Hot Off the Web- February 20, 2012

Personal Finance and Investments

In the Financial Post’s “Early CPP will cost you” Fred Vettese writes that “About 40% of all CPP recipients get their first cheque at age 60, the earliest age possible. This is a surprisingly high take-up rate considering they incur a 36% penalty by starting their pension at 60 instead of 65… The more pension (one) can derive from the CPP, the less (one) has to worry about longevity risk… Under new adjustment factors being phased in between 2012 and 2016, a CPP pension starting at age 70 is 42% greater than one starting at age 65 and 121% more than is payable from age 60… the fear of an outcome that occurs during one’s lifetime (i.e. outliving one’s savings) should trump the fear of something that happens after death (i.e. leaving something on the table).” For those with “significant” RRSPs he suggests tapping that first and delaying CPP. (Very wise advice!)

In Michael James’s blog “MERQ is too extreme to be believable” he proposes MERQ as a better measure of the damage that “seemingly small costs” can cause to your portfolio. MERQ is defined as Management Expense Ratio per Quarter century. He compares a Canadian balanced fund that “has an MER of 2.89% which translates into an MERQ of 51.4%! This means that after 25 years, more than half of your portfolio would be consumed by fees. In contrast, a balanced portfolio of index ETFs from iShares (XIU and XBB) has an MER of 0.235% for an MERQ of 5.7%. So, a portfolio that would have come in at a million dollars without fees would end up with $486,000 with the former fund and $943,000 with the iShares ETFs. (Anything that sensitizes investors to the corrosive effect of fees/costs on their retirement is good. Thanks to Ken Kivenko of CanadianFundWatchfor recommending)

In the Star’s “Ponzi scheme windfall not subject to Canadian tax, court rules” Richard Brennan reports that “The Tax Court of Canada has ruled that money that was made from a Ponzi, or pyramid scheme, is not taxable since it is not income from a source… Gambling winnings, inheritances, gifts, those are examples of amounts that are not considered from a source…. The court ruling, which is being appealed, is highlighted in this week’s edition of Lawyers Weeklybecause of its unusual nature. (Though another legal expert notes that) it was only fair that Johnson did not have to pay tax on her so-called windfall because on the “flip side” the CRA does not allow Canadians to use gambling losses as tax deductions.” (Thanks to KK for recommending.)

You might be interested in playing with Northwestern Mutual’s Lifespan Calculator  which attempts to estimate your personal life expectancy based on some family history and lifestyle choices. (Thanks to EF for recommending)

In AdvisorOne’s “Advisors’ processes define success in retirement income support” Danielle Andrus writes about a new report on “trends in the way advisors will have to deliver retirement income”. ““There’s no one way” to approach retirement income support…they found advisors were split among total return, income floor and bucket style processes. Advisors who want to become leaders need to “get more experience and make retirement income support a priority…A deeper understanding of the broader issues affecting retirees is also important… It’s not just about investment management; Social Security, Medicare and elder care are all important issues that retirees will face. The most significant issue for advisors working with retirees, the report found, is helping them deal with health care costs and sustain the retirement lifestyle they imagined. Half of advisors said they encourage their retiree clients to target a 4% withdrawal rate.“ It appears that over time, more advisors are shifting away from traditional ‘total return’ focused portfolios and are instead relying on some form of sustainable or guaranteed income to serve clients, especially the mass affluent…” (This last point might be problematic for many client situations if advisors concluded that high cost “products” are the answer.)

In the Globe and Mail’s “CPI study could result in big savings for Ottawa, business” Chase and Grant report that “Canada’s statistics agency is refining the consumer price index, a key economic yardstick for matching pensions and salaries to the rising cost of living – and the result could mean sizable savings for governments and corporations that hike payments annually to keep pace with inflation… Statistics Canada acknowledges that one kind of bias that creeps into consumer price tracking can add as much as 0.2 percentage points to the consumer-price-index measure of inflation – meaning that when inflation is measured at 2 per cent, the true rate would be 1.8 per cent.” The article quotes another source which suggest that CPI might be 0.6% on the high side; In the Globe’s “Canadians should demand a debate on CPI changes”Toby Sanger writes that “For a worker with a starting income of $50,000 a year, a 0.6 per cent lower wage increase each year ads up to a cumulative loss of $18,000 over ten years.”  (I didn’t check the arithmetic but the same calculus would apply to CPP and OAS.) See further comments on paranoid(?) seniors at the end of this blog.

