Hot Off the Web– June 15, 2010

Personal Finance and Investments

For an interesting read, see the article “How to think smarter about risk” in the WSJ by York U. professor Moshe Milevsky explaining human capital (the expected remaining earning potential of an individual; you can read more about it in my earlier blog Life-Cycle Investing). This article, an echo of his book “Are you a stock or a bond?”he describes the need to consider your asset allocation more holistically, by looking at the combination of your financial capital (stocks, bonds, etc) and human capital. He calls your ‘personal beta’ the extent to which your personal earning power is correlated with the overall market; i.e. to consider “if markets decline over a prolonged period of time, there is a greater chance you might lose your job, be unemployed for a long time, own worthless stock options and so on”. He goes “so far as to say that if your beta is unmistakably above one, you probably should have little to nothing invested in stocks during the first decade or two of your working life. You belong in bonds.” He reinforces the need to protect your human capital with life and disability insurance, but then he suggests that “people with higher betas don’t need as much insurance as people with lower betas. This is because the economic value of their human capital is lower, and there is less value to protect.” (Some might consider this heresy, after all the market related volatility of your current job doesn’t determine your remaining earning power.) Then he also discusses his view on the relative value of a liberal arts vs. a more technical education, which no doubt will derail some readers from receiving his otherwise important story about human capital.

Jonathan Chevreau discusses the pros and cons of debt in retirement, but the title of his Financial Post article suggests clearly that “Bills, seniors don’t mix”.

Michael Schmidt in the Globe and Mail’s “Investment policy pitfalls” discusses the importance of an Investment Policy Statement (IPS) as the blueprint or roadmap for your financial plan. He also covers the key elements of an IPS: objectives (musts and wants), horizon, goals, risk tolerance, ongoing operational issues (rebalancing, response to different market conditions) and importance of a customized IPS. “The IPS is an excellent way to come to a long-term agreement on how you or an asset manager will manage your portfolio.”

In the Globe and Mail’s “You can be too rich” Ted Rechtshaffen discusses the size of one’s estate, and whether a large(r) estate is necessarily better? He discusses the question of taxes (especially those resulting from a large tax-deferred account upon death), the timing of early gifting to children/grandchildren and/or charities. As an adviser, he suggests looking at size of clients’ estate as an important starting point because he wants to answer two questions: “Will I outlive my money?” and “Do I want to leave this much money at the end?” (He looks at this from a Canadian perspective, but similar, though not identical, considerations must be looked at for Americans.)

In the WSJ’s “Why you shouldn’t convert to a Roth IRA” Annie Gasparro looks at reasons why converting to a Roth IRA is not necessarily the right answer. Some reasons listed why not convert include: large upfront tax bite, too close to retirement (need 15-20 years of growth to recover front-end tax hit), likely change in tax bracket in retirement and tax rates in the future.

Real Estate

Tom Bradley in the Globe and Mail’s “The long and short of real estate investing” looks at why real estate investing is not for him (and perhaps not for you), beyond covering his (your) personal housing needs. Some of his observations are: “there are reasons why I don’t invest in real estate beyond my personal needs. For one, I have a day job, and this type of investing is time intensive. It also doesn’t help that transaction costs are extremely high (commissions, legal fees and taxes), and there are significant carrying costs (maintenance and more taxes)”, “House owners (in Canada) deploy a strategy that is at the core of hedge fund investing – buy long-term assets with short-term financing. The strategy dials up the investment’s return potential, both on the upside and downside. In the case of a house, if rates stay low and prices rise, it’s a beautiful thing. If financing costs rise and cause prices to fall, however, it’s not so good”, and “When I apply my investing skills and experience to the Canadian real estate market, I see a super cycle coming to an end. By plugging low interest rates into mortgage calculators, prices have been driven higher. But rents are coming down. After-tax incomes are likely to be under pressure in the post-stimulation era. And it doesn’t feel like the right time to be adding leverage to a portfolio.” (This is an interesting and well articulated perspective worth considering.)

An American perspective of Canada’s real estate/mortgage market in the WSJ is given in “Oh, Canada! What we could learn from your mortgage market”. James Haggerty reports on the differences between U.S. and Canada like: no tax deductibility of mortgage interest payments, higher down payment requirements and mortgage insurance, recourse to borrower’s other assets in case of default, and no 30 year fixed rate mortgages.

