Hot Off the Web- July 8, 2011

Personal Finance and Investments

In the Globe and Mail’s “Why only millionaires should invest in bonds directly” John Heinzl explains the advantages of buying bond ETFs rather than individual bonds for average Canadians. Fixed income expert James Hymas is quoted as indicating that “ETFs buy in volume, they get much better pricing than retail investors could obtain through their broker, and this pricing advantage for most ETFs will outweigh the management expense ratio. Bond ETFs also provide instant diversification. The notion that bond ETFs don’t mature and should therefore be avoided makes no sense.” Also on the subject of bonds there is follow-on article from last week by Dan Hallett in the Globe and Mail’s “How rising rates may affect bond portfolios” which elaborates on the importance of YTM, rather than distribution rate of a bond or a bond fund, and then he discusses the impact of a potential rise in rates in the context of the iShares XSBShort-Term Bond Index Fund. He shows that in this type of ETF even in very bad bond markets (e.g. rates increase 400 bp) “capital remains largely intact over the average term of the fund”.

In the WSJ’s “The 25 documents you need before you die” Saabira Chaudhuri writes that “Most experts recommend creating a comprehensive folder of documents that family members can access in case of an emergency, so they aren’t left scrambling to find and organize a hodgepodge of disparate bank accounts, insurance policies and brokerage accounts. You can store the documents with your attorney, lock them away in a safe-deposit box or keep them at home in a fireproof safe that someone else knows the combination to.”  The list of documents includes: original will, proof of ownership (houses, cemetery plot), cars, stock certificates, list of brokerage accounts, mortgage escrows, loans/debts, recent tax returns, bank accounts, safety deposit boxes, health-care power of attorney, living will and financial power of attorney, life insurances and retirement accounts, pensions, annuities, marriage license/certificate. After death, a death certificate will be in high demand by all parties the executor will have to deal with.

In Bloomberg’s

“Delay taking Social Security, add annuity to survive retirement, GAO says”Margaret Collins reports on the recommendations of a U.S. government GAO study. The risk of retirees outliving their assets is growing as result of “increased life expectancies and health care costs coupled with declines in financial markets and home equity” and decreasing proportion of retirees with traditional DB pensions. The study recommends delaying social security, buying annuities (though try to delay purchase until interest rates are higher and until you are well into your 70s) and limiting withdrawals from investment portfolios to between 3% and 6% (obviously depending on age). “Almost half of those near retirement are predicted to run out of money.”

Nick Kennedy in AskMen’s “Top 10: Retirement checklist”provides a pretty good retirement checklist: asset level required for retirement, sources of income (portfolio, pension, Social Security), asset allocation, savings rate, life insurance needs (if any), employee benefits, Medicare benefits, Social Insurance benefits, withdrawal strategy, where will you live. (Thanks to MB for recommending)

In part 2 of his look at trusts, Tim Cestnick takes “A closer look at the fine print on family trusts”where he discusses implications/restrictions on: the naming of settlor/trustees/beneficiaries, transfers to the trust, income and distributions from trusts and the required deemed disposition after 21 years. (It’s a great list, but there is no indication of costs associated with such trusts and the likely minimum asset level where it might be cost effective.)

Reuter’s John Wasik in the Financial Post’s “Financial independence day: 5 ways to get there” recommends: “debt is the devil”, “save like a demon” and even “small fees take bit hits”. And he concludes with “Find out how much it would take for you to live comfortably and put away enough money to get there. Develop a dynamic lifetime financial plan that changes with each phase of life. Get a ballpark estimate to see if you’re on track. Financial independence is possible if you can live below your means. Although that sounds unpatriotic in a consumer economy, what you save is what you keep.”

In Bloomberg’s “Safeguards scant for U.S. investors as Registered (Investment) Advisors increase by 36%” Elizabeth Ody writes quotes a story about a couple suing their advisor, an RIA, who invested their assets in a ProShares UltraShort MSCI Emerging Markets Fund resulting in $85,000 loss for them. It’s a long article, which some might consider as one which questions the value of RIAs as opposed to brokers; recall the debate is about the fiduciary responsibility intended, to eliminate conflicts of interest for the advisor, that RIAs must abide by as opposed to the suitability test that brokers are using. (This article does nothing to undermine the arguments of requiring fiduciary responsibility from your advisor, but is does say that you are not protected against stupidity or incompetence of your advisor (whether he is an RIA or a broker). Insuring that the advisor has suitable credentials (e.g. a CFA or CFP) would be a start in that direction. The article also points out that you must also look out for high fees whether you are working with a broker or an RIA.)

