Hot Off the Web- August 2, 2010

Personal Finance and Investments

The WSJ’s Sam Mamudi writes that “Try as investors might, so much depends on chance”; “The biggest factor in long-term returns is how the financial markets happen to perform during the 30 or so years an investor puts money away for retirement.” One dollar saved per year over a 30 year period in a 60/40 stock/bond portfolio produced accumulated assets ranging from about $40-$140 in years ending from 1955 to 2009.  “It’s well established that people attribute bad luck to randomness, but then attribute good luck to their own skill.” Forget about funds trumpeting their returns over carefully selected periods or fund families advertising the returns of their currently hot funds. Focus on what you can actually control: save aggressively, diversify your investments among asset classes, and minimize costs/fees.

In the Globe and Mail’s “Long term is the magic bullet for risk” Dan Richards writes that “The good news is that the longer your holding period, the less you experience sharp drops – the extreme ups and downs disappear and the tops and the bottoms on returns get cut off.” (But…things are a little more complex than that. I am sure this was not what was in fact meant by the usually knowledgeable Dan Richards. This topic is in fact related to the so called concept of “time diversification” which essentially suggests that stocks are less and less risky as your holding period gets longer. Perhaps the best that one can say about this topic in a couple of sentences is that this is, at best, only a half truth and at worst is completely false, like specifically the statement that “the longer the holding period, the less you experience sharp drops”. In an attempt to try to clear up some misconceptions on the safety or riskiness of stocks, I plan to do an in-depth blog on this topic in the next couple of weeks.)

Jonathan Chevreau in the Financial Post’s “AlphaPro unveils balanced ETF” reports that “Horizons AlphaPro Balanced ETF began trading yesterday on the Toronto Stock Exchange under the ticker HAA”. It is estimated to have about a 1% total annual cost (management fee plus administrative and marketing expenses) which is a lot better than Canadian mutual fund expenses which typically cost about twice as much. This ETF manages actively both asset allocation and stock selection The official announcement  of the fund notes that initially 60-80% will be allocated to equities and balance to fixed income securities, and at least 70% will be invested in Canadian securities. . (So while this is a significant improvement over balanced mutual funds, DIY investors could implement a similar balanced portfolio using a passive approach for an annual cost of under 0.5%).

In the Financial Post’s “Seniors losing out on benefits” Jonathan Chevreau discusses Canada’s OAS (Old Age Security) and GIS (Guaranteed Income Supplement) benefits that basically “deliver $14,000 or $15,000 of annual income- much of it tax-free and indexed to inflation”. The GIS provides a safety-net for those who have not worked (much) and are not eligible for (much) CPP (Canada pension Plan) benefits. Some might find it surprising that “37% of all seniors receive GIS”! Many of those who qualify don’t apply/receive GIS and live in significant poverty; one estimate mentioned is that 300,000 eligible seniors don’t receive about $500,000,000 of benefits annually and GIS benefits are retroactive for only 11 months. Chevreau suggests that individuals receiving OAS who still have annual income under $15,000 should check out if they qualify by calling 1-800-277-9914.

In the Globe and Mail’s “Why Canadian retirees are better off than Americans” Ted Rechtshaffen argues that horror stories of health care cost induced U.S. personal bankruptcies, continuous focus by U.S. based media on health care coverage and the self-serving interest of the Canadian investment industry in preserving Canadians’ fears about future health care costs conspire to result in Canadian retirees being in “better financial position than they think”. (Canadian retirees may better off than they think, but not sure about better off than American retirees?)

Real Estate

The May Canadian Teranet-National Bank House Price Index is out and indicates a 1.3% rise for the month and 13.6% house price increase over the year; the increases were largely on the backs of large Vancouver and Toronto annual price increase. The index is now 4.2% higher than the pre-recession peak. “Since…from April to June this year, the number of existing homes sold declined much faster than the number of new listings…the prospect of the harmonized sales taxes coming into effect July 1 in Ontario and B.C. may have had the effect of pushing up sales in Vancouver, Toronto and Ottawa in the preceding months.”


