Hot Off the Web– November 22, 2010

Personal Finance and Investments

In a must read article, Burton Malkiel’s WSJ “’Buy and hold’ is still a winner”he explains why the ‘buy-and-hold’ obit writers are just the latest of a long line of misguided souls. “While no one can time the market, two timeless techniques can help.”Dollar-cost averaging,” putting the same amount of money into the market at regular intervals, implies investing some money when stocks are high, but also ensures some buying at market bottoms. More shares are bought when prices are low, thus lowering average costs.  The other useful technique is “rebalancing,” keeping the portfolio asset allocation consistent with the investor’s risk tolerance.”  He also very eloquently explains the value of low cost indexing and the advantage diversified stock/bond portfolio. “The recommended index-fund portfolios contain bonds, U.S. stocks, foreign stocks (including those from emerging markets) and real-estate securities. The diversified portfolio, annually rebalanced, produced a satisfactory return ($100,000 in 2000 grew to $191,859 by Y-E 2009, while 100% invested in U.S. stocks became $93,717) even during one of the worst decades investors have ever experienced. And if the investor also used dollar-cost averaging to add small amounts to the portfolio consistently over time, the results would have been even better.“ So there you have it from Burton Malkiel: low-cost, regularly re-balanced diversified portfolio, and if you are in the accumulation portion of your lifecycle, then dollar cost averaging makes things even better. Sounds (and is) pretty simple time tested formula! (For Canadians it’s a little more complicated since they don’t have access to a low-cost diversified Vanguard-like portfolio like the Americans do, so must build your own from a few ETFs.)

Tim Cestnick in the Globe and Mail’s “Tried and true tips for saving on tax” lists more tax-saving ideas for Canadians: place highly taxed investments (interest and non-Canadian dividend payers)  in tax-sheltered (RRSP/TFSA) accounts to the extent possible, pay off non-deductible interest with cash and/or investments and borrow to invest, trigger capital gains in low income years or when you have capital losses to offset, and trigger capital losses if you had claimed capital gains in previous three years, etc.

In the Globe and Mail’s “Investment roadmap can keep you on track” Dianne Maley discusses the value that a financial planner can add when she delivers an Investment Policy Statement (IPS) as part of the planning process. (If your advisor doesn’t know what an IPS is, you might consider getting one that does. A so called “know your client” form doesn’t cut it as a plan.) The IPS includes an explicit statement of your objectives and a roadmap of how to get there for both you and your advisor. It includes: required returns, savings rates, risk tolerance, asset allocation and a corresponding portfolio implementation, expected returns and method of operation for both you and the planner, including review process.

In the Financial Post’s “Your TFSA mysteries solved” Jonathan Chevreau answers questions on TFSA’s, like: if you had placed $5,000 in TFSA and it grew to $10,000 you can then withdraw the $10,000 and the following year you’ll have the $15,000 contribution room, and that you can make in-kind contributions so long as they are securities of publicly traded companies (but handle with care as you might trigger capital gains in the process; you also have to be careful with capital losses as these would be lost forever), etc

JT asked for some comments on Rob Carrick’s “A blueprint for monthly yield” and how to approach DIY investing if you may not have the temperament and/or experience to completely go at it solo. I am weary in general of significant commitment high dividend funds because they tend to be less diversified, their price is at least in part determined by their yields and the current low interest rate environment, when interest rates go up their attractiveness will fade, and I personally wouldn’t want to determine my spend-rate based on the monthly income delivered by these funds. My approach is to allocate the necessary funds to meet my expenses for the coming year and then check at year end if I succeeded or not to stay within the planned spending allocation. Those DIY investors who are reluctant to go completely solo, might consider hiring a fee-only financial planner to generate an Investment Policy Statement (including asset allocation and a low cost. 0.1-0.5% MER ETF-based implementation) and then DIY-er could implement and rebalance annually via her online brokerage account, and perhaps pay a visit to the planner for a check-up after 2-3 years.

