Hot Off the Web– February 21, 2011

Personal Finance and Investments

Brett Arends in the WSJ’s “Six ways to boost your investment income”includes the following in his list: CD (or GIC for Canadians) ladders, and prepaying expenses (e.g. in an environment of rising prices at 5%, say on non-perishable foods, buy a one year supply and make 5% return) which are essentially risk-free. (Not mentioned is prepayment of your mortgage, is also risk-free. Arends’s other suggestions: TIPS, blue-chip stocks, selective bonds and MLPs are significantly riskier)

In the Financial Post’s “Make advisors work for investors”Edward Waitzer, while discussing the regulatory changes proposed and under way in many other western countries, comments on the unacceptable state of Canadian state of affairs: “The contrast in the direction, speed and intensity of regulatory reform between Canada and other major developed markets raises a number of questions and suggestions. Why did the OSC start down the path of a “best-interest” standard in 2004 and, while others (including the U.K., Europe and Australia) have caught up, we appear to have fallen back to where we started — disclosure requirements and a relatively static “suitability” standard?…What accountability mechanisms are required to motivate a more focused and intense effort? Why is it that Canadian regulators have shied away from proposing a “best-interest” standard? As one commentator to the SEC staff’s study noted, “If the product sold is that of advice, then that advice should be in the best interest of the client. Anything else is fraud, because the seller is delivering a service different from what the consumer thinks he or she is buying.” “

In the Globe and Mail’s “Financial advice without the preaching” Rob Carrick discusses a recent book by Bruce Sellery in which he provides a Priority Pyramid which essentially suggests these priorities to be: cash flow (make sure it’s positive), debt (eliminate it especially credit card debts), savings (are you saving enough?), taxes (taking advantage of RRSP, TSFA?), investment performance (are you matching benchmarks or better question have you minimized costs) and optimizing returns, (Pretty basic stuff…but if you are not doing anything to plan your financial future at least start with this list.)

John Plender in a debate on the risks/merits of equities vs. TIPS for retirement savings in the Financial Times’ “Lessons from the index-linked bonds battle” suggests that “there are lessons to be drawn from both sides. One from the Bodie camp is that they (and their advisers) need to be more aware of the risks in equities and that while equity returns have a tendency to revert to the mean, they can nonetheless remain depressed over long periods. The message to be drawn from Prof Siegel is that inflation-protected bonds need to be treated with extreme caution at today’s prices. My own conclusion: it would be unwise for private savers to stock up heavily on inflation-protected bonds now and barmy to go to 100 per cent.”

Gareth Morgan in the “The naughty savings industry behaviour” describes from a New Zealander’s perspective the “unacceptable conduct of the international life insurance industry” whereby these “companies have migrated techniques perfected in their insurance businesses to the funds management industry with the result that they systematically usurp the savings of the investing public. As a result the returns to savers in products circulated by life insurance firms have fallen well below what the public could reasonably expect. The companies reject any duty of care to those whose savings they control, and treat their customers as unsecured creditors – so far down the food chain that the funds they entrust are seen as there for the plundering.” (Thanks to Ken Kivenko of the Canadian Fund Watch for recommending.)

Andrew Allentuck in the Financial Post’s “Locked-in RRSPs: The grip is loosening”explores changes in the “once-iron-clad rules governing how Canadians get access to locked-in RRSPs”. But still “In most cases, it remains a time-consuming chore filled with paperwork. It is usually necessary to attain age 55, to be very ill and facing death within two years, or to be downright needy and able to prove it. As well, investors with locked-in plans can apply for unlocking for certain sums to avoid eviction from apartments or foreclosure on their home mortgages. The problem of getting money out is compounded by rules that many would say are restrictive and even paternalistic.” ““Getting money out of locked-in plans is getting easier as provinces and territories and the government of Canada amend laws that have, until recently, made it almost impossible to access locked-in funds…”

In the Globe and Mail’s “A tax expert answers your RRSP questions” John Heinzl highlights some topics covered by Jamie Golombek to RRSP/tax questions addressing: limitations on withdrawals from spousal RRSPs (two years beyond contribution year), whether to contribute to RRSP or pay down the mortgage (unlikely that you can get 4% after tax return on a guaranteed investment anywhere other than paying off your mortgage), and penalties (1%/mo) with RRSP over-contributions.

In the Globe and Mail’s “The power of currency fluctuations”Preet Banerjee discusses the importance of currency fluctuations in financial transactions and some services that are available to deal with them. A couple mentioned are currency forward contracts to lock in the current exchange rate for a future transaction and limit orders whereby the service provider will monitor the exchange rate on your behalf and can notify and execute an order should a specified rate be actually reached. (Other available tools are options (that is the right but not obligation) to buy/sell some currency in the future at a specified rate. These tools are not mentioned for purpose of speculation, but rather as a means of risk reduction in preparation for a future financial transaction.)

