Hot Off the Web- January 23, 2012

Personal Finance and Investments

In the Globe and Mail’s “Your portfolio performance needs a regular check-up” Tom Bradley writes that “Ideally, investors should construct personalized indexes. This default portfolio, or benchmark, would blend the returns from various market indexes in proportion to their particular long-term asset mixes (cash, GICs, bonds, Canadian stocks, foreign stocks). The investors then have something to compare their returns to, and assess how their strategies and hired help have done… the biggest weakness investors have is impatience. They don’t wait long enough for their strategies to play out and as a result, sell when the assets are most attractive. In my view, a proper performance assessment helps foster that much-needed patience.” (If interested in the subject you might want to read an old blog of mine at Benchmarks)

In Registered Rep’s “When you’re 66: A checklist of Social Security and Medicare”Mark Miller tables a checklist for Social Security and Medicare. He writes among other points that “Many seniors worry about the math of lifetime benefits — that is, they fear they won’t live long enough to make delayed filing “pay off.” But those concerns are off the mark… Social Security is built around actuarial principles… to ensure the system pays out fairly among all beneficiaries… But the main value of Social Security is replacement of current income, not accumulation of assets. That’s where filing later can help.”  (i.e. this is where people get confused. Social Security in the U.S. and CPP in Canada is not about maximizing assets at one’s future unknown date of death, but about ‘lifetime’ current income!)

In InvestmentNews’ “Broker fiduciary rule officially in limbo”Mark Schoeff reports that the SEC’s recently issued calendar indicates that the proposal for the much needed ‘fiduciary’ rule for brokers and insurance company product salespeople is now scheduled at ‘to be determined’ date. The brokerage and insurance industry has been fighting tooth and nail to derail this new fiduciary standard of care. If they succeed to delay it past next fall’s presidential/congressional elections they hope that a new administration will kill it for good. (Bad news for U.S. investors, but at least they can go to RIAs for advice with a fiduciary level of care; Canadians don’t have such options.)

In the Globe and Mail’s “Would your finances survive if you couldn’t work?” Angela Self writes about the importance of disability insurance. Such policies are often available as part of your employment benefits with the employer paying some or all of the cost or if one is self-employed one needs to take out an individual policy. Unfortunately the only disability insurance caveat the article mentions is “it’s worthwhile to clarify the terms of your plan with your bank, your financial planner, or insurance company, to confirm exactly what is covered in case of an accident or illness” (The reality is that good disability insurance is not just valuable but essential part of one’s financial risk management plan, but unfortunately reading the fine print of these policies is essential as they are not only expensive but may offer inadequate coverage (covering only 1-2 years of disability, instead of all the way to age 65, have disability definitions which are incompatible with the needs of a professional and too many stories of difficulties of collecting benefits due to aggressive insurance company tactics (as they attempt to protect themselves from potential fraud))

In the Globe and Mail’s “The stock market chart your broker won’t show you” Norman Rothery tables the shocking ‘Total Return of the S&P500 Before and After Inflation’ as the “chart that brokers don’t show you”. He calls inflation the “silent killer” and then adds that “it doesn’t operate alone. It does its dirty work in combination with partners, like taxes and fees that can cut additional slices out of your results.

In DailyFinance’s “Today’s retirement myth: A million dollars is enough” Selena Maranjian suggests a simple means of running a zeroth order calculation of your required retirement numbers (i.e. how much do you need for retirement?). With a 4% withdrawal rate you need 25 times your annual income needs. So for $50,000 required income and no other income sources $1,250,000 would be required; however, if one has $15,000 Social Security and $10,000 other pension income then only $25,000 income needs to be generated from retirement savings and $625,000 would be sufficient. (Thanks to MB for recommending article. By the way, if you are interested in to topic you might wish to look at my blog on the subject after the 2008 market crash What Now? (Oct. 13, 2008)- )

Jamie Golombek in the Financial Post’s “Rethinking asset allocation” and Dan Hallet in the Globe and Mail’s “Should you hold bonds in taxable accounts” tackle the asset location question in our extremely low interest environment. They both question the wisdom of mechanically applying the old rule of thumb in the current low interest environment, which recommends the placement of fixed income assets in RRSP/TFSA tax-deferred/tax-free accounts while placing equities in taxable accounts. Hallet ran some numbers suggesting that for investors in top Canadian tax brackets, it may make sense under some scenarios to place stocks into tax-sheltered accounts and bonds in taxable accounts.