Steve Vernon in “Retirement drawdown: Tips to make the 4% rule work” discusses withdrawal strategies in retirement and evolutions to the old 4% rule, i.e. which looks at the probability of not running out of money for certain asset allocations if you are drawing 4% of assets in year #1 followed by annual increases corresponding with inflation. (The reality is that expecting to set such a plan in motion and expecting it to be effective over a 25-40 year retirement is just not realistic. The key word is flexibility. One way to be flexible is to allow some year to year variability in income (as long as one is not against the wall and must annuitize due to high spend rate relative to assets).Otherwise a good approach is the 4-5% of previous year’s assets method (which is a form of ‘managed payout’). For example see my GMWB IIblog where a payout of 5% of previous year’s assets is used with a balanced portfolio of 7.5% return and 7.5% standard deviation (the second pair of graphs in the blog). If you want to be more conservative you can use 4.5% of previous year’s assets. Your annual withdrawals will have some volatility, but you will have access to all of your capital and you know that you’ll never run out of money since you are drawing 4-5% of what are remaining assets.) (Thanks to VP for suggesting the article)

Preet Banerjee in the Globe and Mail’s “Protect your biggest asset: your future income”discusses the importance of life and disability insurance during your working years to protect your earning power (human capital) as you are building up your assets (financial capital) on the way to retirement. (To meet life insurance needs, for most, term life is the appropriate choice. For disability insurance things get a little more complicated, an you need to make sure you understand what type of coverage you are buying/getting, how you qualify for benefits, and is it for: for 1-2 years, to age 65, for life? And, what type of work must you be not able to do to continue to qualify for the benefits (your old job or one in your office building’s mailroom?)

In the NYT’s “Dear SEC, please make brokers accountable to customers” Tara Siegel Bernard writes an open letter to SEC Chair Mary Shapiro who is working on a recommendation whether the same set of fiduciary standards that apply to financial planners (who in the US, not Canada, already have a fiduciary duty) should apply to brokers and insurance salespersons; specifically that they all should be required to put their “customers’ interests before their own”. The letter is an unequivocal- the answer is yes. (And Canada needs this even more, since even financial planners don’t have explicit fiduciary responsibility. You might also be interested in reading Tara Siegel Bernard’s earlier article on the subject “Will you be my fiduciary?”, where she suggests a specific mechanisms to extract a  commitment for a fiduciary relationship.)

Real Estate

In USA Today’s “Foreclosures hit homeowners not in default” Stephanie Armour reports on the growing problem of “foreclosures against homeowners who are not in legal default”. Specifically, in situations when banks file foreclosure papers erroneously and then they tack “on excessive fees that can drive borrowers into foreclosure”.

Pensions

Jonathan Chevreau reports on the emerging debate in Canada on raising the eligibility age for unreduced government pension (CPP) from 65 to 67 in the Financial Post’s “Is 70 the new 65?”. You can also hear a 5 minute interview with “Keith Ambachtsheer on CBC: CPP expansion talks should also address raising retirement age” on the subject. (Thanks to KK for recommending interview.) Around the globe a big move is under way to increase the age at which one might be entitled to government pensions (see e.g. “Retire in France at age 62? In Turkey, it’s 45”). In the interest of getting all the facts on the table, Bernard Dussault, past Chief Actuary for the CPP, points out the following: “Current CPP contributors pay too much (9.9% rather than 5.5%) to the CPP because their predecessors: did not pay enough into it (3.6% for 20 year, increased to 6% by 1996, etc.) and got full accrual of benefit rights after 10 rather than 47 years.” He then asks: “Why would/should we consider penalizing further the current contributors by increasing the pensionable age? The 9.9% remains somewhat sufficient to afford the payment of pensions commencing at age 65.”

