Hot Off the Web– January 4, 2011

Personal Finance and Investments

In the Financial Post’s “Financial tips for those who hate investing” Laura Dogu suggests that everyone should be able to do the following necessary steps in getting their financial house in order: “verify beneficiaries on your retirement accounts, insurance contracts, and wills”, “review changes in your financial situation annually”, “understand how your financial ‘adviser’ is paid and what his duties are”, and “get your partner involved”.

In the Financial Post’s “When snowbirds don’t come home” M.B. Hutchinson discusses advantages to Canadians in becoming full time residents of the U.S. the article quotes a couple of firms involved in helping individuals in the complexities of making a permanent move, such as “permanent residency visa, health insurance, estate planning and ‘exit tax’ that Canada imposes on its citizens”. The cost of the assistance by the firms mentioned, KCA and Transition Financial, is $10,000+. (Not sure if I am convinced about the lower cost of living in the U.S. once you factor in healthcare, property taxes, similar location as well as the risk of much higher U.S. taxes (and/or deteriorating dollar) in the near future. I think that the ‘advantages’ of such a move are dependent on individual circumstances, and would for many/most be governed by or at least have to include significant non-financial considerations.)

Jonathan Chevreau’s Financial Post article “How much do you need to retire” looked at retirement needs of Canadian couples under four scenarios: (1) “ultrafrugal” (pre-tax $30,000 per year can be realized with CPP/OAS and about $300,000 assets), (2) more comfortable situation with one (or both) of the couple having an indexed DB pension (pre-tax $72,000/year achieved by DB pension and CPP/OAS for both plus a couple hundred thousand reserves), (3) no pension and living in city ( at the same pre-tax of $72,000, even with maximum CPP/OAS would need about $1.3M), and (4) “living large” ($2M is required to generate about pre-tax $84-106,000 annually plus CPP/OAS for an even more comfortable total of pre-tax $130-140K per year). Other estimates mentioned are 15-20 times final year of salary and the assistance of a qualified financial planner. (Of course if you are ready to retire now (by choice or otherwise), rather than thinking of how much you might need, you need to evaluate how much of a lifestyle $30K, 72K or 130K pre-tax buys you and what you can realistically afford given your available assets; assuming 4% from a low-cost balanced portfolio is not a bad starting point.)

Michael Nairne in the Financial Post’s “Put indexing in your stocking”discusses a Vanguard report looking at Canadian stock and bond mutual fund performance which concludes that “Across the board for every asset group, category and time frame, actively managed funds underperformed their comparable indices… Only 21% of funds that were in the top 1/5 of funds in their categories for the five year period ending December 31, 2004 remained in the top 1/5 of funds in the next five years. Outperformance was almost random. Luck trumps skill in the active management game… The high cost of running and marketing mutual funds creates such a drag that even if a manager is skilful, it is difficult to deliver superior returns net of expenses to an investor. Also, actively managed funds often trade frequently piling up commissions and other costs.”

In the Financial Post’s “Larry Swedroe’s 13 New Year’s resolutions for investors”Jonathan Chevreau brings Swedroe’s recommended list of New Year financial resolutions, including: get a financial plan, invest only consistent with your risk tolerance, work only with a fiduciary advisor, avoid actively managed funds, (the very current) do not stretch for yield…and (the very cute but serious one) “if you watch CNBC, make sure the mute button is on”.

Robertson and Perkins in the Globe and Mail’s “What your insurance broker doesn’t want you to know”  discuss the lack of transparency and inadequate regulatory environment in Canada’s life insurance industry coupled with bonuses, free-trips for the insurance sales persons and lack of a fiduciary relationship can lead to less than the best insurance policy for the customer.

And continuing on the insurance front, Jonathan Chevreau in the Financial Post’s “Home insurance- tales from readers” brings some reader experiences with home insurance. One of the most telling one is “a few years ago an insurance agent said to me, (in a moment of weakness?!)” John, don’t insure if you can afford the loss because insurance companies pay out in claims only half what they take in premiums. The other half goes to salaries, overhead and return to investors.” It does not often apply, but is something worth knowing.” (This would not be a surprise to my readers who may have come across some of my insurance blogs like Insurance: To insure or self-insure? Public or mutual insurance company?)

