Personal Finance and Investments

In the Financial Post’s “Sell advice or products, not both” Jason Heath writes what should be obvious by now but seems to have evaded so many: “Conflicts of interest in the financial industry will only disappear when the sale of advice is separated from the sale of products and when everyone understands exactly what fees they pay.” He quotes FPSC’s submission t CSA in which they argue that “there is a “fundamental flaw” in the Canadian financial services industry that sees the “service of professional advice being overlaid on a product sales infrastructure.” And the lack of transparency of fees just aggravates the whole situation. (Must read article if you are interested in the “fiduciary” debate.)

In the WSJ’s “Lifelines for investors in their own”  Carolyn Geer looks at various approaches for investors who want to do it themselves but would like some assistance. The answer today is either a discount broker or no-load fund company which offers “all-in-one” funds which could be either a fixed allocation or a target date fund (Vanguard and Fidelity are mentioned), or managed accounts where a professional manager assembles the portfolio, or buy an off-the-shelf financial plan with recommended investments ($25K minimum and fees ranging between 0.2-0.9% depending on account size/services), or a ‘personal financial planner who’ll provide continuing investment recommendations”, or software based services such as Betterment.com or Wealthfront.com which charge between 0.25-0.35% excluding cost of underlying ETFs of about 0.14%.

In the Financial Post’s “Why we overprotect ourselves from the stock market” Ted Rechtshaffen discusses why he believes that “a five-year GIC is an investing mistake” because investing in stocks over 5 year or longer horizon has been historically less risky than people believe. “…five-year periods since January 1950 the TSX would have outperformed a 2.2% return roughly 90% of the time…. Over 20-year periods since 1950, the worst performance on the S&P 500 (US Market) was 7.0%, while the best was 19.4%. For the TSX, the worst was 6.2% and the best was 14.1%.” (Yes building a portfolio entirely on GICs makes little sense for most, but doing it all with stocks would make just as little sense (see  Time Diversification: Stocks are less risky over the long-term??? (Not!)) especially for those near or in retirement. A balanced portfolio which factors in investor’s risk tolerance into the asset allocation would be more appropriate.)

In the Financial Post’s “Being conservative doesn’t mean embracing inertia”  Yves Rebetez writes “No one seems to care much about paying 1% more here, or 2% more there, but when it comes to your retirement savings, and you have a significant time horizon ahead to grow your nest egg, staying with a comfortable high-cost mutual fund means sharing quite a bit of that egg. ..(with the result being that)  “We turn our investment experience and your money into… our money and your investment experience. ”Mutual fund fees aren’t going away unless investors rise up and make them. … The longer you opt to leave that decision for another day, the smaller your nest egg will ultimately be. “ (Why do people continue to own mutual funds which cost them 1.5-2.5% more per year than an index based ETF covering the same asset class? Beside inertia, the only logical answer I can think of is that you might have a large unrealized capital gain that you might not want to realize now and pay taxes on at this point of time. However, using a back of the envelope calculation, even a 50% gain over cost would means only that 33% of the fund value is the gain which means that at 50% marginal tax rate you lose to tax 16.5% or at 33% rate you lose 11% to tax, which are recovered over 8 and 5 years respectively by lower fees, and from then on you are ahead 2% each year. So don’t necessarily let taxes on unrealized capital gains prevent you from getting out from under the yoke of mutual fund fees. By the way, there are lots of people who have been working hard to shame the industry into reducing mutual fund fees and increasing disclosure associated with them, but you the investor can solve your mutual fund fee problem by simply not buying them, unless you understand that you are getting value for money.)

In the Financial Post’s “Fragmented investment management can add to the tax bite” Joanne Swystun cautions that when using multiple brokers and ‘advisors’ you could end up with tax inefficiencies which could cost you dearly, like: (1) using different advisers for the taxable and tax-deferred portfolio without strict instruction could result in a balanced portfolio in each, (2) placing US based securities in TFSAs causes dividends to be subject to irrecoverable US withholding tax which is not the case for RRSP and (3) treating spouses’ portfolios separately “can miss the opportunity to lessen the family’s overall tax bite by purchasing Canadian preferred and common stocks in that account to better exploit the enhanced dividend tax credit”.

In Business Insider’s “Retirees are greatly underestimating how much they’ll need to save for healthcare” Mandi Woodruff reports that according to a new Fidelity estimate there is good news and bad news on healthcare cost of a 65 year U.S. old couple retiring this year. First the bad news: they’ll need $220,000 for medical care. Now the good news: cost is 8% lower than last year. (Thanks to MB for recommending.)

Real Estate

Canada’s April 2013 Teranet-National Bank National House Price Index  indicates that Canadian home prices increased 2% over previous 12 months, “the smallest 12-month rise since November 2009”. Quebec City had the highest YoY increase at 6.1%, while Ottawa and Toronto were 1.5% and 4.3% respectively. Vancouver and Victoria were bringing up the rear with losses of -2.9% and -3.3% respectively. Month over month changes in the negative territory were recorded for 5 of the 11 cities: Ottawa (-0.2%), Vancouver (-0.8%), Victoria (-0.1%), Quebec City (-0.5%) and Halifax (-0.1%).

In the NYT’s “Today’s dream house may not be tomorrow’s” Robert Shiller does an interesting exploration of what houses represent to people, writing that “houses are just buildings, but homes are often beautiful dreams. Unfortunately, as millions of people have learned in the housing crisis, those dreams don’t always comport with reality.”  He questions/warns about how well (price/value) expectations will be matched by reality after a decade given economic, demographic, taste/fashion/desirability, urban vs. suburban and rent vs. own preference changes are factored in.

In the Globe and Mail’s “US bills propose longer stays for Canadian vacationers” Wingrove and Hui discuss proposed increases to length of permitted annual US stay for Canadians up to 8 months if they can demonstrate that they have a Canadian home, own or lease US property and promise not to work or go on welfare.  However article reminds readers that while Canada has no federal restrictions on how long each year one can be outside the country, provincial eligibility for health insurance has requirements of 5-7 months presence in the country/province. The other problem is the US requirement of filing and paying US taxes if Canadians stays in the US more than six months.

Pensions and Retirement Income

In the Financial Post’s “No pension savings crisis: Canadians have $7.1T in net worth” Lee and Jog disagree that Canadians aren’t saving enough and that they must be forced to save more for their retirement. They argue that the “inadequate savings” arguments exclude real estate (including principal residences) and business ownership components of assets; including these components, based on Stats Canada data, total assets come to $8.8T less $1.7T indebtedness, leaving $199,700 per person. The $8.8T is 40% real estate, 42% in “cash, mutual funds, equities” and 19% in registered pension plans. They argue that including all assets and factoring in that seniors represent the majority of those with mortgage free real estate, there is retirement income problem in Canada. (Since we are just speaking about averages, the $200K per person might be theoretically converted to $8,000/year in indexed pension or annuity (if such beasts were available in Canada), and add that to average CPP of about $7K and OAS of $5K for a total of $20K per person. However to really understand the true state of affairs one would have to break down the population into wealth segments to really understand who holds these assets, and factor in the impact on prices if boomers would really try to sell their principal residences/real estate when they turn 65. And by the way, “reverse mortgages” are not financial “innovations” but transfer mechanisms of the value of one’s home at a low price to mortgage holder. Incidentally Garry Marr’s “Are all our eggs in the housing basket?” discusses the risk of having $3.5T of $8.8T Canadians’ assets in real estate and that reverse mortgages have 5-year rates of 5.4% compared to as low as 2.7% in traditional ones. Segmenting the population into categories like assets deciles and those with or without indexed public sector like pensions might provide a better understanding of whether Canada has a pension crisis or not. For example, using the numbers discussed in the article and adding the not too unreasonable assumption that the top three net worth deciles own 80% of the wealth and the bottom three deciles have zero net worth, then the remaining four deciles have a net worth of $1.42T divided by 14.2M Canadians in those four quartiles then we get $100,000 rather than $199,700 per person. The number would be even smaller for the average Canadian. I think this topic is important enough to deserve a more analytical treatment than used in this article to reach its conclusion. I have no doubt that the Canadian Pension system” is systemically flawed and one of the problems is that the average Canadian is not saving enough for retirement.)

In The Financial Post’s  “Surprise! Annuities beat RRIFs” Fred Vettese writes that based on his calculations he was surprised to learn that annuities are superior to RRIF not just at age 75 but also at much younger ages. Many readers might conclude from this article that annuities are the universal solution to (almost) all retirement income needs independent of personal circumstances (age, health, other income sources, risk tolerance, family situation, etc). To conclude that based on this article without a personalized second opinion from an independent financial expert source would be a grave error. He provides two examples. The first example is based on a 64 year old male who can get a $6,500 annual annuity income stream from $100,000 whereas drawing the same amount from a RRIF invested in stocks and bonds earning 5% after fees, the RRIF would be exhausted by age 92; a more conservative investor who invests primarily in bonds earning nowadays 2-3% would run out of money in his early 80s. (There are many problems with this simplistic analysis, perhaps the most obvious one being the use of a 64 year old male’s annuity rate rather than a joint rate as the basis of the calculation since if that male has a spouse he would leave the spouse a pauper once he dies.) From the description of the second example, I didn’t understand what actually was being done. (Other issues to consider are: how inflation erodes the fixed income annuity payment over 20-40 year retirement, the need to make the annuity decision based in the context of a personal financial plan, the  difference between  insurance (annuity) and  investment (RRIFs contain investment products), and so on. Mr. Vettese is Chief Actuary at Morneau-Sheppell which also happens to be the administrator of the  remains of the Nortel pension plan to be wound up sooner or later; at windup thousands of these pension plan beneficiaries will be required to make the critical decision between RRIFs/LIFs and annuities. Given the importance and seriousness of such a topic (e.g. given the irreversibility of a decision to annuitize) this merits a more nuanced analysis/discussion of the annuity vs. RRIF/LIF decision factoring in individual circumstances; perhaps Mr. Vettese is planning a follow-on article on the subject? I have given a shot to the subject in Annuity or Lump-Sum (LIF): Upcoming Nortel pensioners’ decision, but couldn’t readily conclude that annuities were superior except in specific circumstances. In Canada, unlike in the US, unfortunately you can’t buy a longevity annuity, which would allow the best of both worlds protect yourself against running out of money while not having to annuitize all/most of your assets.)

In the NYT’s “Getting the full picture on annuities and insurance” Paul Sullivan reminds readers that life insurance and annuities are insurance products “but right now, both are being promoted for their tax benefits…

(and)

Many policies carry high upfront and management fees, have limited investment options and penalize people” in case of early withdrawal.

” (People tend to forget the general rules of thumb: insurance is not for investment, insurance is for protection; e.g. life insurance is to protect those who are dependent on your earnings which disappear with you when you die and an annuity is for those who hit the age where there is an unacceptable risk that their assets will be insufficient to meet their basic needs before the end of their life. A great article; thanks to KW for recommending.)

