Hot Off the Web– January 26, 2010

Personal Finance and Investments

David Aston in MoneySense’s “Retirement: Three magic numbers” tries to answer the question of “How much money will you need to retire?” He tackles the answer by framing three levels of retirement” (1) bare-bones basic retirement (rent, no cars, and no cable TV or alcohol), (2) middle-class retirement (“two-cars, some restaurant meals and vacations every year”) and a (3) deluxe retirement (including “vacation home or regular jaunts around the world”. The annual costs for the three levels of retirement are estimated to be: $20-27K, $40-60K, and >$100K; the required assets for a couple, after factoring in and (a pretty aggressive) assumed $30K from OAS/GIS/CPP and no employer pension plan, are: close to zero, $250-750K, and >$1.75M. (Americans’ asset requirements for levels two and three might be lower due to the potentially more generous Social Security income typically available.)

The WSJ’s Brett Arends challenges the “safety” of cash in “A look at long-term returns on cash savings” . He argues that cash invested in government guaranteed form may be safe from volatility and default, but it is not safe from the long-term corrosive effects of inflation and taxes, especially at the currently very low interest rates. So he concludes that “The poor long-term returns from cash are why it makes sense to include other assets–such as some bonds and blue-chip equities–among the emergency lifelines you can tap in a crisis.”

Anna Wilde Mathews in WSJ’s “The skinny on buying disability insurance” looks at considerations in purchasing disability insurance, such as:  private vs. via employer, level of benefits as a percent of salary or total compensation, portability, benefit triggers/exclusions (e.g. what type of job you have to be unable to perform), maximum payout in amount or number of years?

In the Globe and Mail’s “Want to invest? Learn to save first”John Heinzl wants to dispel the notion that investors “can take a small pile of money and build it into a fortune by picking the right stocks and cashing out for a big profit”. He argues that this might be possible just like winning the lottery, but that they get it backwards. “The truth – and this is one of the most powerful weapons you have as an investor – is that you have to set aside money on a regular basis to invest. The earlier you start, and the more you set aside, the better off you’ll be in the long run…. In business terminology, you need to build capital (savings) in order to make a return on your money (capital gains, dividends and interest).” He concludes with: “So when planning your financial future, don’t put the cart before the horse: You have to save first, and then invest, not the other way around.”

In the Financial Post’s “TFSA vs. RRSP- Which is right? Both if you want a dream retirement” Jonathan Chevreau discusses the pros/cons and differences between TFSAs and RRSPs, but you really should have the benefit of both. In “How to choose?”, referring to the savings vehicles available to Canadians, Chevreau points out that (high earner) dual-income couples can save a total of $54K in tax-deferred and tax-free vehicles per year ($22K RRSP and $5K TFSA each). He quotes Ferley that the impact of the currently falling RRSP contributions will result in inadequate savings for retirement and the corresponding negative impact on Canada’s economy. (This is the same sentiment that I expressed recently in the context of the low income-replacement rates that Canada’s retirement income system generates for above average earners, as compared to other developed countries; this does not bode well for the future of Canada’s economy. If people will be retiring with a significant drop in the standard of living, the rising percentage of retirees in Canada’s population will lead to a significant drag on Canada’s economy.)

In the Globe and Mail’s “Getting uncomfortable with bonds? Hang tough”, Rob Carrick discusses the need for bond holdings in one’s portfolio despite current very low interest environment. “Sensible portfolio construction is based on your personal needs and risk tolerance, not interest rate forecasts.” He also discusses the pros/cons of long/short maturity, corporate/government, junk/investment-grade, bond/GIC ladders, nominal/real-return. (Just remember the reason for having a fixed income portion of your portfolio, is that this is supposed to the “risk-free” portion of your portfolio.)

Jamie Golombek writes in the Financial Post’s “Rates ripe for leveraged investing”, that the current low interest rate environment may be the right time to borrow to invest, and take advantage of interest rate deductibility from taxes. The CRA opinion is that “”interest will neither be denied in full nor restricted to the amount of income from the investment where the income does not exceed the interest expense.” The same principle would hold true for interest paid on money borrowed to purchase equity mutual funds, which rarely, or in most cases, never pay out any income distributions.”


