Episode 277: The Cash Wedge w/ Phil Briggs, and and the Four Ds of Tax Planning

0:03This is the Rational Reminder Podcast, a weekly reality check on sensible investing and financial decision-making from two Canadians. We're hosted by me, Benjamin Felix, and Cameron Passmore, Portfolio Managers at PWL Capital. Welcome to episode 277, another week, Ben, and this week is a terrific episode where we welcome off the top our colleague based in Toronto, financial advisor and associate portfolio manager, Phil Briggs. He's going to talk a bit about his decision to join us, as well as he'll talk about the cash wedge. And then after that, Mark McGrath will be here for this week's Mark to Market.

0:43He's going to be covering the four Ds of tax. We'll do a quick look back on episode 108, where we welcome neurologist, author, and financial advisor, Dr. William Bernstein. Such a great episode. Then I'll do a quick review of the most recent book from Seth Godin called The Song of Significance. Do you want to add some color commentary around all this? I don't know if I have any color commentary. I think that's a pretty good setup. I mean, you described everything in the episode. The segment with Phil is great. It's good to hear from one of our financial planners who's in a ton of client meetings and seeing a lot of people and hear the questions that he's being asked and how he's addressing them.

1:19I thought that was a really cool perspective. And also hearing about Phil's journey to PWL was good. Yeah, I like Mark's four Ds of tax planning. It's a nice way to frame thinking about how to deal with tax with respect to investment planning and financial planning. Good episode, but that's more than enough for an intro. All right. Then after that, of course, we have the after show for the three people sticking around. Okay. Let's go to the episode 277.

1:47All right. Welcome to episode 277. Why don't you cue this up with Phil? We're joined today by Phil Briggs, who's a financial planner and associate portfolio manager at PWL. So we've got some questions for Phil about PWL briefly, and then Phil's prepared some notes on the financial planning strategy of the cash wedge, which we're also going to ask him about. So Phil, welcome to the podcast. It's an honor to be here. Thanks so much for having me on. Yeah, great to have you. To start, Phil, how did you find PWL? Let me give you a little bit of background. In terms of my career, I basically stumbled my way into financial services.

2:26I did not end up here due to any type of grand plan or anything along those lines. My undergrad degree is actually in philosophy. I've always really been interested in studying life's big questions like, what does it mean to live a good life? And I've always been fascinated about how people make decisions around how they allocate their time and resources in pursuit of whatever it is a good life looks like for them. So you can see my interests cross over a lot with some of the content that the firm has been putting out over the last number of years. But believe it or not, guys, having a philosophy degree didn't exactly present a clear career path for me.

3:09And so after I finished school, I just got a job as a bank teller while I tried to figure out what I wanted to do when I grew up. And it was initially working at the bank that I discovered that there was this entire world that I really did not know a lot about. And I met a lot of financial advisors that worked there and learned about what they did and started to become really interested in this world of money and investing and retirement planning and taxes and so on and so forth. And that interest grew and grew and actually culminated in what has been over a decade now of studying and doing courses and professional designations and building a career.

3:52And along the way, I've also consumed a ton of personal finance books and podcasts and naturally ended up finding out about PWL through all the content that you guys have put out over the years. And so I've been listening to the podcast. I think I was listening maybe a year or so before I actually joined the firm. Went back all the way to episode number one and caught up while I was out running in the morning and listened all the way through and watched your YouTube videos as well, Ben. I think the first thing that I ever did find that exposed me to the firm was our colleague Dan Bortolotti's Canadian Couch Potato blog.

4:26So yeah, that's how I discovered PWL. Incredible. How did you decide to move from the bank and join us over here? As I was doing all of this reading and studying, it became pretty clear to me early on that there were some really big discrepancies between what I was reading from all of these resources outside of the bank versus what I was being told at the bank itself. I had my eyes open to the fact that using low-cost index funds, for example, was a much better investment strategy for the majority of people compared to the high-fee active funds that I was being encouraged to sell. and I wanted to be able to recommend products to people that I believed in and that I thought were in their best interest.

