Hot Off the Web- July 18, 2011

Personal Finance and Investments

In the Financial Post’s “Some retiree lifestyles cost even more”Michael Nairne writes that the 70% replacement of pre-retirement employment income rule of thumb can safely be thrown away by affluent individuals. A recent U.S. survey showed that 20% of affluent retirees “spent more in retirement than they did when they were working”, typically due to extensive travel, vacation property and charitable giving (including assistance to family). Quoting Gene Perret on retirement: “It is critical to get the budget right…“It’s nice to get out of the rat race, but you have to learn to get along with less cheese.” For the affluent, one of the keys to a successful retirement is knowing exactly how much cheese you need.” (The budget and understanding your expenses are an essential part of retirement finance, affluent or not.)

In the Financial Post, Jonathan Chevreau writes that “Marriage triggers revocation of will”. “…three big life events which need a revisiting of estate plans are marriage, divorce and separation.”Each has a different effect on a will, which people often don’t realize”… Another point to be aware of on marriage or divorce is the revoking of insurance beneficiary designations. There have been several cases involving separation agreements where one spouse agrees not to claim beneficiary designations against the ex-spouse’s estate but the agreement did not hold up in court.”

In Bloomberg’s “Brokers face more disclosure to clients under Dodd-Frank: One year later”Alexis Leondis reviews progress toward raising the bar in the U.S. on the requirements on the level of care/duty by those who put themselves out as advisors to retail customers: the suitability (brokers) vs. fiduciary (Registered Investment Advisers) and how to establish a common and higher standard for both, clarity and transparency for the consumer, role of advisor’s firm (principal/counterparty, commissioned sales, etc), need for advisor to understand what he is selling (e.g. for structured products), disclosures (compensation, services, and conflicts of interest). SEC is expected to table “rules for a common standard by end of this year”. (In Canada, where the need is even greater, there appears to be no movement on part of legislators to raise the bar on standards of care for ‘advisors’)

I’d have difficulty disagreeing with the Globe and Mail’s “Are you a Don’t Do It Yourself investor?” in which Preet Banerjee argues that a 1% lower annual return (6% vs. 7%) for the services of an advisor is money well spent for many (though not all) investors. (If cost is really 1% (rather than the 1.5-3.0% that Canadian mutual funds typically charge or the 2.5% wrap account charge a broker might charge), the advisor is qualified to provide competent advice, the investor actually gets advice (including an IPS, rather than just buying/selling some funds) and acts as a fiduciary toward the investor, then 1% is very well spent by those who can’t do it themselves. Thanks to Carrick’s reader for recommending article.) You might also be interested in reading the Financial Post Jason Heath article entitled “The cost of financial advice”on the same subject.

Real Estate

According to Robert Bridges “A home is a lousy investment”. Bridges argues in the WSJ that “Today’s young people would be foolish to imitate their parents and view ownership as the cornerstone of personal finance.” “In a society increasingly concerned with providing for retirement security and housing affordability, this finding has large implications. It means that we have put excessive emphasis on owner-occupied housing for social objectives, mistakenly relied on homebuilding for economic stimulus, and fostered misconceptions about homeownership and financial independence. We’ve diverted capital from more productive investments and misallocated scarce public resources… So a dollar used to purchase a median-price, single-family California home in 1980 would have grown to $5.63 in 2007, and to $2.98 in 2010. The same dollar invested in the Dow Jones Industrial Index would have been worth $14.41 in 2007, and $11.49 in 2010.” (Of course there is no guarantee that the future will turn out to be the same as the past; a more modest proportion than today, may be more appropriate allocation to real estate as part of one’s assets.

Kimberly Miller writes in the Palm Beach Post’s “New Palm Beach County foreclosures double in month”  that June foreclosures were up over May by  119% in PBC , 44% in Florida and 9% in the U.S., however the numbers are still significantly lower compared to  June 2010 specifically by -26%, -48% and -34%, respectively. “RealtyTrac estimates more than 1 million foreclosure actions that should have taken place in 2011 have now been moved to 2012 or even later “casting an ominous shadow over the housing market”…due to processing and procedural delays.

The Economist’s “Clicks and mortar” provides a very interesting set of interactive house-price indicators for about 20 countries: nominal and real house prices indexes, (Just keep in mind that these are indexes with some (selectable) base year set to 100, and doesn’t really make it easy to compare countries relative to each other at any point in time. Thanks to Carrick’s reader for recommending.)

In the Globe and Mail’s “Toronto trumps Vancouver as country’s most expensive city”Tavia Grant reports that Mercer’s world cost-of-living survey intended to “plan compensation allowances for…expatriate staff” indicate that “Toronto surpassed pricey Vancouver due to its relatively high rental accommodation costs… (as Toronto) moved up to 59th spot worldwide from the 76th position last year. Vancouver climbed to 65th place from 75th last year, and is followed by Montreal and Calgary. Ottawa is the least expensive Canadian city in the rankings.”