In the Globe and Mail’s “The flaws in Canada’s financial adviser system” Barrie McKenna offers a discussion of the “inherent conflict of interest in many client-adviser relationships… and too many investors are left in the dark about the fees they’re paying to advisers and the effect those fees have on returns.” It discusses the need for fiduciary standard of care (i.e. first obligation is to the client), how your adviser gets paid, what your advisor gets paid for, investing is a zero sum game, and “Ms. Singer, the investor advocate, said imposing a fiduciary duty is the right thing to do, particularly at a time when governments and employers are gradually shifting the burden of providing for retirement onto the shoulders of individuals.” (Nothing new in the article, other than finally the F-word is being discussed in Canada as well. In the U.S., Registered Investment Advisors and CFPs already have a requirement of a fiduciary level of care.) You can also read Rob Carrick’s article in the Globe entitled “A dozen ways financial advisers can stretch the truth”.

Real Estate

In the Globe and Mail’s “Two steady housing years ahead: CMHC” Steve Ladurantaye writes that the Canada Mortgage and Housing Corporation forecasts “with low interest rates and a “moderately” expanding economy keeping price corrections at bay. The Crown corporation – which insures Canadian mortgages – has had a consistently rosier view of the market than many private sector forecasters.” However, another article warning about Canadian real estate bubble is the Bloomberg’s “Toronto bubble risk topping New York in condos” where Doug Alexander enumerates some of the warning signals: high-rises under construction in Toronto 148 vs. 59 in NYC and 22 in Chicago, Toronto has 27,500 condo units under construction to be added to 199,000 units in existence, mortgage lending is expanding, mortgages at risk should rates increase on renewal dates (unlike the U.S. where you can not only get mortgages with 30 year amortization, but also 30 year rate guarantee with mostly unrestricted pre-payment option, in Canada 5-year rate reset is the available norm), housing prices are higher than previous peak, affordability  is low even with low mortgage rates with median home price to median pre-tax income ratios of 10.6 in Vancouver and 5.5 in Toronto a “40% deterioration since 2004”. Counter arguments mentioned include: lots of foreign buyer interest, higher than 20-30% of condo buyers are investors, vacancy rates for condos low at 1.3% in 2011, 100,000 come to Toronto each year. Also, you may be interested in the Globe and Mail’s “Housing market shows further signs of cooling” where Steve Ladurantaye reports that Home sales across the country were down 4.5 per cent in January compared to December, the sharpest monthly decline since July 2010. Average prices were 2 per cent higher than a year ago at $348,178, the smallest year-over-year increase in the last year. The association – which represents the country’s real estate agents – also said that market watchers shouldn’t pay too much attention to average monthly prices in the coming months because last year’s figures were skewed by a number of high-price sales in Vancouver.” Adding fuel to approaching correction in Canada’s housing market is the Financial Post’s “Housing market poised for ‘severe correction’, finance professor says” where Alexander and Kolet report that when housing investment as a percentage of GDP exceeds (as it does now) 7% “…it signifies over-investment in housing and two or three years later, we have a severe correction…” (While the future is not necessarily like the past, you be the judge of the current risk!)

In WSJ’s “Righting the wrong” Al Lewis writes, about the $25B foreclosure settlement with US banks last week that “The bankers finally agreed to a wrist slap. Government officials took a bow. And now some deadbeat former homeowners will get checks in the mail for up to $2,000. The settlement is like a heist-movie plot where all the characters get away with it. Most of the $25 billion comes in the form of adjustments to mortgages banks may have had to make anyway… In the end, we can’t really punish the banks for causing the housing crisis, anyway. If we hit them too hard, we’d just have to bail them out again.” Also in Bloomberg’s “Florida homeowners have little to cheer in deal with gangsters” Michael Bender writes that “The settlement may mean as much as $8.4 billion in benefits for Florida homeowners… Mortgaged homes in the state are underwater by $110 billion… Almost a quarter of the state’s homes, 23 percent, have delinquent mortgages or are being foreclosed upon, more than in any other state…”

In the Financial Post’s “U.S. foreclosures hit Beverly Hills, 90210”Tim Reid reports that “…180 houses in Beverly Hills, the storied Los Angeles enclave rich with Hollywood stars and music moguls, have been foreclosed on by lenders… The majority of delinquent homeowners here owe more than US$1-million. Many are walking away not because they can’t pay, but because they judge it would be foolish to keep doing so… Strategic default is an especially appealing option in California, one of only a handful of U.S. states where primary mortgages made by banks are “non-recourse” loans. That means the loan is secured solely by the property, and banks cannot go after a delinquent owner’s wages or other assets if they default.”