In Lasalle Messager’s “Remember working in Lachine Wire and Cable”  Gladys (Murray) Comeau has a letter to the editor imploring her neighbours living in the part of Montreal which was the home of the old Northern Electric Lachine plant, to write to Prime Minister Harper and Minister of Industry Christian Paradis. She writes that “They must be called to task for their indifference to what we have suffered following Nortel’s collapse and for their government’s inaction and disinterest”…She continues that the pensioners’ demand that the government stop post-filing interest for junk bondholders and that “The inconsistencies in the Companies’ Creditors Arrangement Act (CCAA) and the Bankruptcy and Insolvency Act (BIA) wherein there is inequality and no balance between creditors must be addressed.” (Comeau indicated in a separate letter to Prime Minister Harper that she is a surviving spouse of a 41 year loyal Nortel employee whose life has forever been altered by the impact of the insolvency and who needs the survivor pension, which is her late husband’s deferred wages, to continue to live her simple life and not become destitute. Could you believe the arrogance of the bondholders in that they demand post-bankruptcy interest? If this wasn’t illegal, it should be. It’s an outrage. What’s even worse is that the Nortel pensioners have effectively given up the fight over getting priority in bankruptcy relative to unsecured creditors, and now have to fight over unjustified bondholder claims for post-bankruptcy interest on the bonds; how pathetic is that!?! )

Things to Ponder

The WSJ’s “Fed maps exit from stimulus” discusses the fed’s tentative/uncertain exit/unwind plans from QE, but Martin Feldstein also in the WSJ argues in “The Federal Reserve’s policy dead-end” that QE is overrated in its contribution to increasing market prices since 2009 (increasing earnings per share were primarily responsible). “The Fed’s balance sheet has grown by less than $2.5 trillion since the summer of 2007, while the federal debt has grown by more than twice that amount just since the beginning of 2009. As a result, the public has had to absorb more than $2 trillion of net government debt during the past three years…I think the risks are now clear and the benefits are doubtful. The time has come for the Fed to recognize that it cannot stimulate growth and that a stronger recovery must depend on fiscal actions and tax reform by the White House and Congress.”

In the WSJ’s “Man vs. Machine: The great stock showdown” Joe Light discusses a new measure to pick consistently better performing active funds the upside capture to downside capture ratio; but he concludes that “…don’t forget that the most proven indicator of future returns continues to be low fees… The easiest way to minimize costs is to dismiss active managers altogether and simply use low-cost index funds. As hordes of researchers have said, the efficacy of low fees is something you don’t need two decades of historical research to prove. It’s just arithmetic.”

In the Financial Times’ “UK taxmen, police and spies look at Bitcoin threat” Jane Wild reports that  50 civil servants participated in a meeting “entitled The Future of Money, focused on the implications that widespread adoption of the currency might have. As Bitcoin users are anonymous, authorities worry that it could be used for purposes such as money laundering, and that transaction between individuals fall outside boundaries of tax collection.” (Of course Bitcoin-like currencies also undermine governments’ claim to be the only ones having the right to issue legal tender in their respective countries. It is unlikely that governments would stand by idly if such ‘virtual currencies’ would start to have broader acceptance. For example see this report “Here’s why the Feds seized assets from the world’s biggest Bitcoin exchange” )

And finally Gillian Tett’s review of David Stockman’s new book “The great deformation” in the Financial Times’ “How the Fed lost its cred”  she summarizes it as “the American government has badly lost its way in the past few decades, because crony capitalism has perverted policy making and upturned free market principles. As a result, the country is now drowning in uncontrollable debt that will eventually bring it down and destroy the credibility of the Federal Reserve… on my travels across the country I was struck by how many people – be they economists, businessmen or cab drivers – volunteered a sense of unease about the central bank.”

Personal Finance and Investments

In WSJ’s “Risky business: The quiz that could steer you wrong” Jason Zweig discusses the value of risk tolerance questionnaires and suggests that “Many of these questionnaires are unhelpful at best and harmful at worst…” because your risk tolerance, unlike “your IQ or shoe size” is not “determined solely by who you are; it’s also a function of the situations you are in… your tolerance for risk depends on countless changes of context, many of which you might not even be conscious of at the time.. Advisers tend to focus on how large a loss the clients can afford, while the clients think mainly about how painful a loss would feel. So, if your financial adviser asks you to fill out a risk-tolerance questionnaire, use the occasion as the springboard for a deeper discussion.”

In Wade Pfau’s “Dynamic retirement strategies” blog he has a great list of “what should be incorporated in a modeling approach (or what can go wrong with the traditional 4% rule- i.e. taking 4% of assets in year one of retirement and adjusting the amount for inflation in successive years) to determine optimal dynamic retirement income strategy”. His list includes annual consideration of: assets, capital market expectations, spending requirement/desire/can-make-do-with, health status, risk tolerance, asset allocation, life expectancy, need for annuitization, etc. (Yes, an annual or bi-annual reassessment of one’s retirement income needs, ability to sustainably fund those needs and the flexibility to readjust those requirements to reflect what is realistically possible reflect the real world retirement planning and adjustment that retirees must deal with. This is well put in couple of old sayings that I like to quote: “computing (modeling) is for insight not numbers” and “forecasting is difficult, especially about the future”. The only “set and forget plan” that you can count on is to stay flexible/adaptable!)

Real Estate

In the Financial Post’s “Canadian housing: Bursting bubble or gentle landing” Andrea Hopkins reports that Toronto saw a 40% drop in sales in Q1’13 compared to previous year. But many believe that we won’t have a US-like crash because of some of the differences in Canada such as: government’s tighter mortgage lending rules, “Canadians have more equity in their homes than Americans did, the default rate is lower, the sub-prime market is tiny, and mortgage interest is not tax-deductible, so there’s no incentive to build up debt. Finally, mortgages are structured as recourse loans in which assets other than the house are held as collateral. That makes Canadian homeowners less likely to walk away than their American cousins.” But others are concerned, like Robert Shiller “one of the few to predict the U.S. housing crash, sees the same thing happening in Canada — just in slow motion.”

And  in the Globe and Mail’s “Peter Munk’s contrarian bet on the Toronto condo market” Tara Perkins reports that billionaire Peter Munk is making a contrarian bet by investing in Toronto condo market because he believes that he is betting on the people behind the new development and argues that ““Look at Beijing, look at all the money. I’ve got friends who have got kids there, tremendous job opportunities, and the kids will come back because they can’t breathe the air,” he said. “You go to London – one of my daughters lives there, and it’s so overpriced that it’s sick-making. New York has got tremendous attractions, but it’s also got a hell of a lot of problems. Look at the traffic – I have an office there and you can’t go across.“Toronto is absolutely unique. It’s not flawless, but it’s so much better than the possible alternatives … “

Pensions and Retirement Income

In Bloomberg’s “Fink says U.S. workers need mandatory retirement savings” Leondis and Collins report that BlackRock CEO said that “The current system is not working and we need a comprehensive approach that includes some form of mandatory savings in addition to Social Security…The longer we wait to fix it, the tougher the task becomes.” He likes the approach taken by Australia where employers are required to contribute 9% of employees’ income. (Not such a bad idea, though I am not generally inclined toward “mandatory” schemes, the current “voluntary” approach to retirement savings is falling far short of what is needed to maintain living standards in retirement; perhaps auto-enrollment default will work better. The Australian system goes a long way to solve the “retirement savings problem”, however where it failed is that it did not offer a low cost investment/decumulation option built into the scheme.)

Lots of talk continues in Canada about the expanded-CPP and the PRPP, but we see little or no action on the pension reform front. In Canada the PRPP is supposed to help implement a retirement saving mechanism for small businesses. But Canadians are still talking, the U.S. as usual is more action oriented. For example in benefitspro’s “The Online 401(k) launches small business IRA option” Paula Aven Gladych reports on what appears to be a simple and cheap (for both employers and employees) implementation of 401(k)s and IRAs in small business environment (which is the stated objective of the PRPP). Online 401(k) addresses the need for cost effective implementation when employers are required to implement “auto-retirement savings through employee paycheck deductions”. The cost to small employer to implement the IRA is $25/mo while the employee pays $4/mo. The available investments are 10 target date model portfolios made up of exchange traded funds for a fee of only 0.25%- inclusive of investment expenses (ETFs), fiduciary advice and trading costs. (Now this sounds pretty simple; why can’t this be done in Canada?)

And speaking of pension reform the Ontario Teachers Pension Plan created a 23 minute documentary explaining Canada’s (U.S.’s and developed world’s) pension crisis entitled  Pension Plan Evolution which addresses the root causes of the (public and private) pension crisis, such as: shorter work-life due to earlier retirement, longer retirement life due to increasing longevity, unrealistic actuarial assumptions (e.g. plan return rates of 8%), we didn’t address the problems when they started to become apparent almost two decades ago. A solution must be found because that pension system that was built is now collapsing. The solution must be intergenerationally fair so it must be made up of a combination of working longer, contributing more and receiving less in retirement. The pensions must be more flexible (the context is DB, but not explicitly mentioned, target benefits are implied) to be able to respond to a changing world over 20-50-100 years, so flexibility is required to deal with changes in market returns and increasing longevity, for example. (A great documentary that we can only hope, that those working on pension reform will watch. After all, what can’t be done- won’t be done. The timing of the required changes in the public system will be a function of what is politically palatable. In the private sector DB plans are already becoming a historical oddity.)

Things to Ponder

Gillian Tett in the Financial Times’ “Europe and US lines cross on household debt ratio” quotes a recent IMF report which indicates that US household debt-to-income ratio declined from 130%  (2007) to 105% (YE 2012). “In the same period, eurozone household debt has risen from 100 per cent to almost 110 per cent.” (If I recall correctly, the corresponding Canadian number is about 165% and growing and so is public debt in developing world.)

In the Financial Times’ “The cost of hand-to-mouth living” Gillian Tett has an interesting (and sad) article discussing what is revealed by the “big data” that companies monitor about customers. What the data reveals is that the buying patterns, not just what but when, of Americans and how that is influenced by the paycheck and food stamps cycle. “…since 2007, spending patterns have become extremely volatile. More and more consumers appear to be living hand-to-mouth, buying goods only when their pay checks, food stamps or benefit money arrive. And this change has not simply occurred in the poorest areas: even middle-class districts are prone to these swings… the financial fragility of the poorer section of US society has risen sharply in recent years, as unemployment remains high and real incomes and household wealth fall.” She extends her concerns, about the hand-to-mouth life of about 50M Americans on food stamps, to the regression from the progress over the past century, when one of the key measures of societal economic progress was the growing planning horizon. Clearly, hand-to-mouth reduced ‘planning’ horizon to days from years.

In the WSJ’s “Bitcoin vs. Ben Bernanke” James Freeman gets an insider’s view of Bitcoin from Gavin Andresen, chief scientist at Bitcoin Foundation, who says that “I’m hoping to learn…whether a nongovernmental global currency” is possible. “Can you get from where we are to the vision of billions of people all over the world using Bitcoin just like they use any other currency? That’s the grand experiment.” The article discusses strengths (privacy, simplicity of crossborder transaction, etc) and weaknesses (hacker attacks, speculation, fraud and not legal tender) in Bitcoin. “But perhaps the most intriguing aspect of Bitcoin—at a time when the world’s central banks are creating lots of new money—is the promise that the number of Bitcoins will be capped at 21 million.” He suggests that Bitcoin might first take off in a big way in places like Zimbabwe. The article comments on the laughable criticism about Bitcoin being that nobody is responsible for accelerating the money creation process, as central banks are doing, so in a Bitcoin world there is a serious risk of deflation. (What about the inflation risk resulting from central banks’ money printing?)

Diane Francis in the Financial Post’s “Bernie Madoff’s secretary’s crusade to put things right” discusses a new documentary “In God We Trust” in which Madoff’s secretary describes her view of what happened and the personal consequences of the “biggest financial scam in U.S. history (which) was perpetrated right under her very nose, embarking on a private crusade to aid the FBI investigation”. Francis some years ago and this documentary now, argue that the Madoff story was not just a scam/fraud, but involved money laundering and tax evasion.

