Author: Susie Q

Rental Property: Real Life Experiences

Rental Property: Real Life Experiences

Many people view residential rental property as a great investment.  I’ve never had any interest in committing the time I perceive is necessary.  I’ve also not made much money on my residences.  As such, I haven’t seriously considered the purchase of investment property. To get 

Property and Casualty Insurance

Property and Casualty Insurance

Protection against loss is critical for everything you do, including running your own business or earning money from a side hustle.  The primary tool for mitigating business risks is property-casualty insurance.  There are many insurance policies within the realm of property-casualty insurance, each with its 

The Home Equity Fallacy

The Home Equity Fallacy

Building home equity can increase your financial security, but it isn’t necessarily the best way to maximize your net worth.  That is, building home equity quickly isn’t necessarily the right choice for everyone, not even those who have the financial wherewithal to do so.

I’ve frequently heard two statements relating to home ownership that hold true for some people, but I consider them to be fallacies when applied to everyone.

  1.  It is always better to own than rent.
  2.  If you own, you should pay off your mortgage as quickly as possible.

There are definitely people, including me, for whom one or both of these statements are true.  However, in the current mortgage interest rate environment, neither is true for people whose primary financial goal is to increase their net worth!

In this post, I’ll talk about the theory behind how rent is determined, provide a simple framework for comparing options for ownership and renting, and apply that framework under a number of different scenarios to see what happens to your net worth.

Your Priorities and Situation

Before digging into the analysis below, you’ll want to identify your priorities.  The analysis below assumes that your primary financial goal is to maximize your net worth.  It also assumes that you are indifferent between renting or owning from a lifestyle perspective. And, it assumes you have the ability to handle the risks of home ownership.  All of these considerations are discussed in more detail in this post.  You’ll need to consider the extent to which these assumptions apply to you before you use the findings below to inform your decisions.

In many situations, the analysis suggests that either renting or paying down your mortgage (i.e. building home equity) slowly will maximize your net worth.  However, many people, including me, prefer to have as large a home equity as possible.  Characteristics that might put you in the same category as me are that you are:

  • Living off your investments and a preference to eliminate a monthly mortgage payment from your cash expenses.
  • Averse to risk, leading you to not want to find that your investments have decreased in value at the same time you need to liquidate them to make mortgage payments.
  • Someone who likes the comfort of knowing that, in all but the most extreme scenarios, you have a place to live.

Because I have all three of the characteristics, and because my first few home purchases happened when mortgage interest rates were between 9% and 17%, I paid off my mortgages as quickly as possible.  I also paid cash for my most recent two residences with the proceeds of the sales of their predecessors.

Finances Rent vs. Owning, in Theory

In theory, the economic cost of renting should be more than economic cost of owning.  First, the owner needs to make a profit to cover opportunity cost of owning the property.  Second, the owner is taking on risk from the uncertainty in their ability to find renters and the cost and timing of repair costs for which the owner needs to be compensated.

An important consideration, though is the difference between the economic costs of ownership vs. renting and the cash flows of both options.  Specifically, your down payment and the portion of mortgage payments that go towards principal are not part of the economic cost of owning your home.  The principal portion is a transfer from cash to equity in your home.  As such, from a cash perspective (as opposed to an economic perspective), you will often need to pay more in cash to cover the costs of home ownership than to pay rent.

The economic cost of the equity in your residence is the opportunity cost of not being able to invest it elsewhere.  This amount differs from the amount of your down payment and mortgage payments.  The value of your home may increase, so your opportunity cost is the difference between the return you would earn if you invested your money in a different asset, such as the stock market, and the appreciation in the value of your home.

Appreciation from Ownership

When I was young, most people assumed that the price of houses went up every year.  Reality has shown that not to be the case, both when looking at regional and local conditions and also when looking at US nationwide housing price changes.  The chart below shows the average price changes by year from 1988 to 2019, the length of the period available for the Case-Schiller US National Home Price Index on the Federal Reserve website.

Historical Housing Price Changes

As you can see, in most years, the price of houses went up.  However, in 1992 and from 2008 through 2012, the prices went down with the worst year, 2009, reporting a 12.6% decrease in home values.

Other Considerations

A comparison of the financial aspects of renting and owning also has to consider what you are willing to rent as compared to what you might buy.  The inferences above apply only if you are renting and buying the same residence.  If, on the other hand, you are willing to rent an apartment but are only willing to buy a house, the rental option can become much more attractive.  There are economies of scale gained from running an apartment complex that aren’t available to owners of single family homes.  Also, you might be willing to rent a residence that is smaller than one that you might buy.  Again, if that is the case, the rental option might be more attractive.

Rent vs. Own – Simple Illustration

To help you understand the finances of renting and owning your residence, I’ll start with a simple illustration.  In it, I compare three options:

  • Buy your residence
  • Rent the same residence
  • Rent a smaller property

Key Assumptions

Here are the key assumptions for the three options.

Buy Your Residence

I selected a 1,500 square foot house in Des Moines, Iowa for my illustration.  A typical house that size there has a current market value of about $240,000.  The countrywide annual average appreciation is 4% every year.  I have assumed that you pay 15% as a down payment and have a 30-year fixed-rate mortgage at 3%.

