Hot Off the Web- October 10, 2011

Personal Finance and Investments

In Bloomberg’s “That retirement calculator may be lying to you” Carla Fried warns that before focusing on the seven figure output (required assets at retirement) you better check the return assumptions used in the calculator. Many calculators use a very optimistic default of 8% return for a 60% stocks and 40% bonds portfolio. Fried suggests a more modest 5-7% might be appropriate, given very low bond interest rates and very low dividend yields (an important component of historical stock returns). And, of course, if you are using mutual funds, then don’t forget to further reduce returns by the fees they charge (1-1.5% in the US and 2-3% in Canada); however, “In this day and age, there’s simply no excuse for paying [an expense ratio of] more than 0.25 percent for a portfolio of U.S. stocks and bonds, and maybe 0.5 percent for a portfolio of foreign stocks,” says Bernstein.”. (Quite amazing that so many people continue to invest in mutual funds; you recall the old definition of insanity: “doing the same thing over and over again and expecting different results”. Thanks to VP for recommending.)

In WSJ’s “How ETFs have reshaped investing” Tom Lauricella discusses the opportunities and pitfalls that were opened up by ETFs. The opportunities are to use low cost broad index funds to easily build diversified portfolios, including the ability to access previously inaccessible or very difficult (for individuals) to access geographic areas or asset classes. The pitfalls are: the ability of individuals to “buy and sell during the day” and, due to the scramble of fund providers for market share, the availability of niche and/or dangerous and/or opaque funds (e.g. leveraged, inverse, currency hedges, commodity futures based)

Real Estate

The Financial Post’s “What’s the real story of Canada’s housing market?” reports that while housing prices in Canada are up YoY between 5.7-7.8%, the 3rd quarter increases were weaker; “national housing market conceals signs of predictable softening in some regions”.


In the Globe and Mail’s “Canadians unfazed by pension funding woes”Janet McFarland reports that a recent survey “has found employees with a traditional workplace pension plan have a high level of confidence in the strength of the plans and their ability to pay out as promised” despite the facts that: employers are closing capping exiting plans, there are now more public sector employees with DB plans than private sector ones (after a 3.9% drop in private sector ones in 2009 alone),only 25% of private sector employees have a pension plan and “Plan members remain in the dark about the issues and challenges facing Canadian defined-benefit plans”. (And, private sector DB plan members should not forget that in Canada if your employer/sponsor goes into bankruptcy protection with (more than likely underfunded pension) then you will be subject to potentially massive reduction in pension.)

I have written before about Bev Smith, a long-time researcher/activist for women’s rights and member of the Common Front for Retirement Security (CFRS) advisory team, and her advocacy for the recognition of the “value of unpaid work”. Specifically, the drive recognize the societal value of unpaid work and to identify mechanisms to a secure pension benefit (e.g. CPP) for individuals who choose to stay at home to raise small children, or to attend to sick or elderly parents. In her latest brief prepared for federal politicians, Smith “looks at the rationale for caregiver pensions, current situations in Canada and elsewhere, a historical perspective of the issue, the options for how to provide adequate income security and recommendations.” Her recommendation, with supporting arguments, is very reasonable one; essentially, that the government during any full year dedicated to care-giving commits to contribute $1,500-2,000 to CPP on behalf of the caregiver (typical current maximum CPP contribution is about $4,600/year 50:50 shared by employer and employee).

In benefit Canada’s “Hybrid pension plans: Way of the future or just a myth”  Frank Vittese questions the wisdom of Air Canada’s approach to pensions, when they decided to take a two-tier approach of a “slimmed down DB tier, supplemented by a new DC tier”. He argues that the approach is complex to implement, difficult to understand/communicate and is saddled by double costs……For those interested in reading more about ”hybrid plans”  you will find interesting the Towers Watson comprehensive report  “Hybrid pension plans”authored by Hill, Pang and Warshawsky.  Very simply, hybrid plans are some combination of DB and DC plans. Two flavours mentioned are Cash Balance Plan (CBP) and Pension Equity (Benefit) Plan (PEP). What these plans have in common is that like DB plans is they: are eligible for PBGC insurance (in the U.S.), have a ‘defined’ benefit but, unlike DB which defines retirement income, the hybrid plan defines retirement assets based on a prescribed formula (CBPs based on some specified interest rate during benefit accumulation, while PEPs accrue percentage credits throughout one’s career), annuities are the default (thus longevity risk is shared by all participants) but CV is also available, CBP is more like career average pay whereas PEP are final average pay based formulas, the interest rate risk  at retirement (i.e. discount rate for calculation of liabilities side of a DB plan or how much of an annuity you can buy for the accumulated assets for hybrid plans) is borne by employee as income stream is determined by prevailing interest rates (though during working years interest rate risk is borne by employer). Some employers chose to freeze DB plan and start DC plan, others (a few) converted to hybrid plans, though there was considerable controversy associated with this. Typically hybrid plans have lower cost variability for the employer.

In the Ottawa Citizen’s “In patent wars, the casualty is progress”Bert Hill writes about how “patently absurd the technology world has turned”, in reference to the $285,000 owed and unpaid to Nortel engineers for patents filed compared to the $4.5B ($750K/patent) received for sale of 6000 patents. He points out that the engineers will only get a small portion of what’s due to them since debts far exceed available assets. He also discusses recent changes in patent laws and their likely impact on inventors. He also discusses some of the human costs of Nortel’s bankruptcy. (Many thanks to Bert Hill for keeping the subject front and center in the mind of Ottawa’s politicians and public; who knows, perhaps the right thing might still be eventually be done.)