I didn’t come across anything of substance on pensions (other than despite improved stock market returns, the funded status of DB pensions continues to deteriorate from decreasing interest/discount rates which lead to higher liabilities), convincing myself that the discussion of potential OAS changes has been 100% successful in derailing Canada’s lack progress on pension reform and almost universal criticism of the proposed PRPP, as discussed in my last week’s blog OAS vs. Pension Reform?. Pension reform (not OAS “savings”) is the real issue that will determine the retirement of ALL Canadians.

Things to Ponder

In WSJ’s “Simple index funds may be complicating the markets” Jason Zweig discusses whether “index funds might be destabilizing the markets and undermining the very diversification they have long promises?…(some argue that) The rise of trading in index funds…is causing stocks to move more tightly together than ever before—as if they “have joined a new school of fish”…(others argue that while correlations have been high) indexing isn’t the sole cause. Since the 1990s, we have seen the rise of the Internet, the proliferation of electronic trading, a global financial crisis and interventions in markets by central banks around the world.” Ways mentioned to increase your diversification include: use a broader index than S&P500 (e.g. Russell 3000 or Wilshire), “International stocks, emerging markets and investment-grade bonds”, (I am not sold on indexing being the cause of instability…other places to look for source of instability might be the effect of media fanned “risk-on, risk-off”’ behaviour , growing use of derivatives and leveraged/inverse funds, high frequency trading…and if anything index buyers/sellers’ ‘indiscriminate’ buying/selling should create opportunity for active managers to buy/sell mispriced stocks…Let the games begin and see if they can sustainably beat the index and whether you can pick the winners a priory.)

In the Financial Times’ “Western Capitalism has much to learn from Asia”Kishore Mahbubani writes that that it is not Capitalism that is in crisis, but western capitalism. Western capitalism has made three errors: (1) “to regard capitalism as an ideological good, not as a pragmatic instrument to improve human welfare” and the financial industry which  added no new value and had to be bailed out by the taxpayer repeatedly was “allowed to “capture” the regulators whose duty it was to control and supervise its activities”, (2)  “For capitalism to survive, all classes had to benefit from it”, and (3) “to aggressively promote the virtues of capitalism to the third world, including Asia, without realizing that it had to educate its own populations on the critical concept of “creative destruction”. (Thanks to AR for recommending.)

In WSJ’s “Moody’s is worried about everything in investment banking” David Benoit reports that  credit rater Moody’s put 17 firms “under review” including Goldman, J.P. Morgan and the Royal Bank of Canada because they are “inherently risky and little can be done to change that…The report is worried about everything from funding to pay structures, not necessarily new concerns, but the bleakness is stark… capital markets activities create “complex, highly leveraged” balance sheets that are “typically laden with opaque risk exposures that can change rapidly.” Attempts to manage risk can’t be measured, Moody’s argues, so it’s hard to know how a bank is doing. And given risk management “can be tedious and expensive to perform, especially during bull markets” what’s to keep cheeky banks from pushing that aside”. Moody’s also notes that the compensation models create moral hazard, and since the “investment banking business essentially relies on trust” when confidence evaporates in a crisis the firm’s liquidity can evaporate with it.

And, Paul Volker responds very effectively to the full frontal attack against the “Volker rule” which limits proprietary trading by American banks in the Financial Times’ “Foreign critics should not worry about ‘my’ rule” and concludes with “I regret that the effect, if not the intent, of much of the lobbying has been to add complications rather than to clarify the principles involved. As with any new regulation, there will be, with experience, opportunities to deal with unnecessary frictions or unintended consequences. But I certainly take comfort with the stated confidence of the authorities that the rule adopted will be both workable and effective.” A note of caution on regulation in the Economist’s “Overregulated America” where it warns about the difficulty of making cost-effective regulation when it discusses “The home of laissez-faire is being suffocated by excessive and badly written regulation”.

