Hot Off the Web– March 23, 2010

Personal Finance and Investments

In the Journal of Financial Planning magazine’s “Unsafe at any speed? The designed-in risk of target-date glide-paths”Zvi Bodie et al say that despite the fact that U.S. Department of Labor allows target-date funds as an investment default in 401(k), their recent poor performance has resulted in a review of their suitability. The paper (a little technical) explains that the risk is determined by these funds’ glide-path, which is the changing allocation to risky assets like equities as the investor approaches retirement. One of the key problems is the lack of a standardized definition of risk; for example they look at over almost two dozen 2010 target date funds (i.e. whose asset allocation is intended for those retiring in 2010) and the found that their equity allocation ranges from 27 to72%. The authors discuss target-date funds in terms analogous to the terms used by Ralph Nader in “Unsafe at Any Speed” regarding automobiles in the 60s. Dr. Bodie, an advocate for TIPS focused portfolio for retirement assets, argues that target date fund glide-paths are based on fallacies: stocks are a hedge against inflation, time diversification, and probability statistics as a measure of risk. These fallacies in combination with lack of standardization and disclosure could lead to investors moving from more safe to less safe funds. The remedies they suggest include: disclosure of fund objectives and standardization of risk measures. When Zvi Bodie speaks we should all listen, his experience and insight should not be dismissed. Target-date funds failed to deliver on expectations of retirees in the last couple of years.

In the WSJ’s “A hot job for hard times: The life insurance agent”Leslie Scism reports on the re-emergence of the life-insurance agent and of “whole-life” policies. “The 1980s brought a proliferation of mutual funds, giving families an alternative way to put away money for the future, and term-insurance policies, with lower premiums. For agents, the lower premiums also meant smaller commissions. And consumers soon began pricing term insurance on the Internet to find rock-bottom rates….One factor turning this around is the way insurers’ core product, whole life, came through the financial crisis. Competing term insurance, priced much lower, was sold on the pitch “Buy term and invest the difference.” But when stocks plunged early on in the financial crisis, “invest the difference” sometimes meant “lose the difference.” By contrast, money paid for whole life was still there.” Time will tell if the dogs will eat the dog-food (i.e. whole-life policies will catch on) or this is just a temporary re-minting of unemployed real estate agents into life insurance agents, until a better job comes along. (I still haven’t heard anything new as to why most people would not continue to get their protection by term-life policies, but perhaps we will.0

Janet McFarland in Globe and Mail’s “Canadians need to save more: Dodge” reports that “people earning $61,270 a year and retiring at age 65 must save 14 per cent of their annual income consistently from age 30 to have retirement incomes equal to 70 per cent of their preretirement incomes. They must save 11 per cent annually to have a 60-per-cent income replacement rate. For people earning over $150,000 a year, the savings rate climbs to 21 per cent of annual income to earn a 70-per-cent replacement rate when retiring at age 65. Such a savings level is not allowed under current RRSP contribution rules.” Other articles on the C.D. Howe report by David Dodge et al that you might want to read are “Generating 70% replacement ratio to retire at 65 requires 35 years of saving 10-21% of income” and “What level of ‘pensions’ do Canadians really want?”. These findings are not that dissimilar from the calculation I have given under the Planning section of the Education tab using different assumptions which also include expected salary increases through one’s working life. But, it’s not about ‘income’ but ‘expenses’. So it would make a lot more sense to base the financial plan on expected spending levels in retirement, derived from the tracking of spending levels during working years (with adjustment for expected changes in expense levels in retirement like no savings, no children’s education cost, hopefully no mortgage, but perhaps a higher travel and entertainment budget), rather than using some percent of annual income. Kotlikoff’s “Spend ‘Til the End”advocates an approach of “consumption smoothing” throughout life.

