Hot Off the Web- October 24, 2011

Personal Finance and Investments

First a couple of wills/estate related articles: Terry McBride’s Financial Post piece “Outdated will can lead to legal issues” and Rachel Silverman’s WSJ article “Get an estate plan. Now”The former explains the importance of having an updated will, otherwise: the executor might have pre-deceased, wills are automatically revoked upon a marriage, property might be unintentionally bypassing the will (e.g. joint ownership),  major increase wealth excluded , birth of first child excluded, death of a beneficiary excluded, change in beneficiary’s marriage status excluded. The latter discusses the minimum estate plan at each life stage: age 18- power of attorney for finance, health and medical directive; young and single- add desired wealth disposition; “part of unmarried couple”-  “need a will if you want property to pass to partner”;  wealthy- estate planning lawyers for tax strategies; and senior or ill- update will, powers of attorney and health care directives and have important documents in order.”

In the Financial Times’ “Few FoHF yield value, report says”Steve Johnson reports that less than 6% of 1325 funds of hedge funds deliver value above that of the “alpha” of the underlying hedge funds, and 48% actually didn’t even earn the extra layer of fees.

In  WSJ SmartMoney’s “401(k)s: when opting out makes sense”Jeremy Olshan writes that the dropout rate from auto-enrolment is 10-20% and the most successful tactic to get to the dropouts is to re-enrol them every year. Participation in the employer sponsored 401(k) at least to the level that gets matching employer contributions is the no-brainer approach for all but those who are in  the most “dire financial straits”  and perhaps in cases when the plan offers “poor investment choices, or high investment fees”.

“BMO income fund sets yield bar unreachably high”, “Ponzi? No, but high payouts can’t go on forever” and the article a couple of days earlier “When fund yields are too good to be true” which triggered the other two, are worth reading to ensure that before anyone invests in such funds, they understand that the fund payout is not earned by the fund, in fact it is very unlikely to ever earn such high rates of returns, that a significant part (or even a majority) of the payout is ‘return of capital’ (i.e. just getting back the investor’s own money), thus leading to lower future fund NAV (net asset value) per unit (but if you are reinvesting the ‘dividends’ then there shouldn’t be a capital depletion) and they are paying typically 1.5% annually to the fund to perform this ‘magic’.

In the Globe and Mail’s “What does retirement really cost?”Roma Luciw quotes Moshe Milevsky that annuities are not just one of the tools for funding your retirement, “Rather, the annuity price is actually a market signal of what retirement really costs. And, it is the cheapest and safest way to convert a nest egg into a lifetime of secure income.” (As a measure of “cost of retirement” it makes sense, however “safest” only makes sense if you disregard that the insurance company can go bankrupt, that inflation will erode your income, that you’ll have zero residual estate value,  that you won’t have access to the funds in case of an emergency, etc, etc… then yes it is the safest approach…but “cheapest”, I am having even more trouble with…unless of course somebody can find a low cost annuity or a pure longevity insurance which gives me access to mortality credits available when pooling longevity risk without having to hand over the asset management to the insurance company’s ravenous (and unspecified) fees via a pure longevity insurance….still not offered by the Canadian insurance industry due to lack of competition…and I would like to know where can a 65 year old buy a $1,000/month inflation adjusted annuity for life for $230,000, or over 5.2% per year($12,000 of $230,000)- in the US and especially in Canada; and never mind that what you really need is a joint annuity, so where can I buy this??? Perhaps, what the article really means is that if you could buy a zero fee annuity from an insurance company at age 65 (life expectancy was 20 years) then perhaps you could by an immediate indexed annuity of $1,000/mo for $230,000? Let me know where I can find the zero fee insurance company; I am interested. Annuities may be appropriate for individuals of very low risk tolerance; they may even be appropriate for some small part of some individual’s retirement portfolio, but to say the safest AND cheapest, is a stretch. So if the article is really about the question on how much should you aim to save for your retirement, then the cost of an inflation indexed annuity may be the correct conservative measure. However, this has nothing to do with how one would implement a credible retirement plan for the average individual.)

Real Estate

Nick Timiraos in the WSJ’s “Bill would give U.S. visas to foreign home buyers” reports that in support of the US housing market “two Senators are preparing to introduce a bipartisan bill Thursday that would give residence visas to foreigners who spend at least $500,000 to buy houses in the U.S.” (As described in this article, the $500,000 investment in residential real estate buys the ‘investor’ the right to live year around in the US and spend there more of his hard earned assets outside of the US, because he/she won’t be able to work in the US; this is essentially something that some people had argued for before and called it a retirees’ visa. It essentially allows rich elders to buy their way to live near their US resident children. Better than nothing, but not much to write home about. Here is another thought: how about some other real incentives like stopping the FL property tax scam where out-of-staters are being charged 2-10 times the property tax that their neighbours pay in identical housing units. No doubt Churchill was right when he said that the Americans always do the right thing…after they have exhausted all other possibilities. I need to add an update, as a result of a note I received from the usually well informed cross-border tax expert Robert Keats on the subject, who argues that Canadians will benefit from not just warmer Florida weather but also lower tax-rates than in Canada. I guess we’ll have to wait to what the bill will end up offering.)