In the NYT’s “As the payouts rise, new tactics by U.S. pension insurer”Mary Williams Walsh reports that U.S. government run Pension Benefit Guaranty Corporation (which protect private sector DB pensions up to about $55,000 per year; in Canada only Ontario has a program of this nature and it has a maximum benefit of $12,000 a year) “is using new legal tools to make hobbled companies carry more of the burden and protect itself. (In Canada Federal and Provincial governments have been studying and soliciting input on the pension issue for years with absolutely zero action so far, yet the most painless solution is to either grant priority to pension plan underfunding or provide an insurance pool to cover pensioner losses in case of sponsor bankruptcy; see next article below on government inaction in Canada.) (Thanks to MB for recommending article)

The Toronto Star editorial “Pension reform: Governments need to move” pretty much tells it the way it is on the subject of the Canadian governments’ lack of action to resolve (what I believe is) the “systemic failure” of Canada’s private sector pensions. “Politicians, preferring talk to action, are reflexively reluctant to lead on pension issues. Public consultations have dragged on for years.”

In my October 25, 2010 Hot Off the Web blog, I addressed what I considered a bizarre posting at the NRPC (Nortel Pensioners’ and other victims of this bankruptcy) website entitled “Nortel pension funds NOT mismanaged”, of a letter by CAW legal counsel Barry Wadsworth who tries to argue that Nortel’s pension funds were not mismanaged. Arguments in support of the thesis included that the plan could not have been mismanaged since neither the FSCO nor the government brought charges against Nortel. (Sorry, I don’t buy the arguments. The plan is claimed to be 64% funded (yet to be confirmed by the new administrator) didn’t get so without the mismanagement by some or all of those responsible for insuring proper running of the plan, like: Nortel, the administrators (its Board/Officers), actuaries (Mercer), investment manager and custodian (Northern Trust), regulator (FSCO), government (federal and provincial), etc….I also indicated that not only don’t I buy Wadsworth’s arguments, but it is strange that such a letter would be posted without comments from the pensioners’ representatives. It’s nobody’s fault; everybody was just following rules/orders!?! (The following section was added on November 19, 2010) In the interest of helping to engage in a more serious discussion on the subject of mismanagement of the Nortel plan, on November 19, 2010 I replaced the ‘monkeys’ comment with the following reference to an earlier blog discussing the failure of some or all of those who were responsible for and/or benefited from having been involved in the management or oversight of the plan, and who as part of their involvement as fiduciaries, professionals, and/or  regulators, could have prevented the disastrous outcome, but obviously didn’t, at least so far; since the bankruptcy, one could have added others to the list of those who had the opportunity, but so far failed the pension plan beneficiaries like: the lawyers, the judges and the federal/provincial governments and politicians now in power. If interested, you might wish to read one of my old blogs on this subject entitled Systemic Failure in Canada’s Private Pensions: Who could have prevented it? What could be done now? ; it gives a hint why the Nortel pension plan didn’t become accidentally underfunded by about 40%.

Things to Ponder

Harding and Rappeport in the Financial Times’ “Core US inflation slowest on record” report on the latest consumer price data showing that “US prices (excluding food and energy- items which most of us don’t buy J) are rising at their slowest pace since records began (0.6% year-on-year), bolstering the case for the Federal Reserve to complete the planned $600Bn in asset purchases”. The article points to the “divide between the US…and developing countries where rising commodity prices mean that inflation is becoming a serious concern”; China is up t 4.4% and Korea up 4.1% year-on-year. Other concerns in the US are high unemployment (9.6%) and continuing housing glut.

In the Globe and Mail’s “A world of predictable erroneous predictions” Neil Reynolds discusses Dan Gardiner’s new book “Future Babble: Why Expert Predictions Fail”which he calls both disturbing and funny as it documents “the vast human capacity for cognitive error: In other words, the dumb mistake”. “Mr. Gardner argues that people are psychologically wired to seek certainty – which explains the rush to experts who purport to discern the imminent approach of End Times. When one apocalyptic oracle gets it wrong, another arises. For the current generation, the Armageddon is environmental.” (How could we humans predict the future, when we can’t even agree on history?)

And finally, given that it is November and it’s time for the snowbirds to head south, William Hanley provides a much needed snowbird checklist in the Financial Post’s “Checklist for the snowbird shuffle south”. Hanley concludes his article with “Meantime, we always thank the retirement gods for being able to be snowbirds, for having the wherewithal to head to our little piece of paradise each year. We won’t be able to do it forever because our reserves of money and energy will eventually dwindle. Till then, though, we’ll plan on it. “