Hot Off the Web- February 2, 2010

Personal Finance and Investments

Roma Luciw in the Globe and Mail’s “TFSA trumps RRSP, report says” discusses a new C.D. Howe Institute e-brief that TFSA’s are more tax efficient than RRSPs. While I didn’t get a chance to read the report, the simple test on what is better, is whether you expect your marginal tax rate in retirement to be higher than during your working years. If yes (not usually the case), then the TFSA is more tax efficient. Of course you won’t know your tax rate in retirement until you are in retirement due to tax laws in effect at that time and your income from the various sources of retirement (including TBD accumulated assets and returns thereof). A TFSA is a good place to hold (some of) your emergency cash, as it can be removed in emergency and replaced later without penalty. Since forecasting is difficult especially about the future, the bottom line is, why not try to benefit from both TFSAs and RRSPs to the maximum level permitted by your budget, and get the benefit of tax diversification as well. (In fact you might want to read my 2008 blog on TFSA or RRSP? 401(k) or Roth 401 (k)?which looks at the trade-off in more detail. While you are deliberating TFSAs, you might also want to read Chevreau’s “And the TFSA seemed so simple”, where he tries to clear up some confusions over contribution rules.

In the Financial Post’s “Retirees get peace of mind- at a price” Jonathan Chevreau reports on new SunLife product for group DC pension plans which for an additional 1.5% annual fee one can add guaranteed income protection for life to RRSP’s. This sounds like GMWBs, and highly likely with the same drawbacks. If you want “peace of mind” (to the extent that you can get that given that an institution like an insurance company has to often last over 50 years), then buy an annuity. GMWBs are the worst of all worlds. It’s a shame that there are no proper disclosure laws on these products, comparing outcomes of different alternatives under various scenarios. For my money I’ll go with a balanced portfolio and a sensible decumulation strategy (If I can find a cheap indexed annuity, I might reconsider my position.) A couple of years ago or so, I summarized my analysis of GMWBs at GMWB II. What I found in the case of the specific construct described there, was that “The Guaranteed Minimum Withdrawal Benefit (GMWB) products with a 3.5% management fee (including fund MERs) have nothing to offer to even conservative investors, even when they are compared to annuities or GIC/CDs. At 1.5% management fee (including fund MERs), GMWBs may become interesting to individuals who would otherwise invest in an annuity or GIC/CDs (only). But over a 40 year retirement, use of GMWB/ Annuities/ GIC/CD exclusively would lead to a relentless erosion of the investor’s purchasing power. In fact over 40 years the purchasing power would be reduced by 70% given an annual 3% inflation.” (Rates for annuities and GICs changed since when I’ve done that analysis and I would have to do a new simulation to reflect current conditions and “new” product offering, but I doubt that outcome will be radically different.) Of course, these GMWBs could have potential value if there was a catastrophic event, but then, as quote in the article indicates, all bets are off, “including the guarantees behind these products”. Oh yes, it appears that GMWBs could the worst of all worlds even for the insurance companies, as in the case of ManuLife, the most successful seller of GMWB (guaranteed income variable annuity-like) products, came under intense regulatory scrutiny because “the company had not hedged its variable-annuity business and was forced to deal with a growing risk exposure because of the massive stock portfolio associated with its segregated funds. As well, the company’s capital level, usually well above the minimum level set by regulators, was showing signs of distress”, as reported in “ManuLife’s regulatory balancing act”.

The WSJ’s Jason Zweig looks at the value of proper global diversification in “Placing your investing chips in the right countries”. He suggests that you start from capitalization weights of countries/regions in the MSCI All Country World Index which shows, U.S. at 42%, other developed markets at 45% and emerging markets at 13%. “Take those numbers as your base line. If you keep more than that in the U.S. and less in developed foreign markets, your bets are skewed. What insights do you possess into the global economy that hundreds of millions of other investors have somehow overlooked?” (The advice is pretty much similar to my recommendations in the Asset Allocation II blog.)