In the Globe and Mail’s “Home-owning baby boomers should consider “for-sale’ signs” Rob Carrick writes the “massive boomer cohort started turning 65 this year. All those empty nesters will soon have a decision to make. Should they sell now to downsize their family home, or stay on to welcome grandchildren?… (He recommends that for) Baby boomers, the right thing to do with your house seems clear if you put money matters ahead of lifestyle. Sell now and avoid the rush.”


BenefitsCanada’s “NDP tables pension legislation” reports that “New Democrat Pension Critic Wayne Marston reintroduced legislation today …The proposed Pension Protection Act would move pensioners to the front of the line of creditors to be paid out during bankruptcy or restructuring proceedings.” (The NDP is the only party in Canada which has been persistent in trying to give Canadian pensioners some protection of their pensions (deferred wages). Canada, unlike other G7 countries has neither pension benefit insurance program (except the minimal one in Ontario) nor any priority in case the employer/sponsor goes into bankruptcy with an underfunded pension plan. The other major parties have either expressed hostility or at best lip service to doing the right thing.)

In the Financial Times’ “Industry chiefs admit they’re stumped” Pauline Skypala quotes an investment industry chiefs’ group as suggesting that “much of the financial theory underpinning investment practice is misunderstood or misapplied, with the result that the models built on it are flawed…fund managers have abrogated  their responsibility to investors in not making clear the limits of their knowledge.” And now some regulations are driving pension plans to reduce risk (i.e. reduce equity component). (But there are other reasons why investment managers and other pension plan professionals are finding it difficult to understand, what now some of them say they don’t fully understand. There is a saying that goes something like this: it’s difficult to make man understand something, when not understanding it is requirement for his job preservation. So, DB plan was a good idea built on a flawed architecture (coupled with stupidity and greed), and then aggravated by the whole series of potential conflicts of interest (at least in Canada, but somehow I suspect that elsewhere as well): (1) sponsor companies/management which have fiduciary responsibilities to both stockholders and pension plan beneficiaries, but their personal interests are aligned with stockholder, (2) pension professionals like actuaries and investment managers are hired (and fired) by company managers and are also challenged by conflict of interest and the losers are the pension plan beneficiaries, (3) actuarial assumptions, ranging from the aggressive to the ludicrous- like discounting liabilities at interest rates which are a function of the “expected return on pension plan assets”, so the more aggressively the assets are invested, the smaller the liabilities, (4) aggressive and/or inappropriate asset allocation in the hope (or rather in a triumph of hope over reality) that more aggressive asset allocation will lead to higher returns and lower required company contributions, (5) pension plan asset allocations were approached as if ALM was not discovered as yet, when in fact was already (conveniently) forgotten, and (6) regulation/regulators designed to be gamed by companies so we can all pretend that everything is all right (“Don’t worry, be happy.”) Commitments made and already earned must be delivered, but continuing to build sand castles going forward must be stopped. A DC plan is better than a DB plan which is a house of cards.

Things to Ponder

In the Financial Times’ Lex column “Misery indices”indicates that based on the ‘misery index’ which is simply the sum of inflation and unemployment rate, Americans have not been as miserable since 1983, as they are today.

IndexUniverse’s “ETF Briefing Book”does a great review of the ETF world, including: their workings, uniqueness, influence on the market, scare stories of risks- real and imagined, and regulatory environment. (Good read if you want to delve into ETFs a little more deeply.)

In the Globe and Mail’s “Wealth in Canada rebounds, now 8th in the world, report says” Michael Babad reports that according to a Credit Suisse “report released yesterday, Canada is eighth in the world in a ranking of aggregate household wealth, and 13th in terms of wealth per adult, at $245,000 (U.S.), compared to $248,000 in the United States. That’s a sharp reversal from 2000, when Canadian mean wealth was just 56 per cent of the U.S. figure when expressed in U.S. dollar terms.” That’s a household wealth growth of 7.7%/year expressed in US dollars, but only 3.6% “if exchange rate changes are excluded” The full report is available at “Global wealth report 2011”.

And finally, at the risk of finishing off on a downer, in the Economist’s  Buttonville’s article “The view from Doctor Doom” he quotes Nouriel Roubini that there is a 60% chance of a recession in the developed world. Due to the risk, companies are holding back on new investments and “The massive increase in wealth inequality has redistributed income from labour to capital and from the poor to rich. This has reduced the marginal propensity to consume… Fiscal stimulus is being replaced by austerity; there is political resistance to bank bailouts; depreciating currencies to gain export share is a zero-sum game; and monetary policy is becoming impotent because QE merely leads to the build-up of excess bank reserves.”


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