Hot Off the Web- December 22, 2009

Personal Finance and Investments

Ken Kivenko in the‘s “Asset location” discusses the importance of the type of accounts that assets are placed from the perspective of taxes. Kivenko’s subtitle is ‘It’s not what you make that counts- It’s what you keep!’. He starts off discussing numerous examples of advisor errors (or intentional misplacements) which result in extra commission for advisor and additional damage for investors. He also explains the advantages of placing highly taxed fixed income securities in tax-sheltered accounts (RRSP/RRIF/TFSA), placing equities and earning dividends in taxable accounts and the disadvantages of accumulating capital gains in tax-deferred accounts (RRSP/RRIF). He is also careful to point out that tax considerations should not be driving asset allocation, which should first be done independently of asset location considerations.

In Financial Post’s “More employers are considering annuities in 401(k) plans, survey finds” Jonathan Chevreau reports on the growing number of employers to offer annuities as investment options in 401(k)’s. Pension expert Mark Warshawsky is quoted as suggesting that employees attitude to annuities maybe changing due to the heightened sensitivity to risk. (If the annuities are priced fairly and without onerous fees, they may be a good option to have as part of DC plans.)

Fortune’s Geoff Colvin interviews Pimco’s “Mohamed El-Arian: Tough times ahead”.El-Arian’s asset allocation for U.S. based investors is quite interesting and a lot different than what you might typically find recommended. It is 49% equities (15% US, 15% other developed, 12% emerging markets, 7% private equity), 14% bonds (5% US, 9% international), 28% real assets (real estate 6%, commodities 12%, inflation protected bonds 5%, infrastructure 5%), and 9% special opportunities (carbon credits, distressed debt).

For those looking for a fee-only advisor, provides a list that you could use to start your search from, in “Where to find a fee-only financial advisor”. Remember that fee-only does not necessarily mean hourly fees (though some may offer that option as well, in which case you might want to give it serious consideration), more often than not this refers to a percentage of the assets under management; fee only is always better than commissioned sales model that most advisors offer.

WSJ’s Kelly Greene looks at some of the trade-offs of taking Social Security early or late in “62 or 70? When to take Social Security”. Some advisers consider delaying Social Security as a no-brainer for those expecting to live longer than average and don’t need the money immediately. (I agree, since it is almost impossible to purchase a reasonably priced inflation indexed annuity on the market, so this is a cheap way of acquiring inflation indexed longevity insurance.) Greene also explains the advantages of delaying the higher paid spouse’s Social Security, as a means of maximizing the lower earner spouse’s survivor benefits. Other consideration is whether one continues to work while taking early Social Security, as there are some claw-backs to factor in.

Jane Kim in WSJ’s “Revival of managed payout” reviews various managed payout products which “help investors turn savings into (unguaranteed) steady pay-checks.” Some of the products mentioned, among others, are Pimco’s two new real income funds (investing in TIPS), Prudential’s target date funds with guarantees (guarantees are expensive), BlackRock with MetLife plan which gradually increases the allocation to deferred annuities as one gets closer to retirement, Vanguard’s 3%, 5% and 7% managed payout funds. (Unfortunately none of these are available to Canadians as they are U.S. mutual funds, but you can build your own, using your personal asset allocation and your own systematic withdrawal which you could model on Vanguard’s managed payout funds.)

Real Estate

Hagerty and Timiraos in WSJ’s “Debtor’s dilemma: Pay the mortgage or walk away” report on the “growing number of people in Arizona, California, Florida and Nevada, where home prices have plunged, are considering what is known as a “strategic default,” walking away from their mortgages not out of necessity but because they believe it is in their best financial interests.” There is also discussion of the ethical considerations of walking away when the homeowner can afford to pay. They mention that a recent study suggests that perhaps 25% of the defaults fall in to this “strategic default” category. Those who do walk away, will have reduced credit scores which are impacted for seven years, resulting in reduced ability to borrow or buy on credit and having to pay higher interest rates. Some states allow banks to pursue other assets of defaulters. So there are many ethical and financial considerations in making a “strategic default” decision. (In Canada, unlike in the U.S., I believe the bank always has recourse to assets other than the mortgaged home.)


Rob Gerlsbeck in MoneySense’s “The top 22 pensions in danger”rates 181 Canadian companies’ defined benefit pension plans as “safe”, “on alert” or in “danger”. “Since your pension is most at risk if your company goes bankrupt while your plan is underfunded, we based our rating system on just two numbers: the percentage by which a plan is underfunded, and the risk that the company will go bankrupt.” Some of the larger companies on the “danger” list that you will readily recognize are: Bombardier, Extendicare, Rio Can Real Estate. The author correctly suggests that his list is only a starting point for your effort in trying to determine the safety of your DB plan. (Thanks to SI for bringing this article to my attention.)