5:12I wanted to be able to give advice to people that was truly going to be helpful for them. That really caused some feeling a bit conflicted in all honesty. And I also wanted to work at a place where the definition of success was the same for me as it was for the organization. So I'll give you an example. When I was at the bank, I would sometimes have these meetings where I would make a great personal connection with someone. I would learn about their goals. I would learn about what was important to them. And I'd have the opportunity maybe to provide them with some education and have them feeling comfortable and confident with financial concepts that maybe they hadn't understood before.

5:55And we'd work together in partnership and develop a great plan and lay out some clear steps for what they needed to do for success in the future. And everyone would come away from that meeting feeling great. I would feel great. The clients would feel great. But the reality was that if there was no product sale that resulted in that meeting, it was almost like I had done a bad job or that I had missed out on some opportunities in some way. And so I found that really tough. I loved learning how to do financial planning and make these great connections with people. But the environment that I was in was one where you were only doing a good job if you were hitting your sales targets, if you were topping the leaderboards, that sort of thing.

6:38And so after doing that for about 12 years, honestly, I got to a place where I started to think I either need to change careers completely or I need to find a place. I need to find a company, a firm that does evidence-based, objective financial planning that recommends that their clients invest in index funds and that sort of thing. And I will say the podcast played a role in this because the tipping point for me was actually hearing Jordan Tarasoff's first appearance that he did a number of years ago. His journey to PWL and his experiences in the industry really resonated with me and mirrored a lot of the experiences that I was having as well.

7:21And so I think honestly, it was shortly after hearing that episode that I reached out to you guys to see if there was an opportunity to come on board. How long have you been at PWL now? January will be two years. It's gone by quickly. It's nuts. What's your experience at PWL been like so far? So I will say like as someone who worked in the industry for a long time and listened to the podcast every week, I started to develop these ideas or these expectations of what it might be like to work at PWL as an outside And I have to say that my actual experience of working here has exceeded what were very high expectations coming in.

8:02I am part of an absolutely amazing team of people that work together and support one another and quite frankly, just like get along amazingly well and are just great people. I'm learning new things all the time. And so I feel motivated to keep pushing myself to learn more and to grow and to keep getting better because I know that everyone else around me is doing the same thing. And so being in that kind of environment is super inspiring. The other thing that I'll say is there is an amazing freedom in working at a place where you truly believe in the mission of what everyone is trying to do. The analogy that I would use is It's almost like when you have a great meal at a restaurant or you hear a great band or something like that, and you go out and you're telling other people about that.

8:52You don't feel like you're trying to sell them anything. You're literally just telling them about something that you think will make their life better. For me, that's what it feels like to work here and to interact with people. I'm just sharing what I truly believe will make their lives better. And there's an amazing freedom in being able to do that. And so I've never enjoyed my work more. I've never felt more professionally fulfilled. It's been a great change for me. Incredible. Really cool to hear you talk about all that. Sure is. You did come with a planning topic today. So this is something that I think you and I have chatted about a few times as you've gotten questions about it.

9:30I think you've got some pretty cool thoughts. So what is the cash wedge strategy? You're exactly right. I wanted to come on here and talk about this because it is something that consistently keeps coming up in meetings over and over again. And so I thought I'd come on and share some thoughts and get some perspective from you guys as well. So the cash-wise strategy, what it is, it's a strategy that is used in retirement during the decumulation stage. And so the idea is that rather than having all of your money invested in a portfolio of stocks and bonds, you slice off a portion of the portfolio and hold it in cash type products like high interest savings accounts or short term GICs or a combination of the two.

10:13And you hold something like one to three years worth of expenses in cash. And the idea behind this strategy is that this is supposed to protect you against sequence of return risk, which is the idea that if early in retirement, the markets have a big downturn and you're having to sell out of your portfolio while it's down, that that could have a really, really bad impact on your plan overall. And so the idea behind holding the cash is that you can avoid selling from your portfolio, you draw from the cash instead, and give your portfolio time to recover. And then the flip side is that if the markets are doing well, you still have the cash position in place, but you just sell and draw from the portfolio while it's appreciating.

