Hot Off the Web– May 16, 2011

Personal Finance and Investments

Read my summary of Wade Pfau’s very interesting paper in the Journal of Financial Planning entitled “Safe savings rates: A new approach to retirement planning over the lifecycle” (it might even encourage you to read the paper in its entirety). Pfau extends Bengen’s landmark work (where he suggests an indexed 4% safe withdrawal strategy-SAFEMAX) to cover not just a 30 year decumulation, but a complete 60 year accumulation/decumulation cycle. His contribution is that he identifies a “safe savings rate” –SAFEMIN- of 16.6%/yr is needed over 30 years of accumulation, to generate an inflation adjusted 50% final salary replacement rate. He also drives home the effect of market valuations at retirement, and the corrosive effects of fees on retirement income, in addition to effect of asset allocation and accumulation/decumulation intervals.

Anne Tergesen in WSJ’s “Nest egg: Break here”looks at some decumulation strategies that might be available to retiring individuals. But also included in the article is an interesting chart showing what in the U.S. “the typical household headed by an individual age 55-64 has to work with” heading to retirement. Total assets are estimated at $676,000 composed of : 44.2% Social Security, 20.5% primary house, 18% defined-benefit pension, 7.5% 401(k)/IRA and 9.8% other (financial, business and other). (You might wish to note that the primary house value might not even be sellable at that price if a lot of the boomers would actually try to sell, and defined benefit pension are increasingly primarily available to public sector employees. As to Canadians, the equivalent house dollar value might be higher but the CPP/OAS would correspondingly be much lower, so net net the total and the other components might not be that different than in the U.S.; as to the downside risk to housing, in Canada the risk is much higher-see the real estate section of today’s blog.)

Mark Shoeff Jr. writes in InvestmentNews’ “Will new pressures on Dodd-Frank influence the fiduciary standard?” that Republican “lawmakers….(are) questioning whether its recommendation for a universal fiduciary duty for retail investment advice was supported by rigorous economic analysis.” The SEC is under pressure to “balance the desire of advocates, who want broker-dealers to meet the investment adviser standard, with the worries of fiduciary opponents, who argue that a universal standard could raise regulatory costs for brokers and undermine their business model.” Ron Lieber in the NYT’s “Why 401(k)’s should offer index funds”states that “The people who help you with your investments ought to act in your best interest. This shouldn’t be a controversial statement. Yet it passes for one in Washington, where regulators and legislators are still mired in a never-ending debate over whether stockbrokers, certain insurance salespeople and others ought to meet that standard, known in legal circles as a fiduciary duty.” (The financial industry rightly sees itself in a fight for the survival of its current business model. The industry is being squeezed in the growing shift by investors from expensive mutual funds to an order of magnitude lower cost ETFs. At the same time there is the push to require a fiduciary level of responsibility at least by those providing financial/insurance advice to retail investors, in order to overcome the existing lopsided relationship due to the asymmetric information between advisor and investor.) (Recommended by CFA Institute NewsBrief)

In the Financial Post’s “If it keeps you awake at night, it’s too risky”Adrian Mastracci shares his thoughts on incorporating risk considerations into investment strategies. He points to the three major factors influencing the approach: ability to bear risk, willingness to bear risk and the risk level needed to be borne to achieve required return.

In the WSJ’s “Is it time to buy an annuity?” Tergesen and Scism explore annuities for those who want to “restore some financial security” that their lost with the disappearance of DB pensions. You can view U.S. quotes at (For sample Canadian Annuity quotes go to Canadian Annuities– thanks to InvestorsFriend for the link. Note that joint annuity payouts for a 65 year old couple are about 10% lower in Canada (6%) than the US (6.6%) despite comparable interest rates e.g. 10-year Treasury notes in the two countries; that’s the benefit of being in a more competitive US environment). They warn though of some risks like: currently low annuity payouts due low interest rate environment (of course they could also go lower), inflation risk (suggest delaying annuitization, laddering/staggering or some type of inflation rider at an even lower payout), insurance company risk (use only AAA or AA rated companies, split up annuity among different insurers), high cost for given level of lifetime payout (use deferred-income annuity or “longevity insurance” instead of immediate annuity). (You might also be interested in reading my blogs Annuity I, Annuity II, Annuity III, Annuity IV)

Real Estate

In WSJ’s “Home market takes a tumble” Timiraos and Wotapka report that the first quarter’s 3% decline in U.S. home values is the “largest decline since 2008…Prices have now fallen for 57 consecutive months, according to Zillow.” This is happening despite low mortgage rates which lead to better affordability, yet weakness in employment and tightening mortgage credit standards coupled with continuing high foreclosure rates, are pushing home prices lower. Some experts predict a 7-9% drop in the next year. “While some analysts have argued that home prices need to fall to “clearing prices” that will attract more buyers, price declines could also complicate any recovery by pushing more borrowers under water. Zillow estimates that more than 28% of borrowers owe more than their homes are worth nationally. Those numbers are much higher in hard-hit markets such as Phoenix, where more than two-thirds (!!!) of borrowers owe more than their homes are worth.”

