Personal finance and Investments

In Financial Post’s “Time to hatch a new plan” Fred Langan discusses what he calls the “three heresies in the world of money: rent instead of buy; finance retirement with an annuity instead of with investments in stocks and bonds; and give your money to your children well before you die.” He quotes Milevsky that housing is more about consumption than investment and he suggests that if you can rent for <2.5% of market value, you should. (This sounds like a no brainer. On the subject of annuities and giving money to the children well before you die, I suspect would be applicable only to a small subset of individuals at the two extremes ends of available investable assets- annuities on the low and transfer to children the very high end.)

Financial Times’ Steve Johnson writes that “Investors (must be) warned about niche ETFs”. According to Johnson 40% of US equity trading is now in inverse and leveraged ETFs (Ouch!) No doubt you have heard this before, but it is still worth repeating that “many of these ETFs spectacularly fail to provide the expected return if held for more than a very short period – typically more than a day for equity-based funds.”

In Globe and Mail’s “A rule for funding golden years” Rob Carrick suggest the use of Russell Canada “Rule of 20” which says that you need to accumulate $20 in assets for every $1 of annual income (i.e. plan to draw 5% per year). Figure out how much additional (pre-tax) income you need on top of other pension income (CPP/OAS) and multiply 20. (Not sure if I wouldn’t prefer the safety of a “Rule of 25” instead, especially since they suggest a quite conservative 70% bond and 30% stock portfolio mix.)

William Hanley in the Financial Post’s “This a traders’ market, Rosenberg says” quotes David Rosenberg on equities as still being in a secular bear market and he is personally light on equities and, since cash and government bonds return almost nothing, he prefers corporate bonds for his fixed income allocation.

WSJ’s Walecia Konrad writes that there are “Many hidden costs of high-deductible health insurance” . The article is about Americans’ health insurance policies, and she discusses the downsides of high deductibles ($1000 and $5000) such as not seeking help (untreated problems can become serious). She also discusses what to watch out for when shopping for high deductible “lower cost” policies. The bottom line is that high deductible policies are not applicable to low income families. (Only applicable to those more well to do (and healthy) who can afford to self insure without jeopardizing their access to needed care. Canadians need to think about the applicability of high deductibility emergency travel health insurance policies to their personal circumstances.)

Jane Zhang reports in the WSJ’s “Nursing homes rated” that the U.S. government (Center for Medicare and Medicaid Services, CMS) will start an online pilot to allow consumers to rate facilities. They have already “started ranking facilities based on government inspection results, staffing data and quality measures. This “Nursing Home Compare” system, which gives one to five stars to 16,000 nursing homes, is available at medicare.gov/NHCompare.” (Now there are some great ideas that Canada could emulate; I am not aware of such Canadian effort.)

In Barron’s “Target-death-date funds”  Tom Sullivan reports on various topics of a recent Morningstar conference. On inflation: workers have built-in protection with rising wages; however retirees need alternate mechanisms like- TIPS, real estate and commodities. On target “date funds”: last year‘s market collapse indicated that many (most) of these funds, in a stretch for performance, may have over-reached in risk (high equity allocations) causing damage to many near/in retirement. “Some funds might more appropriately be called “target-death-date” funds, said Rekenthaler, because they expect retirees to continue investing until their demise. And given increasing life expectancies, the date may become a moving target.”

In the Financial Times’ “Hedge funds face mountain” David Smith reports that perhaps with an over 50% reduction from 2007 peak in assets under management, hedge funds will do a reset in their objectives. What started out as a “hedging” activity aimed at absolute returns (no losses) uncorrelated with other asset classes ended up in a “ferocious appetite for ever- increasing performance and a disregard for risk.” Perhaps the result will be “a return to original purpose of hedging risk”. (Investors are also looking to see if the asymmetrical “2 and 20” fee structure is justifiable for any but the top performing funds.)

In “Taking control” WSJ’s Jennifer Levitz lists ways on “how to become a better guardian of your own money”. The list includes: (1) to pick a financial advisor (disciplinary history, fiduciary or not, all form of compensation), (2) risk factors for the recommended investment (understand it, include stress test), (3) fund manager and firm interest aligned with investors’ (invested in fund? Size of fund?  In US 12b-1 marketing fees?)

The Financial Post’s Christopher Johnson writes in “Commodities products are booming” that ETPs (Exchange Traded Products) are growing rapidly because the offer easy access to asset classes otherwise inaccessible to retail investors.  He warns that many commodity ETPs that are implemented with futures contracts have significant risks, “including hazards when rolling futures forward from month to month, and exposure to third parties that can combine to wipe out any gains, even in a bull market.” Gold (e.g.) ETPs which are usually implemented with holding of physical gold are not exposed to these risks.

The Globe and Mail’s Rob Carrick throws some light on the alphabet soup of credentials used by financial advisers in “Learning what those fancy letters mean to your financial future”He explains that the most widely used designation by financial planners is CFP, life insurance agents (including annuities) is CLU, and “the gold standard for analytical work and portfolio management” is the CFA. (If you are interested, there are many other designations described in the article.)

Inflation or Deflation? Some ideas on possible protection in your portfolio.

Samuel Brittan writes in the Financial Times’ “Inflation can act as a safety valve” writes that we seem to be struggling with simultaneous inflationary and deflationary fears, and this uncertainly  “is itself a danger to economic stability”. But “The real worry is that shortages of energy and basic commodities may be imposing real speed limits on world growth well before anything like full employment is regained.”