This past weekend’s Whitehorse (not Yellowknife as I have erroneously indicated before) pension summit held by federal and provincial finance ministers ended not with a bang but a whimper. I guess my expectations were way too high despite knowing that Prof. Jack Mintz, the selected pension research director by Mr Flaherty and Menzies, “knew” that Canada’s pension system was not in crisis even before he was appointed as head of pension research in May 2009 (see his Financial Post April 21, 2009 opinion piece “Jack Mintz: Beware of super pension fund”. Some observers even suggested that he may have been selected because of his previously articulated views on Canada’s pensions.) The scary thing is not that Mr. Mintz has not changed his mind (his December 18, 2009 Financial Post article is entitled “Jack Mintz: No pension crisis”) after spending six months bootstrapping himself on pensions, but  that he has not changed his mind despite the data he presented in his report. Though the scariest part is to read The Globe and Mail’s David Ebner’s interpretation of the finance ministers’ consensus that “Finance ministers reject claims that pension system in crisis”

As expected Jack Mintz’s report on pension concludes that all is well with pensions; well the data he presented (even though he indicates that it’s not complete) doesn’t actually say that. What it says that Canada’s pension system does a great job for preventing poverty (we have the lowest poverty rate in all OECD countries, 4.4%), but performs inadequately for moderate to high income Canadians (those who are paying no doubt over 80% of the taxes). More studies and public consultation are planned before the next ministers’ meeting on pensions set for May, when recommendations may be expected. You can read Mr. Mintz’s 28 page report entitled Summary Report on Retirement Income Adequacy; it contains no recommendations (he calls it “policy-neutral”). You may prefer to read a (very generous) two page summary with recommendations by Rotman School’s “Ambachtsheer on the Mintz and Baldwin reports”. (I will summarize my take on the report, after I feel in a more generous spirit, in the next week or so.)

You can read other views on Canada’s pension system and Mr. Mintz’s (federal) and Mr. Baldwin’s (Ontario) reports in:

– the Toronto Star’s Paul Moist article “Creaking pension system is failing Canadians”“Canada’s pension system is inadequate and lags behind other advanced industrial countries in providing decent income security for retired workers. It’s time to catch up.”

– the Globe and Mail’s Janet McFarland’s “Lower living standard looms for many high-income Canadians”“The status quo is an option,” the report says. “However, it is an option that may leave a significant minority of people with moderate to high earnings facing a decline in their standard of living in retirement, and force many people to rely on sub-optimal pension and retirement savings institutions.”

– the Financial Post’s Scott Perkin’s “Let the people save”  “we face significant challenges. But stampeding to apparently simple or “one-size-fits-all” solutions is not the answer. “

-The Globe and Mail’s Jon Kesselman’s “Who will pay to end the looming pension crisis?”“The spoils of this conflict are clear: whether the income security of future Canadian retirees will be ensured by private markets and individual choices, or by public programs and collective choices. The impending battle will be intense, because vested interests and entrenched ideologies are implicated. Already, the various forces can be seen taking their positions.”

Another pension related article is Laurin and Robson’s Globe and Mail piece entitled “Ottawa’s real pension debt” . They argue that if the federal government valued its pension plan liabilities by the same methodology as used for private sector plans, “the pension obligations would have been $58B higher”! If the Federal government values future pension obligations by using equity returns based discount rate, then Messrs. Laurin and Robson are absolutely right. If it makes sense to use expected return on assets, to discount liabilities, would then suggest the use and even more aggressive portfolio (of course with even greater volatility) to reduce liabilities even more? Sounds like lunacy? It is. Returns on real return bonds (as suggested by Laurin and Robson) of similar maturities to liabilities, sound like the correct discount rate for inflation indexed public pension plan liabilities. (Cooking the books and/or under-contributing to the pension plan? Time will tell.)

Things to Ponder

You may want to pay attention to John Dizard’s question in the Financial Times that “Debt default in a developed country is unthinkable-or is it?” . He reminds readers of “A developed, advanced, government-of-laws-not-men such as that of the US could repudiate its debt, and it did so in 1933. In March of that year, the US passed a law effectively repudiating the “gold clause”, incorporated in public and private bond documentation, that promised payment in currency equivalent to a fixed mass of gold”. He then asks, what if any remedies may be available if an EU member state (Greece?) would default on its Euro bonds.

Javier Blas in the Financial Times’ “Gold on the flip side” list the numerous signs of gold frenzy visible not just among retail investors, but also governments and sophisticated hedge fund managers resulting in price breaking the $1,200 barrier (though it has fallen under $1,100 over the last couple of days). But after adjusting for inflation, gold still hasn’t hit the 1980 peak of $2,000 in 2009 dollars. Still some consider gold to be in a bubble and we should expect a correction. According to Nouriel Roubini “The only scenario where gold should rapidly rise in value is one where fiat [official] currencies are rapidly debased via inflation.” At the moment, however, there are “more deflationary than inflationary forces in the global economy”. Warren Buffett also doesn’t believe in gold as an investment. People have difficulty valuing gold; “apart from its price appreciation, it yields no return.” Today’s extremely low interest environment makes the opportunity cost of holding gold very low, but if interest rates start rising, it could be an expensive proposition. Still with supply from mines having peaked in 2000 and new sources of demand having emerged (investors allocating fixed percentage of their portfolios to gold, massive buying via gold ETFs, governments stopped selling and started buying instead, etc), it is difficult to argue with those who see continuing price appreciation, given this demand-supply situation.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: