Hot Off the Web– April 15, 2011
Personal Finance and Investments
In the Financial Post’s “Fixes for the biggest retirement risks” Linda Stern discusses the requirement for “maximum flexibility” and suggestions on how to deal with life’s surprises like: you are forced to retire early, taxes may be higher that you expected, you could live longer and costs may be higher than expected, bad timing by retiring in a bear market.
In Daily Finance’s “Six ways to avoid common retirement planning pitfalls”Sheryl Nance-Nash looks a some of the pitfalls and suggests alternatives such as: don’t think of saving for retirement but building wealth, (Americans should) plan for $250,000 medical expenses through retirement (judging by some of the recent articles on drug expenses that some Canadian had to incur to improve their chance to stay alive, I wouldn’t dismiss the need for an allocation for Canadians as well for medical emergencies), don’t get too conservatives with your investments when you hit 65, and some other ideas on saving/spending and asset allocation .
Finn Poschmann in the Financial Post’s “TFSAs beat RRSPs for the less wealthy” reminds readers that “for low income savers, the RRSP is often not the best tool…(because) in retirement the tax rate is almost always much higher”. Specifically below median earners would be better off with TFSA than RRSP. So the proposed doubling of annual TFSA contribution is a positive development for a lot of Canadians.
In the Globe and Mail’s “The cost of drugs: breaking the bank to stay alive” Andre Picard writes that “Drug therapies have become an essential part of treatment for many ailments, but costs of the latest and most advanced treatments have soared. The response from public health plans has been uneven and often inadequate.” “There are currently 19 public drug plans (mostly for seniors and those on social assistance) and 1,000 private drug plans in Canada. Yet, many Canadians – three million by some estimates – still don’t have sufficient coverage for “catastrophic” drug costs, which are defined as anywhere from 2 per cent to 10 per cent of family income.” (And of course even those who think they have coverage, at times find that the existing coverage may not apply to them since, administrative rules may limit eligibility until the cancer reaches a more advanced stage.) You might also be interested in Carly Weeks article “Avastin debate highlight the challenges of a catastrophic drug program” asks is extending life by a few months worth spending $30,000 of tax-payers’ money?
In a Globe and Mail book excerpt Suze Orman writes “Live below your means but within your needs” and asks her readers to consider the difference between musts and wants. “So “below your means” means making a commitment not to spend every last dollar you take home. “Within your needs” requires that you make a clear-eyed assessment of what exactly you are putting in that category…. I understand the desire to have the things that you want. You feel you work hard, so you deserve those things. But the truth of the matter is that they are just things and those things will never make you happy. Peace of mind will make you happy. Being able to sleep at night will make you happy. Not worrying about being able to retire one day will make you happy. I want you to appreciate where I am coming from: My call to live below your means is the path to having more. Living below your means– but within your needs; this is not about punishing deprivation– will allow you to create more to put toward your goals. I need you to recognize, right here, right now, that your dreams for tomorrow reside in the choices you make today.” (She articulates so well her common sense street smart view of managing your personal finances.)
In the Financial Post’s “Real estate: A ‘secret’ tax shelter” Jason Heath writes that “Rental real estate has been described by some as the equivalent of a super-charged RRSP. What is a traditional RRSP? It’s a tax-deferred savings vehicle; contributions are tax-deductible; it provides a future income stream; and it’s an investment asset. Rental real estate incorporates all of these features, plus there’s no pre-determined maximum tax deduction limit like with RRSPs; withdrawals aren’t forced at age 71 like with RRIFs; contributions can be financed and the interest can be deducted, unlike RRSP loans; and the taxes paid on selling a rental property are at the 50% capital gains tax rate, unlike RRSP withdrawals which are fully taxable.” (Note that I placed this article in the Personal Finance and Investment rather than Real Estate section of this blog, because unlike personal use property (summer cottages and Florida condos which are luxury /lifestyle expenses), rental real estate is an investment on which you at least hope to make money.)
James Stewart in WSJ’s “Asset allocation fallacy” argues that the old adage that your bond allocation should mirror your age (and even some of the more recent target-date fund allocations) is inappropriate except for some of the most conservative and risk intolerant investors. “Like so many aspects of investing, simplicity is appealing but rarely effective. No matter what a person’s age, an asset-allocation plan has to start with an investor’s net worth, balance expected returns with expected needs and take into account risk tolerance. Everyone’s circumstances will be different. Some people simply can’t stomach volatility. But my hunch is that the age/allocation adage makes little sense for most people, and that many older investors should allocate more to stocks than they do.” (I have to agree with him).
