Hot Off the Web– January 17, 2011

Personal Finance and Investments

In the Financial Post’s “Is TFSA or RRSP right for you?” Jonathan Chevreau discusses the differences between TFSA and RRSP and points out that “there are at least two cases where TFSA is preferable to an RRSP. One is low-income seniors hoping to collect Old Age Security and the Guaranteed Income Supplement… (and the other)…people just starting their careers who may be in lower tax brackets.” (you can also read in-depth blog of mine on the subject at TFSA or RRSP? 401(k) or Roth 401 (k)?- it essentially says that if you believe that your tax rate will be lower in retirement (when withdrawing) than today (when you are contributing funds to your retirement plan) then first do RRSP/401(k), otherwise first use TFSA/Roth IRA, but since nobody really knows for sure what the future tax rates will be a little tax diversification might also be prudent.)

Dan Hallett in the Globe and Mail’s “How to test whether cash payouts will still be there tomorrow”reminds readers that “many of these popular monthly income funds pay out more than is likely to be sustainable over the long term. If you spend your cash distributions, pay attention as I illustrate a four-step process for testing distribution sustainability.” He also looks at how you can test the sustainability of current distributions by calculating the required returns from the stock holdings in the fund to insure that fund distributions won’t significantly be return of capital, especially if you’re spending all of the monthly ‘income’.

Jason Zweig in WSJ’s “Why regulators can’t keep ‘safe’ bond funds from sinking” discusses how falling interest rates have led to investors “hankering” for more income. “The fund industry has happily obliged, manufacturing one cruddy new type of bond fund after another. They all relied on complex strategies to promise higher returns at “only” slightly higher risk….(however Zweig warns readers)… If you want to protect your money, be your own lifeguard. Anytime anyone promises you a higher yield at only slightly higher risk, put your hand on your wallet and quickly, carefully back out of the room.”

In the Financial Post’s “Think before firing that fund manager”Michael Nairne suggests careful consideration should be given before you switch funds or fire your fund manager for underperformance (if you are still heavily into active investing despite of the overwhelming evidence against it). Studies have shown that (in the institutional framework) “performance of fired managers exceeded that of the managers hired to replace them for one, two and three years”. Explanations are many including costs and fees associated with switching/selling/buying/taxes and tendency to try to jump into recently high-performing managers who over-performed due to having been overweighed in hot sectors which may be less so in the future. He suggests patience. (Or…you could try a passive approach.)

In the Financial Times’ “The hidden dangers of passive bond investing”John Plender reminds readers of the potentially “malign consequences” of passive bond investments which are designed to replicate the index. A problem of bond indexes is that “some of the least creditworthy borrowers in the system will enjoy ready access to funds regardless”.  To get around this problem, Pimco “has developed an index that uses gross domestic product to set the weights in the index rather than outstanding stocks of debt. Part of the attraction is that it makes sense to lend to countries with high incomes rather than heavy debt burdens. It also results in a much larger allocation to emerging markets.”

Jamie Golombek in the Financial Post’s “Are two ETFs ‘identical’ under 30-day rule?”writes that two ETFs tracking the same index are “identical” so watch out when trying to “dodge the 30-day superficial loss rule” in this manner.

In “So when should I start receiving my CPP benefits”Kathleen Clough reviews some of the coming CPP changes and looks at some of the considerations (like breakeven ages)as to when to start receiving your CPP (Canadian equivalent to Social Security payments). .)(From Rob Carrick’s Personal Finance Reader) (To my mind if you’re in good health and you don’t need it to make ends meet, deferring CPP (and Social Security) as late as possible makes sense especially if you don’t have a DB pension; where are you going to be able to by such a low risk indexed annuity? It is the ideal longevity insurance. If you die early you won’t miss the money; if you live well into your 90s, you will be happy to receive this indexed income)

Real Estate

In the Globe and Mail’s “Pop goes the housing bubble” Gary Mason discusses boomers pondering unloading their large homes to be free of all the headaches that come with them (and perhaps spend some of the proceeds during their retirement) but they “began wondering who is going to buy our homes?” “The ratio of seniors to working-age residents is expected to grow by roughly 30 per cent in each of the next two decades… Who will boomers sell to when they’re ready to move into some swank condo downtown or on a golf course somewhere? This could actually be good news for young people. An oversupply of homes generally means prices fall. But as home values decline, so will home equity, diminishing retirement savings in the process. Home equity is the single largest component of net wealth for most people.”