In WSJ’s “Do you have enough to retire?  Do the math” Brett Arends looks at simplified calculation on how to calculate how much you need to retire.  His steps are: (1) target is “take your current gross income, and deduct the costs you no longer expect to have once you are retired”, (2) estimate various sources of income in retirement such as expected social security (CPP/OAS in Canada), pensions and other income, (3) subtract all income from target and multiply by 20 (by 25 for more conservative types)

Pensions

In the Star’s “Think you’ve got a pension? Well, you’d better think again” Milevsky and Macqueen challenge readers that even people who think that have a “pension”, like a DC plan, might be in for a surprise. True pension plans are a lifetime guaranteed income; everything else might be a triumph of hope over reality. (Public servants need not worry. Thanks to Ken Kivenko for forwarding to me.)

Real Estate

James Hagerty in WSJ’s “Supply of foreclosed home on the rise” reports that 4.6% increase in U.S. foreclosed home inventory in January, is a signal of “further downward pressure on home prices in some parts of the U.S.”

The Financial Post’s Peter Foster in “CREA’s multiple coffer service”argues that “In theory, rising prices should bring more sellers into the market. However, one factor that holds sellers back is the extortionate commission fees dictated by the Canadian Real Estate Association…. The Competition Bureau “has determined that CREA’s rules restrict the ability of consumers to choose the real estate services they want, forcing them to pay for services they do not need. “

Things to Ponder

In NYT’s “Stressful but vital: Choosing a nursing home” Walecia Konrad looks at dealing with “one of the hardest decisions you’ll ever make”, the selection of a nursing home for a loved one. While the leads for information sources provided are all U.S. based, a lot of the generic advice is universally applicable. “Finding a good nursing home takes research and perseverance. You want a safe, engaging and pleasant environment with caring staff and solid medical practices. … Unfortunately, the typical search for a nursing home is made under duress. More than 60 percent of admissions come from hospitals.” The suggests a combination of: public ratings data, repeated visits to the short-listed homes (observing, smelling, interviewing, getting leads/views from clergy/doctors/friends/family, ask about “person-centered care” and “consistent assignment” practices, and staff turnover).

Paul Vieira in the Financial Post’s “Inflation surprise spurs rate speculation” reports that with core inflation rate of 2.1% in February (above the Bank of Canada’s 2% target) and strong retail sales, there is a “risk” of higher interest rates earlier than anticipates before this new data. The Canadian dollar also was less than one cent of parity with the U.S. dollar.

In WSJ’s “Market failure or government failure?” Allan Meltzer argues that government was not the saviour in the recent financial meltdown, in fact government was the cause by its actions and inactions such as: disastrous mortgage and housing policy, allowing Lehman to fail, “too-big-to-fail” policy encouraged complacency of bankers. Inadequate regulations and inadequate enforcement are the problem. He concludes with “Capitalists make errors, but left alone, markets punish such errors.”

Gina Chon in WSJ’s “An alternative to ‘alternative’ assets” looks at “new” approaches to asset allocation being taken by some pension funds.  Instead of using traditional stock/bond/cash type asset allocation complemented by alternatives like private equity, hedge funds and real estate, their focus is shifting to risk based allocation and liquidity. Risk based allocation focuses on “lumping holdings based on how they might perform under various economic conditions, such as slow economic growth or high inflation. The biggest thought is, we wanted to make sure we grouped assets so we understood why we owned them and what we expected them to do in various scenarios.” For example Alaska uses public or private “company exposure for periods of economic growth, real assets to hedge against inflation, high-quality bonds for periods of deflation and market downturns, and special opportunities to take advantage of unique situations in the market.”

And finally, in WSJ’s “Use various passwords” Anna Prior suggests that you “consider creating at least three passwords for different groups of Web sites, says Amit Klein, author of the study and chief technology officer at Trusteer: one password for financial institutions including banks and brokerage firms; one for retail sites that store credit-card information and nonfinancial sites that carry information related to your identity, like social-networking sites; and one for sites that don’t require sensitive user information, such as entertainment and news sites.”