In the Globe and Mail’s “A time for short-term bonds and stable stocks”Avner Mandelman discusses Richard Farleigh’s framework for investing who suggests consideration of four scenarios (and corresponding investments): (1) high growth with high inflation (commodities), (2) high growth with low inflation (stocks), (3) low growth with low inflation (bonds) and (4) low growth and high inflation (protect capital). He then suggests that we are now in (1) and heading into (3) or (4) and discusses what might be appropriate investments at this time.
In the Economists’ Outlook “State by state estimate of shadow inventory” Selma Hepps writes that the four states with worst foreclosure problems AZ, CA, FL and NV “account for 42% of the foreclosure inventory today”. The article shows some very interesting data with FL, CA, IL and NY being the states with the highest (additional) shadow inventory and Florida leads with 441,000 properties. “Time to clear shadow inventory grossly understated” defines shadow inventory as “residential properties caught between foreclosure and the sales market” (i.e. foreclosed but not yet on the market).
It’s about time! Perhaps some good will come from the disaster that befell Nortel’s (and other bankrupt companies’) pensioners. Their crisis and their articulate arguments about the changes needed to fix the sorry state of Canada’s pension system (which I think is in ‘systemic failure’), is starting to show some results. The flicker of hope that the Nortel pensioners will get what is rightly theirs, is still only a glimmer, but I have no doubt that those who come after us will benefit even more from the changes to Canada’s pension landscape. The following three stories will explain why.
The newly tabled Ontario Budgetproposes that on pension plan windup (e.g. in case sponsor bankruptcy), that in addition to the previous compulsory annuitization, pensioners will also be given a LIF option, including (if I understand correctly) self-managed option at your discount broker. This is a major breakthrough. Many thanks are due to the Ontario government for introducing this change. The LIF option will help even those who will be choosing annuitization, in that the availability of an alternative will no doubt improve the annuity offers. The NRPC, and many others, fought hard to effect this change to existing over-paternalistic pension windup rules. The recent NRPC newsletter indicated that it is working on a Nortel Pensioner’s Group LIF (G-LIF) with the intention to provide a guaranteed income stream for life which will be superior to annuities. (Not clear how one achieves a superior outcome from the same sources, if the income stream includes a lifetime guarantee for the pensioner and spouse, but we’ll just have to wait to see what the offer looks like.)
In the Globe and Mail’s “Pension ruling to complicate insolvency proceedings” Jeff Gray reports that “The court ruled this week that two underfunded pension plans at Indalex Ltd. should rank ahead of a secured lender in the distribution of the proceeds of the sale of the company”. (I haven’t as yet read the ruling in detail, but this appears to place pensioners ahead of secured creditors. Clearly, underfunded DB pension obligations are deferred wages, and thus it is reasonable to expect that the company obligations to vulnerable pensioners should be ahead of at least all other pre-bankruptcy creditors. (Nortel pensioners only asked to be placed ahead of other unsecured creditors and the judge in charge of the Nortel CCAA proceedings would not even grant that. I hope for the sake of other Canadian pensioners of future bankrupt companies, that this was the last judge to ever make such a ruling.) More details of the Indalex ruling and legal opinions associated with it are available in the Globe and Mail’s “Indalex pension decision has far-reaching implications”, the Blakes Bulletin’s “Ontario Court of Appeal: Pension wind-up liabilities are subject to ‘Deemed Trust’ “. An even more in depth explanation of what this ruling means is available at “Ontario Court of Appeal decision fundamentally changes corporate restructuring landscape”from Davies, Ward, Phillips & Vineberg; a must read for those interested in the potential implications on pensions. (The more one reads this decision and opinions on the decision, the more Nortel pensioners and those who represent them are no doubt asking: how does this apply to them, and whether the federal government might use this decision as the basis to finally modify the Bankruptcy and Insolvency Act (BIA) to at least raise the shortfall of DB pension plans in priority over other unsecured creditors, or to even higher priority. Judge Eileen Gillese appears to have indicated that a ‘Deemed Trust’ trumps the rights of all other creditors when the sponsor is also the Administrator and thus has fiduciary responsibilities to pension plan beneficiaries. Finally some clarity of thought emerged articulating the challenges (conflicts of interest) of a sponsor/administrator in dealing with their unquestionable fiduciary responsibilities toward a most vulnerable party (the pensioners) versus their other responsibilities toward less vulnerable parties (the investors and lenders).