You might also be interested in an in-depth look at Wade Pfau’s new “Getting on track for retirement” in my blog posted this week entitled “Am I on track for retirement?”. He answers this important question by providing historically worst case retirement ages based on assumptions of historical performance, worst case outcomes and a target initial income replacement rate then adjusted annually for inflation. The answer to this question is key feedback element for all DC plan participants. His results also indicate that historically it was not that risky to increase stock allocation well in excess of 50% before or after retirement.

Real Estate

In USAToday’s “Foreign buyers lifting U.S. home sales”Julie Schmit reports that “For the 12 months ending in March, 31% of Florida’s home sales were to foreign buyers, up from 10% in 2007”. The article says that the combination of stronger Canadian dollar (+18% since start of 2006) and lower real estate prices (Miami-Ft. Lauderdale off by -55%) have attracted many Canadians to Florida real estate. “About 40% of buyers are international vs. less than 35% before the bust (in Miami)…The largest share of foreign buyers (in the U.S.), 23%, come from Canada.

Kim Chipman in Bloomberg’s “U.S. home prices set to climb, HUD’s Donovan says’  reports that “Prices for U.S. homes may climb as soon as the third quarter, ending declines as foreclosures decline make more home available for sale, Housing and Urban Development Secretary Shaun Donovan said…“It’s very unlikely that we will see a significant further decline,” Donovan said yesterday on CNN. “The real question is when will we start to see sustainable increases. Some think it will be as early as the end of this summer or this fall.””

In Palm Beach Post’s “Soaring number of owners pay no property tax in Broward, Palm Beach”East, Williams and Huriash report that there is “a 135 percent increase between 2008 and 2010 in Broward, and a 48 percent increase in Palm Beach” of homeowners paying no property tax because of Florida’s homestead exemptions. “While these homeowners still must pay fees such as fire assessments, the loss of this revenue, coupled with a drop in tax revenue overall, is forcing municipalities to slash payrolls and services.” (This is nothing but the tip of the iceberg on the property tax scam in Florida where the rules (Save-Our-Homes) are rigged so that out-of-staters carry the tax load even though they have no children in the school system and only use services for a few weeks or months of the year. I have no doubt that Florida’s counties and municipalities are working on more creative ways to offload their bloated budgets onto unsuspecting out-of-staters continuing to buy property there. Not a great way to attract investment to the state, though more Canadians are getting sucked in this year, as per previous story.) An illustration of how successful Florida has been in offloading property tax load from Florida residents is that the article indicates “It’s not only the non-payers that concern the cities. While Boynton Beach has 976 homeowners who don’t pay property taxes, “those paying between $100 and $200 make up 27 percent [of the tax base] now…” (Welcome to “save-Our-Homes)

And more bad news on the way for Florida homeowners on insurance prices, as reported in Palm Beach Post’s “Uptick in home insurance rates only the beginning”where Susan Salisbury writes that insurance companies received permission increase prices (e.g. Citizens 10.4%, State Farm 18.8%), and while increases are high, these are just averages; individuals may see much larger increases (e.g. +152% in one State Farm customer’s case illustrated in the article.)

In Canada, according to the Globe and Mail’s “House prices may have hit the top”Steve Ladurantaye reports that according to Royal LePage “While prices saw big year-over-year price increases in the second quarter, “high house prices are concealing early signs of a moderating market.””


In the Financial Post’s “Nortel holders may get 100% recovery on patent sale” Christopher Donville suggests that Nortel bondholders will get 100% recovery based on prices of “Nortel’s US$450-million of 10.75% bonds that mature in July 2016 closed yesterday at 105.25 cents on the dollar”.  (Suggesting improved recovery for pensioners as well, though difficult to fathom pending the resolution of jurisdictional issues and Canadian court decisions which all went against Canadian pensioners’ interests, in the past.) Jamie Sturgeon’s “Battle set for Nortel Cash pile” also discusses the topic. In Ottawa Citizen’s “The puzzling politics of Minister Paradis” James Bagnall explains “why a review of the sale of Nortel patents makes no sense”, and specifically “Had the federal government been convinced Nortel’s intellectual property was a national treasure, the time to act would have been in 2008, when a bailout could have given the company some breathing room.” (The proposed review is more like a sick joke, unless of course the government finally saw the light and wants to use this review to secure Nortel’s Canadian pensions now seriously.)

