Hot Off the Web– November 15, 2010

Personal Finance and Investments

In the Globe and Mail’s “Families come out ahead when they share tax liability” Tim Cestnick continues his previous week’s article with more ways to income split, such as: (1) gift of cash or securities (equivalent to disposition) to adult family members (other than spouse), (2) having “higher income spouse pay expenses” (lower income spouse invests), (3) equal value asset swap with spouse (income against non-income producing), (4) testamentary trust in the will, and other less esoteric items like split pension, spousal RRSP, etc.

In the Globe and Mail’s “Welcome to fund house” John Heinzl explains the difference mutual funds, ETFs, segregated funds, closed-end funds and hedge funds. (This is just that you should know, not that you should consider seriously consider them. You can do just about everything you need to with ETFs, GICs/CDs/Bonds and cash.)

In the NYT’s “When a safety net is yanked away” Ron Lieber reports that MetLife “would stop underwriting Long-term care policies for individuals” and “asked state insurance regulators for permission to raise premiums on many (existing) policies by as much as 44 percent.” Genworth and John Hancock were also seeking massive premium increases on LTCI policies; New York Life (a mutual rather than a shareholder owned company) has never asked for a rate increase. A policyholder asks (a little late) “Would you buy insurance that you may not use for 20 years and will cost you three or four thousand dollars a year, and by the way, at any time, we’re going to increase it 40 percent?” “Insurance is supposed to be for unexpected things that would cause catastrophic losses. But… you may end up paying more than you expected for decades on end for a policy that covers only part of your bills. (If you are interested in the topic you can also peruse a couple of my blogs on the subject LTCI-I Long-Term Care Insurance- An Overview and LTCI-II: A Quantitative View)

Jonathan Chevreau in the Financial Post’s “A TFSA by any other name”discusses the TFSA’s including Evelyn Jack’s observation that starting a TFSA at age 20 with 5% returns would result $838,426 by age 65 tax free, also Gordon Pape’s comment that an aggressive investor (15%/year) could end up with $5M, and of course that you can put $5,000/year into your TFSA even if you have no employment income.

In the Financial Times, Pauline Skypala looks at “Behavioural nudge needed for retirement”(analogous to approaches used to induce people to save for retirement like auto-enrol defaults and save-more-tomorrow commitments). The objective is to induce people to spend “optimally in retirement, e.g. not to over-spend early and run out of money if they end up living longer than expected. Some of the elements mentioned by Skypala are: (1) secure amount needed for basic expenses perhaps by an inflation-linked annuity and other annuity-like income, (2) use insurance or reserves to meet “spikes in spending”, (3)  buy more annuities (if you can afford it) to secure not just basic expenses but also the nice to have things in retirement. (This based on an article by Boardman and Blake on Spending Optimally, which clearly suggests that annuitization is the answer to all retirement income problems…perhaps partly true if you have no desire to leave an estate and it you are prepared to hand over your assets to an insurance company for a 30-40 year promise of an income. The author, an actuary, worked 35 years (most recently on annuities) for Prudential which was also the sponsor of this talk….sounds a little bit like an advertorial. Annuities have their place but, for most people, are not the first place I’d look for retirement income source.)

Rob Carrick in the Globe and Mail’s “The mysterious world of RESPs revealed” looks at some of the complexities of Registered Educational Savings Accounts (RESPs) by referring to moneysmartsblog.com.  Some of the points he makes relate to: withdrawals (contributions can be withdrawn without tax or restrictions, however gains and government contributions are taxed in the students hands and must be used for education), funds usable not just to college/university but also trade school and foreign educational institutions), penalties if not used for education are not prohibitive (gains may even be transferred to your RRSP), and others.

In the Globe and Mail’s “Investing for the long, long term”Martin Mittelstadt discusses the new 50-100 year bonds recently issued in the 6% range by Goldman Sachs, Mexico and others; and “yield hungry investors just snapped them up”. Many are rightfully concerned about these bonds, especially as they’ve been targeted to ‘ma and pa investors”; for example (if yields go down) Goldman has the right to redeem the bonds in 2015 and (if yield go up) the investors are stuck with them for another 45 years before they can get their principal back (if Goldman is still around and the dollars they get are still worth anything.)