Coincidentally, the CBC’s “Ex-Nortel workers look to make pensions an election issue” reports that ex-Nortel workers specifically are fighting to modernize the bankruptcy laws of Canada (BIA) by increasing the priority of shortfalls of underfunded pension plans in bankruptcy and that John Tyson’s Silver Fox Allianceis advocating that affected pensioners consider using strategic voting in about 20 ridings to unseat Conservatives. (It’s a great idea to insure that pensions in general and serious problems with current bankruptcy legislation are pushed to the forefront of election issues. As to strategic voting, I have mixed feelings; most people are not single issue voters, and I personally feel more comfortable if people actually voted for a holistic set of issues (and someone) rather than against something (or someone).
Another thing that I learned while reading comments to articles like this, is the antagonism/hatred that some individuals have for ex-Nortel employees (including pensioners) likely because they have lost money on Nortel stock. That is really too bad because unless the Canada’s failed pension system is fixed, other Canadians who still have private sectors DB pensions will also become victims in the future.)
William Hanley in the Financial Post’s “Time for a pension debate” writes in reference to the recent challenges of the Ontario Teachers’ Pension Plan (e.g. “With 90 teachers over 100 OTPP’s problem is clear”) that “But while that’s so, the levels of the contributions from individuals and the government now total roughly 20% of a salary. Imagine! To get the equivalent of an Ontario teacher’s pension, you would have to save and invest 20% of your pay each year. How many people can and will do that?…The defined benefit pension is just about extinct except for the public sector. And while there’s a lot of pension envy in the air and union-bashing is increasingly in vogue, it’s also true public expenditure levels cannot be maintained without offloading crushing debt levels on to future generations.”
In the financial Post’s “Canada pension myths” Neil Mohindra writes that proponents of pension reform by an expanded CPP option have spread “inaccuracies and myths” and “The reality is that the CPP is not risk free or as low cost, as advocates of expansion pretend. The Canada Pension Plan Act, governing the CPP, includes an automatic mechanism to adjust benefits and contributions to bring the plan back on track if at any point it is no longer considered sustainable in meeting its obligations… the CPP Investment Board is strictly the investment manager for the CPP so its costs do not include all the administrative costs of the CPP such as the costs involved in collecting premiums and paying benefits. “(Don’t you love the disinfecting power of sunlight!?! It is true that while the CPP may not be as cheap as some might lead you to believe, it is fair to say that there may not be significant incremental administrative expenses associated with incremental contributions collected by payroll mechanisms. Furthermore, I’d venture to to suggest that there are good reasons to believe that based on significantly lower administrative costs associated with large (>100,000) 401(k) plans in the U.S., CPP administrative cost reductions may have lots of low hanging fruit for easy picking.)
Things to Ponder
In Bloomberg’s “U.S. argues over peanuts to tame elderly” Laurence Kotlikoff discusses the ongoing debate over U.S. healthcare reform. He ridicules current focus on keeping government running rather than dealing with the big issue of overall growing government spending which is on the path to 90% debt-to-GDP ratio within five years! He argues that the number one problem is the growing spending on healthcare which must be contained. He proposes a government spending cap of 10% of GDP on healthcare, and then manage to that number and still deliver what most Republicans and Democrats mostly agree on which is “making sure that everyone has a basic health plan, that people aren’t penalized for having bad genes or bad luck, that health-care provision remains private, that people face strong incentives to improve their health, and that treatment be determined by medical, not legal, concerns…a desire to maintain private health-care provision…an urgent desire to control costs, part of which, both parties acknowledge, requires changes to malpractice laws”. The problems he says are “that there are too many interests vested in the generational status quo” and “Medicare’s service-for- government-fee system, also called fee-for-service, is an ongoing invitation for the health-care system to spend what it wants on the elderly and ship the bills to Washington”. (If I recall correctly, it was Winston Churchill who said that “the Americans always do the right thing, after they’ve exhausted all other possibilities”.) You might also be interested in El-Erian’s Financial Times article “Obama adds fuel to confusion but no resolution”on the challenges of stepping back from being “responsibly irresponsible” rather than sliding into “irresponsibly irresponsible” behaviour.