In the Financial Times’ “Another knock for DB pensions” Ruth Sullivan writes that “UK government proposals to scrap rules forcing pension scheme members to purchase an annuity by the age of 75 could put another nail in the coffin of ailing defined benefit plans.” “Although the proposed policy change is aimed at defined contribution pension schemes, the move will have a knock-on effect on defined benefit plans…It will not be long before DB scheme members will demand a lump sum from their pension, then fund sponsors will have to find the cash immediately rather than in much smaller amounts over a long period of time.” (This option should be an absolute requirement especially when an underfunded pension plan is wound up in Canada, as is the case with Nortel pensioners. Here a significant number of employees on termination immediately before/after bankruptcy were provided commuted values at old valuations well in excess of what the ultimate pension payout will be for pensioners, but this commuted value (CV) option was not available for pensioners. Just one more flaw in the litany of flaws associated with Canada’s pension system which is in systemic failure and the federal government is just sitting by and watching it disintegrate without any credible concrete action. Only in Canada? Pity?…actually more like Shame!)

Tara Siegel Bernard writes in the NYT’s “Social Security jitters? Better prepare now” that adjustments to Social Security benefits will be required in the future, directly by reducing benefits or indirectly by increasing taxes. Current benefits appear sustainable in full only until about 2037 after which (if unchanged) only 75% of the benefits are coverable. “People 50 and below should change their planning now to incorporate a benefit cut,” said Laurence J. Kotlikoff, an economics professor at Boston University who ran some numbers for us to see what life would be like if the retirement age were immediately raised to 70. That change would translate into a nearly 20 percent cut in benefits…” Some financial planners recommend assuming that only 50-80% of SS security benefits will be delivered, while one planner quoted went so far as to suggest that younger individuals should think of Social Security as gravy and build their retirement plans without factoring it in.

In a new report from the University of Calgary School of Public Policy (led by Jack Mintz, Mr. Flaherty’s pension research chief, who indicated that we have no pension crisis in Canada) entitled “Should government facilitate voluntary pension plans?”; this report does some fast back pedaling on the no pension crisis story and actually is looking for solutions to the crisis. Norma “Nielson’s review of recent research argues that the CPP and other programs provide adequate retirement income for low income earners, and that high income earners use the opportunities they are afforded under the current system to save and invest adequately for retirement (not sure if that’s true given that both CPP and RRSP have such a low cap). However, those in the middle do not have sufficient disposable income to adequately save enough to provide a middle class retirement”. Ms. Nielson also indicates that there may be about 25-30 bp cost advantages to large (CPP/OMERS) scale pension plans over what typically is available to large corporate DC plan members, as well as the likely advantages of auto-enrolment, auto-investment, and auto-annuitization, if finally introduced in Canada. She believes that that with only three large companies providing annuities, the annuity market in Canada is essentially an oligopoly (No doubt!). However, while the author argues persuasively for VPPs (Voluntary Pension Plans), her arguments are less persuasive against government involvement. People with individual RRSPs  and smaller company group RRSPs are still paying not 25-30 bp higher annual costs for their investment but as much as a punishing 150-250 bp higher. Government by providing a voluntary plan with access to large scale low cost pension investment funds and especially low cost annuities (or, even better, pure longevity insurance) would finally remove Canadians from the grips of Canada’s uncompetitive financial industry.  (Thanks to Jim Murta for bringing this report to my attention.)