In the Financial Times’ “Housing weighs down the recovery” Mort Zuckerman looks at how housing, despite a much improved affordability index (“percentage of income to payments on a median priced home”), will likely continue to be drag on the economy because of property values and equity declines, high unemployment rates, growing foreclosures, and “fewer household formations and fewer and fewer buyers accept housing to be a safe investment”.

Steve Ladurantaye in the Globe and Mail’s “Clouds darken over new home construction” reports13% drop on new home construction, similar effect that was observed in the resale market where 30% lower sales volume was observed in larger cities.

In the Globe and Mail’s “Condo reno? Talk about diminishing returns?”Preet Banerjee says that “There are two major reasons why you would want to renovate your home: You want to improve your living space or you are making an investment that will increase the value of your home above and beyond the cost of the renovation. My beef is with people who use the latter reason to justify being financially irresponsible.” (He sounds right on the money to me!)

In the WSJ article “Market for vacation homes is on the rise” Mitra Kalita quotes various real estate sources suggesting improvement in vacation home sales. Of the four locations are mentioned two of them showed low increases on already low sales volumes. Of the other two mentioned, Mercer Island, WA at 182% improvement (again on a very low base 11 increasing to 31) is not a vacation area, but a Seattle residential suburb, while Palm Beach happens to be in an area that I have some familiarity with and it is not obvious that sales are on fire. (Not sure how accurate are the sources quoted by the author given that author mentioned Mercer Island as vacation home area.)

In the Financial Post’s “Canada’s mortgage hazard”Neil Mohindra discusses the reason why “don’t banks set their own tighter credit standards? The answer is, because they are protected by government-backed mortgage insurance, which is mandatory for all mortgages with a loan-to-value ratio in excess of 80%. The government backing is provided through either the Crown-owned Canada Mortgage and Housing Corporation (CMHC) or a private mortgage insurer that has been extended a government guarantee…..(and therefore)…. As long as the government insists on backstopping the risk of high-ratio mortgages with taxpayers’ money, banks simply won’t have any skin in the game and will react half heartedly at most to calls for them to tighten lending standards to address concerns over rising household debt.”


The Economist’s Buttonwood points out a couple of interesting things in “Falling short”. First that “total contributions (employer and employee) into global DC plans amount to 9.6% of payroll. This is a long way short of a DB plan. The gold-plated example is provided by the Bank of England which puts 44% of payroll into its DB scheme. Now the Bank of England takes no investment risk, buying index-linked bonds to match its liabilities.” So when an employer switches from DB to DC plans, the employee typically effectively takes a pay-cut. And second that governments “face the awkward problem that encouraging more pension saving would eat into consumer demand, at a time of still-sluggish growth, and might require more generous tax subsidies, at a time of huge fiscal deficits.”

In Bloomberg’s “Pension envy vexes underfunded public workers”Chris Farrell discusses “The deteriorating condition of many state and local government pension funds has grown into an impassioned topic for cable talk shows. The financial meltdown and recession made apparent what many experts have long known: Too many municipalities routinely underfunded their pension plans while the future cost of their retirement payout promises swelled.” He then proceeds to discuss some alternatives to what one pension expert calls “not a viable funding model” when referring to the current practices used by many of the public pensions.