Utilities are assumed to be $200/month and property taxes and homeowner’s insurance total 1.5% of the market value each year.  In addition, I’ve included 2% per year for maintenance and repairs and 0.5% per year for updates.  These costs are assumed to increase with inflation at 3% per year.

I’ve assumed $1,000 of closing costs at both purchase and closing plus a 5% sales commission when you sell.  Last, I’ve assumed that you leave $10,000 in cash in an emergency fund at all times.

Rent the Same Property

The same house rents for about $1,400 a month, including utilities.  I’ve added renter’s insurance at $120 per year.  Both of these costs are assumed to increase at 3% a year for inflation.

Under this strategy, I assume that you invest the down payment plus emergency fund money at a 7% return per year.  The mortgage payments plus other costs of home ownership are more than rent and renters insurance, so I’ve assumed you also invest the difference at 7% per year.

Rent a Smaller Property

If, instead of a house, you choose to live in an 1,100 square foot apartment, your rent is only $1,100, including utilities, increasing with inflation.  As with the previous strategy, differences between the costs of home ownership and the cost of renting the smaller property are assumed to be invested at 7% per year.

Net Worth Comparison

This section contains a simple comparison of your net worth under the three options described above – own your home, rent a similar home or rent something smaller.  For this illustration, I’ve assumed you own your home for ten years.

Ownership Cash Flows

The chart below shows your annual cash flows using the assumptions above if you buy a home and sell it in ten years.

Ownership Cash Floww

The dark blue bar on the left is your down payment, buyers’ closing costs and the $10,000 of cash you set aside for an emergency fund.  The subsequent ten bars show your mortgage expense (orange), property taxes and homeowner’s insurance (gray), utilities (yellow) and maintenance, repairs and updates (light blue).

After ten years, under the simple assumptions, you can sell your home for $355,000.  From that, you pay 5% in real estate agent commissions and $1,000 in seller’s closing costs.  In addition, you don’t need the $10,000 in your emergency fund.  Thus, at the end of ten years, you get $346,000.  From that, you need to re-pay the remaining $150,000 of mortgage principal, so your net worth is $196,000.  Of that $196,000, $106,000 is from appreciation in the value of your home and $40,000 is from the principal portion of your mortgage payments.

Annual Cash Flow Comparison

The chart below compares the annual cash flows from the three options over the ten-year time period.

Buy vs Rent Cash Flow Comparison

The blue bars show the total of the cash flows in the previous chart from owning your home.  The yellow bars show your cash flows for renting the same home and the gray ones for renting a smaller residence.  These last two sets of bars include rent and renter’s insurance.  I note that the blue bars are taller than the yellow bars because they include your down payment and the principal portion of mortgage payments, both of which allow you to build equity in your home.

Net Worth Comparison

If you own your home, your net worth increases from the appreciation in the value of your residence.  Because you have borrowed some of the money to pay for your house, your percentage growth rate of your home equity is higher than the appreciation rate of the house itself.  This result is called leveraging, as you get the dollar value appreciation of your house while investing only a portion of it yourself.

If you don’t own your home, you can invest the difference between the cash flows represented by the blue bars and those represented by either the yellow or gray bars.  For this simple example, I’ll assume that you earn a 7% annual average return on your money by investing it in the stock market.  To further keep the example simple, I ignore income taxes.

The chart below compares your net worth under the three strategies at the end of ten years.  In the Buy Your Home option, your net worth is equal to your home equity after you sell.

Home Equity & Net Worth Comparison

In this illustration, you have a higher net worth if you buy your home than if you rent the same home. However, your net worth is much higher if you rent the smaller apartment than if you buy your home.

Rent vs. Own – More Realistic Illustration

In the simple illustration, I ignored risk.  All four of mortgage rates, inflation, home appreciation and stock market returns vary widely from year to year.  In the more realistic illustrations, I use the actual values of these economic variables for each period starting in 1987 and ending in 2019 to introduce volatility.  I’ve looked at this time period because 1987 is the oldest year for which I could find home appreciation values.  Had I used even older time periods, mortgage interest rates would have been outside the range of what is shown here, so the probabilities should not be considered representative of all possible results.

I show four sets of comparisons to increase the likelihood that one of them is close to your situation.  In the first comparison, I use the same assumptions as in the simple illustration other than the economic variables.  I increase your down payment from 15% to 50% and 100% of the purchase price in the second and third comparisons.  In the fourth comparison, I retain the 15% down payment assumption but change only the time period you own the home from ten years to two years.

10 Years; 15% Down

The box and whisker plot (described in this post in case you aren’t familiar with reading one) below compares the simulated values of your net worth (i.e., your home equity) after you sell your home if, under the Buy Home strategy, you own it for ten years and put 15% down.

Home Equity & Net Worth Comparison - 10 Years

Because I used ten years of inflation and stock market return data, the data used in the graph include 23 ten-year periods, those starting in each year from 1987 through 2009.  The boxes represent the range from the 25th percentile to the 75th percentile of your net worth under each strategy.  The line in the middle of the box is your average net worth.  The whiskers that stick out of the boxes range from the 5th to the 95th percentiles.

Using these assumptions, the range of ending net worth values from renting the apartment (gray box) are almost always higher than either of the other two strategies.  At the average (solid line in the middle of each box), you have a very slightly higher net worth if you buy your home (blue) than if you rent the same home (orange).  The range of your net worth is wider if you rent the house and has a higher upper end, due to the possibility of attaining high investment results.  Over a ten-year period, the average return on an investment in the S&P 500 is very rarely negative, so you never have a lower net worth from renting as compared to buying the same home based on this time period.

10 Years; 50% & 100% Down

The higher your down payment, and therefore the higher your equity in your home, the higher your net wroth from renting as compared to buying, as shown in the two charts below.

Home Equity & Net Worth Comparison - 10 Years

Home Equity & Net Worth Comparison - 10 Years

The higher ending net worth values when you rent in the comparisons with bigger down payments emanate from the larger amounts that you have available to invest.  That is, if you are comparing your net worth after renting to the option in which you pay for your house in one lump sum of $240,000, you have the full $240,000 available to invest for the entire ten years.  But, when your down payment was 15%, you had only $ $36,000 (15% of $240,000) to invest for the full period plus the amounts that you paid in principal each month.

2 Years; 15% Down

Another scenario in which your net worth will be higher from renting than from buying is if you plan to own your home for a very short period of time.  For illustration, the chart below compares your net worth if you own your home for only two years and put 15% down.

Home Equity & Net Worth Comparison - 2 Years

Your ending net worth is generally higher under the two rental options than the buy your home option.  However, the difference is not as clear as when you pay cash for your house.  There is much more volatility in stock market returns when looking at only two-year periods as compared to ten-year periods, so the range of results under both rental options (in which you are investing your extra cash) is much wider than in the ten-year scenarios.


These analysis show that, in many cases, your net worth will be higher if you rent than if you own.  However, as noted above, maximizing your net worth is not everyone’s priority when it comes to their residence.  As such, you’ll want to consider your priorities and preferences along with these findings in making your decision to buy or rent.

Flex or Fix in Buy vs. Rent

Flex or Fix in Buy vs. Rent

Your residence is likely one of your biggest expenses.  The most common options for residences are renting and purchasing.  There are costs and benefits to both approaches, some of which depend on your lifestyle and goals and some of which depend on your finances.  In 

Holidays on a Budget

Holidays on a Budget

Even in normal circumstances, the holidays can be stressful.  With the concerns about travel and the impact on many people’s income from COVID-19, the 2020 holidays are likely to be even more challenging.  In this post, I’ll provide ideas that might help alleviate some of 

Make the Most of your Benefits Package

Make the Most of your Benefits Package

Many employers offer a benefits package.  The most common benefits are health insurance and a retirement plans, topics I’ve covered in other posts.  Some benefits packages have other features, such as dental and vision insurance, various kinds of disability and life insurance and, in Canada, extended health care.

In this post, I’ll identify the parts of your benefits package for which you might have to pay a portion of the cost.  I’ll also provide a brief explanation of each and what you might consider as you decide whether to purchase them.  Employers often provide other offerings in their benefits packages, such as access to an Employee Assistance Program or medical advisors, at no cost.  Because you don’t need to make an election or pay for these benefits, they are not covered here but you’ll want to be sure you understand all pieces of your benefits package so you can take full advantage of them.

Dental & Vision Insurance in Your Benefits Package

There are many similarities in the coverage under dental and vision insurance.  In addition, the processes for deciding whether to buy them have a lot of parallels, so I’ll discuss them together.

Dental Insurance

Dental insurance pays for preventative dental services (usually two to four cleanings per year), a portion of other dental expenses (fillings, crown, root canals, for example) and sometimes orthodontia. The amounts of these expenses that are covered depend on the deductible, limits and coinsurance.

Every dental insurance plan I’ve had offered by employers has had a very low maximum limit, such as $1,500 or $2,500 a year.  This coverage differs from most other insurance products. Most other insurance products protect against things you can’t afford to lose, such as the injuries caused by a car accident or a tornado that destroys your home, and often have you pay for the “predictable” part through a deductible.

Vision Insurance

Vision insurance generally covers the basics – eye exams related to vision correction, glasses and contact lenses – and doesn’t usually cover more serious eye conditions.  Some eye conditions are considered medical in nature and are covered by health insurance. If you have an eye condition, I suggest contacting your health insurer to see if it is covered as a medical condition.

Networks of Providers

Many dental and vision insurers create networks of providers. My experience is that there are huge differences in coverage in and out of network, so you’ll want to see whether your providers are in the network before making any cost comparisons.

One year, my eye clinic was listed as being in network, but it turned out my specific eye doctor was not. As such, it might make sense to call your eye doctor’s office before selecting vision coverage to confirm that your specific provider is in your network.

Cost Comparison

Because dental and vision insurance have such low limits, they don’t provide much protection against large bills. As such, the decision to purchase them is primarily a comparison of your premium with your covered expenses. That is, you want to answer the question, “Will I recover more from the insurer than I pay in premium?”

Each year, I estimated my family’s dental and vision expenses by type.  For dental, I considered how many family members get regular cleanings, what the visits would cost and whether either of my children had braces. I ignored all other dental expenses, such as fillings or root canals, for this part of my analysis.  For vision, I counted the number of vision exams, pairs of glasses and contact lenses my family was likely to need.

I applied the deductibles, limits and coinsurance to the expenses to get an estimate of what I might recover from the insurer.  I compared that amount with the premium. My post on health insurance provides more information about networks, coinsurance and deductibles.

Other Considerations

Discounts negotiated by the dental insurer with providers are another component of savings.  Similar to health insurance, the cost of dental services provided by in-network providers when you have dental insurance can be significantly less than the cost if you don’t have insurance.  This savings is difficult to quantify initially, but you can estimate it once you have used the same provider under a single dental insurer for a year or two or you can call your dentist and ask about the savings. You can then include those savings in your analysis as a cost covered by the insurer.

You’ll want to research whether your health plan includes basic vision exams for you and your covered dependents.  If your health insurance plan has that coverage (and your provider is in your health insurer’s network which will likely be different from the vision insurer’s network), you’ll want to exclude any recoveries from the health insurer or exclude those expenses from your list before estimating recoveries from your vision insurer.

How to Decide

If the premium and amounts covered by the insurer were fairly close or the premium was less the amount I estimated I would recover (including savings from discounts), I would buy dental and/or vision insurance.  If the premium was significantly more than the covered expenses, I usually took my chances that no one would need any expensive dental work and didn’t make the purchase.   In practice, I bought dental insurance when my kids had braces and usually didn’t buy it otherwise.

As with all other financial decisions, the risk-reward trade-off is an individual one so you will need to decide for yourself how much extra premium you are willing to pay to have a portion of unexpected dental expenses reimbursed by the insurer.  As you do so, remember that there is likely a fairly low cap on the total coverage provided by the insurer, so you’ll want to see how much of that maximum you’ll use up with your preventative and orthodontia expenses in evaluating that risk-reward trade-off.

Many vision insurance plans do not cover anything other than preventative services, glasses and contact lenses.  As such, the decision to purchase vision insurance is often a more straightforward cost-benefit comparison and is less focused on risk and reward.  Of course, if your plan covers other eye issues, you’ll want to take those into consideration in your decision-making process.

Employee Stock Ownership as Part of Your Benefits Package

I have seen three types of employer offerings related to employee stock ownership. I talked about the first, allowing or requiring employees to purchase company stock in their defined contribution plans, in this post.  The second is an Employee Stock Ownership Plan or ESOP which is also a part of a defined contribution plan. The third, an Employee Stock Purchase Plan (ESPP), lets you buy company stock, often at a discount.

Employee Stock Ownership Plan (ESOP)

Under an Employee Stock Ownership Plan (ESOP), an employer contributes company stock to an employee’s defined contribution account.  (For more information about defined contribution plans, see my post on that topic.) The employee cannot sell the stock until he or she resigns or retires from the company, though there are exceptions.

If you want to diversify your company stock holdings, you’ll need to talk to your human resources representative to understand your options, if any.  ESOP contributions are usually subject to vesting (increased ownership by the employee as his or her tenure with the company increases). When the employee retires or resigns, he or she will either receive a lump sum or periodic payments, depending on the terms of the plan.

Employee Stock Purchase Plan

An Employee Stock Purchase Plan (ESPP) allows employees to purchase company stock through payroll deductions.  Many employers offer their company stock at a price lower than is available if purchased through a broker.  The ability to purchase the stock at a discount can be a real benefit, as long as the stock price doesn’t go any lower than your purchase price before you sell it.

ESPPs have varying rules as to how long you have to hold the stock before you can sell it. Also, the tax treatment may be differ depending on how long you hold the stock.   I preferred to have as little of my investments in my employer’s stock as possible. Therefore, I generally purchased stock through the ESPP, but sold it as soon as was allowed to lock in the benefit of the discounted purchase price.

There is a drawback to the approach I took.  If you seek to be a senior executive in a company, company stock ownership is often considered a sign of loyalty and faith in the company.  As such, if this is your goal, you might consider keeping the stock purchased through an ESPP.

Dependent Care Flexible Spending Accounts (US)

Dependent care flexible spending accounts (FSAs) allow you to set aside a portion of your paycheck without paying any taxes on the money. You must use the money to cover out-of-pocket expenses that are related to care of dependent children or parents and are needed to allow you to go to work.  You do not pay Social Security or Federal income taxes on money put into or withdrawn from a dependent care FSA. In many states, you also do not have to pay state income taxes either.

There are restrictions on the types of expenses you can pay from your account. You can generally pay for child daycare (both traditional daycare and nannies), elder care, before-and-after school programs and sick childcare services, among others.  If you plan to use the money for other services, you’ll want to confirm that they are acceptable. This publication from the IRS web site provides lots of details about who can qualify and the types of expenses that are acceptable.

You lose any money you contribute to a dependent care FSA if you don’t spend it in the same year.  For most people, the 2020 maximum contribution was $2,500 if you were single and $5,000 if you are married. That amount hasn’t changed in several years.  If your dependent care expenses are highly likely to exceed that limit, the tax savings make it reasonable to contribute the maximum.  If your expenses are likely to be less, you’ll need to take care in selecting the amount of your contributions so you don’t lose any portion you don’t spend.

Life Insurance Included in a Benefits Package

Many employers offer group life insurance on one or all of the employee, spouse and children.


The type of life insurance offered by employers is term life insurance. It pays the stated benefit amount if the covered person dies during the policy period.  The policy period for an employer-sponsor plan often corresponds to a calendar year.

My employers generally provided life insurance on my life (as the employee) with a benefit amount equal to one year’s salary at no charge.  I was able to purchase more insurance on my life and smaller amounts on my spouse and children at my expense.


Group life insurance won’t provide the stated benefit if the cause of death is excluded from coverage. The most common exclusions with which I’m familiar are suicide and murder by the beneficiary.

If these nuances are important to your decision, you’ll want to ask your human resources representative what exclusions exist under your employer’s coverage. Much more importantly, if you are concerned about your mental health or your physical safety, please seek help! There are free crisis lines that will help with either issue or contact your local hospital for mental health concerns or police for safety issues.

How to Decide

Deciding whether to buy life insurance is often a tough decision, as we all like to think we will still be alive at the end of the year. We especially don’t want to think about what will happen if we or a loved one dies.  However, there are many people who should take advantage of this portion of their benefits package.   I offer some highlights of the decision-making process in the sections that follow, but refer you to my post on buying life insurance if you want more information.

How to Decide About Yourself

As you think about your coverage level, whether you have any dependents and, if so, whether they’ll be able to sustain their current lifestyle without your income and personal expenses are important considerations.  If you have no dependents and very little debt, you might not need more life insurance than one times your salary.  On the other hand, if you have children, have some or a lot of debt or are barely covering your expenses, you might want to buy more life insurance to make sure there is money to pay down your debts and/or support your children if you die.

You’ll also want to consider the cost of the life insurance and whether it fits in your budget. For more information on budgeting, see my introductory post and nine-part series with step-by-step details to create a budget, starting with this post.  If buying life insurance means that you don’t have enough money to cover the basics, you might need to take the riskier approach and not purchase life insurance or not purchase as much.

How to Decide About Your Spouse

The considerations for insuring your spouse are similar to buying insurance for yourself.  You’ll also want to consider whether your spouse’s employer provides any life insurance and, if so, compare the face amounts and premiums between the two plans.

How to Decide About Your Children

The amount of insurance available for the death of children is usually relatively low, in the range of $5,000 to $20,000.  I view the primary purpose of buying life insurance on children as covering funeral and related expenses. If you are able to afford a funeral and everyone who “should” attend can afford to get to the funeral, you are less likely to need life insurance on your children.  However, funerals and travel can be quite expensive, so life insurance on your children could cover some or all of those expenses. As always, you’ll want to evaluate whether the cost of life insurance on your children fits in your budget.

Disability Insurance

Disability insurance replaces a portion of your wages if you are sick or injured.  In the US, where workers’ compensation insurance covers workplace illnesses and injuries, disability usually covers only non-occupational illnesses and injuries. In other jurisdictions, it can cover both occupational and non-occupational illnesses and injuries.

Types of Disability Insurance

Employers offer wage replacement in a number of components, including sick time or paid time-off, short-term disability, long-term disability and supplemental long-term disability.

Sick Time or Paid Time-Off

Sick time or paid time off benefits usually pay you 100% of your wages when you are sick. There is often a limit on how many days of sick time you can take. More recently, vacation days are included in the limit and the total is called “Paid Time-Off.”

Short-Term Disability Insurance

After a stated waiting period called an elimination period, short-term disability insurance will replace some or all of your wages.  I have seen short-term disability plans that pay between two-thirds and 100% of wages (excluding bonus) for between 13 and 26 weeks. I have never had an employer charge me for short-term disability insurance, but imagine some employers might do so.

Some governments outside the US, including Canada, offer programs similar to short-term disability.  If your employer requires that you pay some or all of the premium for a short-term disability program, I suggest you research the benefits provided under any government program in your decision-making process.

Basic Long-Term Disability Insurance

After you have exhausted your short-term disability benefits, you may be eligible for long-term disability benefits if offered by your employer.  The basic long-term disability plans I have seen have paid between 50% of salary and two-thirds of the sum of salary and target bonus. Some long-term disability plans provide benefits for only a limited number of years while others will provide benefits until your normal retirement age.  In all cases, benefits stop, of course, if you recover and are able to return to work. I’ve had employers pay the full cost of basic long-term disability and others that required that I cover a portion of its cost. If you pay some or all of the premium for long-term disability insurance, the corresponding portion of any benefits you receive are not subject to income taxes, at least in the US.

Supplemental Long-Term Disability Insurance

Some employers give you the option to increase the percentage of your income that is replaced by long-term disability at your expense.

How to Decide

The decision whether to purchase any optional disability coverage depends on two key aspects of your financial situation. Are you able to support yourself and your family if you are ill or injured for a long time? Does the cost of the disability insurance fit in your budget?

At one (pretty unlikely) extreme, you don’t need to buy additional coverage because you have enough savings for retirement, any children’s education and maintaining your current lifestyle or you can live on just your spouse’s income for an extended period of time.  At the other extreme, you might find it difficult to afford disability insurance. In that case, you probably are also in the greatest need of it as one missed paycheck could be devastating financially. As such, the decision to purchase disability insurance is a balance between your need for the coverage in case you can’t work, your likelihood of having an accident or becoming serious ill, and your ability to pay the premium.