The story on Florida house market is mixed, prices are down but volume is up. According to the Herald Tribune’s “Southwest Florida home sales up 11% from 2010”, “Florida saw 44,531 homes change hands, up 13 percent from a year ago and up 13.2 percent from the fourth quarter. The median sales price was $123,600, a drop of 6 percent from a year ago and a decline of 7.8 percent from the fourth quarter…Only Fort Myers-Cape Coral and Fort Pierce-Port St. Lucie — two communities hard hit by the foreclosure crisis — saw sales drop. Likewise, those two markets were the only ones to see prices appreciate. Each posted a 4 percent rise in the median sales price in the year-over-year comparison.” Condo sales were up 29% while prices were down 16% from year ago. According to Palm Beach Post’s “2588 single-family homes sold in Palm Beach County”, “Sales of existing single-family homes in Palm Beach County surged 33 percent during the first quarter of 2011 compared to the same time last year, but median home prices continued to slip…the median price for a single-family home in Palm Beach County during the first three months of the year was $193,800, an 18 percent slide from the first quarter of 2010.” (Sounds like the necessary inventory clearance is in progress.)

The Canadian story is covered by Garry Marr in the Financial Post’s “Strong housing forecast for Canada: report”as he reports that unlike the U.S. forecast by Zillow, CREA’s forecast for Canada is all rosy. However, some experts warn that “All things come to an end. At some point, the U.S. market has to bottom. Prices cannot fall forever,” Mr. Guatieri said. “Canadian house prices also cannot continue to rise, at least in some regions, faster than incomes forever.” The article contains a couple graphs covering the past decade of house prices: in the U.S.  the decade started at about $135K peaking in 2006 at $240K and it’s now at $170K; in Canada it started at $155K and it been steadily heading up to today’s $360K. (That’s correct; the average Canadian house price is now twice its American counterpart.)


Another indication that Canada’s pensions are in systemic failure; in the Globe and Mail’s “Pension membership takes a heavy hit in the private sector” Janet McFarland writes that “For the first time, the majority of Canadians who have workplace pension plans are government employees…as the baby boom generation nears retirement…50.2 per cent, or 3.03 million people – of the country’s pensioned workers are in jobs in the civil service or at government-funded institutions such as universities and hospitals.”

The respected Canadian pension legal expert Murray Gold has tabled a thorough and scrupulously accurate description of the systemic crisis that Canada’s pension system is in, especially as it impacts middle income Canadians in his (pre-election) paper entitled  “Pension reform current issues-April 2011”. It is a must read for those interested in the Canadian pension landscape. The author also discussed the positions of the various political parties going into the election. (A couple of comments which I would like to add are that: (1) the CPP is not low cost, even though it is cheaper than typical mutual funds used by Canadians in RRSPs, but is expensive when compared to large scale U.S. 401 (k) plans; the CPP might turn out to be low cost if used on an incremental basis, managing additional funds which do not attract increased administrative costs (see my just posted blog “Is the CPP low cost?”), and (2) Mr. Gold missed opportunity to comment and influence the current debate on increasing the priority of DB pension plan underfunding in case of employer/sponsor going into bankruptcy protection (at least priority above other unsecured creditors) by changing in BIA/CCAA laws; this is unfortunate especially in light of last month’s Indalex decision declaring DB pension plans as “deemed trusts”.)

Things to Ponder

In my last week’s blog I mentioned European regulators’ concerns about some new ETFs drifting into derivatives, swaps, structured products, leverage and other exotic constructs which now make up about 45% of the European market. This week, mutual fund manager Tom Bradley in the Globe and Mail’s “Cracks appear in the ETF halo” writes that he gets “pretty steamed up about the lack of scrutiny ETFs get….(and) fee are edging up (there are even performance bonuses in a few cases), complexity is emerging as a real risk and performance often lags behind the target indexes. He then replays some of the recently voiced concerns by the European FSB (derivatives, opacity, complexity, swap counterparty risk) about “illiquidity, counterparty risk, poor disclosure and misaligned incentives”.  I received another article from a reader (VP) this week on the same subject entitled “Man vs. machine: The ETF monster” and I didn’t see new revelations in there about heightened risks of ETF vs. similar mutual funds. Broad index based “plain vanilla” ETFs should have little more risk than the collection of underlying stocks that they are composed of and implemented with. An exception to this is intraday trading issues (e.g. stop-loss orders) which don’t exist with mutual funds and were discussed in previous articles after the flash crash last year (e.g. Eleanor Laise in the WSJ’s “Danger: Falling ETFs”). Coincidentally, Pauline Skypala also weighs in on the debate in her Financial Times article “Scrutinize ETFs but don’t limit choice” writes that ETFs are” the new bogeymen on the block” due to increasing complexity and synthetic implementation (e.g. swap based implementations). Skypala says that if ETFs are to be divided into complex and non-complex categories with different (more restrictive) handling instructions for complex ones, then same must be done for mutual funds. (Risks are everywhere (as I found out that even my DB pension was not safe (even though financial advisors used to suggest that your DB pension can be considered part of your fixed income allocation). But the broad index “plain vanilla” ETFs are no riskier than mutual funds investing in the same asset class. While not all ETFs are created equal, they do have one thing in common, they are a rapidly growing threat to the mutual fund industry’s gravy train. You can expect to see growing hysteria from mutual fund managers who are trying to protect their turf.) You might also be interested in my earlier blog on ETF risks entitled ETF Concerns: There are risks, but thanks I’ll stay with ETFs for my money in which I discuss how, used as originally intended, passive index based ETFs on broad/diversified asset classes, with low-cost, high liquidity, and limiting trading with appropriate order types, ETFs are still my preferred portfolio implementation.)