In the Globe and Mail’s “As look-alike ETFs abound, so do questions”Shirley Won writes that look-alike ETFs are now mushrooming , but investors must understand the differences between the products like: what type index is being implemented (e.g. cap-weighted, fundamental, equal-weighted), how is it implemented (built from underlying stocks/bonds or physicals (gold, silver) or futures), lowest cost wins, and many other considerations.

Jamie Golombek in the Financial Post’s “Estate tax rises from the dead” looks at estate tax implications for Canadians who own U.S. equities and real estate. The new law “reinstates the U.S. estate tax at 35% and with a US$5 million exemption…allows Canadian residents to prorate the US$5 million exemption based on fraction of their U.S. situs property divided by their worldwide estate…Mathematically, this means that if your worldwide estate is under $5 million you will get a full exemption from U.S. estate tax and need not be concerned.”

In the WSJ’s “Slow and steady saving still pays” Tom Lauricella shows how regular retirement savings contributions independent of rising and falling markets which are invested in low-cost index funds is the road to accumulating the required assets for retirement.

The Financial Advisor reports the arrival (in the U.S.) of variable annuities built from low-cost index ETFs in “Variable annuity offers ETFs from Vanguard, iShares”. While this is a good idea and an improvement over the existing variable annuity options, the 1.75% “annual separate account expense” is still too high and guaranteed lifetime income still comes only at an incremental fee. The article suggests that the total cost of this product is in the range of 2.35-2.55% (could be as high as 3.25%) but is about 1% lower than typical GMWBs. (Better, but not good enough, so handle with care.)

Real Estate

The October 2010 S&P Case Shillerhome price index was released last week and the news is not good. “The double-dip is almost here, as six cities set new lows for the period since the 2006 peaks. There is no good news in October’s report. Home prices across the country continue to fall.” says David M. Blitzer, Chairman of the Index Committee at Standard & Poor’s. “The trends we have seen over the past few months have not changed….On a year-over-year basis, sales are down more than 25% and the months’ supply of unsold homes is about 50% above where it was during the same months of last year. Housing starts are still hovering near 30-year lows.” “While the composite housing prices are still above their spring 2009 lows, six markets – Atlanta, Charlotte, Miami, Portland (OR), Seattle and Tampa – hit their lowest levels since home prices started to fall in 2006 and 2007, meaning that average home prices in those markets have fallen beyond the recent lows seen in most other markets in the spring of 2009.” (Not a pretty picture!)

And to drive home that U.S. house prices may not have bottomed as yet, in the WSJ’s “Home prices are still too high” Peter Schiff suggests that to get house price back to the historical trend-line a further 20% decline is required. He also suggests that prices may also overshoot on the downside given “bloated inventories, 9.8% unemployment, a dysfunctional mortgage industry and shattered illusions of real-estate riches”. Though not everybody agrees, as Nick Timiraos reports in “Economists: Expect no home-price growth in 2011” that a survey of economists predicts flat house prices in 2011 in the U.S. Whereas, according to Tim Kiladze (referring to a Scotia Bank report) in the Globe and Mail’s “Down under housing market booms, Canada simmers”, Australia’s real estate market continued to soar (for now at least), and of twelve markets followed “inflation-adjusted home prices jumped higher in 2010 – Australia, Canada, France, Sweden, Switzerland and the U.K. Germany and the U.S. had relatively flat house prices, while Ireland, Italy, Japan and Spain all suffered price declines.”

Meanwhile in Florida house sales are down and prices fluctuate, but few are convinced that the bottom has been reached, as reported in “November home sales fall in Palm Beach, Broward counties” and “Florida existing home sales slump in November”

Pensions

In case you missed my pre-holiday commentary on the Canadian federal government’s latest pension ‘reform’ proposal (The PRPP (Pooled Retirement Pension Plan): An agreement to do no pension reform but deliver more fees to Canada’s financial industry.) and on the Ontario government’s agreement not to force pension plan beneficiaries into annuities in case of a pension plan windup (New Flexibility in Ontario Pension Windupis great only if it includes self-administered options like those already available for RRSPs/TSFAs.)

Ontario finance minister Duncan communicated to the NRPC (the former Nortel employees representatives) that he decided to broaden the available options upon pension wind-up. The Nortel NRPC announcement neither excludes a self administered option, (ominously) nor does it explicitly mention it. Without a self-administered option, the new windup options are not real options if they just drive pensioners into the waiting arms of the same high cost insurance companies which would have otherwise provided the annuities. The cost structures of GMWB-like insurance company guarantees are even worse outcomes than annuities (e.g. GMWB II). For those interested in the topic can also read Janet McFarland’s Globe and Mail article “Ontario says Nortel workers can opt for private pension management” which covered the mid-December announcement.

As to the new federal pension reform proposals (described in “New pension plan would require employers to offer it but allow opt-out”, “Finance ministers agree to private pensions ‘framework’”,, “Pooled pensions make sense in principle” and “Quebec support gives Ottawa key ally in pension debate”), few beside the Financial Post’s Terrence Corcoran in “Terence Corcoran: The Willy Loman pension myth” think that the new proposal will answer the systemic failure of Canada’s pension system. Mr. Corcoran seems to believe that if boomers would only sell or take a reverse mortgage on their overpriced homes, they would be home free (or more like free of their homes); perhaps consideration should be given to what would happen to home prices if all boomers would attempt to sell their homes when they turn 65?!? (The very few supporters of Mr. Flaherty’s latest proposals outside of the financial industry, fail to understand that this is not primarily about who pays (one of the reasons that expanded CPP was replaced with new proposal), but it is about: how much is being saved, how the corrosive effect of fees eats away at the value of the individuals’ retirement accounts, and whether longevity risk is adequately managed in the proposal; none of these are addressed adequately, so far. One of the key excuses used by opponents of the expanded CPP approach is that you don’t want to increase (employer paid)  payroll taxes at a time of weak economy (which by the way, many believe is just an excuse to force the new pension money through the private sector)…it would be very simple to provide the same auto-enrolment/payroll-deduction option proposed for PRPP also for the expanded CPP, so that both employers and employees could opt out and/or adjust the level of their participation as a percent of salary above some minimum level (e.g. current or some higher minimum level of contribution) You have to break the eggs to make an omelette.) Pension expert Bob Baldwin addresses some of these issues in “Let’s take the CPP- and be creative” (Thanks to Bernard Dussault for bringing this article to my attention.) Actuary Jim Murta is also not very impressed with Mr. Flaherty’s proposals which he calls “The pension gift” to the financial industry. In the Financial Post’s “How Pooled Registered Pension Plans will change the pension landscape” Jonathan Chevreau quotes a number of pension experts’ views on the proposal, and I’ll let you judge the views, but concern about fees is overwhelming. Also in the Financial Post is Greg Hurst’s “Is the piggybank broken? Dial down the rhetoric on pensions” where he suggests that we should give the financial services industry a chance o prove that all who have concerns “on whether Canada’s financial services industry can be effective as fiduciaries given implicit conflicts relative to delivery of services as profit-making enterprises. Nonetheless, for understandable political reasons both federal and provincial governments have decided to entrust a significant degree of the future retirement income security of Canadians to the financial services industry. The industry must now honour this trust and meet the challenge of delivering PRPPs at costs that meet or beat the CPP benchmark.” (The Canadian financial industry’s track record is dismal. In Australia where a pension scheme introduced over a decade ago was very effective at forcing higher savings levels, ended up significantly discredited due to the high fees and lack of effective competition among their financial oligarchy. Giving the industry time to prove that they will rise to the challenge is something Canadians can ill afford, especially the boomers who have even less time than savings.)

In the Globe and Mail’s “Pension plans treading water” Janet McFarland reports that “Canada’s pension plans are ‘running in place’ and are struggling to return to financial strength”. Much of the discussion in the article is focused on the erosion of the gains due to increases in equity prices by the increases in liabilities due to decreases in interest rates. (There is no mention of asset liability matching as a best practice in pension plan management. Instead, some pension plan sponsors find it convenient to recklessly gamble with pension plan assets belonging to plan beneficiaries in the hope of higher equity returns in order to reduce their pension plan contributions. The upside is to be reaped by the management and shareholders of companies, while the risk is being borne by the employees and pensioners; e.g. see Nortel pensioners.)