In the Ottawa Citizen’s “Nortel pensioners to see average 18% cut in benefits” Bert Hill reports on the interim the pension cuts being implemented effective August. The 18% applies to the average non-negotiated pension plan member ($24,000 average pension and average age of 74) in Ontario. If my back of the envelope calculations are correct, Ontario pensioners with whose pensions are $12,000, $48,000 and $72,000 will likely face immediate reductions of about 0%, 25% and 31%, after including PBGF benefits. (Of course since indexation has been eliminated, the pensioner will see the corrosive effect of inflation further reduce their purchasing power year after year.) Those pensioners who have done some of their service outside of Ontario and are not eligible for PBGF for that service will be correspondingly lower. There is some confusion about why Ontario pensioners’ plan is 70% funded but for non-Ontarians it is 59%. The entire plan is probably 59% funded as the plan is specified to include a partial inflation indexation. However, Ontario does not recognize indexation for PBGF calculation, so Ontarians’ funded status is reported without indexation, thus making it appear higher. From a Commuted Value (CV) perspective (i.e. if someone chose to take the LIF option) somebody with same years of service and same age in this plan should receive the same CV/LIF value; the difference is that each $1 buys less of an indexed than and un-indexed pension.

An Ontario government news release “Nortel pensioners get greater choice for their pensions” indicates that “Measures in the 2011 Budget responded to the request of Ontario Nortel pensioners to allow plan members to opt out of the pension wind-up process. Members who choose to opt out will be allowed to transfer the commuted value (current lump sum value including the Ontario Pension Benefits Guarantee Fund (PBGF) entitlement) of their pension to any financial institution that offers a life income fund (LIF). Members who choose not to opt out of the wind-up will be offered their guaranteed pension annuity, plus their Ontario Pension Benefits Guarantee Fund entitlement, through the conventional wind-up process.” (Thanks to VK for recommending article.)

Some may agree or disagree with some or most of Fraser Institute’s Mohindra’s arguments in his opinion piece on pensions “Pension overkill” , but I doubt that many could agree with his concluding paragraph, that delay introducing pension reform is good. Every day of delay adds another nail in the pension coffin for private sector Canadians already in retirement, near retirement or even within 10-15 years from retirement. In   Pension Reform: It’s not rocket science, I  suggest four tests for  pension reform:  (1) “encouragement”  for saving,  (2)  provision for low-cost professional asset management, (3) provision for low-cost  longevity insurance, and (4) securing already earned private sector pension plan benefits with strengthened regulatory framework backed-up by priority over other  creditors in case of company bankruptcy. Whether one believes in mandatory or voluntary savings, it has something to do with the degree to which you believe in individual freedom vs. the government forcing you to act in your interest, but perhaps a combination of the two extremes is the right answer. The U.S. has introduced auto-enrolment with option to opt out for 401(k)s (like RRSPs). The result was a significant increase in the employees’ participation rates. There is no more time left for procrastination. The damage to Canadian boomers is accumulating daily.

In the Financial Times’ “Rating the not-so-perfect pensions” Pauline Skypala discusses the latest Mercer Global Pension Index report (October 2010) which rates retirement provisions for 14 countries, ranking Netherlands as #1 and China #14 (Canada is #5 and U.S. #10). Mercer allocates 40%, 35% and 25% to adequacy, sustainability and integrity components, respectively. Skypala says that the index was launched “to promote Melbourne as a fund management centre, and attract international fund managers to help diversify Australian pension fund portfolios. But if it creates more debate over how to achieve that elusive perfect pension system, it will be a better publicity stunt than many.” (I didn’t read the 2010 report in detail, but I recall being significantly distressed with the methodology which in 2009 gave surprisingly high rating to Canada #4, probably to a significant extent due to the relatively generous minimum guaranteed retirement income by the state thus minimizing poverty.) No doubt one could have a vigorous debate about what factors to focus on and how to assign weights to those factors, but that’s more work than a ‘publicity stunt’ is worth.)

Things to Ponder

In Bloomberg’s “The economy can’t grow with debt” Reinhart and Rogoff write that “Our empirical research on the history of financial crises and the relationship between growth and public liabilities supports the view that current debt trajectories are a risk to long-term growth and stability, with many advanced economies already reaching or exceeding the important marker of 90 percent of GDP… we think it would be folly to take comfort in today’s low borrowing costs, much less to interpret them as an “all clear” signal for a further explosion of debt… Those who would point to low servicing costs should remember that market interest rates can change like the weather. Debt levels, by contrast, can’t be brought down quickly… historical experience and early examination of new data suggest the need to be cautious about surrendering to “this-time-is-different” syndrome and decreeing that surging government debt isn’t as significant a problem in the present as it was in the past. (Well worth reading. Also if you are interested in the subject you might care to read their excellent book which I reviewed some time ago at “This Time is Different”.) A related article on the subject of debts and deficits, is the Economist’s “Why Italy ought to be okay” which includes an interesting  table showing some of the key moving parts going into government debt dynamics). You can also read a warning from Martin Wolf in the Financial Times’ “From Italy to the US: Utopia vs. reality”

In the Financial Post’s “Rich-poor gap still widening” Christine Dobby writes that according to a just published Conference Board of Canada report “The average Canadian is better off than he or she was a generation ago, but the gap between the rich and the poor continues to widen… In addition to creating social tensions and potentially alienating the middle class, income inequality matters from an economic perspective if it means Canada is not best using the talents of its population, Ms. Golden said. “You have to put this against the fact that we are now in a labour shortage economy, so we need to be maximizing the skills and talents of the population.”” She also discusses other opinions on whether this is necessarily bad. Canada’s Gini index (measuring inequality on a scale of 0=complete equality and 100=complete inequality) of about 30-32 (depending on who is counting) makes it less unequal that the US at 40, UK at 36, Mexico at 48, but more unequal than Denmark at 29 and Germany at 27. (If you are interested in the subject, I recommend Branko Milanovic’s “The haves and the have-nots” , which I just finished reading, and is reviewed in the NYT. In addition to the extensive data present on income distributions within countries, among countries and globally among individuals, Milanovic presents some interesting arguments why the recent financial crisis may have been the inevitable result of growing inequality rather than derivatives and inadequate regulation.)

Dan McCrum in the Financial Times’ “Pimco reverses course on US government debt”writes that “Bill Gross has reversed course, with the manager of the world’s largest bond fund scaling back bets against the value of US government debt in June as investors sought safety in Treasuries. Pimco’s $244bn Total Return fund increased its holdings of government debt for the second consecutive month and returned its overall position in what it terms “government-related securities” to zero…” (Pimco is feeling the heat as interest rates on US Treasuries have surprisingly decreased rather than increased as expected by Mr. Gross- and many others.)

In the Financial Times’ “EU faces worse fate than bank crisis”John Dizard writes that “The point here is that dramatic crises do occur, such as the sudden unpluggings of Lehman and Iceland, but they are not the existential problem peripheral Europe is now facing… Euro policy people are talking up unlikely risks (like Greek default leading to a Lehman-like crisis), and ignoring those that are real, and chronic. Deepening stagnation is much more dangerous, than any “Lehman 2” scary monsters.”

Chris Flood reports in the Financial Times’ “Low cost ETFs reap fat profits” that European banks are making a killing on synthetic or derivatives, rather than “physical”, based ETFs. With just 2.8% of the assets they generate 13% of Europe’s funds management industry’s profits. These synthetic funds happen to be the ones that European regulators are concerned about due to their exploding number and complexity.

This past week, I came across a number of articles on the subject of tail-risk, which I also discuss in my new in-depth blog Risk perspectives”. In “How to manage tail risk” (thanks to Ken Kivenko for recommending the article, details are available in “A constant volatility framework for managing tail risk” )  a constant volatility approach is suggested given that volatility varies with time; thus one could define periods of high and low volatility, and reduce exposure of portfolio during periods of high volatility using a short-term market volatility driven long/short futures overlay (rather than options). (Sounds good but difficult to determine to what degree there is some element of what some might consider data mining involved; this also says that market timing works, which as we know is very difficult to do.) Another article is the Financial Analysts Journal’s “Who should hedge tail risk?”  in which Robert Litterman argues that investment banks are the natural buyers of tail-risk insurance and long-term investors are the natural sellers of such insurance (exactly the opposite of what actually happens). Litterman looks at three options for long-term investors who are worrying about their tail-risk: (1) “buy equity tail-risk insurance”, (2) “sell some equity”, and (3) ‘sell even more equity exposure and also sell equity tail-risk insurance”. He shows that of these the first one is the most expensive and the third one the most effective as measured by volatility reduction and return enhancement between 2005-2011. He says that “My advice to long-term investors is that the next time someone knocks on the door selling a tail-risk insurance product, they should ask for a two-sided market. Perhaps the opportunity is on the other side.” Similarly, GMO Capital’s James Montier in “A value investor’s perspective on tail risk protection: An ode to the joy of cash”concludes that “Tail risk protection appears to be one of many investment fads du jour. All too often those seeking tail risk protection appear to be motivated by the fear of missing out (not fear at all, but greed). However, the surge of tail risk products may well not be the hoped-for panacea. Indeed, they may even contain the seeds of their own destruction (something we often encounter in finance – witness portfolio insurance, etc). If the price of tail risk insurance is driven up too high, it simply won’t benefit its purchasers.”

And finally the WSJ’s Tom Lauricella looks at five “Questions retirees must answer”: (1) when to start Social Security (for most delay might be the best due to resulting larger benefits)? (2) work part-time (consider need for income, structure to your life and social value)? (3) where to keep money (discount brokerage) and how to withdraw it (typically most suitable order is taxable, tax-deferred (401(k)/RRSP) and then non-taxable (IRA/TFSA))? (4) pay off mortgage (yes, subject to liquidity constraints, given the available returns on fixed interest savings)? and (5) who to delegate decisions when no longer capable (update will, power of attorney, health-care proxy)?


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