blog23may2011

Hot Off the Web– May 23, 2011

Personal Finance and Investments

In the Financial Post’s “Change your ETF strategy, up your profits” Jonathan Chevreau laments that he is unable to take advantage of a switch from capitalization to fundamental index-based ETFs because of the tax implications of the sale. He indicates that recent fundamental index returns were 2-4% better than capitalization ones. Similarly, in Investing Daily’s  “Equal weighted index ETFs: Pros and cons” Jim Fink looks at equal-weighting index ETFs vs. capitalization-weighted ones and concludes that over the last 8 years the former have outperformed the latter by an average of 3.6%/yr. (There is an assault on the capitalization weighted indexes, by latecomers to indexing in general and ETFs in particular. You’ll find more and more articles discussing the advantages of “equal-weighted” and “fundamentals weighted’ indexes over cap-weighted ones, but only time will tell what was/is the right answer. For now I am also sticking with cap-weighting. There are opposing views as to the source and sustainability of any advantages over cap-weighting; some express the view that the primary differences are related to “value” and “smaller capitalization” tilt of these indexes and the effect may be transitory. Furthermore these less common indexes are not as scalable to inflow of assets as the cap-weighted indexes. Some even suggest that if you want value or small cap tilt just buy cap-weighted indexes with those characteristics.) (Thanks to VK for recommending article.)

John Heinzl in the Globe and Mail’s “The portfolio rebalancing act’ explains what rebalancing is and how it can be implemented (“buying or selling securities in your portfolio to bring the asset allocation back to predetermined targets. It’s a way to control risk and potentially improve returns.”) Appropriately allocating new moneys to underweighted asset classes is another approach. The frequency of rebalancing can be based on elapsed time (“once every few years”) or on asset class percent change in excess of 10 percent from its target. Rebalancing can also be driven by investor’s age or other source of risk tolerance change. “Bottom line: Rebalancing may provide a small performance benefit, and it can help take the emotion out of investing. But it should be done judiciously, particularly in taxable accounts.”

In WSJ’s “Coverage for when vacation is scrubbed” Scott McCartney writes that “more travelers are buying insurance in event of hurricane, terrorism, illness and other disasters, but exclusions abound”. But he warns readers that a careful reading of the policies is required because often among the exclusions you’ll find: pregnancy, pre-existing medical conditions, organized sports injuries, scuba/sky-diving, and hurricane only if hotel is “uninhabitable”, terrorism only within 30 days of the trip. The author suggests that you should look for “cancel for any reason” coverage for which you can comparative shop at InsureMyTrip.com; such policies are typically 6-12% of the cost of the trip compared 4-10% for standard policies.

In Bloomberg’s “Insurers pair Long-Term Care with Life to entice older buyers”Elizabeth Ody reports that sales of LTC insurance are falling but customers seem more attracted to hybrid LTC and Life policies. “The policies generally are built using universal life, which has an investment component, and may pay out the death benefit early to help pay for care.” Customers seem to be attracted by the idea that (dependent on the terms of the policy) they get their money back one way or another: any time if benefits never used, full death benefit upon death if LTC benefits never used, defined LTC care benefit until life policy exhausted or longer (depending on riders purchased). (I haven’t seen the specifics of such policies, but they do sound better the LTCI policies)

Jonathan Burton, in the WSJ’s “Stress-test your portfolio”,writes that “What you don’t know can hurt you”. He suggests stress testing as a way to help protect for “risks known and unknown”. Examples provided (with recommended approaches to protect against them) include: (1) impact of higher inflation and interest rates (broad diversification, shortened bond maturities…but then can’t totally ignore possibility that higher inflation/interest rates won’t happen…remember that “Diversification isn’t about maximizing return; it’s about minimizing risk”), (2) Black Swans: ‘disaster, wars, political and economic upheavals and social unrest” (safe havens like gold, Treasuries) (3) perpetual risks: market and company risk, and (4) risk you should fear: playing it too safe (“if you’re comfortable with everything you own, you are not diversified” and “You hate bonds: you ought to own some bonds. You hate gold: own some gold. You’re scared to death- own stocks because maybe things will have a happy ending”).

In WSJ’s “Get a mid-retirement checkup” Tom Lauricella suggests that even DIY investors consider a mid-retirement checkup with a professional, of course this is in additional to the annual checkup that one should perform. This should include: review of spend rate (budget) and withdrawal rate, revised life expectancy (which is just the average rather than 70-90 percentile longevity that might be appropriate for a healthy retiree), are you spending too much on investment fees, do you need to be more aggressive with your portfolio (at least 20% of assets). Other more major changes might even be needed such as: sell/downsize/reverse-mortgage your home, a fixed annuity of some or all of the remaining assets. Many planners suggest involving your children in this especially if it looks like you may be heading into financial difficulty. You should also consider visiting the very simple to use Vanguard’s Retirement nest egg calculator (This is also a teachable moment. As you gradually increase your equity allocation say from 40% to 65%, at a 4% withdrawal rate, pay attention to the units on the vertical axis; after a certain point the probability of success will plateau or even decrease, but the projected portfolio balance will still be increasing. This is not intended to encourage you to take more risk, but only to take as much risk as you need to take and even that only within the context of your risk tolerance. Of course you should also review all the caveats which come with the simulation.)