And finally, in the Globe and Mail’s “Master of doom Marc Faber is gloomy about Canada” Darcy Keith reports some of Faber’s opinions/forecasts on Canada (“huge leverage in the private sector”, “strong currency”, “slowing economy”, “price levels relatively high”, “housing market may well be in bubble territory”, “Canadian banks more risky investments”), gold (“I buy gold every month…with maximum allocation of 25%”), market crash ( one is coming this summer).

Personal Finance and Investments

Last week I mentioned a PBS documentary without having watched it or having provided the link to it in its entirety.  I have now seen it and it’s a must see; here is the link “The retirement gamble”, take the time to watch it. It covers the history of retirement income, how we got from a defined benefit to a defined contribution world and its result, including the impact of cost, passive vs. active fund management, fiduciary vs. suitability standard, advisers vs. salesmen, financial industry lobbying to preserve the current system.

Forbes’ “Senior ‘specialists’ often swindlers” reports that according to a recent Consumer Financial Protection Bureau report on senior specialist titles that The Bureau found that there are more than 50 different senior designations that financial advisers use to indicate that they have advanced training or expertise in the financial needs of older consumers. These designations can confuse older consumers, who are already at risk for deception and fraud.” The CFPB’s head indicated that the “report underscores the need for consistent high-level standards of training and conduct for those advisers who want to acquire a bona fide senior designation… The CFPB would like to see some regulation of these folks, but I have a simpler plan: Require anyone who sells a financial product to become a fiduciary. They must place the client’s interests above those of their firm. If they don’t, you can take them to court.” (Thanks to Ken Kivenko for recommending. All roads lead to Rome, or fiduciary in this case; I wonder how long it will take government to force this issue to its logical conclusion.)

In WSJ’s “’Target’ funds vulnerable to rate rise” Pleven and Light discuss vulnerability of target-date funds, now an accepted default for 401(k) with $500B of accumulated assets, should interest rates increase significantly. These target-date funds, which automatically increase the fixed income allocation with age as one approaches retirement in order to reduce market risk, may actually expose the investor’s portfolio to higher interest rate risk. “The simplest way to gauge the risk of bond losses is by a measure called “duration,” which tracks a bond’s sensitivity to interest rates. The value of a bond portfolio with an average duration of five years, for example, would sustain a loss of 5% if interest rates rose by one percentage point immediately.” The portfolio losses would be determined by “the size and speed of an interest-rate increase, the percentage of bonds held in the portfolio and the types of bonds held”. (Losses would be especially unpleasant for those expecting to convert assets in their 401(k) to an annuity. Still, losses would be mitigated by the annual interest paid by the bonds.)

In the WSJ’s “Retirement plans need dusting too” Tom Lauricella  suggests that with just having filed tax returns, it may be a good time to review: assets, liabilities, spend rate, speak to accountant about changes which might increase tax efficiency, check need for portfolio rebalancing, plan for required minimum withdrawals from tax-sheltered accounts, consider opportunity to reduce mortgage with assets in fixed income investments and most importantly assess whether we are on track with our retirement finances. (What a great idea!)

In IndexUniverse’s “Vanguard Total International Bond Fund nears launch” Cinthia Murphy reports that Vanguard’s new international bond ETF to be available shortly which will have: 0.2% expense ratio and is “designed to track the Barclays Global Aggregate ex-USD Float Adjusted RIC Capped Index (dollar hedged), and will tap into a universe of 7,000 high-quality corporate and government bonds from 52 countries… The index underlying the strategy caps single-issuer exposure at 20 percent, and issuers that individually represent more than 5 percent of the mix may not constitute, in the aggregate, more than 48 percent of the overall portfolio.”

Real Estate

The just released February 2013 Case-Shiller Indexes indicate that in the U.S. “average home prices increased 8.6% and 9.3% for the 10- and 20-City Composites in the 12 months ending in February 2013. The 10- and 20-City Composites rose 0.4% and 0.3% from January to February… “The 10- and 20-City Composites recorded their highest annual growth rates since May 2006; seasonally adjusted monthly data show all 20 cities saw higher prices for two months in a row – the last time that happened was in early 2005… As of February 2013, average home prices across the United States are back to their autumn 2003 levels…” Some of the highest YoY increases were Phoenix (23%), San Francisco (19%), Las Vegas (18%), Atlanta (16%) and Detroit (15%); the lowest YoY increases were New York (2%), Chicago (5%) and Boston (5%). For those interested in Florida, Miami and Tampa increased just over 10% each. In WSJ’s “Housing market accelerates” Nick Timiraos notes that “Supplies have dwindled as banks have pushed fewer homes through foreclosure and because many homeowners are either unable or unwilling to sell due to a variety of factors related to the housing-crash hangover. Meanwhile, demand has picked up as the economy has added jobs, which has boosted household formation. Rising rents and falling mortgage rates have made ownership more attractive… prices are rising even as the homeownership rate fell during the first quarter to 65%, reaching its lowest level since 1995, according to a separate report Tuesday by the Census Bureau. The report showed that relative to 2004, there were 7.2 million more renters but just 400,000 new homeowners, according to Capital Economics.”  (For a little added local color, see “Real estate values-Where do they stand in Century Village”. Thanks to AR for recommending.) In the National Post’s “’Greedy investors’ snapping up US housing” Matthew Goldstein reports that in Las Vegas investors’ “added firepower helps explain why home prices in this metropolitan area of 2 million people are up 30% over a year ago, far more than the national average of 10%. Permits for new home construction are up 50%, twice the national average.” The article notes that the central bank induced low interest rates are driving “people to put cheap credit to work at riskier activities that can spur growth – for instance, buying shares in new companies, investing in oil wells or renovating houses. Prodding investors further out on the so-called risk curve… (but) The combination of rising acquisition costs, prolonged rental lead times and declining rental income is disrupting the spread-sheet analysis behind Wall Street’s bet… (and) in about half of the zip codes in the Vegas metropolitan area, at least 70 percent of homeowners not in foreclosure were under water on their mortgages.”

In Palm Beach Post’s “Will ‘Rental Nation’ plague your property?” Kim Miller writes that “As corporate America sops up the remnants of the real estate crash, it’s not only more difficult for the traditional buyer with financing to find a home, it’s also planted a niggling concern about how it could change the fabric of the American community… But a responsible landlord is not guaranteed and while no one is bashing renters, experts say it is human nature to care more for where you live when you own… The idea of a long-term home means more attention is paid to its upkeep and more consideration is given to neighbors. Increased stability creates a bond to protect a common interest, such as if an unwanted store or strip club is proposed nearby… Florida’s homeownership rate at the beginning of 2005 was 73.2 percent. That fell to 66.2 percent by the end of 2012.”

In the Globe and Mail’s “The real cost of home ownership”   Rob Carrick looks at the differences between home ownership (mortgage, property tax, routine maintenance costs, insurance, less frequent major expenses (e.g. roof, chimney, furnace, a/c, windows, painting, etc)  and renting. By the way Rob is “A former homeowner, now a renter: one year later and still loving it”.

Pensions and Retirement Income

In the Financial Post’s “Is a pension alone enough to retire on?” Jason Heath  does some interesting back of the envelope calculation for a person earning average Canadian income with a government pension which shows what powerful income replacement mechanism can an indexed government  pension be. What a great illustration of the power of a government pension, yet he answers, to the question of whether the individual should work an extra couple of years to increase retirement income and reduce risk of running out of money, with another question: “does it really matter if stress (of continuing to work a couple of extra years) shortens his lifespan in the interim, perhaps to the point where he doesn’t even make it to retirement?”

Also in the Financial Post, is Barbara Shecter’s “Canada can’t afford CPP expansion, independent business group says” in which she reports that the Canadian Federation of Independent Business (CFIB) believes that an expanded CPP “would hurt the Canadian economy and result in significant job losses, according to a report from the Canadian Federation of Independent Business… The short-term impacts are substantial, yet benefits could take decades to be fully implemented.“ (While it is true that as with all saving for the future, the benefits will take decades to flow back, the reality is that the PRPP is not the answer, and while I am not an advocate of what people usually think of as an “expanded-CPP” I think there is more than one way to skin that cat, as I have described in previous blogs e.g. “Expanded-CPP Plus”.)

In BenefitCanada’s “When the money just sits there” Dowdell and Tamburro look at trends in defaults for Canadian Capital Accumulation Plans (employer initiated/administered CAPs like RRSPs or taxable accounts in DC pension plans). They used to be money market funds and now employers are considering target-date defaults in Canada. “The idea is to save and grow money for retirement, not just let it sit.”  (US 401(k) accounts already accumulated $500B assets in target-date funds; in Canada it is still being discussed.)

Things to Ponder

In IndexUniverse’s “Swedroe: Beware of investment books” Larry Swedroe, a respected adviser/planner/author has been “getting a lot of calls and emails about recently published books that have investors freaked out. Just as with the rest of the investment pornography, these books shouldn’t cause investors to abandon their investment plans… Because bad news sells more than good, more often books are of the apocalypse variety… Investors would be wise to treat doom-and-gloom books just like the rest of the investment porn industry, and not let it affect their investment plans.”

In InvestmentNews’ “Glass seen as half-full for equities” Timothy Noonan has an interesting article on Russell’s capital market expectations. “The equity market has room to run.” With year-end 2012 P/E of 16.4 “only marginally higher than historical average… the average annualized equity return for such a P/E in the following 10-year period was in the range of +7%.” On the bond side they argue that we are not in bubble territory, and even if interest rates were to increase coupon payments moderate bond losses; (as mentioned above) duration is the suitable measure to assess interest rate risk of bonds. They suggest levers that active bond managers might use in a “rising rate environment”: decreasing duration, “investing in bonds with higher yields and higher risk” and going global to diversify geographically and currency-wise. Overall Russell is optimistic despite the remaining “macro-economic distortions…such as under-funded social obligations, sluggish developed economy growth, and youth unemployment.” But as usual there are opposing views about how the world is about to unfold; for example The Economist’s Buttonwood in “Following the Japanese script” reports that according to a SoGen report “economies are doomed to slide into a deflationary squeeze and that equities are doomed to de-rate relative to bonds. Mind you, he does think we are nearing the end-game.” (So they agree on bonds but disagree on stocks. Forecasting is difficult especially about the future!)

And finally, In WSJ’s “Investor, know yourself” Meir Statman writes that to become a smarter investor one must get in touch with one’s feelings, because “emotions working under the surface” affect decisions of even people who consider themselves “cold and analytical”. Humans are risk averse and avoiding risk denies us potential returns. To help us better understand our state of mind consider the following questions. How much are we willing to lose? (Think of it how much reduction of standard of living you are prepared to take with a portfolio that has a 50:50 chance for 50% increase in standard of living. Statman indicates that average American’s answer is 12.5%! (With that kind of market risk aversion, we leave ourselves exposed to inflation and longevity risk.)  Other questions probe one’s: fear of regret (more risk averse so are you taking enough risk?), overconfidence (too aggressive), attention to detail (control spending, save adequately), extroverted tendencies (less risk averse so double check before going out on a limb), generosity/agreeableness (watch out for naiveté), open to new ideas (don’t be too trusting, have you saved enough?) and worrywart (use a financial adviser to craft portfolio for you). And in InvestmentNews’ “Meir Statman on perils of markets: ‘If you want real risk get married’” Meir Statman, in a speech to financial advisors, indicated that “You don’t need to be a psychologist, you need to be a good friend… Provide advice as a friend, and as a good person… Anyone can do an asset allocation plan, what is the difference is the kind of emotional contact you establish with your clients, and one way to do that is to reveal some of your own vulnerabilities… Know yourself and your clients, and be their teacher,” he said. “What we all want is bond-like risk and equity-like returns, but you can’t have that.”