Joel Klein goes further in the WSJ’s  where he argues that some public “Why teacher pensions don’t work” “Defined-benefit systems aren’t merely Ponzi schemes. They discourage talented teachers who would prefer front-loaded compensation. To cover the underfunded pension obligations to teachers and other public employees, cities and states have little choice but to divert money from what would otherwise be their operating budgets. And since schools make up a big part of those operating budgets, education will get significantly shortchanged as we make up for past underfunding.“ He suggests that a better way to attract new teachers would be to pay higher starting salaries and increases at the beginning in exchange of reduced pensions; he argues that this would be a clear win-win all around.

CARP’s survey summarized in “Pooled Registered Retirement Plan Poll Report” concludes that “The majority of members reject the idea of PRPPs (the latest federal government proposal for pension reform), both outright, and after it is explained that they will not feature the safeguards of the CPP. The majority of members are uninterested unless PRPPs feature the same low rates, risk guarantees and defined benefits as the CPP, and these requirements are “extremely important” to close to one half of members. Members do not trust the private sector to provide safe, risk-free, low-cost retirement plans, and the majority agree an enhanced CPP has a vital role to play in retirement security, whether along with PRPPs or alone. Members are in favour of auto-enrolment in PRPPs only if they have fee caps and other protections and if there is a choice of plans in which to enrol.”

And speaking of the federal government’s PRPP proposal last month as the solution to Canada’s systemically failed pension system, I have pulled together a comparison of the PRPP in terms of some of the key parameters for a credible pension reform against a number of other proposals that in my view are still on the table before or after the next federal election (expanded CPP in some shape or form, Liberal Party White Paper SCPP and Ambachtsheer’s CSPP) or is already implemented (Saskatchewan’s SPP). PRPP comes up wanting in comparison to the others based on the little that’s known about it and much which is not included/mentioned/defined in the proposal. There may even be value to a dual approach, i.e. a combination of an expanded-CPP and a DC plan riding on the same administrative platform. You can read my analysis/comparison at “Pension Reform: It’s Not Rocket Science”.

It is not often that I’ve been able to even partially agree with Jack Mintz on pension related matters, but in the Financial post’s “Jack Mintz: Retirement 101: but he says that “I don’t see why a modest CPP expansion cannot happen even if the pooled multi-employer pension funds are developed”. (As indicated in the previous paragraph, a dual approach might in fact have merit, so long as the PRPP is implemented  with the best features of the SCPP and the SCPP as the blog mentioned there “Pension Reform: It’s Not Rocket Science”.)

Things to Ponder

In the Globe and Mail’s “Provinces’ misguided mistrust of a national regulator” Barrie McKenna rightly savages the provinces’ obstructionism against the creation of a national regulator. He says that it is “…the right thing to do. It would save millions of dollars, improve enforcement and enable the regulatory regime to grow and evolve along with fast-moving national and international financial markets. It’s a national embarrassment that Canada stands alone among industrialized countries in subcontracting securities regulation to subnational governments.” On the other hand Terrence Corcoran in the National Post’s “Regulatory showdown” says “Why fix something that is not only not broken, it’s been a boon to the economy?” (Mr. Corcoran obviously hasn’t read the Rosens’ book “$windler$”unmasks Canada’s lack of investor protection. With the adoption of IFRS, they say, it will get worse!). As I have indicated before, I believe that a single national regulator is the right answer, however it is only a necessary but not sufficient condition for better investor protection in Canada.)