11:01And then if you need to, in the good years, you can also sell and refill the cash position as necessary. So that's kind of the basics of how it works. Might seem like a dumb question, but why do you think people find the cash wedge appealing? I don't think it's a dumb question because a lot of people do seem to find it appealing recently. I think it feels like it's a safer strategy, especially for retirees. I hear from people all the time. hey, we were focused on growth while we were working and accumulating. Now we're retired, we're deaccumulating. So we need to shift into something that's more conservative.

11:36We need to protect ourselves. And I do get it. The idea of drawing from a portfolio that's declining in value could feel scary for a lot of people. And so I think it's that, it's the feeling of safety in combination with, and I think part of the reason why it's coming up more and more often is because of the current environment that we're in. Cash is paying higher interest rates than we have seen in a very, very long time. And the markets are coming off a pretty lousy 18-month stretch. And so I think it's natural to say, hey, why am I holding these stocks? Why am I holding these bonds? They're not doing great.

12:12I see 5 % on cash. Why wouldn't I want to include some of that in my portfolio? What problems do you see with the strategy? There definitely are problems with the strategy. The main one being the fact that you are going to get a lower expected return from cash over the long term. And I know this is something you guys have already covered recently on the podcast. I looked it up. It was back in episode 265. So if anyone hasn't listened to that, go back and check that out for Ben's deep dive on why you maybe don't want to hold cash for the long term. But just to reiterate some of those thoughts, holding cash in the portfolio is generally okay if you're going to use that to fund some kind of short-term goal.

12:54So if you've got a car purchase coming up or a large renovation that you're going to do on your house, sure, raise that, hold some cash, use it within a year or two. That totally makes sense. But if you're going to commit to holding cash in your portfolio for the long term, that's likely going to make you worse off than being fully invested in stocks and bonds because you're going to get a lower return. Why is that? Well, the reason is cash isn't going to fluctuate at all in value. Its nominal value is guaranteed. So it's safe. And the reason that anyone would even consider investing in something that doesn't have a guarantee where there is some uncertainty like stocks or bonds is because they're going to demand a higher expected return in order to do that.

13:42And I think probably everybody listening to this podcast understands that concept that you'd expect to get a higher return from stocks and bonds over the long term compared to cash. But when it comes to the cash wedge strategy itself, I think the key question is, understanding that you're going to get a lower return from cash over the long term, is that offset by the fact that you can time those withdrawals and not have to withdraw from your portfolio during a downturn? Is the impact of being able to do that enough to offset the lower expected returns from cash? And so to me, that was the key question as I looked into this, and I found a couple of good resources where that exact question actually was analyzed.

14:26So the first one was an article called Sustainable Withdrawal Rates, the Historical Evidence of Buffer Zone Strategies by Walter Warhide and David Nannigan, which was actually published in the Journal of Financial Planning. And so that article outlined the details of a study that they did where they tested out decumulation strategies, holding anywhere from one to four years worth of cash reserves. So the cash-wide strategy and the remainder of the portfolio was then invested in stocks. And they tested out a few different things. They looked at different withdrawal rates. So withdrawing anywhere from as low as 3 % of the portfolio to as high as 9 % of the portfolio.

15:07And they also did it over different periods of time, as few as 15 years up to as long as a 30-year time horizon. And the way that it worked was they assumed that if the portfolio was down, they would draw from the cash. And when the portfolio was up, they would replenish the cash position. And so the key findings in this study was ultimately that the cash wedge strategy did make people worse off. It had a higher failure rate than the non-cash wedge strategies. The biggest negative impact of holding cash was experienced at the higher withdrawal rates and the longer time horizons, which I think intuitively makes sense.

15:47Cash would be expected to have more of a negative return over a longer period of time, certainly, but also if you have a much higher spending rate from your portfolio. And then in terms of the exact question that I was interested in, they did conclude that the drag on returns from holding cash had a bigger impact than being able to time your withdrawals and not having to sell from your portfolio when it was down. You were actually better off just being fully invested, selling from your portfolio during the good years and the bad years, and holding cash and being able to avoid selling during a downturn didn't make up for the lower expected returns.