John Heinzl in the Globe and Mail’s “Covered call ETFs: Look before you leap” warns readers that while “income hungry investors are snapping up yield products as fast as marketers can crank them” these products are not the same as fixed income and preferred shares, but come with equity-like risk with only slightly mitigated downside, as well as capped upside. (i.e. don’t include in your fixed income allocation)

James Carney in AdvisorOne’s “Contact prospects with SOS (Second Opinion Service)”suggests that financial advisors consider offering a Second Opinion Service (SOS) not necessarily as just a way of generating revenue, but also as a way of identifying clients with whom to build a long-term business relationship. (A Second Opinion Service could actually be a very valuable service to investors to calibrate their self-managed or advisor-managed portfolios.)

In the Globe and Mails “RRSP vs. TFSA: Tim Cestnick on where to put spare dollars”Tim Cestnick provides a refresher on the trade-offs between RRSPs and TFSAs: “…at its most basic level, the decision between an RRSP and TFSA comes down to your marginal tax rate today and your expected rate in retirement when you start to draw money from the plan. If you expect to have a higher marginal tax rate in retirement than today, then contributions to a TFSA make more sense since you won’t face tax on withdrawals later”…and vice versa. He also mentions some special circumstances when other considerations might govern when TFSAs are preferable to RRSPs, like: if you get OAS/GIS payments withdrawal won’t affect benefits, better for seniors as they have no age restrictions, there are no required minimum annual withdrawals so are preferable if you don’t need the funds.

In Rotman International Journal of Pension Management’s “Three certainties and a speculation: Reflections of a pension professional” 2009 article Don Ezra tables three certainties: (1) “retirement is expensive”, (2) people are better off when lifetime annuities are available, and (3) “investment education has zero chance of making the average person an expert investor”. (I can’t argue with the first assertion. I’d have to qualify the second assertion with “if it was low cost and for people late in life (>75)”, “if it was indexed” and add that it is applicable “for some people”. However the 3rd certainty, authoring a website and blogs on retirement finance education for DIY investors, I find it disconcerting if true and it may well be. (Thanks to Ken Kivenko for recommending the article.)

Even more interesting is Don Ezra’s follow-on 2011 RIJPM article entitled “How should retirees manage investment and longevity risk in a defined contribution world?” in which Don he looks at: three dials people can turn to achieve their lifestyle and bequest objectives in retirement (spending-spend what is required for the desired lifestyle or cut back lifestyle, longevity protection-buy insurance to cover some level of lifetime income or self insure, and investment- use risk-free approach or take investment risk to extend/enhance life/value of assets), at wealth zones (pre-annuitized wealth, essential, lifestyle, bequest and endowed zones similar in spirit to Maslow’s hierarchy of needs pyramid; he measures the boundary between these zones with annuities to remove longevity risk from the analysis), the relative importance of investment risk (higher early in retirement) vs. longevity risk (more important later in retirement), and Ezra concludes with ‘new’ alternatives to annuitizing (pure longevity insurance and GLWBs). (Very interesting read; highly recommended!)