Real Estate

In the Financial Post’s “Home prices continue to climb”Garry Marr reports that “Canadian home prices continued their upward march in April, driven by strong investor demand in Vancouver, as cracks in the Toronto condominium market may be starting to appear.”  Year over year prices increased 8% in April while volume decreased 4.4% since March and 14.7% since April 2010.  But CREA warns that the price increase “figure was skewed due to “surging multimillion-dollar property sales in selected areas of Greater Vancouver””. In 2010 50% of the Toronto condominium buyers were not intending “to occupy their units”.  He provides a calculation which suggests that today’s buyers are counting on capital appreciation, because they must carry “huge operating losses”. (Even if the indicated $600/mo operating loss, at the current 3% variable mortgage rate, is not that “huge”, but with variable rate mortgage it can easily increase by 50-10% over the life of the mortgage.)

In the Globe and Mail’s “The ins and outs of buying U.S. real estate” Dianne Nice reports on misconceptions about buying U.S. real estate as explained by cross-border wealth management expert Dale Walters. The reality is that: rental and capital gains are reportable in both US and Canada, there are disadvantages to ownership via a Canadian corporation, and others. Walters, in a separate Q&A offered the additional following thoughts when buying US real estate: among options for Canadians owning US real estate are US or Canadian trust (advantage avoid probate where in trust, avoids US estate tax if Canadian trust but there is effectively no tax if net worth <$5M), typically no need for lawyer real estate agent takes care of everything and title insurance guarantees title, for rental property best to buy as LLP entity to limit personal liability, for personal use property joint ownership by spouses is preferred as ‘Tenants by the Entirety’.

Pensions

In the Financial Times’ “Pension savers need protecting”Pauline Skypala writes that “Workplace retirement schemes should cost as little as is necessary to deliver them, and be sufficiently regulated to ensure members’ interests are properly safeguarded. Employers have an interest in both those factors… Nest (the new UK government run pension system) “should be designed to deliver good-quality saving where the market cannot supply it cheaply enough.”  Employers have expressed concerns that  Nest at 0.43% total cost (a pension cost level that Canadians could only dream of) is not sufficiently lower than private sector pension costs range of 0.4-0.6%. (If only Canadian pension reform would progress with similar speed and clear objectives designed for the best interest of members, but so far there is no visible progress at all.)

In this 2009 article entitled “Annuity analytics: What is guaranteed rate really worth?” Moshe Milevsky gives a very clear explanation of the real story behind GLiB (Guaranteed Lifetime Income Benefit) Variable Annuities. Specifically, he explains that in the example given whereby the quoted 7% guaranteed growth rate over 10 years and the guaranteed 5% lifetime withdrawal rate after 10 years cannot be looked at in isolation; in fact he says that the (7%, 5%) pairing in this example translates into a (guaranteed) 2% yield! The promise in these products is the upside if the investments perform better, but after fees there is little likelihood of any upside. (The insurance industry has had very low uptake on traditional fixed immediate annuities. So they introduced these new types of variable annuity products (GLiBs, GMWBs) with promise of upside while providing a floor to the downside. Unfortunately much of the upside is illusory and the downside protection is of limited value considering other options. Thanks to Ken kivenko of Canadian Fund Watch for referring the article) (This item might turn out to be very timely for Nortel pensioners after they were recently told that the Ontario government has relaxed pension windup constraints and LIFs will be a permitted option, and just before they are about to find out what group-LIFoption has the ex-Nortel employees’ representatives (NRPC) been able to negotiate from a selected, but as yet un-named, financial institution.)

In the WSJ’s “Employees win new benefit protection” Ellen Schultz reports that the US Supreme Court rules in a recent Cigna case that “if an employer had breached its fiduciary duty to the employees, a court could order a trustee to amend the terms of the plan to conform to the terms in the summary. “ “”The Supreme Court has ruled that the era of rights with no remedy is over, and that employees should be made whole for inaccurate or misleading information about the benefits that they earn”. (Employees in major western democracies are having their already strong benefit and pension protection strengthened…everywhere but in Canada. Here the pensioners and the long-term disabled continue to be victimized while legal protection from employers shirking their contractual responsibilities appears non-existent.)

With trillions of pension liabilities many companies are increasingly concerned about potential costs of longevity increases associated with these liabilities. Oliver Suess in Bloomberg’s “Death derivatives emerge from pension risks of living too long” discusses how the market is emerging for insurance products to take on the longevity risk of pension funds. However the market is still too small, there is very little liquidity and there is significant counterparty risk.