John Murawski in “Nortel retirees plead for benefits” reports that the Research Triangle Park area’s 4000 pensioners and dependents were outraged and pleaded with Nortel’s U.S. bankruptcy judge to prevent Nortel from stopping health and life insurance benefits. In an earlier article it was reported that the judge advised Nortel to negotiate the matter directly with the pensioners. Under pressure Nortel “withdrew its request to terminate benefits. But the company told the court it may resubmit a similar request later.” (Last week’s Hot Off the Web referred to Bert Hill’s article on “Nortel’s Canadian, U.S. creditors face different experiences”)

The NYT’s Julia Werdigier reports that “Britain plans to scrap mandatory retirement age in 2011”. “If approved by Parliament, employers would no longer be able to dismiss workers at age 65 without giving a reason or without paying severance…The change is intended to help Britain reduce its pension burden as people live longer, and to allow people to keep working if they want to for financial or social reasons.” But business groups are clearly unhappy as they believe it would raise “a large number of complex legal and employment questions”. The new law “would allow for individual employers, especially the likes of air traffic controllers or police officers, to keep a compulsory retirement age if it could be objectively justified.”

Things to Ponder

Carl Richards in the NYT’s “Outliers matter: Why average is not normal” reminds readers of the folly of counting on average returns and disregarding the low probability extreme events or events that are never supposed to happen, like Black Swans. “If you take the daily returns of the Dow from 1900 to 2008 and you subtract the 10 best days, you end up with about 60 percent less money than if you had stayed invested the entire time….(As to) what happens if you were to miss the worst 10 days. Keep in mind that we are talking about 10 days out of 29,694. If you remove the worst 10 days from history, you would have ended up with three times more money.”

In the Bloomberg Businessweek’s “Government Deficits could be the next ‘Black Swan’” Ben Steverman interviews Nassim Taleb. Mr. Taleb reminds people that Black Swans are “events that you can’t forecast, and you need to be robust to these events”.  “Citizens should not depend on financial assets as a repository of value and should not rely on fallible ‘expert’ advice for their retirement.” “People should have three sources of variation in their income. The first one is their own business that they understand rather well. Focus on that. The second one is their savings. Make sure you preserve them. The third portion is the speculative portion: Whatever you are willing to lose, you can invest in whatever you want.” There is significant danger in investing in government debt, “unless you invest in your own home currency in very short-term Treasury bills. Because governments can print more of their own currency, the risk comes from a rise in interest rates rather than a government default.”

ABC News’ Hew Jones in “Global body proposes rule to end insurer “black box”” reports that the International Accounting Standards Board (IASB) “will replace a mishmash of national approaches which makes it hard for investors to compare the profitability of insurers and reinsurers from different countries.” “Some have called the existing system a black box. There is a bit of a concern the new rule will increase earnings volatility, but you will get a better alignment of assets and liabilities which will hopefully reduce volatility rather than increase it”. (from CFA Institute Financial NewsBrief) However in the Globe and Mail’s  “Canadian insurers dispute proposed accounting rules” Tara Perkins reports that Canadian life insurers will challenge the new rules because “The insurers currently ensure that the time horizon of their assets matches their liabilities (for instance, if they sell a 30-year annuity, they will match that with a similar term bond). The new rules threaten to separate the two sides of the balance sheet, so that assets and liabilities move separately, increasing volatility.” Canada’s national banking regulator and finance minister support insurance companies’ challenge.

In the NYT’s  ”Technologies help adult children monitor parents” Hilary Stout discusses remote monitoring technologies and services becoming available in the U.S. which “provide enough supervision to make it possible for elderly people to stay in their homes rather than move to an assisted-living facility or nursing home — a goal almost universally embraced as both emotionally and financially desirable.”

And finally, you might find interesting a five minute CNBC interview “Steve Wynn takes on Washington”. Wynn, a casino/real-estate developer, says that the unpredictability and uncertainty that America’s businesses face is frightening compared to China which is a relative oasis of stability; predictability in China compared to Washington is like comparing Mount Everest to an anthill.

P.S. As a follow-on to the first article referred to above on the key role played by chance in the assets that you’ll accumulate for your retirement, you might be interested in (re-)reading my old one pager on the related subject of Control What You Can .


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