Hot Off the Web– December 6, 2010

Personal Finance and Investments

Avner Mandelman in the Globe and Mail’s “Looking to invest in a back-tested fund? Don’t” explains why you should not put much faith in funds touting so called “back-tested strategies (“Back-testing involves simulating what would have happened in years gone by if the manager had bought and sold stocks (or other securities) based on certain criteria…”) Issues associated with back-testing include: “future bias”, “forecasting the past”, “phantom trades”, etc. His conclusion: back-testing is useless nearly always.

Rob Carrick, in the Globe and Mail’s   “No shame in sticking to your investments” reminds readers that when evaluating their investments not to forget to include dividends received (i.e. price return vs. total return)

In the Globe and Mail’s “Your tax, RRSP questions answered” John Henzl answers some tax and RRSP questions: selling stock in non-registered account and buying it back <30 later in registered account will considered “superficial loss” and disallowed by CRA, you don’t have to claim RRSP contribution immediately following year to when it’s made, there is no withholding tax on U.S. dividends if security is held in RRSP (not TFSA) account.

Rob Carrick interviews financial tracking tool Mint.com’s CEO in the Globe and Mail’s “Want to better manage your money? First, pay attention”. His advice as to the most important thing that people can do in their personal financial management is to “know where you spend”. (Certainly very important as spend rate is one of a handful things that are under your control and insight in where you spend empowers you to make trade-offs.)

In the Journal of Financial Planning’s “The effect of emergencies on retirement savings and withdrawals” Gordon Pye explains why “The sustainability of investment withdrawals depends on uncertainty about the returns to be earned on the investment and the expenses to be covered by the withdrawals…(specifically) the possibility of the emergencies reduces the initial annual withdrawal for comparable sustainability from 4 percent to nearly 3 percent…(or another way of looking at it is that it) significantly increases the savings requirement for those seeking to sustain a given standard of living.” (Interesting article, analytical details aside it makes sense that if you want to make allowance for possibility of future emergency expenses, you might have to go with a lower initial than expected annual withdrawal, if you plan to increase it with inflation each year. The other approach might be is to withdraw a fixed (not more than about 4%) of current assets each year early in retirement.)

In the Globe and Mail, Dianne Nice looks at “Insurance products you can probably do without”. Examples where self-insurance or cheaper alternatives or you are already covered by other insurance include: mortgage life insurance, accidental death insurance, rental car insurance, child life insurance…

Jonathan Chevreau in the Financial Post’s “Return of 10% all but impossible” discusses recent reductions in forecasted return expectations. The impossible nominal 10% should be replaced with a more conservative 4% real return for a balanced portfolio, and who knows you might have a small upside surprise. (4% real is what I’ve been using as my personal planning number for a balanced portfolio.)

“Excerpts from “The Only Guide You’ll Ever Need for the Right Financial Plan: Managing Your Wealth, Risk, and Investments”by Swedroe, Grogan and Lim Lots of common sense here especially about risk. He suggests 0% equity allocation for investing horizons of 1-3 years. For 5 years 20% and for 10 years 70% modified up/down dependent on income…“With Index funds you just get the asset class and diversify away all the idiosyncratic risk. And you have the same expected returns with a lot more diversification. The smart investor is willing to give up the far-right risk tail, which is the next Microsoft, but in doing so also dramatically reduces the risk of the far-left risk tail, which is the next Enron. Dumb investors take idiosyncratic, uncompensated risk. They may think they’re smarter than the market, or they may hire the next Peter Lynch, but the evidence shows that people who try fail with tremendous persistence. Investors can control the amount of risk they take; they can control how much you diversify the risk they do take; they can control their costs and their tax efficiency.”” (From Ken Kivenko’s Dec 1, 2010 Fund Observer)

Real Estate

The September S&P Case-Shiller Home Price Index shows a 2% decline in the third quarter and prices are 1.5% lower than year ago. In the month of September 18 of 20 metropolitan areas showed price declines. “The national economy is certainly the number one issue for housing. Additionally, there is a large supply of houses on the market and further, hidden, supply due to delinquent mortgages, pending foreclosures or vacant homes. New construction is running at less than half the pace needed to meet normal demand, so a sustained recovery could be a ways off.” and in the Economist’s “Falling again”the comment is “The bright side is that these data are released on a significant lag. The outlook for the American economy as a whole was deteriorating during the months represented by the latest index. From October on, the outlook has improved. So, too, may home prices. But European crisis is flaring up once more. And Congress may not extend unemployment benefits again, which could tip some subset of households into foreclosure.” (Recommended by CFA Financial NewsBriefs)