Things to Ponder

In a Center for Retirement Research study “The potential impact of the Great Recession on future retirement incomes” Butrica, Johnson and Smith estimate that working age Americans will on the average have $2,300 or 4.3% lower annual incomes at age 70 due to the Great Recession of 2008. “Retirement incomes will fall most for high-socioeconomic-status groups, who have the most to lose, but relative income losses will not vary much across groups.”(Thanks to MB for recommending.)

The Financial Times’ “Bill Gross: Sticking to his guns”reports that the “bond king” Mr. Gross is testing his investors’ patience having  shifted out of US government debt to “negative 4%” weighting in his fund. “The evidence that Treasury yields are unsustainably low is as compelling as that showing Japanese property prices and tech valuations were ludicrous – but many prescient money managers were tossed overboard for refusing to participate in those bubbles. Pimco must hope that it has amassed enough goodwill to avoid charges of Gross negligence while waiting for the market to turn.”

Jason Zweig adds his list reasons why buyers of U.S. Treasuries should be worried in WSJ’s “Own government bonds? Here is why you should be worried”: the current debt limit battle in the U.S. Congress is between possible default and continued out-of-control spending, many major investors reduced or stopped lending to the U.S. government except on very short term maturities, government may use “financial repression” by “keeping short-term interest rates below the level of inflation, a government can pay off its bondholders with cheapening money”, which then  via ripple effect pushes rates down elsewhere when a flood of USD fleeing the U.S. land there. “Until Washington can get its act together, most individual investors would probably be wise to boycott buying long-term government debt. Financial repression may compel U.S. institutions to buy bonds at yields that all but ensure negative returns in the long run. You don’t have to join them.”

The gold debate continues. Here are a couple of articles in case you are interested: “Soros sharpens gold bubble debate” and “Suddenly, gold isn’t looking so solid” (This is not a recommendation, but I still have 5% of my investable assets in gold, not for speculation but as an insurance against the paper currency debasement in progress.)

Leslie Scism in the WSJ’s “MetLife defends death-benefit approach to  regulators” reports life  insurance companies routinely use Social Security databases to cut off annuity payments (some as far back as the 80s) but are not necessarily using the same databases to pay life  insurance policies at the death. Arguments for the different approach include the contractual requirement that a life policy beneficiary request payment and deliver a death certificate and the difficulty of applying the database to older life policies which do not contain Social Security numbers (annuities required the associated Social Security numbers for tax reasons). Florida insurance regulator Kevin McCarty was quoted “We want to ensure that insurance companies use as much effort to find and pay benefits as they do to find and collect premiums” in Bloomberg’s “Insurers may owe more than $1B in unpaid policy benefits”. (Feels like unsavoury practices even if rationalizable to some extent.)

In the Globe and Mail’s “Your money beliefs could be hurting your bottom line”Angela Self discusses behavioural aspects such beliefs associated with wealth in lower income and lower net worth individuals. The limiting beliefs which will continue to deprive these individuals of acquiring wealth include are: money worship (more money/possessions equals more happiness), more avoidance (rich people are greedy, don’t save more and money corrupts), and money status (self-worth equals net worth)

In WSJ’s SmartMoney’s “The invisible stock bubble” Jack Hough writes that markets “despite having racked up a decade worth of typical gains in the 26 months after their recessionary low, do not look expensive. The S&P 500 trades at 15.3 times trailing earnings… Those numbers might be luring investors toward a cliff, however. History suggests today’s corporate earnings are unsustainably high relative to the size of the economy. The real price-to-earnings ratio, based on a more normal level of earnings, is well over 20”. “Last year corporate profits reached 9.4 cents per dollar of national income. That’s 47% too high by historic standards. If earnings were to shrink to their historic average, the aforementioned P-E ratio of 15.3 for the broad stock market would rise to nearly 23.”

In the WSJ SmartMoney’s “The stealth retirement community” Catey Hill reports that “Many older Americans are staying home and teaming up with their neighbours to get cheaper health care and other services.” There is also a reference to an information sharing website on starting your village at Village to village network.

And finally, in Daily Finance’s “Test driving retirement: How to ease into your golden years” Sheryl Nance-Nash looks at ways that people who have to delay their retirement until 70 due to insufficient savings, may still be able to “practice retirement”. “Simply put, practicing retirement  is a way to dip your toes in the retirement waters and see if they are too hot, too cold, too “just not yet”, or just right. Are you really ready financially—and emotionally? Where are the gaps in your plan? The “tenets at the heart of the strategy: keep working full or part time, don’t touch your nest egg, delay taking Social Security benefits, and keep invested in a diverse portfolio.”   (Thanks to MB for recommending)

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