Real Estate

In Agenda with Steve Paikin “The case against home ownership” there is an interesting discussion with Shiller, Soper, Florida and Saber primarily in the context of the Canadian real estate market as to the relative merits of owning vs. renting. The highlights of the discussion include:  long term real estate returns are lower than equities, ownership restricts labour mobility, 70% recent/current ownership level is at an all time high, affordability is becoming a serious issue as measured by home price to income ratio as well the percent of income spent on housing often at 40-60%, Canada may be in a bubble given that appreciation was comparable to U.S. but correction was not, ownership means you are janitor and real estate speculator (leverage), massive housing investment is a misallocation of a nation’s resources so why encourage it,…Arguments for ownership were limited to arguments like: forced savings, psychological (pride of ownership, home is my castle) (The program is about 45 minutes long, thanks to Rob Carrick’s Personal Finance Reader for recommending it.)

Pensions

In the Financial Post’s “Pension shortfall bigger by $65B” Paul Vieira writes that according to a C.D. Howe Institute report “Ottawa’s pension obligations to bureaucrats, soldiers and Mounties are $65-billion higher than the presently estimated unfunded liability of $142.8-billion…The gap is the result of the federal government’s reluctance to use accounting methods private-sector firms are obliged to employ in determining pension solvency, said William Robson, president of the Toronto non-partisan group.” The problem is a common one, and relates to using inappropriately high discount rates for liabilities in order to reduce required contribution. (And we know how well founded private pension plans are?!? J)

Tom Stable in the Financial Times’ “Golden chance to do right by retirees” discusses U.S. regulators raising warnings that “the financial services industry must protect senior citizen investors” and the importance of such action given baby boomers growing reliance on personally managed accounts due to reduced access to pensions. “…many products hatched in this setting – such as variable annuities or target date funds – may be more profitable for firms than they are beneficial to older investors…” (It’s questionable that industry self-regulatory bodies are capable of doing the necessary job to protect investors; in fact  current constructs of government run regulatory bodies have also proven essentially ineffective in protecting investors, e.g. the pathetic performance in the US by SEC-Madoff or in Ontario by FSCO on pensions).

Another related story in the Financial Times’ “A direct line to investment products”where Pauline Skypala asks: “Why is it that asset management is one of the only areas where the addition of the internet has increased intermediation rather than taken middlemen out? Fund managers have not embraced the internet as a means of going direct to their customers.” (Major rethink of the financial services industry is required to turn it into a more investor friendly contributor to the economy.)

The November 12, 2010 “issue of CARPAction Online is devoted primarily to the Private Members’ Bills that are particularly relevant to CARP members and older Canadians”. You can read about C-501(BIA changes to gives priority in bankruptcy to pension plan underfunding), C-478 (on retroactive CPP benefits), and others.

Things to Ponder

Jason Zweig in the WSJ’s “Are ETFs a menace- or just misunderstood”discusses a recent report on ETFs “which argues that ETFs are radically changing the markets, raising the prospect of a panic-driven market meltdown”. But critics called the report “riddled with untruths”. The report raises three concerns. “First, these funds have overconcentrated the ownership of thinly traded stocks. Second, they have led to an escalating number of trading failures. Third, ETFs could trigger another massive market swing like the May 6 “flash crash.” After some discussion Zweig concludes that investors don’t “need to fear that ETFs pose a “systemic risk”” as suggested by the report, but he does think that “these funds still need to do a better job of explaining exactly how they work”.

Justin Lahart in the WSJ’s “A way, day by day, of gauging prices” reports on an interesting new “method to scour the Internet for online prices on millions of items and then use them to calculate inflation statistics for a dozen countries” instead of having government “workers visit or call thousands of stores and other establishments to collect prices”. The method may provide indications where government inflation figures are being massaged to reduce inflation related payments, interest on inflation indexed bonds or social security payments, to its citizens. And on a related topic in the WSJ’s “Is Sarah Palin right about inflation?” WSJ’s Brett Arends discusses how steeply rising commodity prices (cotton, wheat and other agri-products, coffee, lumber, cattle…) are increasing costs which ultimately will passed onto to consumers in the form of higher prices or result in lower corporate profits (and lower equity prices). Increased consumer prices, unless costs pressures reverse, can be expected to “show up in stores by early next year”. You might also be interested in reading “The deflation myth”.