Things to Ponder

In the Globe and Mail’s “Unrest: Don’t ignore what’s happening in the streets” Michael Babad writes “Policy makers around the world should play close attention to what’s happening in the streets…people are speaking with a unified voice, telling their leaders they’ve had enough…Amid high unemployment and harsh cutbacks, these things have a way of blowing in the faces of politicians”; similarly, in the Financial Times’ “In praise of Wall Street protesters” John Gapper writes that “I think they should stick with it – their disenchantment with bankers is shared by virtually everyone, and vagueness hasn’t hurt so far… If they force politicians not to buckle to the complaints of the financial services industry, that will be something.” In the WSJ;s “Democrat’s populist puzzle” Weisman and Meckler discuss the difference in approaches taken by the Democratic (quiet contemplation to decide whether to ride this tiger) and Republicans (demonstrations won’t help create jobs) (It is actually interesting to watch…are we hearing that “We’re as mad as hell, and we’re not going to take this anymore”?…we’ll have to wait and see…a couple of signals to watch might be: will protesters stick with it and whether more will join them?… and what happens to: whether the “Volker rule” pertaining to the regulatory changes of the financial industry talked about since the 2008 collapse will be executed (separation of traditional banking from “casino gambling”, and fiduciary responsibility for all advisers/brokers, end high fund/advice fees inconsistent with value added, dare I say pension reform, and will more people redirect their investments from high cost mutual funds to low cost index funds…etc, etc…and of course demonstrations are planned for Canada on the 15th)

In Bloomberg’s “Michael Lewis slams Wall St., leadership deficit”he answers questions on: Occupy Wall Street movement (“They’re right to be angry, but they have to figure out what they want if they’re going to have any effect. If there were specific demands, it would start to get very interesting.”), Wall Street changes (very limited to date, and the “big firms…manipulated the legislation in ways that are not good for the rest of us”; and they shouldn’t have been given any place at the negotiation table) and on parasitic behaviour (“The common theme between public employee unions, say, and Wall Street bankers is an excessive focus on the short term and a weird blindness about the long term. It’s unsustainable behavior, parasites everywhere killing their hosts.”)

In the Financial Times’ “Gold bugs beware- the bubble is bursting”Mark Williams opines “If gold is falling in a weak economy, and investors are willing to own US dollars again, imagine how it (gold) will perform when the global economy eventually moves from chaos to prosperity, and more traditional investments – those that produce products, dividends and jobs – come back in fashion. Gold has lost its shine.” (Who knows?!? In the meantime the printing presses may be working overtime generating more ‘dollars’ and if the economy takes off then likely inflation will too.)

In the WSJ’s “The case against commodities” Liam Pleven writes that despite the now accepted practice to include commodities in portfolios “there’s a case against commodities, too: the human tendency to feed our appetites ever more efficiently, which periodically undercuts commodity prices and in extreme cases has even wiped out entire markets…The risk is that inventors and innovators will respond to rising commodity prices or scarcity by discovering other ways to meet market needs.”

In the Financial Times’ “Investors seek protection from extremes” Demos and McCrum discuss significant inflows into funds promising “Black Swan” protection. Other steps taken by investors to protect against tail risk include investment in iPath S&P 500 Vix Short-term Futures ETN which saw a 138% price appreciation since August. The article quotes an alternative investments expert as “The normal things that people do in traditional hedges, which make money when equities go down, have become a lot more expensive”. (i.e. the price of insurance gets very expensive by the time people believe it will be needed.)

In the Financial Times’ “Radical thinkers might have a point” Pauline Skypala quotes one such radical thinker as saying that “he would not be looking to go back into equities until they were yielding more than 10 per cent with a price/earnings ratio under 5. In his book he maintains the bear market that began in April 2000 in the west is nowhere near over. The policy lessons from Japan are clear: “all policy options fail because there is too much debt”. The market lesson is equally stark: “once the equity cult ends, it does not return”. (Dividend yields of 10% and PE ratio of 5 would mean another 60-70% market drop; let’s hope that we won’t get that radical.)

Barry Eichengreen in the “Why the dollar’s reign is near an end” discusses the gradually the U.S. dollar will have to share its reserve currency status and the implications of this change. The world is moving from significant dollar advantages (deep USD denominated bond markets, safe haven currency status and “dearth of alternatives”) to a world of eroded USD advantages (emerging alternative safe havens, internationalized renminbi). The impacts he foresees are: higher finance costs for budget deficits, difficulty to run up large trade deficits, which will likely result is a 20% depreciation of the USD.

The Economist’s Buttonwood column “Another month, another Monday, another mess”  considers the available and contemplated options being discussed around a financial rescue of Greece and the European banks which are at risk if Greece defaults and squarely comes down against spending the money on rescuing the banks, but instead “on things that actually might help the economy in the long run”, like “$20,000 to every business that gave an annual contract to someone from the long-term unemployed register” or “upgrade the tube system in London, which would surely enhance productivity”.

And finally,’s  “Canada outlines proposed regulations for energy drinks”reports that Canadian government is taking step regulate energy drinks’ “labelling and formulation requirements” to “prevent overconsumption of caffeine and other ingredients such as vitamins, and to help parents monitor the caffeine intake of their children and teenagers”. While I am not in position to assess the importance/value and effectiveness or lack thereof of such regulation, I have no doubt that improved regulation of financial products is at least as necessary as that of power drinks; however protection from some of the financial industry’s toxic products and/or excessive fees which poison many Canadians’ retirements doesn’t appear to be on the front burner of legislators.


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