Personal Finance and Investments

In the Globe and Mail’s “Why Preet Banerjee is choosing renting over buying” Preet Banerjee looks at the financial advantages of renting vs. owning in Toronto. Even at the currently ultralow interest rates the $550,000 condo with 5% ($27,500) down payment and almost $20,000 closing costs, would still result in monthly costs of $3,300 when buying vs. $2,200 if renting. For those not planning to live there for 10 or more years, but having the discipline to save the extra $1,100/mo and adding in the risk that Toronto condo valuation might actually decrease (and that mortgage rates might be significantly higher in 5 years), renting may be a no-brainer.

In Investment News’ “Blackrock launches ETFs for fixed income laddering” Jeff Benjamin reports that BlackRock launched target maturity (2016 IBCB, 2018 IBCC, 2020 IBCD and 2023 IBCE) corporate bond funds. “While BlackRock is touting its new lineup as being geared toward institutional investors, the ETFs are also ideal for financial advisers looking to build laddered-bond portfolios. The rollout of these types of target-maturity ETFs adds a fresh endorsement to the traditional bond-ladder strategy as a mean of protecting principal.” The advantage of these types of ETFs is that (unlike typical bond funds which never mature) these mature on the indicated maturity date. Annual fees are 0.1%.

Real Estate

In the Financial Post’s “Canadians enjoy a large wealth gap over U.S. counterparts, but will it last?” John Shmuel reports that “Canada’s net worth is a “very healthy” 648% of gross domestic product, compared to 550% of GDP in the United States…(with housing being the main contributor) “The value of U.S. households’ net housing wealth has slumped from a peak of 180% of GDP in 2006 to only slightly more than 100% of GDP now…In contrast, Canadian households’ net housing wealth has continued to trend higher and now stands at more than 130% of GDP.” That could change soon. Capital Economics estimates that, based on the ratio of house prices-to-per-capita-incomes, U.S. housing prices are 20% undervalued while Canadian homes are 30% overvalued.”

In the Palm Beach Post’s “County home prices soar 28 percent in March” Kim Miller reports that according to the Realtors Association PBC existing home prices were $249,894 or 28% higher in March 2013 than those sold in March 2012. “The number of closed sales on existing single-family homes in Palm Beach County last month showed a 12 percent increase to 1,266. Sales of existing single-family homes statewide jumped 9 percent in March from last year to 19,631, with the median sales price showing a 15 percent gain to $160,000.” (At least some of the differences likely have to do with differences in the type of homes sold in the two periods and differences in the proportion of the homes sold being distressed sales. Furthermore the visible inventory is likely just the tip of the iceberg of the shadow inventory held by banks and private sellers waiting for better prices.) In fact USAToday’s “Home sales dip as demand outstrips supply” addresses some of the “apples and oranges” difference between the sales last month and previous March.

Pensions and Retirement Income

In the WSJ’s“They are changing our annuity!” Greene and Scism report that “In the past decade, Americans heading into retirement have racked up a total of $661 billion in an estimated six million variable annuities with benefit guarantees… After four years of cutting benefits in products sold to new customers, insurers now are going after contracts held by longtime customers. The changes include clamping down on fund choices, raising fees, blocking additional account contributions and even trying to buy back the contracts.”   The article includes some valuable advice to those who already own such variable annuity contracts, the changes being made and options available are not necessarily to advantage of the investor, stay invested in aggressive funds otherwise what’s the point of the guarantees don’t trade it in without thorough independent analysis. (Most of these variable annuities with assorted guarantees are mostly pretty lousy deals given their very high annual costs as I indicated in a series of blog some many years old GMWBs)

In the WSJ’s “Want financial security? Look to the Renaissance” in which Moshe Milevsky explains the 360 year old history of tontines and how they work. In the tontine he describes, 1000 participants each contribute $1,000 to buy a $1M 30 year 3% Treasury bond; each year the $30,000 interest paid by the bond is equally shared by survivors, thus the death of some would result in an increased payout to survivors. (Great idea! In fact tontines are a great way to explain/sell a tontine related product already available in the U.S. (though not in Canada) which solves what happens to the principal once all participants die. It is called “longevity insurance” or “longevity annuity” or “delayed payout annuity” see some of my blogs on the subject of longevity insurance. If sourced from a low overhead source (perhaps a mutual life insurance company) or perhaps even offering such an option for part of one’s Social Security or CPP payout, retirees could protect their income security from longevity risk.)

Things to Ponder

In The Financial Times’ “Misuse of collateral creates systemic risk” Satyajit Das explains how collateral practices, rather than reducing risk just shift risk potentially creating systemic risk. He points to the sources of (no pun intended) collateral damage that people tend to overlook: shifts emphasis from borrowers’ creditworthiness to the collateral, overlooks risk in value and liquidity changes of the collateral, “asset liability mismatches” and more. Das writes that “Collateral use creates undesirable linkages between banks and sovereign debt, which compound crises. It encourages the creation of high quality securities that lenders are willing to lend against.”

In InvestmentNews’ “Brokers slammed in PBS documentary” Jason Kephart reviews the PBS documentary aired this week entitled “The retirement gamble” in which “advisers are blamed for steering investors into high-fee investments such as actively managed mutual funds in order to boost their own income”. Among those interviewed were: Helaine Olen (“the term “financial adviser means almost nothing”), Teresa Ghilarducci (“It’s one of the products Americans buy that they don’t know its quality. It’s one of the products Americans buy that they don’t know its danger.”),  John Bogle (“The magic of compound returns is overwhelmed by the tyranny of compounding costs,” he says. “Do you want to invest in a system where you put up 100% of the capital, take 100% of the risk and get 30% of the return?” and Jason Zweig (“One of the ultimate dirty secrets of the fund industry is, a lot of people who run other fund companies own index funds in their own accounts and don’t talk about it — unless you put a of couple beers in them.”) (I haven’t seen the documentary as yet, as I’ve been on the road for the past several days, but certainly sounds worthwhile to watch.)

In the Financial Times’ “Gold: losing its charm?” Jack Farchy writes that not everyone is losing faith in gold despite of the $243 drop in price “from Friday morning to Monday evening” the previous weekend. On one hand Farchy writes that investors shouldn’t be surprised given the rapid rise of gold price to $1,920, George Soros’s recent warning that this was “the ultimate bubble” and Warren Buffett ridiculing investment in gold, India imposing import taxes on gold, the announcement that Cyprus will sell gold reserves to pay to help dig out of its crisis. But many others are sitting tight given that “governments have been printing money at an unprecedented rate” and they believe that they will be ultimately proven right. In fact this week the Financial Times reported that “Asian bargain hunters pile into gold”.

In the Globe and Mail’s “Is it worth making the shift to fundamental indexes?” Andrew Hallam discusses the clash between Bogle (advocating capitalization weighted indexes) and Arnott advocating fundamentally weighted ‘indexes’) and while back-testing suggests that in the past fundamental indexes may have outperformed, “back-tested studies are theoretical…(because) they don’t compare actual products available to investors”. Hallam writes that he won’t be changing his investments to fundamental indexed ones before watching them for another five years, though he might start adding some. (I haven’t even started adding some.) And speaking of alternative indexing approaches in IndexUniverse’s “RSP turns 10; Returns nearly twice SPY” Cinthia Murphy reports that Guggenheim S& 500 Equal Weight ETF (NYSE: RSP) almost doubled the performance of the capitalization weighted SPY over the past ten years. The article explains that “It’s the idiot savant of outperformance—you take the stocks in the S&P 500, you weight them equally and you rebalance. It’s translated into huge outperformance over the years, and you can say that’s because of the tilt toward small and midcaps, which is true…” “That tilt is known for delivering outperformance in bull markets, but is also known for underperforming the broad stock market when things go south.” The article points to other issues with the equally weighted portfolio like more frequent rebalancing and higher costs and taxes.

And finally, in the BloombergBusinessweek’s “How did the world’s rich get that way? Luck” Charles Kenny discusses some of the potential sources of income inequality and that much of it may be attributable to the good fortune of where you were born, the wealth and value system of your parents rather than to your hard work.

Personal Finance and Investments

Jason Zweig reports in the WSJ’s “The bond market can’t be this easy to beat- can it?” that active intermediate bond funds beat the indexes by 1.8% the last 12 months, resulting in investors piling into these funds even as they are deserting active stock fund managers. But investors might be making a mistake by assuming that ”the laws of financial physics have been suspended”. The outperformance is largely due to managers taking more duration (interest rate) and credit risk, and Zweig recommends that you check out how the active bond funds performed compared to the indexed based ones in a bear market.

In Bloomberg’s “The calamity of so long life: How not to outlive your assets” Carla Fried discusses the implications of not just women’s longer life expectancy at age 65 (20 years vs. 17 for men) but also the less understood variability of individual longevity; 65 year old women in the top health quartile have a 62% and 42% chance of living to age 85 and 90 respectively. Coupled with their greater longevity, women also have more conservative portfolios, thus increasing the risk that they run out of money. Some of the suggestions to ameliorate the problem include: delaying start of Social Security payments and considering the purchase of a much cheaper longevity annuity (longevity insurance) where one buys a lifetime income stream starting at age 85 with a single premium at age 65,as a backstop against living too long. (e.g. see some of my longevity insurance blogs at Longevity Insurance )

In the Financial Post’s “Where should I hold U.S. dividend stocks” Jason Heath discusses asset location instead of asset allocation for Canadian investors. He discusses the trade-off between the placement of various assets in taxable/RRSP/TFSA accounts, as well as W-8BEN to reduce the withholding tax to 15% on US dividends which is then recoverable as a foreign tax credit on the Canadian tax return. “Dividends on U.S. stocks held in an RRSP are tax-free…however… U.S. dividends earned in a TFSA are subject to withholding tax. Since TFSA earnings aren’t taxable on your Canadian tax return, the withholding tax can’t be claimed as a credit and part of your potential investment return is forever lost… Other things being equal, I think U.S. stocks should be held in a non-registered or RRSP account,”

In the Financial Post’s “How to avoid the dreaded return gap” Michael Nairne discusses the well known phenomenon that typically the “average investor’s returns from their fund investments lag the returns earned by the funds themselves” because investors invariably get their timing wrong and end up “buying high and selling low”. He has four reasonable recommendations “to avoid inflicting this costly return gap on your portfolio”: define your strategic asset allocation, rebalance back to target allocation as allocation drift with market movement, don’t invest through the rear view mirror, and modify strategic asset allocation as your circumstances change.

In the Financial Post’s “Canadian deposits safe under bail-in, but no guarantee: Carney” Canadian Press reports that according to Mark Carney “the Canadian government has pledged not to dip into individual deposits. Carney did not answer whether there should be a total hands-off treatment to non-secured accounts as well, which in Canada would mean deposits over $100,000.”

Real Estate

Canada’s March 2013 Teranet-National Bank Home Price Index is up 0.4% during March and is up 2.6% over previous year. March is first up-month following six consecutive down-months. Victoria was the only city down in March while Calgary and Edmonton were the two cities showing increases in excess of 1% in the month. Ottawa, Toronto and Montreal had 0.1%, 0.2% and 0.7% increases during March, respectively.