There are a couple of interesting annuity related articles in the NYT last week, one is Ron Lieber’s “The unloved annuity gets a hug from Obama” and the other is Paul Sullivan’s “Annuities: What you need to know”. Sullivan and Lieber’s articles review the types of annuities (immediate, deferred, etc), how concerns about their shortcomings (inflation erosion, loss of control/capital, spousal income after annuitant’s death, etc) led to the increase in their complexity and cost, annuities in a portfolio context and disadvantages of annuities (high cost, taxed like income, etc). Lieber’s article discusses that the Obama administration is considering ways to increase Americans’ level of interest in annuities, as way of transforming DC pension plans into lifetime income. Insurance company executives are salivating at the thought of President Obama as an annuity salesman. Congress is even considering a tax incentive. Lieber concludes with “The basic annuity is almost certainly underused. Sure, you may be able to arrange a better income stream on your own, but not without a lot of help from a financial planner or a lot of time managing it yourself. Then there’s the possibility, however small, that you’ll spend too much in spite of yourself or run into a once-in-a-generation market event that will cause you to run out of money sooner than you expected.” (Both articles forgot to mention ‘longevity insurance’, now available in the U.S. whereby a single premium of $1 at age 65 you can buy about $0.8-0.9/year of lifetime income starting at age 85; this may be the best of all worlds maintaining control on over 90% of your assets and protecting yourself in case you live much longer than your life expectancy! You can read more about longevity insurance in the Longevity Insurance- What does it buy you? blog. You can read my blogs on annuities at Annuity I, Annuity II, Annuity III, Annuity IV.)

The WSJ’s Eleanor Laise in “Risks lurk for ETF investors” discusses some risks associated when dealing with more esoteric ETFs. The problems discussed include: liquidity due to regulatory scrutiny, high bid-ask spreads when funds have low assets and daily volume, liquidity issues due to liquidity of underlying securities. Some experts recommend using limit orders and not trading early in the day when volatility may be higher. (But then established ETFs used for participating in broad asset classes which have high daily trading volumes would probably protect you from most of the problems mentions. I do have a different concern about potential exposures due to some ETFs’ security lending practices, but that’s for another time.)


WSJ’s Craig Karmin reports on pension plans using leverage to increase returns in “Public pensions look at leverage strategy”. After getting burned by overexposure to stocks, pension funds are now looking at leveraging up their bond portfolios in the hope of reducing their sponsors’ contributions to the plan. (Sounds like another disaster in the making.)

Ottawa Citizen reports that “Federal unions fear pension assault”. The article reports that “union leaders haven’t heard from the government that their pensions are possible targets for savings to help reduce the deficit, but they know ministers are facing pressure to wipe out the gap between public and private sector plans.” (That’s a big gap to close and one that should at least be narrowed if not closed. Back in 2007 a key question in my submission to the Ontario Expert Commission on Pensions was about the “Political sustainability of the growing gap between those who are and are not eligible for “public sector” pension”. Of course, one way to close that gap is to take action on (rather than just study and talk about) the next generation pension system for the private sector employees who are now suffering from the systemic failure of Canada’s pension system.)

Nortel pensioners, and in fact other private sector Canadian pensioners, will be interested in reading James Bagnall’s Ottawa Citizen article “The waiting game”. This article will give you a view of the level of protection that Canada’s pensioners receive under the laws of Canada. The answer is unbelievably somewhere between zero and not much protection; it all comes down to what a judge can and/or is willing to do to protect pensioners interests when the assets end up not even being in Canadian jurisdiction. It is not even about pension underfunding getting preferential treatment in bankruptcy court (which it should or, when it does not, like in other civilized countries government pension guarantees should be provided), it is whether Canadian creditors will even get equal treatment to U.S. and U.K. creditors. Amazing!?!

Real Estate

Canada’s November housing index was issued last week at Teranet-National Bank House Price Index and the index continues its upward trek. November was the second month in which the index was higher than 12 months earlier, the seventh month to have uninterrupted month-on-month increases and it was only 0.1% below the August 2008 peak. Of the six cities which constitute the index, only Calgary is showing a yoy decrease in prices.

The Ottawa Citizen reports on the “6th Annual Demographia International Housing Affordability Survey: 2010” thatVancouver has become one of the most unaffordable housing markets in the world, with Toronto and Montreal not far behind” in “Ottawa slips in housing affordability”. The metric used is median house price to median gross household income ratio, with >5 being “severely unaffordable”. Actually, Vancouver at 9.3 is #1 in a survey covering Australia, Canada, Ireland, New Zealand, UK and the US. New York and London are “only” 7.0 and 7.1. Toronto is a mere 5.2; Ottawa is 3.7.

In the Financial Times’ “Lessons for American housing market”Robert Pozen looks at the three key differences in the Canadian housing market which helped avoid the U.S. disaster: higher minimum down-payment requirements, in case of default mortgagee is “personally liable for any deficiency that remains after foreclosure or sale”, and no mortgage interest deductibility. Interestingly, home ownership in Canada rose to 68% just as in the U.S., suggesting that all the American subsidies to promote home ownership just led to higher prices rather than being necessary for the intended goal of higher ownership level.

WSJ’s James Hagerty in “Housing momentum builds but perils persist” indicates that while the market is healing further, price drops may be in store due to: “job market weakness”, continuing high default and foreclosure rates (Miami, Phoenix, Orlando, Jacksonville and Tampa), and while inventories are down the “shadow inventories” have yet to emerge.

Steve Ladurantaye in the Globe and Mail’s “Battle to unlock the housing market”discusses Canadians’ (belated compared to the U.S.) assault to secure more transparency in the real estate market. This is an existential threat to the Canadian real estate agents’ income; however many believe that time has come to permit Canadian home buyers and sellers to benefit from lower cost new transaction models enabled by the internet (e.g. open and free data), and allow home buyers to voluntarily elect to purchase additional services that they may wish from real estate agents.

Things to Ponder

In Globe and Mail’s “Home cents” Chaya Cooperberg writes about the non-financial preparation required for retirement, like: start talks with your partner at least ten years before retirement on your respective vision of life after work, and prepare a “bucket list”. On the same topic Jonathan Chevreau in the Financial Post’s “Only half of retired couples share a vision for retirement”quotes Lovett-Reid “If you’re saving madly for a trip around the world, and your spouse is planning on starting a business, you might be headed for some challenges. Couples who discuss their dreams openly and work with a financial advisor they trust can create a roadmap for success.”

In the Financial Times’ “Calls for new Bretton Woods not so mad”Gillian Tett reports from Davos on Nicolas Sarkozy’s calls “for a resurrection of the Bretton Woods global currency accord. “The prosperity of the postwar era owed much to Bretton Woods … we need a new Bretton Woods…We cannot preach free trade and also tolerate monetary dumping.” (Who could he be referring to?) Ms. Tett believes that this may not be such a bad idea, in order to prevent a major currency upheaval related to the dollar carry trade when central bankers start tightening, as part of their respective exit strategies. However, there appears to be little chance of success given China’s opposition to a renminbi revaluation.

Also from Davos is WSJ’s “At Davos, bankers are on the run” in which Walker and Moody report that the “The scorn poured on the industry at this year’s get-together in the Swiss ski resort is a sign of a mounting international backlash against the financial sector. Popular anger about banks’ role in the financial crisis, and their behavior in its aftermath, has spilled over to the world’s elite business executives, politicians and regulators. Since gathering here Wednesday, they have been aiming sometimes bitter recriminations at the tainted masters of the banking universe.” “”That those who create jobs and wealth may earn a lot of money is not shocking. But that those who contribute to destroying jobs and wealth also earn a lot of money is morally indefensible,” Mr. Sarkozy said.”

In the Globe and Mail’s “Where is the next bubble going to burst? I bet China”Avner Mandelman discusses his reasons why the Chinese bubble is ready to burst (overcapacity, hooey official statistics, market manipulation by the state, recent steps taken indicating likely future natural resource requirements, and signs that “signs the Chinese leadership is getting really scared of its own people”. But not everyone agrees with him.

And finally, in the Globe and Mail’s “Danny Williams travels to U.S. for heart surgery” reminds me of Quebec Premier Bourassa’s trip to the U.S. some years ago for cancer treatment. These people are/were the leaders of their provinces and most knowledgeable of the state of their provinces’ (and Canada’s) health care systems relative to that available in the U.S.. What, if anything, is the message here for Canadians and Americans?


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