Accidental Death & Dismemberment Insurance

Accidental Death & Dismemberment Insurance (AD&D) provides additional life insurance if you die in an accident. It also pays you a percentage of the face amount of the policy if you lose or lose use of a body part, such as an arm, a leg or an eye.  Many employers offer this coverage. Some charge for it while others do not.

Business travel accident insurance is a form of AD&D that provides coverage only if you are traveling for business when the accident occurs.  Some policies also provide coverage if the accident occurs on the employer’s premises. Most employers do not charge for this coverage, but some may.

How to Decide Whether to Buy AD&D

I generally did not buy AD&D coverage, though obviously didn’t opt out of it when my employer covered the full cost. I had a desk job for my whole career, so could have gone back to work with at least some amount of disability.

If you have a career that is more physical, you’ll want to think about what injuries would make you permanently unable to pursue your current profession. You’ll want evaluate the amount of benefit that would be provided in case of loss or loss of use of a body part.  If your employer’s policy covers accidents in the workplace, you’ll also want to consider whether your workplace is dangerous, such as a manufacturing facility or an oil well, and, in the US, any recoveries you might receive from workers’ compensation insurance. As always, you’ll want to evaluate the potential benefits of this coverage in your specific situation relative to the cost of the insurance and whether it fits in your budget.

Group Legal Benefit

Some employers offer a group legal benefit either at their or the employee’s expense.  Features of this component of a benefits package can include:

  • A discount on legal representation.
  • Telephonic legal advisory.
  • On-line tools.
  • Other free or reduced-fee services.

I’ve never paid much attention to a group legal benefit, as I considered any legal expenses in my budgeting process and have been very fortunate that I have only had very predictable legal expenses (such as writing wills).

If you anticipate that you might need legal advice, it would make sense to estimate the value of any benefits your employer provides and compare them with the cost charged by the employer.  Even having a will written if you have dependent children can be quite expensive, so the value of the discount might be enough to justify the cost.

Extended Health Care Insurance (Canada)

In Canada, many of the basics of healthcare are provided through the government health plan.  However, many important expenses are not covered, including prescription drugs, medical devices (e.g., crutches, wheelchairs and orthotics), various practitioners (e.g., chiropractors, physiotherapists and psychologists) and many other types of medical expenses.

Extended health care insurance covers a portion of these costs, with the portion and specific costs covered varying from plan to plan. Some plans include dental and vision coverage, the portion of ambulance services not covered by provincial insurance, and semi-private hospital rooms.  The insurance includes many of the same coverage features (limits, deductibles, coinsurance) used in US health insurance. If you are considering the purchase of extended health care insurance, I suggest that you read my Health Insurance post, excluding the sections on HealthCare Flexible Savings and Health Savings Accounts.


I want to thank Laura Kenney for her invaluable help with making sure I clearly explained these aspects of a benefits package.

The Case for a Few Good Stock Runners

The Case for a Few Good Stock Runners

Many investors limit the amount of their investments in individual companies to manage the risk in their portfolios.  Others advocate holding on to stocks whose prices increase faster than the rest of your portfolio (which I’ll call stock runners) as long as the reason you 

Celebrating Our Second Birthday!

Celebrating Our Second Birthday!

We hope you will help us celebrate our second birthday on Friday, October 2, 2020!  In the past year, we published 26 posts on topics ranging from life insurance to investing to financial planning to bitcoin.  In this post, I review what we’ve been doing, 

Why I Chose Patience over Re-balancing

Why I Chose Patience over Re-balancing

Many financial advisors recommend re-balancing your portfolio no less often than annually to ensure the asset allocation is consistent with your risk tolerance, as illustrated in this post from Schwab.  In the past, I haven’t been one to re-balance my portfolio, so I spent some time thinking about why I haven’t followed this common advice.  Up until recently, almost all of my invested assets have been equities, equity-based mutual funds or exchange-traded funds (ETFs).  As such, I didn’t need to do any re-balancing across asset classes.

In this post, I’ll explain re-balancing, its specific purpose and examples of its benefits and drawbacks.  I’ll also explain my strategy (which may or may not be right for you).

What is Re-balancing?

Re-balancing is the process of buying and selling securities in your portfolio to meet certain targets.  In the case of asset classes, the primary purpose of re-balancing is to maintain your target risk/reward balance.

Some people have targets that define their desired allocation across asset classes.  One common rule of thumb is that the portion of your portfolio that should be in bonds is equal to your age with the rest in stocks.  In my case, that would mean roughly 60% of my portfolio in bonds and 40% in stocks.  The goal of this rule of thumb is to decrease the volatility of your investment returns as you get older and closer to that age at which you need to draw down your assets in retirement.

How Does Re-balancing Work?

The process of re-balancing is fairly simple.  Periodically, such as once or twice a year, you compare the market value of your investments with your targets.  If there is a significant difference between how much you own in an asset class and your target percentage, you sell the portion of your investments that is above the target and reinvest the proceeds in something different.