On the U.S. side of the border the situation is also grave. Dave Carpenter in the Associated Press’s “Baby boomers near 65 with retirements in jeopardy” looks at the challenges of the 10,000 baby boomers a day that will turn 65 over the next 19 years, the challenges due to: inadequate savings, retiring too early, disappearance of traditional DB pension plans, lost decade of stock returns, expectation that their homes were the ticket to a comfortable retirement before home prices collapsed, two-thirds of 55-64 age group still has mortgages, people claim early (at 62) the Social Security benefits, difficulty to get a job in a environment of 10% unemployment, etc

In the WSJ’s “Pensions push taxes higher”Jeannette Neumann reports that “Cities across the nation are raising property taxes, largely citing rising pension and health-care costs for their employees and retirees…Tax increases and budget cuts are raising pressure on state politicians to tame growing pension costs, and the topic has become a significant issue in elections.”

Things to Ponder

First and foremost a must read is Christine Harper’s sobering and disconcerting summary of what actually was the outcome of the U.S. financial reform (not much…) in Bloomberg’s “Out of Lehman’s ashes Wall Street gets what it wants as government obliges”; this likely means that we should be preparing for the next financial crisis in the coming years. (Recommended by the CFA Financial Newsbriefs)

William Hanley in the Financial Post’s “Bonuses flow in the heart of markets”writes that “Even as millions of Americans compete for still scarce jobs, Wall Street has fewer players and just as much aversion to truly competitive pricing of its range of services…. That the Street can put aside a sum of US$90-billion for bonuses is proof that America is not being well served. The sums being made are further evidence that the rich keep getting richer — often at the expense of a still-struggling middle class that was so badly served in the run-up to the financial crisis and its aftermath… The Street is what it is — a place apart, motivated by nothing but the pursuit of money, working to line its pockets… So don’t expect any changes to the way the Street does business. It is basically impervious to outside regulation and has shown little willingness or progress in regulating itself.” (Bill could have added that much of the financial industry creates no value, unlike most other industries, except for itself.)

In a Financial Times opinion piece entitled “Future shock? Welcome to the new Middle Ages”Parag Khanna writes “Imagine a world with a strong China reshaping Asia; India confidently extending its reach from Africa to Indonesia; Islam spreading its influence; a Europe replete with crises of legitimacy; sovereign city-states holding wealth and driving innovation; and private mercenary armies, religious radicals and humanitarian bodies playing by their own rules as they compete for hearts, minds and wallets. It sounds familiar today. But it was just as true slightly less than a millennium ago at the height of the Middle Ages.”

For those who think that hitching your cart to the (rocket scientist) financial model builders will lead you to higher returns, consider Gillian Tett’s Financial Times article “How not to fall foul of the model makers”where she writes that “in the world of physics, scientists can deduce theories, laws and equations which tell you how the world works in its own, absolute terms. But “there are no genuine theories in finance because finance is concerned with value, an even more subjective concept than heat or pressure,” he observes. And unlike physics, financial experiments are not repeatable – history changes how markets work… In essence, they are a tool to help us think, and order our world view, and explain something that is hard to grasp.”

I couldn’t resist including the Globe and Mail’s “Looming deflationary trend takes the sparkle out of stock rally”where David Rosenberg still believes that “Prices in many areas seem to be deflating, not rising as you might expect on the back of a recovering economy.” (If Dave is right interest rates will not be increasing as fast as most are predicting for 2011, but I need more convincing.)

In the Barron’s “The beginning of the end of Dollar hegemony”Randall Forsyth writes that “when monetary history….is written decades from now…2010 could be a watershed marking the beginning of the end of the dollar-based, Western-centric monetary system…The demand for dollars from the rest of the world has been of inestimable benefit to the U.S. economy. It quite simply allows Americans to consume more than they produce and save less than they invest; in other words, to live beyond our means. The dollar’s dominance will not be toppled in 2011 but will wane over the coming decade and beyond. And America will have to start picking up the tab for what had been a free lunch.”

And finally, in the NYT’s “The Sidney Awards” David Brooks gives out his “best magazine essays of the year awards” and the best of the best goes to Michael Lewis’s Vanity Fair piece “Beware of Greeks bearing bonds” (which I mentioned in my October 11, 2010 Hot off the Web blog), a fascinating read and with lesson to be learned by those who think that we can just keep on spending from the public purse. You might find some other of his winners worth reading. I particularly enjoyed William Deresiewicz’s “countercultural lecture at West Point” (a non-financial piece) entitled “Solitude and Leadership”, and much of what he said resonated with me, at least.