In the Lethbridge Herald’s “Author warns of fraud schemes” Gerald Gauthier reports on highlights of well known Canadian forensic accountant’s new book “Swindlers” and his related speaking tour. Rosen warns that “You are on your own as an investor because the securities commissions and the auditors and the self-regulating organizations are not doing what people think they do…”. “The U.S. Securities Exchange Commission has “tons more” legal teeth than Canadian securities regulators to protect investors…The scams and so on that we see in our forensic practice, three-quarters of those you could not get away with in the U.S. That’s how loose and slack Canada is…” And to make things even worse, in 2011 “Canada is scheduled to begin adopting a new International Financial Reporting Standards (IFRS) for corporations to follow when filing official financial numbers. The U.S. has said that (the IFRS) is a race to the bottom, and they’re not interested in it, whereas Canada foolishly adopted this stuff.” (Thanks to Larry Elford for the article…I already had a very positive report from WET who attended Al Rosen’s Toronto presentation.)

Much ink has been spilled the past week about GE2, exchange-rate mispricing, competitive devaluation, debasement of currencies in general and the U.S. dollar in particular, and gold and its potential role in some new reserve currency for the world.

In WSJ’s ”The man who called the financial crisis 70 years early”Jason Zweig reports on economist Palyi in the 30s warnings against: “push toward universal home ownership would “make the population fixed to the ground” by “overburdening them with housing costs.””, “”quantitative easing,” characterizing it as “a sort of Santa Claus to the economic system” that can lead to “runaway inflation”” and “sooner or later, too much credit always turns into a giant debit as borrowers crumple under the burden of escalating interest payments.”

World Bank President Zoellick, in an expression of concern about the apparent massive printing of U.S. dollars by the Fed, suggested that “The system should also consider employing gold as an international reference point of market expectations about inflation, deflation and future currency values” in “Zoellick seeks gold standard debate”; others are calling it inappropriate in “Zoellick’s call on gold standard dismissed” and “The gold standard” . There are concerns about exit strategies from the current low interest environment discussed in “Flaw in Fed’s ideological repositioning on asset prices” and what might be the only remaining credible investment options (30 year U.S. Treasuries and some Euro denominated assets) in David Rosenberg’s “In a QE2 world, only a handful of investments hold appeal” (Sound like pretty risky bets except at the margins as insurance.) Competitive devaluations to drive exports are discussed in “Fed global backlash grows” while the Economist’s Buttonwood in “Monopoly money” expresses concerns about  a debtor nation like the U.S. printing money to repay debts since it can do so easily as the dollar is a reserve currency and concludes that “the currency set-up is unsustainable and QE only adds to that sentiment. Can the world’s largest economy and debtor nation follow a consistent policy of devaluation, and thus penalizing its creditors?” A more in-depth analysis is given in the Economist’s “Beyond Bretton Woods 2”which looks at available options to evolve the monetary system.

Other voices on dollar valuation ask if “It’s time for some trend reversals” on the dollar at least in the short-term, or perhaps even in the long-term as in the Financial Times’ “Undervalued dollar is a rare opportunity” where Dhaval Joshi argues that “deflation retains the upper hand over inflation” given that the Fed only inflated by $2.4T whereas the normal housing stock to mortgage debt relationship deflated money supply by $3.5T. The result being an undervalued dollar “which could be a once-in-a-generation opportunity for long-term investors”

In Bloomberg’s “Sex tops salary in quest to lift taboos” Matthew Lynn says that despite no more embarrassment associated with discussing “death, disease, and depression” or even sex, however money (how much they earn and how much they have) remains taboo. Yet, the author argues, everyone would benefit from such openness by: being in better position to negotiate superior compensation, feeling “less insecure about what we are making”, and “would make us more financially responsible”.

And finally, in the Financial Post’s “Let’s put seniors in jail, and criminals in nursing homes”, Jonathan Chevreau writes about a joke making the email rounds, and of course most jokes usually have an element of truth. The joke essentially suggests that given the far superior level of care (at the public expense) in jails as compared to nursing homes, some desperate seniors might consider engaging in some “victimless crime”.