Norma Cohen writes in the Financial Times’ “UK pension trustees are urged to review lending terms” that pension regulator expressed concerns to plan trustees about stocks and government bonds being lent by custodian banks for a fee with questionable collateral, thus exposing the pension plan to losses.  “In return, however, the pension fund was being given gilts (government bonds) from third world countries which, while they had the nominal value of the UK gilts, would have proved almost valueless had the bank gone under and the pension fund tried to sell the replacement assets. Pension funds were being paid for the risk of lending their assets but the returns were minuscule. Some figures cited to me were a return of £900 in every £1m lent.“

In the Pension Research Council report “Implications of the financial crisis for long run retirement security”Olivia Mitchell discusses the difficulty of managing retirement risk in an era of financial (and geo-political) instability, increasing longevity and given the 50-100 year contracts (way beyond the lifespan of most institutions) that individuals effectively enter with “themselves, employers, financial institutions and governments.” Mitchell’s conclusion is that “we must find ways to become more resilient as individuals, managers, and policymakers, which will require reinventing retirement. Part of the task is to enhance financial literacy and political responsibility. We will also need to save more, invest smarter, and insure better against longevity. Another task will be to develop new products which can be used to hedge longevity and better protect against very long term risks including inflation. But when all is said and done, most of us will simply have to work longer to preserve some flexibility against shocks in the long run.” (Well worth reading research report.)

Janet McFarland’s Globe and Mail article “Middle income retirees face pinch” comments on the just published report by the Steering Committee of Provincial/Territorial Ministers on Pension Coverage and Retirement Income Adequacy entitled “Options for increasing pension coverage among private sector workers in Canada”. Ms. McFarland writes that “The report suggests a bleaker outcome for future retirees than a similar paper commissioned by the federal government from tax expert Jack Mintz and released in December at a meeting of finance ministers in Whitehorse. While Mr. Mintz’s report concluded that Canada does not have a major pension problem that needs fixing, the provinces’ report says government pensions in other major developed countries provide far more income to retirees than Canada’s public plans, while private-sector pension coverage in Canada is declining. “ (This report should be another nail in the coffin of Mr. Mintz the tax but not pension expert’s report tabled at the Whitehorse conference convened by the federal government; however I wouldn’t count on it since many suggest that Mr. Mintz was selected to do the report since he previously expressed views that resonated with the Conservative government’s prejudices. Oh well, time will tell if the “damn the facts, I know the answer”, or the reality staring them in the face will prevail.) “”Shortfalls appear to exist in both the mandatory and voluntary parts of Canada’s retirement income system,” the paper argues. “Specifically, those earning between approximately $30,000 and $100,000 appear to be the most vulnerable.” And while most of today’s retirees have sufficient income to maintain their preretirement lifestyles, “concerns have been raised about the fate of future retirees,” it adds.” The report discusses primarily two options: the Canada Supplementary Pension Plan (a voluntary DC component to be added to the CPP) and an expanded CPP that would increase replacement rate and/or upper limit of covered salary. The table in Appendix D in the report gives a quick comparative overview of the two options. (I haven’t had a chance to read the entire report but I would prefer “longevity insurance” type product to be a key element in whatever is the selected solution, however the two options tabled are great starting points for a short discussion and quick action; either of these proposals would be a vast improvement over what we have today for private sector employees. What I haven’t seen addressed anywhere is how the current pensioners, who are victims of the current systemic failure of Canada’s pensions, will be transitioned to the proposed new systems.)

Liz Crompton in the January 2010 issue of Good Times in an article entitled “Is your pension at risk” (not available online) does a good overview of Canada’s pension crisis in general and Nortel pensioners’ crisis in particular. She has some great quotes taken from the (federal regulator of about 10% of Canada’s pension plans) Office of the Superintendent of Financial Institutions (OSFI) website indicating that “Canada doesn’t have a national pension guarantee plan because such a fund “could reduce incentives for plan stakeholders to face, manage, and solve their problems themselves”; Ms. Crompton adds, again quoting from the website, that the OSFI “mandate is “to contribute to public confidence” in the country’s financial system.” She also interviewed me for this article as recommending people to: do more for themselves, understand what you’re investing your hard earned dollars and control what you can(spending, saving and investment costs).