Let’s say your target is 75% stocks and 25% bonds.  You start the year with $10,000 of investments – $7,500 in stocks and $2,500 in bonds.  If stocks go up by 10% and bonds go up by 5%, your year-end balances will be $8,250 in stocks and $2,625 in bonds, for a total of $10,875.  Your targets though are $8,156 of stocks (75% of $10,875) and $2,719 of bonds.  To put your portfolio back in balance, you would need to sell $94 (= $8,250 – $8,156) of stocks and buy $94 of bonds.

You can avoid selling any assets if you have money to add to your investments at the end of the year.  Continuing the example, let’s say you have another $500 available to invest at the end of the year.  That brings your total available for investment to $11,375 (= $10,875 of investments plus $500 cash).  Your targets would be $8,531 (= 75% of $10,875) for stocks and $2,843 for bonds.  In this case, you would buy $281 of stocks and $219 of bonds to meet your targets, eliminating the need to sell any of your assets.

What Does Asset Allocation Do?

The chart below compares the average annual returns and risk profiles of several sample portfolios with different mixes between stocks and bonds.  In the middle four portfolios, the first number is the percentage of the portfolio invested in stocks and the second number is the percentage in bonds.

Annual Returns for Different Asset Allocations 1980-2019

Average Returns

In this chart, the average annual return is represented by the blue dash.  When the blue dash is higher on the chart, it means that the returns on the portfolio were higher, on average, over the historical time period.


The green boxes correspond to the ranges between the 25th percentile and the 75th percentile.  The whiskers (lines sticking out of the boxes) correspond to the ranges from the 5th percentile to the 95th percentile.   When the box is tall and/or the whiskers are long, there is a lot of volatility.  In this case, it means that the annual return on the portfolio varied a lot from one year to the next.  At the opposite end of the spectrum, when the box and whiskers are all short, the range of returns observed historically was more consistent.

Comparison of Portfolios

I have arranged the portfolios so that the one with the most volatility – 100% in the S&P 500 – is on the left and the one with the least volatility – 100% in bonds as measured by the Fidelity Investment Grade Bond Fund (FBNDX) – is on the right.  You can see how adding bonds to the S&P 500 reduces volatility as the height of the boxes and whiskers gets smaller as you move from left to right.  At the same time, the average annual returns decrease as bonds are added to the portfolio.  Over the time period studied (1980 to 2019), the S&P 500 had an average annual return of 8.7% while the Bond Fund had an average annual return of 7.2%.  By comparison, returns on investment grade bonds are currently generally less than 4%.

Another Perspective

Because stocks and bonds are not 100% correlated, the volatility (spread between tops and bottoms of boxes and whiskers) of owning a combination of both is less than the volatility of owning just the riskier asset – stocks.  As I was preparing the chart above, I noticed, though, that the bottom whisker for the 100% bonds portfolio goes lower than the bottom whisker for the 80% bonds portfolio.

Specifically, there were more negative returns in the historical data (i.e., more years in which you would have lost money in a single year) if you owned just bonds than if you owned the portfolio with 80% bonds and 20% stocks.   The 80% bond portfolio had a negative return only 7.5% of the time while the 100% bonds portfolio had a negative return 10% of the time!  As more bonds are added to each portfolio, the blue bar/average moves down.  This downward shift actually moves the whole box and the whiskers down.

This relationship can be seen in the chart below.

The dots correspond to the portfolios in the previous chart with labels indicating the percentages of stocks in the portfolios.  The horizontal or x-axis on this chart represents the average annual return.  Values to the right correspond to higher average annual returns (which is good).  The vertical or y-axis represents the percentage of years with a negative return.  Values that are higher on the chart correspond to portfolios with more years with negative returns (which is bad).

Optimal Portfolios

“Optimal” portfolios are those that are to the right (higher return) and/or lower (fewer years with negative returns).  Any time a point is further to the right and at the same level or lower than another one, that portfolio better meets your objectives if probability of having a negative return is your risk metric.

More Stocks Can Be Less Risky

I have circled two pairs of dots.  The ones in the lower left corner are the two I’ve mentioned above.  The 20% stocks (80% bonds) point is lower than and to the right of the 0% stocks (100% bonds) point.  As you’ll recall, the average return on the 20% stocks portfolio is higher than the average return on the all-bond portfolio so the dot is to the right (better).  The percentage of the time that the annual return was less than zero was smaller for the 20% stocks portfolio so the dot is lower (also better).

There is a somewhat similar relationship between the 60% and 80% stocks portfolios (circled in green in the upper right).  The 80% stocks point is at the same level and to the right of the 60% stocks point.  As such, if average annual return and probability of a negative return are important metrics to you, moving from 80% to 60% stocks or 20% to 0% stocks would put you in a worse position as you would have less return for the same risk.

Re-balancing Can’t Be Done Blindly

Setting a target asset allocation, such as 80% stocks and 20% bonds, allows you to target a risk/reward mix that meets with your financial goals.  As I indicated, the purpose of re-balancing is to ensure that your portfolio is consistent with your goals.  However, it is important that you considering the then-current economic environment when re-balancing.

Interest Rates

For example, interest rates are lower than they were at any point in the historical period used in the analysis above.   Over the next several years, interest rates are unlikely to decrease much further, but could stay flat or increase.  If interest rates stay flat, the returns on bond funds will tend to approach the average coupon rate of bonds which is in the 1% to 3% range depending on the quality and time to maturity of the bonds held.  This range is much lower than the average annual return of 7.2% in the illustrations above.