16:25So that was the first resource. The second was an article, Ben, actually, that you sent me when we were chatting about this, which was called The Bucket Approach for Retirement, a Suboptimal Behavioral Trick by Javier Estrada, who's a professor of finance at the IESE Business School in Barcelona. And in this one, again, this was another study. They did a similar type of test. They looked at the differences between a cash-wide strategy versus 11 different portfolios that had a static allocation of stocks and bonds and was just rebalanced regularly. And essentially, they found the same thing, that actually having a fully invested portfolio and just rebalancing that on a regular basis resulted in lower failure rates, fewer shortfall years.

17:13If you think about rebalancing, rebalancing is essentially doing what the cash wedge purports to do. If stocks have a great year to maintain your 60-40 allocation, for example, you're selling from stocks. If stocks have a bad year, and unlike say last year where both stocks and bonds were down, but normally you tend to see bonds maybe don't decline quite as much as stocks. So to maintain your 60-40 allocation, you're selling from bonds in years when stocks are down. And so rebalancing meant that it wasn't necessary to implement a cash wedge strategy. And again, according to this study, you were better off just being fully invested the whole time.

17:53And so the broad conclusions of both of these studies were having a cash wedge might make you feel better. There may be some psychological benefit to implementing a strategy like that, but more than likely it's suboptimal and is going to make you worse off over the long run. Therefore, what do you tell clients who want to put a cash wedge in place? So for me, my number one goal always is that my clients can achieve their financial objectives. And if they can still do that using a cash wedge strategy, and that's going to allow them to sleep well at night, and they're going to feel good about their financial plan overall, I'm totally fine with that.

18:31The best financial plan is one that you can stick with and actually execute on. And so if you feel better about doing a cash wedge, then I'm good with that. I feel the same way. It's like when people ask us about, should I lump sum invest or should I dollar cost average? Lump sum investing has been shown to be the optimal strategy. But if you feel better about dollar cost averaging into the markets over time, even if it's suboptimal, as long as you can still achieve your objectives and you feel better about doing it that way, then I think it makes a lot of sense. I love that answer to the question.

19:02Would you explain to the client that it is logically suboptimal, however, if it feels right? 100%. Of course, you want to say this isn't necessarily the strategy that I would recommend, but this is where you've got to understand both sort of the quantitative and the qualitative factors that go into developing a plan. And so me giving a whole bunch of recommendations that just don't quite feel right in the back of your mind, we want to try and find a solution that we can actually implement and feel good about. Other than the cash wedge to address this concern, what else do you think investors can be doing?

19:39I've been thinking a lot about for the folks that ask questions like, should we be implementing a cash wedge? Should we hold cash? I think that part of where this comes from is a desire to feel in control over your money. I don't know about you guys. I've been getting a lot of questions like, in this current environment, Should we be doing anything different? Should we be holding cash? Should we be revisiting our asset allocation? Is there any change? You hear this all the time. That is something that I learned very quickly. And I'm sure you've had the same experience, Phil. I've been in financial services for 11 years now.

20:19And at first I was hearing that question and was thinking to myself, this must be a crazy time. This must be unusual. then you eventually quickly realize that all the time people frame questions that way. Given all of the uncertainty that's happening right now, or given this thing that's going on right now, there's always something happening in the world that people fixate on, but it's just the nature of markets because they're forward looking and the future is always uncertain. So there's always going to be something that's the big uncertainty that's on people's minds. Trust me, 33 years in, that's an absolute truth.

20:52I totally get it. It's not fun to hear like, hey, don't do anything. I know you feel worried. I know you feel worried about your plan or you're watching the news and it sounds scary, but don't worry. You don't actually need to do anything. My suggestion would be instead of tinkering around with the investment portfolio, which there's a truckload of evidence at this point that suggests that we start making active decisions and messing around with the portfolio, it's probably going to make us worse off over the long run. So instead of doing that, let's take that desire for control and apply it to things that we have more direct control over.