And speaking of Tom Bradley, he has book entitled “It’s not rocket science- Plain English advice for managing your investments” available for free online which you might enjoy reading. It is a collection blogs and articles written by Bradley over the past years. (Thanks to Ken Kivenko of Canadian Fund Watch for recommending it.)

Despite the title of this Financial Times article “A good time to snap up healthcare and tech stocks” might suggest, this is an article about behavioural finance. Bill Miller describes Daniel Kahneman’s look at how the subconscious affects human behaviour. “He said that while we live in a conscious world, much of our behaviour is automatic and driven by the subconscious. Psychologists call the subconscious System 1 and conscious behaviour System 2. System 1 is more or less automatic and System 2 involves attention, time, logic and analysis. The work he described has implications for how markets function. If one is a contrarian value investor, one’s portfolio is a function of System 2. The time horizon is years. The market, though, is a real-time information processing mechanism and is almost entirely governed by System 1: a piece of news comes out and the market reacts almost instantaneously.”

John Dizard in the Financial Times’ “Reasons not to fondle your gold” writes that “gold is “real” money… Real money, un-invested in any enterprise or security, does not earn any return.” But, “If “real” rates on bonds, or equities, are high, holders of money have more incentive to use their cash to buy assets… When real returns are high, the fiat-currency price of gold will stagnate or decline. When real returns have been low or stagnant, as they have been during the past decade, the gold price has been strong… Cheap money, expensive gold; expensive money, cheap gold…(so given the actions of the Fed and this administration)… this gold (and silver) price correction will be followed by a resumption of the secular bull market.“

And finally, commenting on a Jonathan Chevreau article that I mentioned in last week’s blog in which he recommended that to double your retirement income (in context of the CPP) you should retire at 70 instead of 60, I got a note from a reader (NA) suggesting that if data that he has seen is correct then working longer is usually associated with dying younger. I’ve been searching for some references showing any relationship between longevity and retirement age, but I was only able to find the good old Boeing example which is mentioned in “Optimum strategies for creativity and longevity” where Sing Lin quotes data based on which he concludes that working 10 years beyond age 55 one shortens average lifespan by 20 years. Then I found “Is retirement good for you?”which refers to a Shell study concluding the opposite. (Perhaps people retire or keep working for different reasons that that may be totally unrelated to their longevity. People might retire because: they can (have the necessary resources/pensions) or they have to (failing health, were fired and can’t get a job, etc) or they hate their job; similarly people keep working because: they have to (don’t have resources/pensions allowing them to stop work) or they love their work (they self-actualize) and they can continue to work (they are healthy and there is demand for their skills). Of course just because one study appears to show strong correlation, does not necessarily mean that there is causality. Still, even if early retirement is not necessarily correlated with increasing longevity, many are starting to argue, that increasing longevity should be accompanied by later retirement (from a societal affordability perspective). If any of you have seen scientifically derived data showing correlation between longevity and retirement age, showing causal or non-causal relations, I would appreciate seeing it.)

And really finally, I must also mention that in my less than successful search for scientifically based references showing correlation between retirement age and longevity, I came across a TED video entitled “Dan Buettner: How to live to be 100+”. In this 20 minute video Buettner suggested that genetic makeup might contribute less than 10% to average longevity (90% is lifestyle related), and that the two most dangerous times in one’s life are birth and retirement (the latter related to purpose). Buettner also concludes that the study of common threads among a number of communities which had unusually long longevities identified 9 common factors: (1) moving naturally (not exercise, but physical activity embedded in the way of life), (2,3) right outlook (downshift to decompress, and having purpose), (4,5,6) eating wisely (a little wine, a plant slant, 80% rule- i.e. never eat until full), and (7,8,9) connecting (loved ones first, belonging to faith-based community, right tribe-i.e. surround themselves with the right people). (If we lived according to these common threads, we may have to really sharpen our pencils for our financial planning to insure that we don’t run out of assets.)

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