If interest rates go up, the market price of bonds will go down, lowering returns even further.  As such, the risk-reward characteristics of bonds change over time.  I would characterize them as having lower returns and higher risk (the one-sided risk that prices will go down as interest rates go up) now than over the past 40 years.

Stock Prices

Similarly, the S&P 500 is currently close to or at its highest level ever in a period of significant economic and political uncertainty.  While I don’t have a strong opinion on the likely average annual returns on the S&P 500 in the next few years, I think it is likely to be more volatile in both directions than it has in the recent past.

If you re-balance your portfolio, you will want to form your own opinions about the average returns and volatility of the asset classes in which you invest.  With these opinions, you can decide whether the asset allocation you’ve held historically will still provide you with the risk/reward profile you are seeking.

Re-balancing and Income Taxes

Another consideration when you are deciding whether and how often to re-balance your portfolio is income taxes.  Every time you sell a security in a taxable account, you pay income taxes on any capital gains.  If you lose money on a security, the loss can offset other capital gains.  On the other hand, if you own the securities in a tax-free (Roth or TFSA) or tax-deferred (traditional or RRSP) account, re-balancing has no impact on your taxes.

Re-balancing Example

Let’s look at an example of the taxable account situation.  If you targeted a portfolio of 60% stocks (in an S&P 500 index fund) and 40% bonds (in FBNDX) from 1980 through 2019, you would have made the transactions shown in the chart below.

Rebalancing Stock Transactions

In this chart, the bars represent the amount of the transaction as a percentage of the amount of stocks held at the beginning of the year.  A bar that goes above zero indicates that you would have bought stocks in that year.  A bar that goes below zero indicates that you would have sold stocks in the year.  The proceeds from every sale would have been used to purchase the bond fund.  Similarly, the money used to purchase stocks would come from a corresponding sale of the bond fund.

In every year, you either sell some of the stock index fund or the bond fund.  The difference between the price at which you sell a security and the price at which you buy it is called a capital gain.  You pay income taxes on the amount of capital gains when they are positive.  In the US, many people pay a Federal tax rate of 15% on capital gains in addition to any state income taxes.  The Canadian tax rate on capital gains is of about the same order of magnitude.

Reduction in Return from Income Taxes

Income taxes, assuming a 15% tax rate, would have reduced your annual average return from 8.4% to 8.1% over the 1980-2019 time period.  Put in dollar terms, you would have had just under $250,000 at the end of 2019 if you started with $10,000 in 1980 and used this asset allocation strategy if you didn’t have to pay income taxes.  By comparison, you would have had about $220,000 if you had to pay income taxes on the capital gains, or 12% less.

As you consider whether re-balancing is an important component of your financial plan, you’ll want to make sure you understand the impact of any income taxes on your investments returns.

Why Only Equities?

You may have been wondering why I was invested almost solely in equities for all of my working life and not in a combination of asset classes, such as stocks and bonds.   My philosophy was that I preferred to use time to provide a diversification benefit rather than an array of asset classes.  By keeping my invested assets in stocks, I was able to take advantage of the higher expected returns from stocks as compared to bonds.

The chart below helps to illustrate this perspective.

Annual Returns - 1980-2019 - Time vs. Rebalance

It compares the volatility of the annual return on a portfolio of 100% stocks over a one-year time period with the same portfolio over five years and with a portfolio of 60% stocks and 40% bonds over one year.

The blue bars on the first and second bars (100% stocks for one year and five years, respectively) are at the same level, meaning they had the same average annual return.  Both the box and whiskers on the second bar are much more compact than the first bar, indicating that the annual returns fell in a much narrow range when considered on a five-year basis rather than a one-year basis.

Cost-Benefit Comparison

Comparison of the first and third bars highlights the cost and benefits of diversifying across asset classes.  The box and whiskers on the 60/40 portfolio are both shorter than the 100% stock portfolio.  That is, there was less variation from year-to-year in the annual return for the 60/40 portfolio than the 100% stock portfolio.   However, the average return (blue line) on the 60/40 portfolio is a bit lower because the 60/40 portfolio had an average annual return that was less than the 100% stock portfolio.

My Focus

The comparison on which I focused in selecting my investment strategy is the one between the second and third bars.  That is, I compared the volatility and average returns of a 100% stock portfolio over five years with the volatility and average returns of a 60/40 portfolio over one year.  As can be seen, there has been less volatility in annual stock returns when considered in five-year time periods.  Yet, the average return on stocks is higher than the average return on the blended portfolio.  Because I didn’t anticipate that I would need to draw down my investment portfolio, I was willing to look at risk over longer time periods and tolerate the year-to-year fluctuations in stock prices in order to expect higher investment returns.

Your time horizon until you might need the money in your investment portfolio and your willingness to wait out the ups and downs of the stock market are important considerations as you decide whether this strategy or a more traditional blended portfolio is a better fit for you.

Diversification: Don’t Get Misled by these Charts

Diversification: Don’t Get Misled by these Charts

Diversification is an important component of any investing plan.  It assists you in limiting your risk either to a single asset class or a single security within an asset class.  However, I have seen a couple of graphs from which you could form the wrong