In Palm Beach Post’s “New kid on the block: Corporate titans” Kimberly Miller reports that interest of major investors are diving into the Florida’s distressed real estate market with not just the intention of selling perhaps at a profit in 5-10 years, but also because “…there is a long term paradigm shift in the affordability of people to own homes. There is a definite portion of this population who will be renters for a while in nice communities…more than 109,000 Palm Beach County homes have been foreclosed since 2008-creating renters out of homeowners…”  The article also contains a table showing the “Homestead exemptions decline” indicating a drop of 172,045 fewer homestead exemptions in 2012 compared to the peak of 4,505,042 in 2007, as a measure of home ownership rates. (The silver lining of non-homesteaders, heavily discriminated against on property taxes, is that the fewer homesteaders there are, the more homeowners there are who pay their fair share of the property tax burden, thus decreasing the unfair share being carried by non-homesteaders.)

Pensions and Retirement Income

In WSJ’s “Union-employer proposal would hit some retirees” Kris Maher reports that “a coalition of unions and employers is proposing changes to the federal law that governs pension plans of about 10 million people…” Of these 1450 multi-employer plans funded by groups of employers in “construction, trucking and retail food…more than half are funded to at least 80% level of their liabilities…but 150 plans are headed toward insolvency”. For the plans in trouble the proposal is to change the law to permit reduction of benefits to those already retired to prevent deeper cuts later. The coalition is also recommending a new type of pension plan which offers less risk to employers but more security that offered by 401(k) plans. (A sign of things to come!?!)

Things to Ponder

Diane Francis in the Financial Post’s “It’s a mad, mad market world” discusses Bitcoin’s fall from $266 peak to $60 in a matter of days, followed shortly by the fall of gold prices to under $1,400 almost 30% off the peak of about $1,900. Francis finds surprising that given that millions of people are worried about “…the fact that governments continue to ruin their currencies by racking up debts, printing money and taking draconian action against taxpayers. In the past, the fearful have bought gold and driven up bullion prices to nearly US$2,000 an ounce in recent history. What’s curious is that gold prices have ebbed, the Bitcoin is not a viable alternative and yet fears remain.” She writes that gold bugs suspect a conspiracy of central bankers to “scare people away from gold and silver by driving down their prices. (Certainly possible but there is no evidence.) When gold hit $1,900, the Federal Reserve panicked because they realized with the dollar deteriorating so rapidly, compared to bullion prices, that soon it would also deteriorate its exchange value with other currencies. The Fed had to cap the price of gold and stop the rise.” In the WSJ’s “Gold on track for biggest one day fall since 1983” Shumsky, Freeman and Wallop also discuss the (April15) in day drop of gold of about 9% which they attribute to “a lot of margin calls being triggered” due to the drop of gold below $1,500. In Bloomberg’s  “Paulson loses more than $300M as gold declines” Katherine Burton reports that “Billionaire John Paulson lost more than $300 million of his personal wealth on his gold bet, as the precious metal fell to its lowest price in almost two years. “ And David Berman in the Globe and Mail’s “All that shine and no substance: the reality of gold” writes that the gold slump has left a lot of investors wondering “how this setback could possibly happen to an asset that has long been touted as a haven in a risk-filled world”. He opines that “Let’s be blunt: Gold has had nothing to do with safety over most of the past decade. During its 650-per-cent rise since 1999, whatever virtues it held as a hedge against economic calamity or inflation were pushed aside by speculative fervour… But gold has always had shortcomings as a haven. It pays no dividend, generates no profit and has little industrial use, making it impossible to value the metal in the same way as most other investments.” And Bloomberg’s “The price of gold is crashing. Here’s why” indicates that according to a JPM report global (30 countries representing >90% of world economic output) inflation has fallen from 4% in 2011 to 2.5% in February 2013 and is heading to 2% toward the end of the year.

Furthermore Terence Corcoran in the Financial Post’s “Gold versus Bitcoin” pulls it all together concluding “With Bitcoin, there appears to be nothing there. With gold, at least there’s the gold.” The article also contains a bankers explanation of Bitcoin “Bitcoin is ‘regulated’ by its peers and mathematics. And Bitcoin is not a currency like fiat money. It is a value transfer system which is given value only by its users. So the ECB, FED, etc. have no mandate to control a ‘virtual currency’ just because they call it (Bitcoin) that! It will just go underground. Bitcoin is like Light and Air. Free to use and transfer. Owned and issued by the people and NOT the State!” However, Corcoran reports that central banks already fired the initial salvo when “The ECB warns that bitcoins “could have a negative impact on the reputation of central banks” and are already technically subject to central bank regulation.” (And sure enough that Bitcoin basically puts in question not just the reputation of central banks, but through the central banks’ arbitrary currency creation/debasement actions puts in question the meaning of money which we have come to trust at least in the developed world as a store of value of assets one has accumulated for one’s retirement years. Some might say that it is a wake-up call on the house of cards we are building? Donald Coxe comments on the money vs. gold as a store of value point in a Globe and Mail interview where he concludes that “But that doesn’t mean gold won’t regain its status as the established store of value. Paper money might have replaced it if central bankers had remained central bankers and not major agents in national economic policies and priorities.” Those who are thinking about gold to speculate on its price I wouldn’t bother, but those who think of it as (a small) insurance against financial catastrophe might have a point…and the entry price is 30% lower than a few month ago.)

In the WSJ’s “As America ages, shortage of help hits nursing homes” James Hagerty reports on the on the worsening labor shortage of “one of the nation’s fastest growing occupations-taking care of the elderly and disabled- just as the boomers head into old age. Low wages (<$12/hr), high injury rates (5.3/100 full time workers, more than double the rate for manufacturing, construction and all industry average, and on par with animal slaughtering, and only 15 and 30% lower than sports teams and fire fighters!) and the “work can be unpleasant and physically draining”. However the need will grow in line with the exploding over age 65 population from 40M in 2010 to 73M in 2030 and almost 90M by 2060. The quality of care is generally negatively correlated with the turnover rate of nursing aides, which ranges between 43% and 75% a year!

In Bloomberg BusinessWeek’s “The reason healthcare is so expensive: Insurance companies”  Jeffrey Pfeffer reports that in the discussion about reasons for the high cost of US healthcare compared to other developed countries there is little mention of the chief culprit that 20 years ago “…health-care administration cost somewhere between 19 percent and 24 percent of total spending on health care…” but a decade later this has grown to 30% of the total cost while the percentage of people involved in healthcare administration has grown to 25% of total healthcare related workers. Pfeffer argues that the primary reason for this is that large employers typically hire insurance companies to administer the health insurance plan on a cost-plus basis so “Because insurers are paid a fixed percentage of the claims they administer, they have no incentive to hold down costs. Worse than that, they have no incentives to do their jobs with even a modicum of competence.”

And finally, in the WSJ’s “Will Google’s Ray Kurzweil live forever?” Holman Jenkins writes about prolific inventor and entrepreneur Ray Kurzweil who believes that “his chances are pretty good of living long enough to enjoy immortality.” He explains that people tend to think linearly and “They have a hard time grasping the “accelerating, exponential” change that is the nature of information technology… Mr. Kurzweil expects medical technology to be adding a year of life expectancy every year. We will start to outrun our own deaths.” He figures that while today “when hardware crashes (person dies)… the software dies with it”. In time “we will become software and the hardware will be replaceable”.

Personal Finance and Investments

In the Financial Times’ “Beware the costs of actively managed funds” John Authers asks “Why defend the indefensible? Traditional actively managed mutual funds are obsolete.” The arguments that: active managers can exit market before it dives (but do they?), index funds are guaranteed to underperform the index by costs (but outperform active managed funds on the average after costs) and choosing the index funds is ignoring the active managers who consistently outperform (but how can you tell which ones will do so in the future?), are all made to look ridiculous in the face of the real facts. Authers only concedes one point which is the service that active managers perform for the entire market by “seeking out inefficiencies”.  He furthermore argues that the only way to beat the index might be to abandoning diversification completely and invest only in  5-10 stocks or in a couple of sectors, with the adverse consequences should you bet wrong! You might also be interested to read the Globe and Mail’s   “How to respond when your adviser tries to dissuade you from index funds” in which Andrew Hallam lists ways to counter your advisor’s attempt to push you away from index funds. By the way in the Financial Times’ “Why passive investing is buy high, sell low” Somerset Webb makes some (mostly weak) counter arguments against passive investing: passive will always underperform index, buying high selling low on price (cap-weighted) indexes like during the dotcom bubble, the benefits of non-traditional indexes (e.g. fundamental indexes). And speaking of passive investing, for those who still have not fully converted to passive investing spend the 53 minutes required to view the video “Passive investing: The evidence that fund management industry would prefer you not to see” it is compelling. (Thanks to VP for recommending video.)

In WSJ’s “Questions to ask your adviser about fees” Chana Schoenberger suggests some questions to ask to better understand how your adviser gets compensated and how that might affect the advice that you get: “How are you registered? (‘registered representatives” or RIAs registered investment advisers” or sometime both or dual or hybrid registered so you may get dinged for sales/transaction/trailer commissions/fees and well as fees for advice, e.g. see “Hybrid advisers may have skewed report on commission business” ), “What am I paying you and your firm directly?”, “What payments are built into the products I may buy from you?” (e.g. trailer costs on funds, bid-ask spreads on bonds).

In WSJ’s “Pay off that mortgage now” Brett Arends argues that “Repaying a mortgage early offers…a risk-free return in the form of the interest saved. Nowadays anyone with a mortgage of 4% or 5% can earn more by repaying the loan than by investing in bonds, which have been rallying for most of the past three decades.” He suggests using money already allocated to bonds in one’s portfolio.

The Economist’s “Trimmed hedges” discusses the necessity to take with a very large grain of salt even the only thing that hedge funds supposedly do disclose, since they “routinely revise their performance data, often in ways that seem designed to fool outsiders…Counter-intuitively, most fixes aim to make performance look worse than originally stated…(because the use of performance fees based on high watermark valuations) managers have an incentive to belittle past returns. Indeed they are the most avid revisers, knocking an average 0.62% off the numbers. In contrast, funds with no need to beat past high-water marks typically inflated their first submissions by 0.4%, making them look more successful to prospective backers”. (Surprised? Perhaps you shouldn’t be.)

Real Estate

In the Financial Post’s “Signs of a Canadian housing downturn are everywhere” Theresa Tedesco reports that Canadian home sales were off 15.8% over the year ago volume and off 2.1% during February of this year. “Almost 80% of local markets posted year-over-year declines in house sales while new listings dropped 60%; worst in Toronto, Vancouver, Montreal and Saskatoon.” We heard much about the correction under way in Toronto and Vancouver but “But signs of another bust in the making point directly to the Greater Montreal area, which has as many individual homes for sale right now as Toronto and Vancouver combined — just under 32,000 — while at the same time, it has twice as many condominiums on the market than Toronto… while Ottawa has not only seen its MLS inventory spike, its condo market has seen active listings jump by a whopping 40% year over year as prices fell 4% during the same period.” The economic consequences to a correction in house prices and demand can be significant in Canada not only because of the wealth effect felt when prices are rising, and the opposite when falling, but also because 27% of the Canadian economy is housing related, which is even higher that the 24% number at the peak of the US housing bubble!