Alice Ross in the Financial Times’ “FSB urges regulators to keep an eye on ETFs” reports possible European regulatory tightening of ETFs because “What’s important to us is that the product evolves in a stable way so we avoid accidents we’ve had with other financial innovations, like securitisations prior to the crisis”. Areas of concern mentioned include “swap-based exchange traded funds, which rely on a swap contract with an investment bank to meet the return due to investors” and the need for a cap on securities lending in “plain vanilla” ETFs. (Sounds like areas well worth looking at; if interested you might want to read my earlier blog on this subject ETF Concerns: There are risks, but thanks I’ll stay with ETFs for my money )
In reference to the recent Sokol/Berkshire Hathaway front-running like incident, the Financial Times’ “Front-running: the grey areas are huge” discusses potential solutions to prevent fund managers from benefiting by buying stocks expected to increase in price when their fund starts buying large quantities of that stock. The article states that “the grey areas are huge” and among the solutions suggested is treating this as insider trading.
In WSJ’s “Is the market overvalued” Browning discusses the debate on whether the U.S. stock market is overvalued or not. On the yes side are Shiller and Arnott who use CAPE (the cyclically adjusted PE) ratio which they calculate at 23 (which in itself is higher than historical average, but hasn’t necessarily meant a market downturn historically)and on the other are Bianco and Siegel who make a number of modifications to that calculation (uses operating vs. as reported earnings, restricts historical comparables to post-1960 vs. 1914, and argues that current higher retained earnings will drive earnings higher than historically) and Bianco calculates PE at 14.5. Mr. Bianco’s arguments are tenuous according to many analysts, however Larry Siegel’s challenge to Shiller’s calculations on the grounds that “to keep that once-in-a-75-year event in your data set, to say that is normal earnings, doesn’t seem to be realistic” is more credible. (So perhaps, the ‘truth’ might be somewhere between 14 and 23.)
On a related topic in the Financial Post’s “Coxe sees turning point for market”writes that Coxe “believes commodities will take on the role as the lowest risk asset class because we know they are needed, we know how much can be produced, and they move up in price as risk increases. Mr. Coxe said seasoned commodity investors see a tremendous opportunity here as conventional forecasting prepares for what will be its toughest two years ever.”
John Bogle in the sobering Financial Times article “Wall St’s illusion on historical performance”explains how even on a before tax basis, $10,000 invested over 50 years at the historical US equity returns of nominal 9% will become not the illusory nominal $743,000, but only about $44,000 real purchasing power. “Combined, these three errors have an impact that is hardly trivial. Counting on historical stock market returns to repeat themselves is one error; counting in nominal dollars rather than real dollars is another; and counting on capturing the gross returns of the stock market rather than net (after-cost) returns is yet another… My message is that we should treat numbers with great caution. We should remember that those who present numbers are rarely without bias and that the past is rarely prologue. It’s not that we shouldn’t be counting; rather we should be counting with scepticism, and with all the perspective and wisdom that we can muster” (A must read.)
Surprise! The Financial Times’ Steve Johnson reports that “The fund industry ‘overpaid by $1,300B’”(that is $1.3 trillion or close to 2% of global GDP) relative to the “value it delivers”, according to a survey of 2600 industry participants and government officials. “The bulk of the value destruction, almost $1,100bn a year, equivalent to 1.9 per cent of global gross domestic product, is seen as impacting on clients. This includes $300bn in excess fees for actively managed long-only funds that fail to beat their benchmark (this figure is quoted as $834bn in the draft report but it is believed IBM has since revised it lower)… Across the financial sector as a whole, IBM said “alpha generation” or the ability to deliver index-beating returns, was “pitiful”, despite the huge sums paid in pursuit of this. Perhaps unsurprisingly, it found 87 per cent of investors expressed no loyalty to their “primary investment provider”.”
In the WSJ’s “Fed’s low interest rates crack retirees nest egg” Mark Whitehouse writes that the Fed is saving the U.S. economy on the backs of retirees. In “Whose economy is this?” The Economist comments further on the WSJ article that with the ageing American population about the “growing divide between the demands of the working and the non-working portions of the American population. The Fed’s task will grow ever more difficult as more Americans age into the latter group, and that is a matter of grave concern for those in the former, as Japan’s working-age population can certainly attest.”