Now for some Florida real estate perspectives, first is Tom Bayles’s Herald Tribune article “In home market, a bit less distress” where he reports that Southwest Florida’s foreclosures, unlike the rest of the U.S., show a decline in the past three months. But not everyone agrees that this is a good sign; many think it is just “banks are letting delinquent borrowers stay longer in their homes rather than adding to the glut of foreclosed properties on the market.”

M.P. McQueen in WSJ’s “Trading down: Can it still bankroll your retirement?” reports on a new study that the real estate bust has affected mobility in general, but among seniors the most. The “narrower price gaps between the upper and middle markets”, the higher mortgage burdens due to “cash-out refinancings”, high transaction costs and returning/objecting adult children are all contributing to the fewer “trade-downs”

Non-homesteaded Florida property owners should not hold their breath for lower property taxes resulting from falling property values. Jennifer Sorentrue reports in the Palm Beach Post that the “Palm Beach County administrator wants 13.4 percent increase property tax rate”; the tax rate increase will soak up any decline in assessed property value. Hopefully, the resulting property tax increases of Florida’s homesteaders whose assessed property values will rise, and who are voters, will constrain the tax rate increases. That is how the system is supposed to work, but it’s unfortunate that we need a real estate market devastation to get this mechanism to work. It would be real nice, but I am not counting on it, if Florida would use this opportunity of the real estate devastation to equalize the discriminatory property tax system. But that would require vision and bold leadership, which so far hasn’t been visible. Who knows, perhaps the next Florida governor will do the right thing for Florida and the out of state property owners.

Mike Morgan adds context to the Florida situation in Barron’s “Florida’s new land of make-believe”explaining that “extend and pretend” is the term used in real estate circles to describe the current mode of operation. For example “as home prices continue to fall in most markets, builders continue to add inventory, and banks continue to juggle delinquent mortgage portfolios with smoke and mirrors. Loan modifications extending the life of the mortgage or reducing the principal may be the ultimate when it comes to “let’s play pretend.” Delaying foreclosures only magnifies the problem.” Also, that “At the end of 2009, 48% of residential mortgages in Florida were underwater, compared with 24% nationwide. Since the end of 2009, these numbers have continued to grow darker, as unemployment grips the nation. If that weren’t bitter enough, the Mortgage Bankers Association reports that 13.4% of Florida homeowners are in foreclosure, compared with 4.58% nationwide. That means more than one of every eight homes in Florida is in foreclosure. And it gets worse. With more than one of every seven not-in-foreclosure residential mortgages in Florida at least 60 days late, the foreclosure rate is sure to climb.” He concludes with the existence of some buying opportunities if you are looking for a home with some unusual attributes, otherwise he recommends renting. (Not surprised, especially for an out of state resident not planning to make his home in Florida, I would definitely suggest renting given the discriminatory tax system against non-residents.)


Federal and provincial finance ministers met and mostly agreed to work towards some minor tweaks to the Canada Pension Plan (CPP); nothing specific in size or time frame. The only important discernible result is the turnaround by Mr. Flaherty’s view about the state of Canada’s pension system from all is good to we have a problem. We’ll have to wait until the next ministers’ meeting in the fall to get a better view of what might actually be intended. The bottom line for current pensioners is that there is nothing contemplated for them at this time. Here are a video and a number of articles to give you an idea of what is considered and how it’s being viewed by different constituencies.

Watch CARP’s Susan Eng on Pensionsin a bruising (to interviewers) interview on BNN. (CARP is the Canadian version of AARP.) She responds to the aggressive questioning in a calm and logical manner to questions related to finance Minister Flaherty’s recent proposal to build a small increment on CPP. (CARP has been advocating a simple solution; build (not a small increment) on the CPP platform and just expand CPP contributions and benefits.) To whet your appetite she points out current pensioners will get no benefits from the proposal just tabled, but CARP and its members support it because pension reform is necessary for current retirees’ children and grandchildren. But she points out that Mr. Flaherty’s proposal is a 180 degree turnaround which clearly recognizes that pension reform is required, rather than the previous steadfast position that all well with Canada’s pension system.