21:28So things like how much are we saving or how much are we going to spend out of the portfolio? If we have the ability to have some flexibility in our retirement plan around how much we're taking out of the portfolio, that will make actually a really, really big difference. So for example, if we can spend less in years when the markets are doing poorly, or maybe just not increase our spending with the rising cost of living, as an example, for a year or two, to give the portfolio some time to recover. In years, then when the markets are doing better, we could spend more. And what we, I think, have found in doing financial plans is that having that kind of flexibility actually gives you the ability to spend more on average over the life of your plan.

22:16And so I think if we can apply that desire for control to things like that, where we have more direct control, maybe that helps us feel safer and better about the plan. But it doesn't make us worse off by making a bad decision with the portfolio. I'd be interested, though, do you guys have any additional thoughts beyond that around anything that people should be doing? I think one thing that we do always is we stress test is what we call it. We stress test financial plans. We use Monte Carlo simulation, which is imperfect in many ways, but it does give us some level of information about what happens to this financial plan if returns are not what we expected them to be.

22:53Monte Carlo is not perfect, like I said, but it's always helpful to be able to say to a client, listen, we have tested your financial plan in scenarios that are much worse than what we're actually living through right now, and you're still in great shape. I like having that as a component of the analysis to be able to tell a client that we tested for situations like this, and you're still going to be okay. I agree. And the thing with Monte Carlo that I find is in our plans, oftentimes we've stress tested it and we've just assumed that you're going to keep spending the same throughout the life of your plan.

23:29So if it's a situation where we've run Monte Carlo, we've stress tested the plan, the plan is still successful at your current spending rate, well then you can probably proceed with confidence that you're still in pretty good shape but if you're able to be flexible with your spending it's likely to make you that much better off so yeah it's a really great point the combination of those two i think are very helpful for sure that current spending rate is the thing that i really fixate on like to understand what is your base spending needs and what's your supplemental wants on top that you should have very clear knowledge of what those two numbers are so things do get rough what do you absolutely need per month or per year so that you can drop your spending down because we all know that variable spending over lifetime means greater total spending over the lifetime, but you need to know those numbers.

24:15That's exactly it. If you can take a look at your budget and track and make sure you have an understanding of where everything's going, that would also be a helpful exercise rather than getting in there and messing around with your portfolio for sure. The uncertainty thing, you can try and solve it with asset allocation, which is tricky. and probably more realistically, you can solve it with spending. Those are two different ways to solve the same problem. But I think, like you said, Phil, that the spending side is much more in our control than outcomes from varying asset allocation approaches.

24:46Absolutely. Cool. All right, Phil, that was a great topic. It was awesome to hear your thoughts about finding PWL and your time at PWL so far. So we really appreciate you coming on the podcast. Yeah, it was a pleasure to be here. Thanks again for having me on. Really appreciate it. Yeah, super fun to have you on, Phil. So with that, let's go over to our other colleague, Mark McGrath for this week's Mark to Market. Mark, welcome back to the podcast. Thank you. Thank you. Good to be back. What are we talking about today? What are we talking about today? We're talking about tax. Awesome. One of my favorite topics.

25:20We're not going to go too detailed today. I'm going to try to keep it high level. I'm going to talk about something that I call the four Ds of tax planning. This isn't something I made up. If you Google the four D's of tax planning, you'll find lots of stuff on there. There's three D's of tax planning or five D's or whatever, but the four that I'm going to talk about today, I think are kind of the core idea. So I use this when I'm doing financial planning work for clients, when I'm trying to think about the tax planning for their situation, I try to kind of run myself through this four D checklist just to kind of make sure I'm not missing anything and to make sure that I'm framing and thinking about their tax situation correctly.

25:52So the four Ds are deduct, defer, divide, and decrease or diminish. What that means is there's essentially four high-level ways that you can save tax, but they operate all differently. So the first one is deduct. And I think this one's fairly common and a lot of people will understand this just intuitively. Think about your RSPs. Deductions reduce the income on which you're going to pay tax. So simple scenario, you earn$100 ,000 per year. You're going to pay tax on$100 ,000. if you contribute$20 ,000 to an RRSP, you get to deduct that$20 ,000 from your income and you only pay tax on$80 ,000. So that's how a deduction works.