Real Estate

In Palm Beach Post’s “Palm Beach County home sales up 24% in 2011” Kimberly Miller reports that while median home prices were off 15% in 2011 to $193,700 and sales were up 24% in PBC. Only two of 19 regions in Florida (Ft. Myers and Treasure Coast) showed declines in volume for the year. State-wide volume was up 9% while median prices at 131,700 were 3% off previous year. US-wide volume was up 1.7% and median prices at $164,500 were 2.5% off 2010. All-cash sales accounted for 31% of homes purchased nationally in 2010. Condo prices in PBC were 14% down at $77,500 and 2% state-wide at $88,300; condo sales were up 30% in PBC and 15% state-wide. “One looming cloud on the real estate horizon is the shadow inventory of foreclosures destined to hit the market after a long slog through the courts. In Palm Beach County, about 34,820 foreclosure cases are pending. State-wide, there’s an estimated backlog of 260,815 cases.”

In the Globe and Mail’s “Our love affair with home ownership might be doomed” Preet Banerjee quotes Ben Rabidoux’s website on some Canadian real estate stats which warn on Canadians’ infatuation with real estate. “In 1975, the average size of a house in Canada was 1,050 square feet. Fast forward to 2010 and new homes being built almost doubled to an average of 1,950 square feet. This increase in house size is accompanied by a decrease in the average number of people living in a household. In 1971, it was 3.5; by 2006, that number fell by a full person to 2.5. Whereas in 1999 the price of a home was 3.2 times income, this had ballooned to 5.9 times income in 2010… if Canadians approaching retirement age feel as though they haven’t saved enough for retirement, they will likely turn to their fallback plan – downsizing their homes to free up cash… there might be selling pressure for the bigger homes as retirees downsize, they are downsizing into the more modest homes, which provides some buying pressure for smaller houses… throw in the highest debt-to-income ratios in history for the average Canadian and the long-term prospect of interest rates rising…”

In the WSJ’s “Amid squeeze on home equity, a revival of reverse mortgages” AnnaMaria Andriotis reports that reverse mortgage initiations are dramatically up in 2011 over 2010; three top active U.S. reverse mortgage lenders reported 30-200% increases in initiations. While these appear attractive to homeowners, financial advisers generally “recommend them only as a last-gasp way to raise cash… because borrowers are still responsible for property taxes and homeowner’s insurance, if they fall behind, lenders can foreclose on the property… Also, reverse mortgages carry hefty fees. Origination fees can be up to 2% of a home’s value, capped at $6,000, says John Lunde, president of RMI. Closing costs vary but are often about 2% of the loan and there are also mortgage-insurance fees charged by HUD…(some financial planners say that reverse mortgages might make sense) for people in their 80s, who are usually able to convert more home equity into cash than younger borrowers.”


In benefit Canada’s “Is it time to eliminate PBGF?” Fred Vettese the chief actuary of Morneau Shepell and the Province of Ontario’s appointed administrator of the leftovers of Nortel’s pension plans argues that Ontario should do away with the PBGF (which the OECP recommended to be raised from $12,000 to $24,000 only about 3 years ago. His argument being that so few Ontarians still have a pension, so it is not fair to the rest of Ontarians to have to pay for DB plan deficits. (Well, if the PBGF premiums were set correctly, and pension regulations and enforcement were modified to insure that plan sponsor cannot manipulate and minimize contributions by use of actuarial shenanigans, there wouldn’t be pension deficits. So I am with Mr. Vettese on cancelling the PBGF, but only after the necessary regulatory changes are effected and after the Bankruptcy and Insolvency Act (the BIA/CCAA) has been modified to raise priority of trust funded pension underfunding in case of sponsor bankruptcy.)

In the Financial Post’s “MP benefits denounced as ‘rip-off on a massive scale’” Tim Shufelt reports that “The pension plan covering Canada’s federal politicians, which is often criticized for its lavish retirement benefits, is dangerously underfunded… With essentially no assets set aside to fund future benefits, the pension fund for Members of Parliament and senators suffers from a deficit of more than $1-billion, according to a report by the C.D. Howe Institute released Wednesday… Unlike other pension funds, the MP pension does not invest its contributions, but rather pulls a legislated annual return of 10.4% from public coffers… MPs qualify after just six years, minimum retirement age is set at 55, and benefits can reach a maximum of 75% of the best five years’ average pay.” (No wonder MPs don’t see the urgent requirement for pension reform. I suspect Canadians are ready to sign on to this same pension plan; it sounds a lot better than the proposed PRPP for the rest of us. Complete report available at “MPs must lead by example on pension reform”)