The Edmonton Journal’s “Alberta wrong on pension issue”argues that Alberta (the only province beside Quebec which is not in CPP anyways) is opposed to small and gradual CPP improvements ostensibly because it would cause job losses, and infringement on Canadians’ financial liberty (because voluntary participation was rejected as too expensive(?)), But the Journal indicates that “most Albertans, if understandably wary of the creeping nanny state, understand the difference between government intrusion and government protection. “

Bill Curry in the Globe and Mail’s “Flaherty pushes for expanded CPP” reports that “Mr. Flaherty surprised many with a letter to his fellow finance ministers last week siding with “modest,” mandatory premium increases to fund higher benefits. He said Sunday that the feedback from Canadians was clearly in favour of some kind of CPP reform.” He also “also signalled his support for efforts to encourage the private sector to create large pension funds that could be used by small businesses and the self-employed”. The Canadian Federation of Independent Business called the mandatory part of the proposal “very disturbing” and just another “payroll tax”. The proposal wasn’t clear whether there would be increased premiums to provide a higher percent of coverage up the current maximum of $47,200, or to increase the maximum income covered to a higher level. Keith Ambachtsheer (rightly) is quoted as indicating that the latter option is preferable “because it targets middle-income Canadians who aren’t saving enough and avoids placing too high a burden on workers with low incomes.”

Adrian MacNair in the National Post’s “Flaherty’s pension plan is a tax increase on workers” says that “Something about the idea of forcing people to make larger contributions to Canada Pension Plan is almost beyond collectivist, into the territory of organized crime”, and that “The worst part of it all is that the Finance Minister is resisting any idea of a voluntary plan that would allow workers to opt in or out of an elective add-on that would compete with private mutual funds.”  Similarly, the National Post opinion piece “CPP: a bad investment” excoriates the proposed CPP increase for because it is contrary to Tory principles of “market-based solution” with questionable data and arguments. There are many things wrong with proposal, but none are addressed in this unsigned opinion piece. But don’t worry no action appears imminent as no schedule has been tabled, though results of some more detailed work will be reported at a fall federal-provincial meeting. (More study and still no action, but at least there is now general agreement that Canada’s pension system (renamed retirement income system) needs work…i.e. it is broken after all, contrary to even very recent denials.)

There is no question that the pension reform campaign waged by tens of thousands was effective. It confirms that we have a serious problem with Canada’s pension system. Unfortunately he chose the path of least resistance and lowest implementation risk and lowest payoff to Canadians. A small(?) increase to CPP. Depending on how small, it might be called tinkering at best or perhaps rearranging the deck chairs on the Titanic at worst. The Conservatives no doubt hope that this will allow them to claim that they solved the pension problem, but it may actually backfire. Many Canadians will consider this just another tax increase, others may see through this as just window dressing and not really solving the problem, especially if the increase will be small. But most importantly, it still leaves the field wide open for the opposition parties to still address the real pension problem. Of course what has been described so far is not only a small adjustment, but there is no mention of fixing the problems of the people whose DC plan is systematically eaten away but high fees, or whose DB plans have been or are at risk of being significantly reduced because the plan sponsor declared bankruptcy with an underfunded plan. And finally, this will provide little if any help for those already retired or are the front half of the wave of baby boomers, unless there will be significant intergenerational transfers (which would be intolerable).

A couple of other pension stories, first a U.S. pension story by Jeannette Neumann in WSJ’s “Pension cuts face test in Colorado, Minnesota” reports on a couple of the U.S. states’ attempt to prevent eventual bankruptcy of their pension plans by reducing the 3.5% fixed cost of living adjustment to a maximum of 2% in the future. “Seeking to dismiss the case, the defendants, which include the Colorado pension fund, contend that “to claim that a cost-of-living adjustment can never be adjusted defies law and logic.” The defendants also highlight the exigencies of financial stress: “There can be no dispute that preserving the solvency of the Public Employees’ Retirement Association is a legitimate governmental interest.”” The matter will be decided by the courts.

The other is Jane Taber’s report that MP’s gold plated pensionsare not even on Flaherty’s radar for review, who quotes Canadian Taxpayers Federation saying that “After six years an MP is entitled to a pension – the smallest amount for which is twice the maximum of CPP, for which one must work their whole life! MP pension reform is badly needed so they can lead by example”. Sounds like this type of pension would be good enough for all Canadians.

Things to Ponder

In the Financial Times’ “Long-term performance of commodities not improving” Peter Tasker argues “Commodities have not even done their job as risk reducers. During the credit crisis the commodities indices mimicked the gyrations of other risky assets, with the correlation to stock markets of individual commodities such as copper and oil rising to new highs.” “The complicated answer is that commodities don’t deserve to generate any return. As the name suggests, they are undifferentiated lumps of naturally occurring materials. Value needs to be added to them by the application of knowledge; it is investment in that process of application that earns the return…As societies become more sophisticated, knowledge generates ever greater returns. By contrast, societies in which commodities are highly valued are by definition primitive.”