In the Financial Times’ “No end soon to markets’ herd-like moves” John Authers writes that after an annus horribilis last year, active managers are finally delivering some outperformance in January 2012. (But one month does not make a trend!) “There is no great mystery about why fund managers did so badly last year. Correlation between stocks hit record levels. If all stocks rise and fall in unison, it is hard for anyone to outperform.” In January correlations have decreased somewhat making it easier for those looking for mispriced stocks. But (correctly) Authers argues that “Given the cheap “beta” now available, and the superior resources open to those intent on chasing “alpha,” or non-market returns, it will still be hard for active, broadly diversified long-only equity mutual funds to justify their existence.” (And for those who think that the outperformers can justify their existence, to derive a benefit from that outperformance you’ll have to identify them in advance; good luck!) Also in the WSJ’s “In New Year, being more active is thus far good (financial) advice”Sarah Morgan writes “But some fund managers and analysts say this year’s stable market plays into the hands of stock-pickers. After a year of intense volatility, with stocks moving largely in lock-step based on big-picture economic fears, stocks have been less correlated in 2012.” (Good luck again to investors trying to identify future sustained winners in the stock picking game.)

In WSJ’s “The cost of living longer- Much longer”Charles Passy discusses longevity trends, the relative ease of the life insurance availability even for older individuals with medical  histories that would have been uninsurable even 15 years ago and the cost of growing longevity. The longevity impacted amounts in the US are of the order of $27T (including the $1.6T annuity market, $10.5T face value life insurance market, $8.9T IRA and 401(1) markets and $5.6T private and government pension plans). The article suggests that “to prepare for four additional years of life span over current projections, someone who’s 50 years old now would need close to $160,000 beyond his or her current retirement savings to maintain a modest lifestyle, experts say. And increasing a nest egg by that much, assuming historical rates of return and inflation could mean squirreling away an additional $2,500 a year.” “Since 1940, American men have gained about a year of life expectancy — and American women, 1.1 years — with every five-year period.” Experts disagree about the rate at which longevity will be increasing in the future, but some argue that historical longevity increases are not guaranteed to continue at the same rate due to societal and lifestyle (e.g. growing obesity) factors offsetting improvements from medical improvements; some argue that to increase “…average human life beyond 90…medical scientists would have to come up with a way to slow the biological processes of aging itself.” The article also mentions new pure longevity insurance options that have recently become available (e.g. from Hartford and MetLife- sorry none available in Canada) as well as the need to planning retirement to at least age 95 or even 100 (for those with a family history of longevity). (Some of the insurance companies’ interest in selling more life insurance might also be related to the need for hedging their portfolios of annuities.)

And finally, while some seniors might think they are paranoid, others might feel that their retirement finances are under attack! Let me explain. Is the CPI reduction (mentioned in the Personal Finance section above) just another nail in seniors’ financial coffin?  Artificially low government (central bank) mandated interest rates impacting seniors’ fixed income returns (negative returns after inflation, in Canada 2.5% in January, and certainly after taxes), low interest rates are also accelerating disappearance of DB pension plans (due to rapidly escalating liabilities at least partially driven by low discount rates), no protection (no priority for underfunded pension plans) when companies go into bankruptcy to escape pension obligations, the recently proposed OAS ‘savings’ and now proposed CPI reductions. To argue that the CPI (used to index among other things Canadians’ CPP and OAS/GIS) is overestimating inflation is to forget that the CPI value is already lower than actual inflation due to its “quality driven” downward bias (i.e. if a previously optional features in a product were now standard, then the higher new price may not be reflected in the CPI, whether you wanted that feature or not). Furthermore, the basket purchased by seniors is significantly different than the CPI basket and results in seniors experiencing higher inflation than reflected by the CPI (see my Senior Inflation blog) and add to that the fact that wages are typically rising faster than the CPI so seniors will continue to fall behind the rest of the population. And then this past week the Drummond report (which I did not read as yet) was released addressing Ontario’s precarious financial situation and recommended solutions; among the recommendations is that “Prescription drugs for seniors in Ontario should be reviewed”. As the oldest Boomers officially became seniors (aged 65) some paranoid seniors might feel that there is an orchestrated push under way to reduce/eliminate/delegitimize some of the benefits that they were promised and/or they paid for and they counted on as they finally become eligible. An example of what some might consider delegitimization is an article in the USAToday entitled “As senior climb from poverty, young fall in” where Marisol Bello reports that “The ratio of senior-to-child poverty was close in 1980: There were three counties with more than 20% of children living in poverty for every four counties with 20% of seniors in poverty. Now the two are reversed, and the gap has widened considerably. Eight counties have high child poverty for every one that has high senior poverty. Nationally, official Census numbers show 9% of seniors in poverty. Among children, 22% — 15.6 million — live in poverty.” Paranoid or not, if you are a senior it is time to prepare to further tighten your belt.


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