In the Palm Beach Post’s “Growing shadow inventory of foreclosed homes driving up prices in Palm Beach County” Kimberly Miller reports that shadow inventory “the number of foreclosed homes that are not listed…including continued borrower default” is up by 82% in Florida (from 175,707 in Q1’2012 to 319,147 at end of Q1’2013). These “…properties are a boon and bane to real estate. They offer the tease of more inventory in a property-starved market, but can also can deteriorate, hurting neighborhoods and threatening to cut sale prices if too many rundown homes go up for sale at once… But the pileup in the shadow inventory is also a case of banks not wanting to take a hit on distressed properties…Lenders don’t want to reduce a home’s value by 40 percent on their books and pay thousands of dollars to rehab it for sale”.  “If we don’t see more inventory, and buyers outpace sellers, it may increase prices too much in too short of a time period,” Brink said. “We are going from one extreme of too much inventory to too little.”

And in the spirit of the last sentence of the previous paragraph, in the Globe and Mail’s   “Hey aspiring snowbirds: The Florida housing market could be rebounding” Andrea Cornish writes that following the 40-50% drop in home/condo prices “Rock bottom prices and a high exchange rate made purchasing U.S. property an attractive proposition for northern neighbours. According to the National Association of Realtors, nearly a quarter of home sales in the 12 months ending in March 2012 were by Canadians.” (While there is one sentence about Florida’s high foreclosure rate of 13.7%, much of the article refers to quotes from various real estate people who, some might suspect of trying to pump up the market….no mention of the discriminatory property taxes against non-residents if prices really were to increase (I am not counting on this)…and the fact that it may cost as little as 50-70% as much to rent as the carrying costs of condo ownership even excluding cost of capital, when you factor in taxes, maintenance costs, insurance, special assessments, etc…and in any case, the key word in the title of this article is ‘could’, given the shadow inventory mentioned earlier which I have seen quoted at the equivalent of 29 months of sales compared to the normal level of 6 months!)

In the WSJ’s “Cheaper by the dozen” Telis Demos reports about firms having bought up foreclosed single-family homes which they are now starting to offload to hedge funds and private REITs. These investors are trying to capitalize on the rental boom since the 2008 financial crisis “But the business model still is in the early innings, and it isn’t clear how efficient it is. Much will depend, analysts say, on the expertise of individual managers in such nuts-and-bolts items as leases and building maintenance. Investors are nibbling, in part because they are hungry for returns at a time when interest rates are hovering near zero and in part because there are strong signs of a housing-market recovery… (but) The potential headaches of being a landlord include prolonged vacancies, unexpected maintenance and repair costs, deadbeat tenants and difficulty refinancing… repair costs are greater for single-family-home rentals than they are for comparable apartments in a single complex.” “There are two big questions for investors: Will the REITs produce the income they expect, and will they be a good vehicle for profiting from rising home prices?”

Pensions and Retirement Income

In the WSJ’s “The pension rate-of-return fantasy” Andy Kessler discusses the consequences of municipal bankruptcies like the recent one in Stockton, CA and the ‘fine work’ done by actuaries ( who by the way he suggests are people “who really wanted to be accountants but didn’t have the personality for it”) assuming 7.5% returns on pension plan assets when ten year  Treasury bonds are paying 1.74%. Realistic returns today might be 3% rather than the 7.5-8.5% assumptions floating around. As reality starts to sink in municipalities (read taxpayers) will dramatically have to increase pension contributions, but likely so will employees. And of course, like in the private sector, DC plans will likely be replacing DB plans in municipalities and states and in the case of bankruptcy “the only thing left is to cut retiree payouts, something Judge Klein (in Stockton’s case) has left open… When Wisconsin public employees protested the state government’s move to rein in pensions in 2011, the demonstrations got ugly—but that was just a hint of the torches and pitchforks likely to come.” (Unlike the case of US private sector employees whose DB pension plans are generously insured by the PBGC, public sector pensions have no such insurance on the expectation that they can always resort to raising taxes to cover shortfalls.)

Things to Ponder

And speaking of bankruptcy related litigation, my mind jumps to the almost $1B that was charged so far to the Nortel estate resulting primarily from legal costs, there is a Financial Times’ article entitled “Prosperity requires more than the rule of law” in which John Kay notes that “…spiralling costs of litigation establish an environment in which the rule of law operates in favour of bullies and the rich and privileged – a process whose outcomes closely resemble those of dispute resolution in very primitive societies… even with legal costs absorbing almost 2 per cent of gross domestic product, the US is an affluent country…but impediments to growth…(include)  sclerosis arising from the conflicting demands of too many established vested interests.” (Wow…2% of US GDP goes to legal costs…now here is an opportunity to take an axe to…this sounds as corrosive to society as Canada’s mutual fund fees of 2-3%.)

See my review in my earlier blog this week of “Paper Promises- Debt, Money, and the new world order” by Philip Coggan. It is a timely book given the discussion generated by the Bitcoin bubble (see at the end of this blog) as well as the growing pressure among some states in the US who are losing confidence in the Fed money printing and would like some mechanisms to re-establish a gold-backed US dollar or gold as legal tender. As a teaser to get you to read this book, you can read one of the subjects discussed in it being retold in the Economist’s “Where did all the money go?”  where Buttonwood (Philip Coggan) discusses how bubbles develop and what happens to the trillions which evaporate when bubbles collapse. “…those equity and property prices. In a free market, like an auction, prices are set by the marginal buyer and seller. If there is an imbalance between willing buyers and sellers (as there was in American, Spanish and Irish housing in the middle of the last decade), then prices will rise sharply. The average homeowner feels wealthier as a result. But only a small proportion of the housing stock (or of equities) trades on any given day. The price set by marginal buyers and sellers is not the price that could be realised if all owners of the asset in question tried to sell their holdings at the same time. In such a moment, there will be more willing sellers than buyers, and prices will plunge. High house or share prices, relative to personal incomes or profits, represent a bet that the good times will continue, and that incomes and profits (and cash flows in the form of dividends or rents) will rise significantly in future. When that bet proves wrong, the wealth disappears. ”

In IndexUniverse’s “Fed should up reserve requirements” Jeremy Siegel discusses some ideas about how the Fed might unwind the current quantitative easing (e.g. by sharply raising bank reserve requirements), about the reasons for the historically low interest rates being not just a consequence of QE but also a demographic phenomenon especially in the developed world where aging population which has been badly bitten by two stock market crashes in the last dozen years is increasing its risk aversion at the same time as pension funds are also pulling back on equities to reduce market risk; and yet Siegel believes that stocks are quite cheap by absolute measures and relative to other assets, and that people will overcome their fear of the equity markets and some of the $11T sitting in money market funds will find its way into the market.

And finally, the Bloomberg Businessweek’s “Bitcoin may be the global economy’s last safe haven” if nothing else it’s an educational article on how money can be created out of thin air…you don’t even need central bankers or precious metal or other backing, just a bunch of people who will believe/trust that someone else will accept it in exchange of some goods/services…and it’s good to go…well at least until it’s not (“Ugly day for Bitcoin as virtual currency price plunges” 41% from its intraday high and “Et tu, Bitcoin” demonstrating human that gullibility or the triumph of hope over reality or other similar sentiment has no limit?…but according to the Economist’s “Mining digital gold”  even if Bitcoin crashes, it might change the financial world the way Napster changed how music is bought.)… and by the way in a sign that people are losing confidence in the Fed (even though credited with having saved the US from a depression starting in 2008) and its monetary policy with moves to promote gold as legal tender in some US states as discussed in  “Trust in gold not Bernanke as U.S. states promote bullion” and “Midas moment: States rush to make gold legal tender” (Not sure what any of this actually means, or how one can reconcile this with the recent drop in gold prices and forecasts of its further softening in the near future. Still all this talk might be further undermining trust in money (and money is all about trust) and our financial system, or is perhaps just a teachable moment for those controlling our currencies and/or all of us collectively about the meaning/creation of money.)

Details

Coggan explains some very complex topics as simply as possible:

-the nature of money and what it’s good for: media of exchange, unit of account and store of value

-forms of money: precious metals, government created banknotes and banking created credit

-Warning: “any system (democracy) that allows net debtors (normally the majority) to outvote net creditors (usually the minority) has its potential weaknesses”

-the ‘trilema’ of exchange rate systems is that you can only choose two of the three options: fixed exchange rates, free capital movements and control over interest rates (i.e. monetary policy)

-the “gold standard” defines currency convertibility to gold…a return to the gold standard is a victory of creditors over debtors…not a likely scenario unless we enter a more serious crisis than we currently have

-covers the historical landscape and explains the creation of the Breton Woods agreement, the IMF, the replacement of gold with the US dollar as it became a reserve currency, the ‘seignorage’ benefit of the US in being able to print dollars at zero cost to buy goods overseas, the end of Breton Woods in 1971 with the end of convertibility of the dollar to gold, the move to floating exchange rates

-relationship of currency exchange rates, inflation and interest rates, the “carry trade” of borrowing money in low interest countries and lending in high interest ones,

-the Euro: its drivers and its flaws

-the creation of bubbles: rising stock prices due to an instantaneously “small preponderance of willing buyers to push prices higher. And this can happen for quite a while, provided they don’t want to realize their gains”…i.e. a lot of people can have paper profits so long as they don’t try to cash them in, so in a bubble the money was never there…furthermore a bubble changes behaviour in a lasting way

-asset prices are closely tied to debt (e.g. in housing bubble there were three stages: hedge borrowers (can meet interest and capital repayment), speculative borrowers (can meet only interest payments) and Ponzi borrowers (can meet neither interest nor capital repayments, i.e. they just want to ‘flip’)

-the “Greenspan put” protected those who gambled with other people’s money…some accuse him of “asymmetric ignorance” because “he would intervene if market fell sharply but not if it rose quickly”

-“savings glut” in China and Mid-East had to be invested in US Treasuries so forced prices up (interest rates down)

-banks/financial industry are like croupiers in casino making money on every transaction…many banks became “too big to fail” exposing economies to “systemic risk” and all is lubricated by government, bankers and light touch regulatory environment…financial sector rent seeking resulted in a transfer of wealth from the rest of the community

-explains how in 2008 banks failed, the inadequacy of Value-at-Risk measurement, unknown unknowns and Black Swans…first LTCM bailout, then Bear Stearns bailout but not Lehman…subprime mortgages Credit Default Swaps and their collateral problems…and the bailout which transformed private debt to government debt

-how sovereign debt is not “risk free” and how the hidden debt public pension and healthcare for retirees and invisible public sector employees pension deficits and healthcare costs are enormous compared to visible debt which governments incur in the open market (e.g. effective total government debt in the EU is 434%!) and demographics just aggravates an already serious situation

-some mechanisms for reducing pension cost: later retirement, career average vs. final salary pensions, shift from DB to DC plans, reduce/eliminate pension indexing

-retirees hoping to sell their houses to generate income in retirement will drive prices lower (excess of seller relative to buyers due to demographics) as well as financial repression (low interest rates) will drive income down in retirement

-explains the “debt trap” as debt-to-GDP approaches 100%; when government debt hits about 100% of GDP and interest rates are 5% and growth is 4% one can’t reduce debt without a “primary surplus” of revenues over expenditures (excluding interest payments) but that may drive the economy into recession, reducing GDP and thus increasing Debt/GDP ratio!

-consequences of debt crisis in the long term: inflation, stagnation and default…QE is the triumph of debtors over creditors and expanding money supply is merely a form of redistribution of wealth…when one of these three will happen there will be a crisis of similar or greater magnitude than 2008…the first symptom was the European crisis and the next one will be the China/America relationship…

-looking ahead Coggan sees: the USD continuing as a reserve currency even as it continues to depreciate against the Renminbi at about 10%/year with US (unable to stop buying/importing/borrowing) and China (unable to stop manufacturing/exporting/buying US Treasuries) locked into this (deadly) embrace, continuing financial repression for decades to allow debt burdened governments not to sink in face of the accompanying interest payments, return of capital controls forcing local saving into government bonds, and ultimately creditors will be disappointed because of the wealth transfer from them to debtors.