In the Financial Post’s “Good advice need not be costly”Jonathan Chevreau reviews again various compensation schemes used in the financial industry, the type of advice you might be getting often depends on the product that is sold by the adviser, and concludes with “Rather than paying a full-service broker or fund salesperson, you can contract for it separately by engaging a fee-only financial planner alongside your discount brokerage account. You then end up in the best of all worlds, which is the route I myself ultimately travelled.”

Real Estate

In Barron’s “Up and down Wall Street: Worse than you ever dreamed” Alan Abelson reports that “according to the Realtors’ reckoning, existing-home sales last year declined 5%, to 4.9 million. By CoreLogic’s count, however, existing-home sales totaled a meager 3.6 million, a drop of 12% from the ’09 total. The disparity between the two is also graphically evident in their respective gauges of the size of the inventory of unsold houses. The Realtors figure the overhang is around nine months worth of supply, but CoreLogic counts the visible inventory of homes with a “for sale” out in the front yard at 16 months. Normal is six or seven months…Home prices, meanwhile, have been caught in another downward spiral, reflecting a lack of demand and a huge supply, the bitter fruit of the great bust that followed the wild and woolly boom and a prime victim of the jobless recovery in the economy at large. If current trends persist, those already sharply lower prices, CoreLogic predicts, by spring will be down more than 10% from last year’s comparable stretch.”

In the NYT’s “Housing bubbles are few and far between”Robert Shiller writes that “It will take a while for the housing market to recover fully. Still, many people continue to think of housing as an investment, and so it does seem that we are in danger of encountering another whopper bubble someday. Even so, both the history of land bubbles and the slowness of shifts in public opinion suggest that such bubbles will be fairly rare. Add the new policy restraints, and a new national housing bubble looks even less likely anytime soon. “

In the Globe and Mail’s “Why buying US real estate is still a gamble”Tara Perkins writes that the rising loonie and still falling US real estate prices drive more Canadians to buy US property. But she suggests that there are other considerations to factor into the buying decision, such as: estate taxes, property maintenance costs, property taxes (especially in places where foreigners and even out-of-staters are carrying an unfair share of the tax burden like Florida), potentially still lower prices and staying low for a while, and large unsold inventory. These considerations are even more important for investors rather than those who buy personal use property, given their differing intentions and measures of success.

For those who think of timeshares as real estate, in the WSJ’s “Dumping timeshares”Al Lewis reports that Marriott is spinning of its recession ravaged timeshare business. “The dirty secret of the timeshare industry is that anybody who buys one from a developer has simply been the victim of an aggressive sales seminar. Go online and find thousands of timeshare owners trying to sell their timeshares for a fraction of what they paid — many priced at $1.These buyers placed a bet that they would be able to take a vacation every year for the rest of their lives. They didn’t expect a recession, unemployment, illness, divorce or any other calamity. They didn’t foresee gasoline and airfare prices spiking so high that they couldn’t reasonably get to their dream destinations. Now they’re stuck paying rising fees.

Pensions

In the WSJ’s “Boomers find 401(k) plans come up short”E.S. Browning reports that according to a Federal Reserve study, assuming that an 85% replacement rate (which is not my favorite metric, but it does get the message across) is required,  “The median household headed by a person aged 60 to 62 with a 401(k) account has less than one-quarter of what is needed in that account to maintain its standard of living in retirement…Facing shortfalls, many people are postponing retirement, moving to cheaper housing, buying less-expensive food, cutting back on travel, taking bigger risks with their investments and making other sacrifices they never imagined.” The article suggests that the DB to DC switch, which was a license to print money for money-mismanagement firms and an opportunity to reduce pension expenses for employers, is turning into a disaster for Americans. People don’t understand that 6% contribution with a 3% employer match is well below the minimum of 12-15% recommended by Vanguard. (In Canada, with CPP/OAS maxing out at about $16,000/person instead of $26,000 for US Social Security, you can expect an even worst picture; the combination of lower government pensions and much higher investment management fees will likely require aiming to closer to 20%+ level of savings to achieve replacement rates.)

Things to Ponder

In the Financial Times’ “Gold will keep its shine this year” Jack Farchy writes that “With the consensus among analysts growing ever more cautious on the outlook for the gold price this year, gold bears (and bugs) need to pay attention to developments in China. Some of the biggest physical bullion traders, who see the strength of demand from China (and much of the rest of Asia) are finding the bearish views hard to swallow. .. (but) It is a well-worn dictum that investor appetite for gold moves in an inverse relationship with real interest rates. When real rates are low or negative (ie when inflation is near or higher than interest rates) gold benefits as the opportunity cost of holding it is relatively low, and its properties as a wealth-preserver come to the fore. With investors bringing forward their expectations for when central banks in the US, eurozone and the UK will raise rates, gold demand in those countries could suffer.”