In the Globe and Mail’s “Retired economist advocated CPP expansion” and Financial Post’s “’Big CPP’ gets new wind” Janet McFarland and Jonathan Chevreau, respectively discuss economist Keith Horner’s “A new pension plan for Canadians: Assessing the options”. Horner argues that “pressure is building for reform” due to insufficient savings, increased longevity, lower returns on investment, declining pension coverage in the private sector and aging population (and of course high cost associated with individual saving plans). Also, Canada’s OAS/GIS/CPP/QPP replacement rates are well below OECD levels at average and above wage levels. He compares three options: a mandatory DB plan and two DC plans one optional and one mandatory, but he ends up favouring the mandatory DB proposal based on a modest expansion of the CPP/QPP. (I am never fully comfortable with thinking of the CPP as a DB rather than a target benefit plan, given that the government may (as it has already done in the past) just legislate higher contributions or reduced payouts, unilaterally.) He also argues that if plan is DB, then it must be mandatory to prevent adverse selection. “Horner’s proposed DB plan entails a modest expansion of the Canada and Quebec Pension Plans that would raise the benefit rate from 25 to 40 percent of earnings up to $48,300, and from 0 to 25 percent of earnings between $48,300 and $96,600. Combined employer/employee contribution rates would be 3.6 percent of earnings below $48,300 and 6 percent above.” If my recollection is correct, Horner’s is the only proposal to even discuss transition provisions for older workers, such as “benefit rates that decline (or contribution rates that increase) with a participant’s age at plan start-up”. (I have only had a chance to skim Horner’s report so I am not sure about all the details, or if he addressed how to deal with workers near or in retirement, e.g. could they buy-in to the plan at a specified price for some specified benefit? Lots of good ideas and no doubt the government need to be prodded into the right direction, but government is now on the path to handing additional savings/contributions to the Canada’s high cost financial services industry via its PRPP proposal, and is in total denial about the urgency of pension reform judging by the glacial pace at which it appears to be proceeding.) You can also read Gregg Hurst’s comment on Horner’s proposal in Jonathan Chevreau‘s “Myths of defined benefit pensions” . Hurst prefers DC over DB plans in general and specifically over this enhanced CPP implementation. His arguments are based on generational conflicts (inequities), and other risks like “increasing longevity, the demographic “bulge” and intermittent…recessions”.

The Toronto Star’s John Cocker in “Imagining a world without pensions” and The Telegram’s Brian Jones in “Pain and pensions” examine the disastrous state of Canada’s pension system. Cocker writes that “A retirement income policy that assumes Canadians will take responsibility for their own welfare in retirement could result in disastrously low levels of senior income. We have to turn this argument around — rather than getting rid of pension plans, we need to strengthen and expand them. A pension plan that provides meaningful replacement income is our best line of defence against widespread senior poverty.” While Jones writes that “A recent Statistics Canada report points to what is coming. Only 39 per cent of Canadian workers have a pension plan through their employer. That number drops to 25 per cent among workers employed by private industry. In contrast, 80 per cent of people on a government payroll – civil servants, postal workers, teachers, university employees, health-care workers – have a workplace pension plan. This pension disparity is essentially a three-tiered system that will result is huge inequalities among retirees. Strangely enough, the awful prospect of a two-tiered health-care system raises loud cries of opposition, but the current three-tiered pension system is accepted with eerie silence.” (Does anyone still question that Canada’s pension system is in ‘systemic failure’?) (Thanks to BS for recommending these two articles)

In WSJ’s “401(k) law suppresses saving for retirement” Anne Tergesen reports that while the auto-enrolment law introduced in the U.S. in 2006 has increased significantly participation rate, it has resulted in many people ending up saving less than they might have done so without this law. Many companies misinterpreted the law to set savings rate at 3%; other employers added auto-escalation, an automatic 1% annual increase in savings rate up to 6%. However these savings rates are still too low as many prior to the introduction of this law voluntarily enrolled at the 5-10% level. “Many companies said they selected a 3% default contribution rate in part out of concern that a higher rate could prompt employees to drop out of these plans…Another factor may be pushing down default rates: Some companies that match some employee contributions can save money with a lower default rate.” (But, not mentioned in the report is that the average contribution rate dropped from 7.9% to 7.3% most likely because the number of savers was increased by about 15M (about 25%) joining the plan due to auto-enrolment and they just left default at 3%, thus bringing average down. Auto-enroll worked exactly as intended! To further improve the situation the default could be set to 5% and/or auto-escalation not capped until 10-12%, remembering that if employee receives salary increases each year the 1% point increase in savings rate might be accompanied by little pain.)