Caroline Baum in Bloomberg’s “Don’t expect your paystub to signal inflation”writes that the Fed using core inflation measure (excluding food and energy) as the primary indicator of inflationary pressures, seems to get additional comfort from the fact that wages are showing little or no increases. But Baum says that prices lead wages rather than the other way around, and with 200,000 jobs created last month and commodities near a bubble state, the 0-0.25% Fed overnight rate may not be appropriate.
Martin Wolf in the Financial Times’ “Waiting for the great rebalancing” writes that “Pressures are building up for a rebalancing of the world economy. The private sector has long been trying to send a large net flow of capital from the world’s relatively sluggish rich countries to its dynamic emerging ones. But the governments of the latter have resisted, by intervening in currency markets and sending the capital back as official currency reserves. But forces now at work in the world economy seem likely to bring this recycling to a natural end. If so, that would be very helpful, though it would also create new challenges…(and) that the impact of these changes will include higher real interest rates, global rebalancing and higher real exchange rates in emerging countries… structural forces are also likely to generate the needed “great rebalancing”. But the road to adjustment has only just begun. Watch out: it is likely to be bumpy.” And in the related article “IMF reverses position on capital controls” the WSJ reports that “The International Monetary Fund, which for decades has been unwavering in its support of the free flow of capital, reversed itself and said developing countries can under some circumstances put up barriers to protect their economies… The IMF traditionally has advocated open markets for investment flows, as have banks, hedge funds and portfolio managers who want free movement of clients’ money. However, ultralow interest rates in developed countries and high rates of return in developing nations have helped drive huge volumes of capital into some emerging economies. IMF Managing Director Dominique Strauss-Kahn said the fund is taking a “very pragmatic” view of capital controls, the use of taxes, interest rates or other policy tools to curb flows of cash in and out of countries.” (A very slippery slope!)
In a scary, but very realistic WSJ article entitled “The inflation solution?” Holman Jenkins describes the “setting the stage for a potential inflation solution to the developed world’s vast debt overhang, both official debt and unfunded promises to future retirees. Think it can’t happen here? It can, especially when countries representing more than 60% of the world’s GDP, including Europe, Japan and the U.S, are seeking the same escape from unaffordable commitments. Central bankers like Weimar’s Havenstein or Peru’s Coronado or Zimbabwe’s Gono didn’t set out to become hyperinflationists. They made the best of a bad dilemma, financing the state through money printing rather than letting it collapse into anarchy.” And he concludes with “Have no fear that our decision-makers will impose both fiscal austerity and inflation on us when it becomes absolutely unavoidable. The momentous question is whether they will do anything productive in the meantime.”
In Vanity Fair’s Of the 1%, by the 1%, for the 1% Joseph Stiglitz writes that “it’s no use pretending that what has obviously happened has not in fact happened. The upper 1 percent of Americans are now taking in nearly a quarter of the nation’s income every year. In terms of wealth rather than income, the top 1 percent control 40 percent. Their lot in life has improved considerably. Twenty-five years ago, the corresponding figures were 12 percent and 33 percent…. While the top 1 percent have seen their incomes rise 18 percent over the past decade, those in the middle have actually seen their incomes fall… An economy in which most citizens are doing worse year after year—an economy like America’s—is not likely to do well over the long haul.” He then gives three reasons: (1) growing inequality is the flip side of shrinking opportunity, (2) “the distortions that lead to inequality (monopoly power and preferential tax treatment) undermine the efficiency of the economy”, and (3) “a modern economy requires “collective action”—it needs government to invest in infrastructure, education, and technology”. “The personal and the political are today in perfect alignment. Virtually all U.S. senators, and most of the representatives in the House, are members of the top 1 percent when they arrive, are kept in office by money from the top 1 percent, and know that if they serve the top 1 percent well they will be rewarded by the top 1 percent when they leave office.” Stiglitz concludes with “there is one thing that money doesn’t seem to have bought: an understanding that their fate is bound up with how the other 99 percent live. Throughout history, this is something that the top 1 percent eventually do learn. Too late.” (Interesting read.)
And finally, Jonathan Chevreau in“70 or bust! The Economist’s case for raising the retirement age to 70” discusses the Economist’s “70 or bust” article which says that aggressively raising retirement age to 70 is necessary and inevitable, and in “How to stay alive by avoiding Retirement” Chevreau discusses a new book by Keith Davies who says that “retirement is “the kiss of death,” “a fiscal fiasco in the making” and “disastrous in every other way””.