In the Financial Post’s “Why Canada’s public pension format is patently unfair”Mark Sutcliffe writes that “The central problem is this: the guaranteed, indexed, defined-benefit format is patently unfair. In a defined benefit pension plan, if the market doesn’t perform, the shortfall has to be made up by someone. In the case of public-sector pension plans, that someone is the taxpayer. So the private-sector worker whose RRSPs or employee pension value takes a hit when the markets drop is then given a second hit: he or she has to chip in to prop up the pension of a retired government worker, who has no such liability. Canadians without pensions or with plans that are susceptible to market conditions are effectively the insurance policy for the public-sector plan. And, thanks to the performance of the markets recently, there’s a huge shortfall right now.”

Things to Ponder

In the Globe and Mail’s “Another theory for the gold run” Simon Avery reports that the dramatic rise of the price of gold in the past decade may not have been driven by fears of currency debasement, but by “financial repression” of emerging market consumers (e.g. India and China allows residents to invest only in local shares and deposit savings in a bank). Between 1999 and 2010 “…a total of 29,342 tons of gold were purchased globally for both investment and jewellery. ETFs accounted for only 2,200 tons, or less than 8 percent and central banks were net sellers.  But retail purchases from emerging markets amounted to more than 23,200 tons, or 79 per cent of total demand, “far and away the primary demand component over this period.” China and India alone accounted for 9,000 tons, which was more than the developed world as a whole purchased, they say.”

And continuing with the “Capitalism in Crisis” series, in the Financial Times’ “The crisis raises legitimate questions about capitalism itself” Pimco’s Mohamed El-Erian sums up last week’s series of articles as “…the crisis in capitalism is caused by two distinct failures: the inability of the system to deliver sustained prosperity through economic growth and jobs; and the perception that it is grossly unfair and socially unjust.” He writes that to fail one of these is a problem but to fail so spectacularly on both is a real “crisis”. He argues that people forgot that finance is not an end in itself but only there to serve the rest of the economy. Developing countries (especially China) were successful in using capitalism to “pull millions of its citizens out of poverty” but that success led to unsustainable imbalances. And “too many of the institutions that are critical for the smooth functioning of capitalism utterly failed to deliver when they were needed most.” El-Erian says that after four years of crisis, none of the problems have been corrected nor have steps been taken to prevent the repeat of such crises.

In the Financial Times’ “Trust no one with your money is the legacy of the crisis” Satyajit Das writes that “The first casualty of war is said to be the truth but, in financial crises, it is trust that dies.” Money instead of being a “mechanism of exchange and a store of value that galvanizes economies” is now being debased through QE and artificially low interest rates. Government bonds which used to offer “risk-free return” now offer “return-free risk” due to threats of sovereign default according to Jim Grant. “Limits of policymakers’ tools”, having been exposed, undermine “trust in money, government bonds and, ironically, central banks.”

John Kay in the Financial Times’ “A real market economy ensures that greed is good” argues that “our intuitions about the merits of scale and centralization are generally wrong” but the market economy is better at identifying products, preferences and prices; it also allows endless experimentation. He then concludes with an example; the difference between North Korea and the U.S. is the “the degree to which the quest for profit is directed towards the creation of new wealth rather than the appropriation of wealth already created by other people”, with a market economy encouraging the former while restricting the “latter through rules and regulations”.

And finally, in the Globe and Mail’s “Low P/E ratios offer ray of hope amid dark outlook” the perma-bear David Rosenberg sees a (half-hearted) ray of hope in lower trailing P/E ratios of 13 and even lower forward ratio of <12. Such low P/E ratios”bolster confidence that this market is unlikely to take a devastating plunge. One could even argue that equities at current levels, with current earnings expectations, are good value.”


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