On one hand, WSJ’s Perry and Moffett in “Euro-zone’s risk of deflation grows” report that inflation rate is zero in the 16-nation euro-zone. “Deflation can hurt businesses and consumers by reducing incomes while debts remain fixed. Falling prices also can prompt shoppers to defer spending to wait for lower prices, further depressing economic activity.” On the other hand, John Taylor writes in the Financial Times that “Exploding debt threatens America”. If spending continues to rise much faster than GDP then federal debt may be heading from 41% to 80% of GDP over the next 10 years. This kind of debt adds systemic risk to the economy. The gap can be closed by raising taxes 60% (unlikely) or increase inflation to reduce debt service payments as a percent of GDP. Doubling prices could be achieved by 8% (not 10%) annual inflation over 10 years. “That 100 per cent increase would make nominal GDP twice as high and thus cut the debt-to-GDP ratio in half, back to 41 from 82 per cent.” The Fed’s buying of longer term Treasuries to reduce long-term rates “adds credibility to this scary story, because it suggests that the debt will be monetized.” (That’s very scary for retirees who have little or no inflation protection.)

At this moment the sentiment is leaning to worrying about inflation. So Brett Arends in WSJ’s “Is your portfolio ready for hyperinflation?” reports on “Black Swan” author Nassim Taleb associated fund which is betting on commodities and gold against Treasury bonds. If you don’t have the minimum $25M admission fee then he suggests, among others: refinancing your home into a new 30 year fixed mortgage (still available in the U.S.), sell all long-term bonds that you may still be holding, TIPS and managed gold funds. In another WSJ article Arends asks “Investing in gold: Bubble ahead?” . While paper currencies are being threatened by flood of liquidity, he wonders if the already highly appreciated gold is in late stages of its bull market with more and more western investors now piling in. He asks if you think that gold will be over $3500 in 20 years. If not, he suggests that zero-coupon Treasuries maturing in 2038 can be bought today and will turn $965 into $3500 (annual 4.6%, but that’s interest and taxed at income rates rather than capital gains rate for gold appreciation.) Jonathan Chevreau also writes about portfolio ideas for inflationary times in the Financial Post’s “Take the risk out of saving for retirement” where he refers to Zvi Bodie’s recommendations for worry-free investing. He suggests a few stocks and 90% of the portfolio invested in inflation linked bonds (TIPS in the US and RRBs in Canada). Implementation options differ depending on the advisor (e.g. RBBs in tax-deferred accounts and indexed annuities without tax sheltering) and current RBBs yield 2%. If yields spike, RBBs could lose value. (You may be interested in my blogs from a couple of years ago on Bodie’s work at Life-Cycle Investing and “Protecting the Downside, while Participating in the Upside”)

A couple of more final thoughts on inflation in Financial Post’s “Don’t worry about inflation, TIPS show” where Chris Swann argues that with Treasuries yielding 3.5% and TIPS offering 1.5% you don’t need to worry about inflation predicted at 2%. Then of course some don’t believe in TIPS at all, since they argue that inflation adjustments are cooked by the government as in “TIPS flunk inflation test” (A little dated, July 2008, but you might want to read the arguments anyway.)

Real Estate

On real estate the tea-leaves are not black and white either. The dark side is “More homeowners facing foreclosure” the NYT’s Jack Healy reports that over 12% of mortgages are delinquent or in foreclosure, up slightly from last month, and are expected to continue “rising as more people lose jobs or are forced to trade full-time work for part time.” On the brighter side WSJ’s Justin Lahart’s “Index suggest home sales are set to rise” reports that the National Association of Realtors pending home sales index increased 6.7% forecasting increased closing over the next 60 days. (Rea estate agents always find the bright side.)

And in a sign of the times for those readers who are interested in Florida property taxes, the Palm Beach Post reports that “Palm Beach County budget proposal call for 13.5% tax hike, 175 layoffs” . The plummeting property values in Florida are devastating the state’s tax base, necessitating rate increases throughout the state. (No doubt that the recently introduced “portability” of SOH (Save-Our-Homes) tax benefits for Florida residents and the increase of homestead exemptions further favouring Florida residents over out of state property owners have also helped significantly in reducing the tax base. What this means to non-homesteaded property owners is that despite decreases in property values over the past year we won’t get the expected tax reduction since they’ll be offset by the planned rate increases.)

WSJ’s Brett Arends explains “Why your mortgage won’t make you rich” “The real benefits of home ownership are any capital appreciation, plus the imputed rent, minus the effective cost of the mortgage and property taxes, other costs, and the return you could earn on your down payment elsewhere.”

And finally, on the need for pension “superfunds” as opposed to more RRSP room, Ian Russell writes in Globe and Mail’s “A flexible RRSP to give boomers room to recover” that “superfunds “ (with low costs and professional management) are not the answer to help boomers recover their losses of their retirement savings. Russell (president of Investment Industry Association of Canada) proposes INSTEAD more RRSP room to allow boomers with few years left till retirement to increase their tax sheltered savings. (Yes, higher RRSP contribution limits (allowing more tax deferral) are a necessary part of the solution BUT so are the “superfunds” to stop the asset haemorrhage resulting from management and transaction fees incurred in RRSP and other accounts. BOTH are needed NOW.) Steven Chase’s Globe article describes the non-public sector pension crisis in “Canada’s growing pension puzzle” and argues that more RRSP room is insufficient to solve current problems.