The Globe and Mail’s Michael Babad in “George Soros sees fall of financial system ‘as we know it’” reports that Soros predicts Act II of the financial crisis and ““The collapse of the financial system as we know it is real, and the crisis is far from over””. Similarly in Barbara Stcherbatcheff’s CNBC piece “Financial crisis has “only entered Act II”: Soros” he is quoted as saying “We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us budget deficits are essential for counter-cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double-dip.” and Financial News’ Mike Foster in “Time to spy on hedgies, says Soros”quotes him on derivatives as saying that “regulators cannot ignore them because if too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or a collapse. They have to monitor the positions of participants in order to detect potential imbalances. That means that all the positions of all major market participants including hedge funds and sovereign wealth funds need to be monitored.”

In Fortunes “Even Bernanke can’t overlook deficit crisis” Colin Barr reports that “The problem isn’t just that the United States is on track to run a budget deficit worth a tenth of its economic output this year, or that the gap will close only gradually in coming years. The bigger issue, Bernanke notes, is that the workforce isn’t growing nearly fast enough to pay for all the people who stand to retire over the next two decades. This isn’t a problem that can be dealt with via tax reform or federal spending cuts alone — not that those are exactly coming fast and furious as it is. There are currently five workers for every retiree in the country, Bernanke said. That stands to shrink to three workers by 2030 — at a time when “expenditures on health care for both retirees and non-retirees have continued to rise rapidly as increases in the costs of care have exceeded increases in incomes.” That’s not a workable formula…”

The answer to the question in the Globe and Mail’s “Why Jeff Rubin still sees triple-digit oil prices in 2011” is that his prediction is still intact and in fact it’s aggravated by the BP oil disaster. His only caveat is if we go back into recession that would drive oil prices back to $40 per barrel

The WSJ’s Kelly Evans in “Deflation is worrisome but not certain” reports that some see the low yields signalling impending doom, indicating that “investors are overwhelmingly risk averse and increasingly concerned about deflation”  and that “we are one recession away from deflation”. Martin Wolf is on the same page in his Financial Times article “Fear must not blind us to deflation’s dangers” where  he argues that “Premature fiscal tightening is, warns experience, as big a danger as delayed tightening would be. There are no certainties here. The world economy – or at least that of the advanced countries – remains disturbingly fragile. Only those who believe the economy is a morality play, in which those they deem wicked should suffer punishment, would enjoy that painful result.” And just to add another nail to the coffin, the WSJ’s Zeng and Gongloff in “Bond giant Pimco buys Treasuries in recent weeks”report that after “months of deriding U.S. Treasury bonds” Pimco capitulated and started buying Treasurys and shifted their “stance to neutral from underweight”. So they have at least deferred their previous fears of inflation and interest rate increases.

And Jonathan Ratner in the Financial Post reports that “Double-dip recession ‘practically inevitable’: UBS”because “UBS says it is entirely clear that the current recovery is based on the artificial distortion of the natural or originary interest rate, which is preventing “the liquidation of past malinvestments and which is inevitably causing new intertemporal dis-coordination and a further weakening of the economy’s wealth-generating forces.”” “Economic growth may well be quite solid in 2010 and 2011. Politicians and central bankers can delay the bust with ever more interventionary policies. But what they cannot do, is prevent it from happening altogether.”

On those cheery notes, the stock market kept advancing for the last few days. Not everyone (the doomsayers and those piling into the stock market) can be right at the same time.

And finally, Steven Rattner (President Obama’s arecent uto restructuring chief) in WSJ’s “Wall Street doesn’t get it” suggests that Wall Street is making a big mistake: “by conveying little sympathy for the many suffering Americans and brushing off responsibility for the excesses of the last bubble, Wall Street has managed to exacerbate the public anger, which in turn has been quickly transmitted to our elected officials in Washington. Chief executives can preach all they want about the need for courageous political leadership but the cold, hard reality is that no elected official—not even the president—could survive full-throated resistance to the current tsunami of populism.”  He argues that America’s income inequality (“30,000 Americans should not command a full 6% of income in this country (a higher percentage than at even the end of the Roaring ’20s)”) is unsustainable, especially given that “income of the average American worker (after adjustment for inflation) was lower in 2008 (let alone 2009) than it was in 1999.”


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