Larry Macdonald in the Globe and Mail’s “The bargains and pitfalls of buying U.S. real estate”quotes Bob Keats (author of “Border Guide”) that “These are the best buying prices I have ever seen for U.S. housing prices” and combined with a 30% stronger loonie than in 2004, may tempt some to jump into some investment (or personal use) property in the U.S. Of course there are risks as well to consider: cheap by Toronto standards is not necessarily cheap in Florida, as a Canadian you can’t do repairs on your house if it’s an investment property, property management from distance including possibly a tenant who stops paying rent, potential title problems when buying foreclosed properties, withholding taxes on rentals. (It is difficult to forecast future real estate prices or the US$/CAD exchange rate; the area that I am familiar with has not as yet shown any price stabilization due to excess inventory. Certainly prices are about 50% lower than 2006 peak, after tripling between 2000 and 2006. But one other important pitfall worth mentioning in the Florida property context is the dramatically disparate property tax burden carried by Canadians (and other out-of-staters) who cannot become homesteaded in Florida. On lower priced homes this is due to the $50,000 homestead exemption, while on higher priced homes it is further aggravated by SOHA (the so called ‘Save-Our-Homes Amendment’) which limits homesteaders’ property (principal residences of Floridians) tax increases to inflation or 3% whichever is lower, while there are no limits on non-homesteaded properties. It is not uncommon for a seasonal Canadian owner to pay 2x, 3x or 10x as much as his homesteaded Florida neighbours in the identical condos.)

Pensions

Jon Kesselman in the Financial Post’s “Is the piggybank broken? – Expand CPP now”argues that “As a mandatory public scheme, the Canada Pension Plan offers many advantages over individual savings and workplace pensions. Expanding the CPP is the best option for improving Canadian workers’ retirement income security; it can ensure results that none of the many alternative reform proposals for private schemes can provide.” (Certainly and expanded CPP could be an important piece of the overall Canadian pension puzzle, but given the currently proposed modest and gradual expansion, it will do nothing for non-public sector Canadians in or near retirement. Also no credible solutions to the pension crisis can be claimed without protection of already earned private sector defined benefits, again mostly affecting those near or in retirement.)

Read my review of Rosens’ book “$windler$” which unmasks Canada’s lack of investor protection. All scams are “dependent on conflicted auditors, inadequate or non-existent regulations, ill informed directors, crooked managers and gullible investors.” You can add actuaries to the conflicted, self-regulated professions, underpinned by inadequate regulations as they affected Canadian private sector pensions. At the risk of flogging a(n almost) dead horse, you can read about the pathetic level of private sector pension protection in Canada in a couple of my older blogs What’s wrong with private-sector DB pension plans? Problems and solutions and Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now? ; is that an echo that I hear? The book enumerates assorted Nortel accounting scams including: revenue recognition, earnings from operations (rather than net income), bonuses, and expense reserve manipulations If these scams were in fact perpetrated as suggested by the authors (and Nortel did pay about $2.5B to settle-including hundreds of millions of cash that would have been better spent to shore up underfunded pensions) can you imagine that the pension fund was not scammed as well???)

Things to Ponder

In the Financial Times’ “Investors must pay attention to country risk”James Mackintosh reminds readers about the “power of even the weakest states” that the “Weimar Germany tried to solve its problems in 1923 by seizing precious metals and foreign currency, even sending police to raid the cafés of Berlin’s Kurfürstendamm and empty customers’ wallets.”  Given the taxing power of state, Mackintosh questions how the yield on Irish corporate junk bonds can be lower than on the sovereign debt. He suggests that this means that investors believe that “governments will prefer to restructure debts than to stave off default by seizing private assets.”

Isabel Gorst writes in the Financial Times’ “Russia moves closer to importing grain” that Russia, which was “in 2009 the world’s third largest wheat exporter, may need to import grain.” The author indicates that the combination of the summer draught and cash-strapped farmers scrimping of on fertilizers might further reduce next year’s crop. This combined with growing agricultural needs due to improving diets in half the world’s population (China and India), can drive prices higher. In “Corn drives risk of agflation shock”Javier Blas write that “In a market in which just 500,000 tones of extra supply or demand could send prices spiraling higher or lower, traders are talking now about really shocking numbers..”

And finally, Simon Johnson in the Huffington Post’s “The economics and politics of Elizabeth Warren” described the direction set by Elizabeth Warren the chief of the new US Consumer Financial Protection Bureau: “…the best way, in my view, to strengthen those middle class families is to find solutions that are deep and lasting, that strengthen the markets, and that will create a robust, competitive consumer credit industry that works for families, not against them….to make that market work for buyers and sellers alike: a level playing field where the best products at the best prices win…I’m not using the word “market” as coded language for a return to the Wild West where companies use deception to pick off every consumer they can get in their sites. A free market is one where consumers have the ability to make well-informed choices, where the choices are visible and the terms are clear, and where there are cops on the beat to make sure that everyone plays by the same rules.” (Gee…how refreshing…might also help with investment and insurance products.)