Christie and Katz in Bloomberg’s “Hedge funds may pose systemic risk in crisis” write that “Hedge funds and insurers might threaten U.S. economic stability in a time of crisis, according to a report aimed at helping regulators decide which non-bank financial companies warrant Federal Reserve supervision. An exodus of hedge-fund investors could “cause activity in some markets to freeze,” said the Feb. 3 report by staff of the Financial Stability Oversight Council. The report, obtained by Bloomberg News, also said the failure of a large insurance company could “result in dramatic and destabilizing actions being taken by investors.”” (Recommended by CFA Financial Newsbriefs)

Jessica Holzer in WSJ’s “Panel proposes regulatory responses to Flash-Crash” reports on the “flash-crash” panel’s recommendations which include:”limit up/limit down” system, elimination of “stub quotes”. “We cannot overstate the importance of addressing the most pressing issues highlighted here,” the report said. “The net effect of that day was a challenge to investors’ confidence in the markets.”

In WSJ’s “Split in economy keeps lid on prices”Hilsenrath and Lahart report that US consumer prices increased 1.6% in January  YoY due to goods increasing 2.2% and services 1.2%, the latter representing 67% of consumer spending. The Fed is betting that commodity driven increases in prices of goods will not spill over into services, as it did in the 70s, because of still high unemployment and challenging housing markets.

In the Financial Times’ “Sharper teeth for financial watchdogs”Brooke Masters reports that “UK financial watchdogs will be given powers to ban retail products and warn investors about pending enforcement actions when the Financial Services Authority is broken into three bodies late next year.” (The UK is ahead and moving faster to protect investors and retirees than Canada…why is that so?)

In the Globe and Mail’s “At the Fed, new inflation worries surface” Kevin Carmichael writes that “The Labor Department’s producer price index, a measure of wholesale costs, rose for the seventh consecutive month in January on higher commodity prices. The core measure, which subtracts food and energy prices, rose 0.5 per cent, the biggest one-month increase since October, 2008.“This should add to investor concerns about inflation driven by commodity prices,”…The Fed minutes indicated that it’s only a “few” members of the FOMC who have serious concerns about inflation. But that’s more than at most policy discussions last year.”

Diana Henriques’s NYT article “From prison, Madoff says ‘Banks had to know’” reports that in an interview Madoff  “asserted that unidentified banks and hedge funds were somehow “complicit” in his elaborate fraud, an about-face from earlier claims that he was the only person involved”. But Ann Woolner in “Madoff credibility ends when his mouth moves”writes that “Whether “should have known” turns out to be as powerful as “knew” in this case remains to be seen. Unless Picard can prove that JPMorgan was either truly complicit or seriously suspicious, he’ll have a tough time getting the full $6.4 billion he seeks from the bank.” (Difficult to believe that anyone would believe anything said by such deceitful liar who destroyed the lives of thousands of individuals and charitable capability of dozens of institutions?!?)

Noah Buhayar in Bloomberg’s “US Variable-annuity sales increase as Prudential, MetLife report gains” reports that VA sales increased from $33B to $38.5B in the fourth quarter YoY.  VAs are high cost GMWB-like structured products (see my GMWB I , GMWB IIblogs) sold to conservative investors, promising lifetime guaranteed minimum payments with hopes of participation in market upside. (These are great products for the insurance companies and their salespeople; not so great for the wealth of the buyers of these products. As the saying goes, buy their stock rather than the product.)

In Tom Bradley’s Globe and Mail article “Risk-free?” Be careful what you wish for”you might not agree with some or most of what he writes, but you have to respect his final point that “in pursuit of safety, you should be careful what you wish for. You may end up with risk-free returns”.

And finally, in the Financial Times’ “Research finds reason for active fund managers” John Authers reviews a recent research paper on active fund management which validates the need for active managers to help keep the efficient. His summary is that “Markets are not perfect. They have inefficiencies, which passive investors cannot exploit. Therefore it is rational to devote money to active managers to go out and find those stocks that are selling too cheap. The problem becomes decreasing returns to scale. The more active managers there are, the less the chance they will find juicy mispricings…. As the industry grew, active managers dominated. Then they grew too big and pushed against diminishing returns, so passive indexing grew. Collective action problems mean that active management’s share of the pie continues to be greater than it should. What does this mean for savers? The arguments for index funds remain overwhelming. Yes, as index funds grow, they will create more opportunities for active managers. Active management will never go away. But when you entrust money to an active manager, make sure it is one with a specific plan to exploit a market inefficiency – not one just hanging on in hope that others will give up first. (Good luck in finding the winners a priori.)