Things to Ponder

In the Financial Times’ “The $10 minibar beer is no basis for capitalism”John Kay writes that “If the winner of the competitive race is the company that is most innovative, not in productive efficiency or customer service, but in the ingenuity and opacity of its tariff structures, consumers will not be happy, or well served, in the long run… Encouraging bad decisions through teaser mortgage rates was a central contributory factor in the financial crisis. Business practices whose rationale derives from consumer ignorance and producer knowledge create a larger problem. When people see many examples of minor exploitation of consumers in their daily lives, they will conclude that extensive exploitation is characteristic of business as a whole. And they may be right. If caveat emptor is seen as a dominant business principle by both producers and consumers then the legitimacy of capitalism and market organisation will not long survive.”

Ari Weinberg reviews again the concerns surrounding securities lending associated with ETFs in the WSJ’s “When ETFs are lenders”. He cover the mechanics of lending the individual components of ETF, the entire ETF, the daily adjusted collateral and income derived from it (and at least some) for the benefit of ETF holders associated with lending. Shorting is the reason for lending. Most of the expressed concerns have been disposed of more or less completely except for the possibility, which has actually occurred, that one of the ETFs ends up being >100% short, meaning that more of the ETFs have been sold (due to lending/borrowing activities) than are actually in existence. “Still, at a recent securities-lending conference hosted by data company Data Explorers, 46% of industry insiders responding to a survey said they believed that net-short ETFs could pose a systemic risk for securities markets…The SEC has not taken a position on the subject, but is likely studying it. The current relatively low level of securities lending activity, primarily due to very low interest rates is recovering quickly “so expect the noise on ETFs and lending to get louder before it settles.”

In the Financial Times’ “Who really knows how markets work?”Pauline Skypala looks at the views of Myron Scholes and Roger Ibbotson on how markets work. Scholes argues that “Markets are not perfect, he admits – their pricing can be off, but that does not mean governments can do better. He is dismissive too of the “black swan” thesis promulgated by Nassim Taleb. There is nothing new in such thinking: he has known since 1962, from Benoit Mandelbrot’s work, that stock returns are not normally distributed and there are likely to be “fat tails”. The question is not about the existence of black swans, but about why these unpredictable events occur and whether we should just accept they will happen or try to plan for them.” Ibbotson’s view is that “stocks will always outperform bonds, he is unapologetic about sticking to it. There is such a thing as the equity risk premium, he says. The only reason for stocks to underperform is if the market gets bid up too high that it has to fall. Bonds have done as well as stocks over the past 30 years because of falling yields that furnished a capital gain. It is more likely now that yields will rise.” Skypala concludes that “The abiding impression from most meetings with financial academics, and industry practitioners too, is what little real knowledge anyone has about how markets work, what aggregate risk is being run, and what we should do about it.” (That’s comforting.)

In Barron’s “Tail-risk tribulations” Michael Santoli writes that “There has been a vogue for financial instruments that purport to insulate the wary investor from “tail risks” events. But such protection can be tricky to pull off correctly.” Quoting GMO’s James “Montier makes the point that defining the precise risk, then designing its antidote, and then weighing exactly when one should begin shouldering the cost of carrying such insurance, is easier said — and sold — than done. One must, he says, be a value investor when considering all these factors, and in the end plain old cash is probably an under-appreciated cushion against bolts from the blue. “Over-engineering” is an important hazard, he notes, as “it is too easy to construct an option that pays out under a very specific set of circumstances,” yet that does not by definition offer broad tail-risk protection.” Same topic is addressed in the NYT article “A new investment strategy: Preparing for end-of-times” which likely triggered the Barron’s article.

And finally, I couldn’t resist including the WSJ’s “Five lessons Olympic athletes can teach business leaders” contains a list of strategies (also applicable to personal performance or goal achievement). Included in the list are; a vision and short term goals toward it, feedback (measurement) on how you are doing, self-belief/confidence, “controlling the controllable”, pressure is positive.


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