emotional pull of the bird-in-the-hand: ‘If you die early (so the argument goes), you’ll leave money on the table, so take CPP as soon as you can’. However, the only guarantee is that your payments start sooner, not that you’ll receive more. And ironically, the early uptake may in fact increase the likelihood that you will receive less, as we’ll see following.

The ‘bad “good” advice’ is the mainstream practice of using a breakeven age. It compares two starting ages, say 60 and 65, focusing attention on whether you will reach the age when the cumulative receipts are the same. This plays to our behavioural tendency to favour the near-term (from first age to second age to breakeven age), thereby undervaluing the lifetime income security that CPP offers. On top of that, academic research shows we tend to underestimate our life expectancy, making it even more likely to choose the earlier start.

According to Canada’s Chief Actuary, life expectancy at age 60 is 85.9 for men and 88.5 for women. In my own experience, I’ve never seen a suggested breakeven/crossover age much over 80. This has long been my discomfort with this approach, as you are betting on being in the ‘dies-before’ half of the cohort population. You lose (statistically) simply by being average, and it gets worse the longer you live.

Measuring the dollar difference

Early uptake would not be a concern if it in fact leads to a better financial outcome. To test this, MacDonald departs from the breakeven approach, favouring a calculation of the current dollar value of the expected loss, or “Lifetime Loss”.

For someone with average life expectancy entitled to the median CPP income who takes at 60 rather than delaying to 70, the Lifetime Loss in current dollars is over $100,000.

The model factors-in the drawdown of RRSP/RRIF savings until the CPP begins. Including this component, it finds that most people will still be much better off by bridging this way, than by taking CPP early and stretching their RRSP/RRIF money over the expected retirement years.

Notably among the scenarios canvassed in the paper, someone entitled to the maximum CPP pension who lives close to age 100 (a 25% probability from age 60 according to the dataset used), the current dollar loss can exceed a quarter of a million dollars.

Advisors have a key role

To be clear, Lifetime Loss is not intended to be applied without consideration of individual circumstances. There are many situations where it would make sense to begin early, such as when there is a known life-limiting health condition, or when someone is trying to preserve income-tested benefits or shield against the Old Age Security clawback.

For most people, it’s a challenge just to identify all the contributing factors in making such a decision, let alone evaluate the trade-offs among them. It’s both technically complicated and emotionally charged, which together can be overwhelming.

In addition to being a dependable information source, financial advisors can guide their clients by applying some of the lessons of behavioural finance:

Loss aversion holds that we feel the pain of loss twice as much as the joy of gain, which is what Lifetime Loss illustrates in concrete terms.
It also frames the discussion on the more likely scenario of longevity, as opposed to early death.
Lastly, it anchors at the later age of 70, to be lowered as the analysis warrants rather than having to make the uphill battle from age 60.

Ultimately the decision should be informed by individual particulars and reliable evidence. In the latter respect, I recommend this paper as a helpful resource for all financial advisors.

^{1 https://www.fpcanadaresearchfoundation.ca/media/5fpda5zw/cpp_qpp-reseach-paper.pdf}

FOMO and market timing

Turbulence can breed troublesome behaviour

Fear-of-missing-out — FOMO — can have a dangerous influence on investors who subscribe to ‘market timing’. Acknowledging that there is always a time when you enter, remain and exit, market timing suggests that you can get better investment returns by predicting when to move in and out of markets or asset classes, sometimes on short timelines.

Witness yesterday, October 24, 2018: With eyes & ears pealed to devices awaiting the Bank of Canada interest rate call (it went up by 0.25%), markets took a tumble. Closest to home, the Toronto index had its largest one-day decline since 2015.

Are these events connected, could you have predicted this, and could you have moved to avoid fallout? “Maybe” on all counts, but most importantly on that last one, should you?

The financial planning lens

Financial planning is the broad view of you, informed by your past and aware of your future, so that you can act confidently in your present. A critical component of this is how you view and manage your investments, from the overall purpose of funding your future, down through the particular parts with nearer-term intentions.

As conditions change out there, you need to make appropriate adjustments so the investments continue to serve your defined purposes. It’s about getting and staying informed, and being at-the-ready. You’re not merely reacting and being driven by observations, but rather responding in a measured manner that always comes back to you.

From principles to the practical – What experienced financial advisors say and do

Market timing as a concept has been around as long as markets. As to its ease-of-use and effectiveness, the website Investopedia points to research from Morningstar that suggests it most often comes up short in both respects. That said, none of us are made of pure logic. We’re emotional, some more than others (especially in turbulent markets), which makes the notion of market timing enticing. How do you keep yourself on-track?

First, look to your advisor to provide you with insight, backed up by credible research, until you are content that you understand what is going on presently. That’s what our advisors do, and based on their experience they can share how they have dealt with this in the past. And without downplaying the seriousness, relevant stories and analogies also help as emotional reinforcement, so here are some I’ve collected from a few of our advisors:

Not in my house

Advisor Paul Shelestowsky asks, “If one day you woke up and found out your $500,000 house is now worth $450,000, would you sell it, put the money in cash, rent for 6 months, then buy your house back for $500,000?”

Cruising along

Advisor Nancie Taylor points out that, “Cruise ships will often run into rough water during a voyage, but you don’t jump on the life rafts and abandon ship. You trust the captain and crew to get you to your destination.”

Wear blinders, but don’t act blindly

Advisor Jordan Damiani sums up, “Blinders keep a race horse focused on the track ahead, not on the distractions at the side. In fact, they’re not blinders at all – they’re ‘focusers’.” In short, focus on your individual time horizon, goals and risk tolerance, with diversified investments that take speculation out, so you have a successful long-term result.