Bottom Line

This is an educational book but a pretty dismal story for retirees whose public (and private) pensions and healthcare benefits will continue to be eroded, while their retirement assets earn minimal or negative real returns.

Personal Finance and Investments

In Market Watch’s “3 investing rules to rescue your retirement” Jonathan Burton reports on a telephone interview with Malkiel and Ellis (about their new book The Elements of Investing) who indicate that “to maximize yield, safety and capital gains during what they expect will be a lengthy period of below-average total returns from stocks” you must remember: that cost matter, to rebalance regularly and that indexing beats the “loser’s game”.

In Index Universe’s “SPIVA: Active bond managers shine in 2012” Cinthia Murphy reports that in 2012 over 50% of active managers in all categories underperformed the indices except the short and intermediate active government bond fund managers over one year. But ability to beat index deteriorated in all fund categories as observation period increased. The short government bond fund category remains the only one where over 50% of active managers beat indices over 3 years, and over the 5 years there is no fund category where >50% active managers outperform the index.

In Investment News’ “Advisers making statement by shunning formal investment statements” Jeff Benjamin writes that “With the industry shift toward advisory-based relationships, it is surprising that so many advisers remain uncommitted to the best practice of utilizing investment policy statements (IPS) with all clients… 61% of those surveyed are not doing it for all clients and many are not doing it for any of their clients…” (Not clear what type of ‘advisers’ were surveyed what percent were RIAs who are fee-only compensated and are required to  meet a fiduciary level of care in the US, but one can assume that the vast majority (if not all) of those surveyed were not RIAs. One might even be encouraged by the numbers which suggest that about 40% actually provide an “investment statement”, if it only were a real IPS. But then of course an IPS is not free and few customers are willing to pay for it explicitly and equally few ‘advisers’ are willing to provide it “free” except to those with significant assets.)

In the Financial Post’s  “Make tax efficiency part of your investment strategy” David Kaufman writes that “While all investors should think in terms of risk-adjusted returns, tax-paying investors should also think of their after-tax risk-adjusted returns.” He also discusses two mechanisms that some investors used to convert income into capital gains: a tax wrapper which uses total return swaps and corporate-class structures which allow deferral of taxes indefinitely. He points out the recent changes announced in the Canadian budget essentially end the former, whereas the latter is of questionable value given the corrosive effect of the cost of funds used in the corporate-class structures. In conclusion he warns that “Sound investments strategies come first; tax efficiency comes second.”

In the Financial Post’s “Testamentary trusts under scrutiny over tax benefits” Jamie Golombek writes that “The budget also indicated that the government was concerned with the growth in what it called the “tax-motivated use of testamentary trusts and the associated impact on the tax base.” As a result, the government is planning to issue a consultation paper to the public on whether the tax benefits that arise from taxing income inside testamentary trusts at graduated rates should be eliminated.”

In the Financial Post’s “Asset allocation rules for any age- even 82” Jason Heath discusses how asset allocation might change with age. The old asset allocation rule(s) of thumb that percent of stock allocation should be (100-age) might with increased longevity even change to (110-age) or (120-age). But it might even change further in case when there is a high probability that you’ll be passing much of the assets on to the next generation, in which case you might be using their age in the rule of thumb, which would lead to a much higher allocation to stocks. He concludes with “Investment strategies, financial planning and rules of thumb are fluid and personalized. Take everything I or anyone else says with a grain salt. After all, it’s your money.” (Of course, he is right that ultimately asset allocation is derived from your individual risk tolerance, in which age is just one of the many factors to consider.)

In WSJ’s “How funds massage the numbers, legally” Carolyn Geer discusses ways in which funds massage their returns with “tricks of the calendar” by appropriately selecting over what interval performance numbers are to be reported or omitted, or by crafting forward going portfolios based on only including previously outperforming sub-managers, or by using back-tested returns to demonstrate “the returns they would have earned in years past if they had been investing the way they do today” which are “made-up” returns not “actually earned in real time”.

In Index Universe’s interview “Bernstein: Make peace with T-Bills” Bill Bernstein says “Get over the low expected returns of fixed-income instruments, because you don’t have a choice.” Don’t stretch for yield with emerging market credits, long maturity bonds, high dividend stocks unless you are prepared to take significant capital losses at some unknown future time. Stay short with fixed income assets and wait for the inevitable reversion to the mean. Use the equity portion of your portfolio to get your appropriate risk exposure.

Real Estate

The January 2013 S&P Case-Shiller Home Price Indices indicate that US “average home prices increased 7.3% for the 10-City Composite and 8.1% for the 20-City Composite in the 12 months ending in January 2013…” while the prices increased during the month of January by 0.2% and 0.1%. The report includes city by city MoM and YoY price changes for the metropolitan areas in the indices. The report comments that “Economic data continues to support the housing recovery. Single-family home building permits and housing starts posted double-digit year-over-year increases in February 2013. Despite a slight uptick in foreclosure filings, numbers are still down 25% year-over-year. Steady employment and low borrowing rates pushed inventories down to their lowest post-recession levels.”

However in Canada the Financial Post reports that “Toronto, Vancouver home sales fall sharply in March” with March sales being off in Toronto and Vancouver 17% and 18%, respectively over same month in 2012. “The sales last month were the second lowest March total in Greater Vancouver since 2001 and 30.2% below the 10-year sales average for the month…”

Situation resolved: Canadians driving in/to Florida will be happy to hear that according to a report from the Canadian Snowbird Association “Florida’s legislation requiring foreign drivers to possess an International Driving Permit to legally operate a motor vehicle has been officially repealed… The repeal is retroactive to January 1, 2013.” (This will come as a great relief to those who for a few weeks since mid-February, when the existence of this new Florida requirement became widely known, were significantly apprehensive whether they might be charged for driving without a license or perhaps their Canadian insurance might be invalid.)

Pensions and Retirement Income

In the WSJ’s “How to save more for retirement without really trying” Jason Zweig discusses mechanisms increasing retirement savings by means of harnessing “the most powerful force in the financial universe: inertia. The only thing people hate more than making decisions is changing them….So when people want to save but can’t bring themselves to do it, their retirement funds need to do the saving for them—automatically” with defaults of auto-enrolment, auto-escalation coincident with salary increases. Auto-escalation is the necessary additional step to drive retirement savings up from the very low levels set using auto-enrolment (often as low as 3%).

In the Financial Post’s “Ernst & Young’s multiple Nortel roles shrouded in mystery” Barry Critchley describes the multiple roles that E&Y plays in the Nortel bankruptcy. Not only it is the “monitor” for the Canadian bankruptcy court in this case but it is also the administrator for Nortel UK, the ”Indirect Tax Service Advisor in the U.S. the Unsecured Creditor Committee and the Ad Hoc Bondholder Group control in the U.S. estate…. And those multiple roles mean that its decisions and actions can affect one class of creditor at the expense of another, given that there are more creditor demands than available cash to pay them all.” (If I recall correctly, E & Y was also Nortel’s advisor in preparation to the declaration of bankruptcy protection. So why are Nortel’s Canadian pensioners surprised that they are getting nothing but scraps in every court decision and that bondholders are dug in to milk the Nortel estate even for post-bankruptcy interest?)

In Benefit Canada’s “Are DC plans too risky?” Fred Vittese makes the case with historical data showing that DC pension plans are not nearly as risky to employees as commonly believed. His example is based on 8% contribution rate over 30 years with a target of 30% of final average pay starting with data from 1938; on retirement assets are annuitized in an indexed annuity with 10 year guarantee. The outcomes of the simulation ranged between 15% and 55%, but if employee chose execute some evasive action when outcomes were poor (like work extra two years and take only a 50% indexed annuity), the range narrowed to 24%-55% and “the pension was 30% or more in 43 out of the 46 30-year periods and never fell below 24%.” Then he goes in for the kill that “a pension of 30% of final average pay seems to be a reasonable target relative to an 8% contribution rate…(especially when compared to) the Canada Pension Plan (which) has a target pension of 25% with a 9.9% contribution rate and the death benefit is less generous”! (That expanded-CPP sounds much less attractive in this context. Eh???)

In Rabble.ca’s “The ecstasy and the agony of Canadian pensions” David Agnew has a great article summarizing the good, bad and ugly of Canada’s private sector pension system. He concludes with the question of when will Canada correct the injustice in its private sector pension system? He offers a series of solutions: stopping windup of pension plans into annuities, establish a proper pension insurance program in Canada, make multiemployer pension plans the norm, raise priority of pension plans in case of employer bankruptcy and provide some form of expanded-CPP. Furthermore he points out that most of these solutions are already implemented in most of developed countries in the world and have been recommended by various federal and provincial government initiated pension reform commissions.

Things to Ponder

In the Financial Times’ “Cyprus confiscation could happen in the UK” Neil Collins opines that it could since the UK’s debt level has passed that what can be managed by conventional means “as the deadweight cost of servicing it stifles the growth needed to pay it down”. In that case what’s left is “inflation, taxation or confiscation”. He argues that the first seem harder to achieve than previously thought, taxation is already close to the limit of what is possible. This leaves confiscation as the only credible choice. (Governments could use printing presses when available to them to deal with local currency debts. The UK has this option, which ultimately leads to currency depreciation and/or inflation.) And John Greenwood in the Financial Post’s “Ottawa’s bank ‘bail-in’ talk could be bad for debt holders” writes that last week’s Canadian budget also mentions “plan to establish a roadmap for what happens when a bank gets into trouble, proposing a “bail-in” approach… “This regime will be designed to ensure that in the unlikely event a systemically important bank depletes its capital, the bank can be recapitalized and returned to viability through the very rapid conversion of certain bank liabilities into regulatory capital,” the budget said. ”And bank deposits are liabilities and some fear that this might imply a Cyprus like approach to confiscate some percentage of deposits. Finance Minister Jim Flaherty’s office issued a statement that “the bail-in scenario described in the budget has nothing to do with depositors’ accounts and they will in no way be used here.”

And by the way, in the Financial Times’  “Cyprus capital controls threaten eurozone” John Plender discusses some of the implications accompanying the “solution” to the Cyprus crisis including capital controls that “would last only a matter of weeks”. He argues that by this will likely last longer than a few weeks (similarly to Iceland’s controls still in place today having been established in 2008) and with this measure the euro in Cyprus has been effectively devalued. This will leave questions whether similar “solutions” will be applied elsewhere in troubled eurozone countries. He discusses how exchange controls are usually a precursor of totalitarian regimes which not only restrict the movement of money but people as well.

In both “Jack Bogle warns ‘Prepare for two massive market declines in the next decade’” and  “Jim Rogers: Major crash ahead for US investors” Bogle and Rogers are predicting significant market declines in the next few years as a consequence of the escalating debt. The Rogers article suggests that debt expansion and money supply approaches are analogous to pyramid schemes. The Bogle article is less apocalyptic but still sees a couple of significant market swoons, but he suggests that “The market goes up, and the market goes down. It’s never failed to recover from one of those 50 percent declines.”