In the NYT’s “Banks are poised to pay dividends after 3-year gap” Schwartz and Dash report that as a result of strong U.S. bank earnings “the nation’s largest banks are ready to begin restoring their dividends in the first half of the year, after a three-year pause to repair their damaged balance sheets. The reversal could put billions of dollars in the pockets of pension funds and retirees who had viewed bank shares as dependable sources of income.” The authors indicate that timing and size of the dividends will have to be made palatable to the public after its anger due to the bank bailouts as “everyone’s afraid of headlines that say just two years after the bailout, the fat cats are getting dividends again” (From CFA Financial NewsBriefs)

SmartMoney’s “Five reasons to still like gold” includes: inflation is still seen as a solution to many major central banks, there is a drive to devalue all major currencies and central banks started buying gold again. Edward Chancellor however is not so sure; in the Financial Times’ “Valuation riddle for the yellow metal”he looks first at investor behaviours which might suggest that gold is in a bubble. He then looks at what he calls valuation: gold is around $1400 vs. last century average of about $440 in 2010 dollars, or vs. about $600 production cost, but “looks less pricey compared with other commodities”. And then there is the falling confidence in paper money. After all his gyrations Chancellor concludes that fair price is around $1000. “This is not to say gold will not rise over the coming year or that there is no need to hedge inflation risks. Rather that prudent investors should look to other, less meretricious, assets to protect the purchasing power of their savings.” (Who knows? Forecasting is difficult, especially about the future!)

In the Financial Times’ “Bogle’s vital remedy for capitalism’s ills” Pauline Skypala reviews John Bogle’s book “Don’t Count on It”in which he “identifies modern capitalism’s flaws…and examines how we can begin to repair the damage before it is too late”. “He quotes Mr. Swensen (Yale University endowment CIO): “Investors fare best with funds managed by not-for-profit organisations, because the management firm focuses exclusively on serving investor interests.”It is true in theory, but not always in practice, as investors in products managed by mutual life assurance companies discovered in the UK… Bogle’s prescription for a better system is relatively simple: to demand proper fiduciary management from money managers. They must prioritise client interests, act as responsible corporate citizens, charge reasonable fees and eliminate conflicts of interest. Amen to that. It may sound like nostalgia from an old-timer, or idealism from a visionary. But without such changes, investors and society will continue to be short-changed as the financial community carries on regardless.”

The Economist’s Buttonwood in “Boomtime prices without boomtime conditions” observes that “the Baltic dry index, often seen as a proxy for demand for commodities and thus economic growth” is down, but both railroad and trucking traffic is up in the past year. And with oil nearing $100/barrel again westerners will notice that they are “no longer price-setters” for commodities and they’ll no doubt notice that “One can have boomtime prices without boomtime conditions.” In the Financial Post’s “Inflation rekindled in nonchalant markets” Mike Dolan tackles the same topic and concludes that despite problems in the developed world, the global growth rate in excess of 4% is above trend line and “aggregate global demand affects global prices regardless of slack in the west”.

And finally, in the Financial Times’ “East and west converge on a problem” Martin Wolf continues his “great convergence” topic of the previous week by drawing on Ian Morris’s new book “Why the West Rules- For Now”. Morris argues that despite human ingenuity, “what any group of human beings is able to achieve is determined by geography. The impact of a given geography also changes: 1000 years ago oceans were a barrier; 500 years ago they were a highway…. His conclusion is that the west was somewhat more advanced than the east until the fall of the Western Roman Empire, behind it from then until the 18th century, and then ahead. Eastern exploitation of the “advantages of backwardness”, a recurring theme, suggests another reversal in the 21st century… “social development” is an amalgam of four factors: energy use; urbanisation; military capacity; and information technology. The first is fundamental: the capture of energy is a necessary condition for existence; the more complex and advanced the society the more energy it captures.” An OECD study has argued that while the rise of China and India were so far win-wins for the east and west in many aspects “The biggest challenges arise where zero-sum outcomes are more likely. Resources are a big example. Political power is another. A rising east must alter the balance of global power and the abundance of cheap resources… Will ingenuity continue to overcome scarcity, or not? If the answer is “yes”, all of humanity might come to enjoy the historically unprecedented lifestyles of today’s most favoured people. If the answer is “no”, we might, instead, fall prey to what Prof Morris calls the “five horsemen of the apocalypse” – climate change, famine, state failure, migration and disease.”


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