One might think that given all the talk of currency controls, out of control debt and monetary policy and governments will almost always choose inflation if the available options are is to inflate, stagnate or default, that gold would be considered a safe-haven of sorts that would continue to appreciate in value. However Bloomberg News “Gold ‘bubble’ will turn into bear market- SocGen” quotes one analyst that “Gold is in a “bubble” after the best annual run in at least nine decades and will head into a so-called bear market as a stronger U.S. economy helps increase interest rates and cut bullion demand… Investors are unlikely to raise gold holdings because inflation has remained low…” (The old saying still holds that “forecasting is difficult especially about the future” so I won’t even attempt it.)

In MarketWatch’s “In China, honor thy parents or get sued” Matthew Heimer reports that the over 60 population in China is expected to triple over 40 years and become about 30% of the population. The government has introduced new “filial-piety” laws which “prohibit “’discrimination, insult, ill-treatment and abandonment’ of the aged.” They also require employers to approve leave for children to visit their parents, and even allow parents to sue kids who don’t visit often enough.”

And finally, in the Financial Times’ “How bankers believed their own hype” Gillian Tett discusses new research based on bankers who were deeply involved in subprime lending that they “not only lived by the mortgage sword, but suffered under it too” and that “…it is groupthink and wishful thinking – not deliberate malevolence – that poses the biggest risk in finance…” (i.e. with the market continuing to improve and more people jumping in for the ride, don’t lose sight of your strategic asset allocation which is determined by your risk tolerance, especially if you are about to retire or already a retiree.)

Personal Finance and Investments

In the Globe and Mail’s “Ten rights investors should expect from financial advisers” Rob Carrick reports that the CFA Institute has issued a Statement of Investor Rights which specify 10 investor rights, that investors should demand from their financial professionals, and financial professionals should explicitly commit to. “Among the rights you should demand: You have the right to honest, competent and ethical conduct; to independent, objective advice; and to an explanation of all fees charged to the client. The most important point is a basic one – that your financial interests take precedence over those of your adviser and his or her company.” (Certainly a great initiative intended to set high investor expectations as to their rights. The CFA Institute Code of Ethics and Standards of Professional Conduct (available in the Standards of Practice Handbook) already explicitly require that CFA Charter holders adhere to an even broader and more stringent set of requirements in client relationships and requirements are backed up by a Professional Conduct Program including sanctions when appropriate. Disclosure: I am a CFA Charter holder.)

In the Financial Post’s “Accountants: The unsung heroes of financial planning” Jason Heath reminds readers of the fast approaching tax season and suggests that “people take a life-long view of taxes. It’s not necessarily all about paying the least amount of tax today that matters.” Furthermore Heath argues that with the available tax preparation technology today “I’d rather see people pay an accountant for tax planning and do their own taxes.”

In the WSJ’s “To save, workers take on health cost risk” Anna Wilde Mathews reports on the some U.S. employers started offering employees “a sum of money and allowing them to choose their health plans at an online marketplace”. The outcome of using such “employer-centric” “private exchanges” has been employees “were willing to choose lower-priced plans that required them to pay more out of their pockets for health care”, demonstrating that people make different choices when they are spending their own money.

Real Estate

The February 2013 Canada’s Teranet-National Bank House Price Index indicates a -0.2% MoM decline and 2.7% YoY increase in Canadian home prices. Quebec City, Toronto and Calgary were among the cities doing better than the YoY average, while Ottawa and Montreal had below YoY average increases; Vancouver however declined -1.5% over the previous 12 months. On a MoM basis the index declined for the sixth straight month. Among decliners during February were: Calgary (-1.2%), Toronto (-0.3%), Montreal (-0.4%) and Ottawa (-0.8%).

In the National Post’s “Home sales have plunged almost 16% in a year as price gains slow”  Andrea Hopkins reports that according to the Canadian Real Estate Association Canadian home sales were down -2.1% MoM and a staggering -15.8% on a YoY basis. CREA opined that “the government’s move to tighten mortgage lending rules in July 2012 has slowed the market, and lower activity is expected until at least the June-to-August peak season.”

In the Globe and Mail’s “Vancouver’s vacancies point to investors, not residents” Frances Bula reports that according to a new report “Nearly a quarter of condos in Vancouver are empty or occupied by non-residents in some dense areas of downtown, a signal that investors play a significant role in the city’s housing market.” Vancouver in total had 7.7% of “dwellings that showed up as either “unoccupied” or occupied “by a foreign resident and/or by temporarily present persons” on Census Day 2011”; this compares unfavorable with 5.4% in Toronto and 5% in Calgary. The article discusses the implications of the absence of “active full-time population” on the community in general and more specifically actual supportable commercial activity in the area.

In Palm Beach Post’s “Palm Beach County home prices up 27 percent from year ago” Jeff Ostrowski reports that “The median price of an existing home sold in the county rose to $235,000, up 27 percent from a year ago and 8 percent from January, the Realtors Association of the Palm Beaches said today. Sales volumes continued to rise, too. There were 1,012 single-family home sales last month, up 9.6 percent from a year ago and up 5 percent from last month…. Prices were buoyed by shrinking inventories. It also helped that there were fewer low-priced foreclosures and short sales dragging down prices.” But John Tuccillo warns that “This is a price number that reflects what’s selling in the market, and it does not necessarily reflect appreciation…It shows directionality, but it’s not a measure of values.” The other effect built in is the drop of 40% in foreclosure sales from a year ago.

Pensions and Retirement Income

In the WSJ’s “Retired coal miners fight to retain benefits” Kris Maher discusses the impact of the bankruptcy of (an acquirer of) retirees’ employer which is “asking a bankruptcy-court judge to throw out the union contract that guarantees retirement (health) benefits”. The US company indicates that its plight is at least in part due to unsustainable rise in retiree benefit costs and much higher costs than its non-unionized competitors. (Retirement benefits promised/earned as part of employees’ overall compensation package often over a lifetime of employment are now increasingly under threat due to economic circumstances in general but further aggravated by demographics. By the way, I think I have seen this story somewhere before…oh yes, it happened to Nortel employees and retirees, except the impact wasn’t just on “retirement benefits” often funded from company operating funds, but also trust funded pensions earned over 30 or more years of employment- and Canada has no pension guarantees like the US and the UK, except for Ontario guarantee to protect the first $12,000 of pension a year. You say unconscionable? I agree.)

Things to Ponder

In this IndexUniverse interview with Larry Swedroe entitled “Swedroe: Using Buffett to model behavior”, Swedroe discusses his new book “Think, Act and Invest like Warren Buffett” which appears to be, but in fact is not, a contradiction of his long time advocacy for index investing. The interview (and presumably the book) focuses on the importance of: passive over the futility and loss of control with active investing, asset allocation, no market timing, low-cost investments and advice, real advice being about retirement planning and quarterbacking your entire “financial services team”, staying the course and “keeping your head when all about you are losing theirs”, and forgetting about all the forecasters. (It sounds like a great book, which I haven’t read yet, which condenses much of Sweadroe’s financial wisdom.)

You can find some interesting statistics in Jamie Golombek’s Financial Post article “Here is what the wealthiest of the wealthy in Canada earn- and pay in taxes” . Based on 2010 taxes filed by 25.5M Canadians: (1) the top 1% (255K) earned 10.6% of total income, paid 21% of total taxes and needed a minimum of $201K of income to qualify, (2) the top 0.1% (25.5K) breakpoint was an income of $685K and median age of 51K, while the top 0.01% (2550) breakpoint was $2.57M and median age of 55. Golombek also provides comparative US data: to break into top 1% requires $370K and they paid 37% of total US taxes, while top 10% breakpoint is $116K and they pay 71% of total taxes. In Canada the top 10% paid 55% of taxes. The bottom 50% in the US paid 2.4% of US taxes, while in Canada 4% of taxes.

In the WSJ’s “What can you do to steer clear of a ‘custody’ battle” Jason Zweig writes that generally speaking we assume that when a “custodian” holds your assets and the assets are “segregated”, and these assets are safe even if the custodian becomes insolvent. However, recently some doubt surfaced about this assumption. The SEC found that “one-third of firms with potential infractions appeared to have improper custody arrangements… and (according to a recent article in Legal Journal) federal rules on custody are wispy, state laws are contradictory and there is no absolute protection if a custodian goes bust.” Zweig suggests that “it is prudent to divide your assets among more than one mutual-fund company or brokerage. You want maximum independence between your investment adviser and the custodial firm he uses.”

Japan, well into the third decade of deflation and stagnation, is changing course.  The Financial Times’   “Japan sets course for hyperinflation” calls the new policies of yen depreciation, targeting 2% inflation and large fiscal deficits as “increasingly destabilizing” with the potential to “rekindle uncertainty and upheaval across the globe” and “may be setting the stage for a global inflationary spiral, perhaps beyond anything previously experienced”. The WSJ’s  “Stagnant Japan rolls dice on era of easy money” argues that a weaker yen is a given but this increases the risk that other nations will undertake competitive devaluation of their own currency; but others worry that QE won’t work in Japan due to rapidly aging and shrinking population. The article also expressed concerns about the risk of import price increase driven inflation ahead of desired increase in profits and wages, which would further slow the economy. Gary Shilling in Bloomberg’s “Why global economies face an age of deflation” argues that deflation rather than inflation will be course of the global economy because historically inflation occurred when simultaneously both government and private sector overspend, as when there are wars under way. “In the 95 wartime years since 1749, wholesale price increases averaged 5.7 percent. In the 168 peacetime years, they fell 1.2 percent annually on average.” The US now exiting wars, private sector is aggressively deleveraging, savings rate is increasing, the population is aging, there is excess supply, the risk of potential protectionism and competitive devaluations, decreasing power of labor; these all are powerful deflationary forces which will ultimately prevail. (The answer to the question of whether we are on the way to inflation or deflation in the coming years continues to be obscured by thick fog. You might also be wondering what Canada’s finance minister was thinking when he decided to make those arm-twisting telephone call to mortgage lenders urging them not to drop rates: fear of fueling Canada’s house bubble, or trying to preserve/increase profitability of banks to build up their reserves or concerns over inflation/deflation?)

In the Financial Post’s “Europe is a complete disaster, and its luck may have just run out” Joe Weisenthal writes that “The crisis in Cyprus is a good opportunity to take a step back and remind ourselves how incredibly broken the Eurozone remains. For one thing, the whole reason the Eurozone has these sovereign debt crises is because while the countries share a common currency, they don’t share a common Treasury. So it is literally possible for a country to just run out of cash. That can’t happen in a country like the U.S. or the U.K., which are capable of creating their own money.” So Cyprus needed a bailout which requires not just the approval of its legislature but also that of the German parliament; the attached conditions to the bailout had to be not just palatable to the former but ‘brutal enough’ to be passed by the latter. However Gillian Tett in the Financial Times’ “US ‘snowbird’ effect is what Europe needs” argues that “if hordes of German, Dutch or Finnish pensioners could be forced to spend money in Greece or Cyprus, that might rectify those pesky current account balances and boost activity down south.” You might also be interested in reading the Economist’s “Just when you thought it was safe…” analysis of the complexities and potential fallout of the Cyprus crisis.

And finally, those seeking some non-financial retirement advice might be interested in reading Diane Cole’s interview with Pat Boyle in the WSJ article   “Why you need to find a mission” which discusses “getting a purpose in life” because “having a purpose in life can help stave off cognitive decline and promote a broadly healthier, longer life.” Cognitive decline is 30% slower in people who are purposefully pursuing their goals, are connected to other people and are physically active. Finding a purpose doesn’t happen spontaneously but starts with asking yourself what’s energizes, motivates and makes life meaningful to you. (Preparation for this aspect of retirement, which some call Life 2.0, is as important as the financial one if one wants a smooth transition into retirement.)