Real Estate

The U.S.S&P Case Shiller report for November is out today and the 10/20 City indexes are still down on a YoY basis about 5%, and “Charlotte, Las Vegas, Seattle and Tampa posted new low index levels”. On the positive side, “Los Angeles, Phoenix, San Diego, and San Francisco have seen price increases for at least six consecutive months.” The10/20 City indexes are off about 33% from their 2006 peaks, and they are back at approximately 2003 levels.

The WSJ’s Justin Lahart reports in “Existing home sales plunge” that December sales of previously owned homes is down 16.7% from November and volume is back down to August level, but 2009 sales in total were up 4.9% over 2008, the first increase since 2005. Median prices were also up 4.9% at $178K over 2008.

In “Palm Beach County’s median home price inches up 1 percent in December” the Sun Sentinel reports that “For 2009, Palm Beach County’s median home price fell 21 percent to $239,000 compared to the previous year, while sales increased 25 percent. Broward’s median price dropped 26 percent to $205,700, and sales rose 38 percent….The median price for a Palm Beach County condo at year-end was $107,300, down 25 percent from 2008. Broward’s median condo price fell 38 percent during the year to $82,600. Florida’s existing home sales increased 31 percent in 2009, while the median price dropped 24 percent to $142,600.” However the inventory overhang is still significant, 9-15 months in Broward and 2-4 years in Palm Beach County and then there the is the “worrisome “shadow” inventory of properties that includes rentals, foreclosures and expired or withdrawn listings.” Southwest Florida sales are also up while prices are down as reported in Herald Tribune’s “Housing sales leap in Southwest Florida” .

Things to Ponder

In the Financial Times’ “A myriad of funds is no use to investors”Pauline Skypala argues that because there are too many funds and too many fund managers it drives investors to select funds based on historical performance. “They should focus instead on the investment process and look for managers with a true positive information ratio, which is the relationship between the excess return a manager has delivered and the risk taken to achieve that end.” Skypala figures that perhaps the reason why the financial industry doesn’t want to look at this issue is because: industry doesn’t want the good managers identified (lots of bad ones would be fired) and would lead tremendous amount of new assets pouring into good managers who would suddenly find it more difficult to outperform. She also discusses the value of active vs. passive asset management and whether at a low enough cost there opportunity to add value by active approaches.

The related Steve Johnson article in the Financial Times “Norway’s active vs. passive debate” also tackles the active/passive debate, without finding overwhelming evidence in support of active management. What was interesting in one of the studies mentioned: “70 per cent of all the active returns could be explained by exposure to a handful of systematic factors. Thus, for equities, much of the excess return above the benchmark derived from the fact the fund was overweight small-cap stocks…(and) a “significant fraction” of the active return component of the fund could be replicated by constructing portfolios designed to mimic the behavior of the factors.” Therefore one “could enjoy the bulk of excess returns that active managers have appeared to generate by investing passively, as long as the benchmark used is sophisticated enough to incorporate systematic factors.”

Rob Arnott in the Financial Times’ “Why poor moral ethics prove costly” discusses “the distinction between moral ethics (doing only what is right) versus legal ethics(doing only what is allowed).” Some of his observations include: abandonment of the “moral principle of intent to repay when we borrow” and the US’s advancement of “situational ethics to a high art”. Specific examples given include the legality of incentivizing brokers to sell mortgages to those who can’t afford them, to create/sell mortgage backed securities with issuer having “no skin in the game” to meaningfully monitor ongoing creditworthiness of borrowers, to buy a CDS which is a “bet on a company’s failure and to then take actions to facilitate the company’s demise” (This is no doubt a significant contributor to the recent liquidation rather than restructuring of Nortel.) He goes on to discuss similar examples at national level (Medicare, Social Security, Fannie Mae, Freddie Mac). While all these are legal, he judges them as unethical constructs. He concludes with “if we do not police the behavior of our own community, if moral ethics does not govern business behavior, society will seek to raise legal ethics, through more laws and regulation, in a doomed effort to force the missing moral choices. If we do not invest in businesses that condone unethical conduct, countries that are increasingly reckless in their governance, or individuals who seek to profit from others rather than with others, we not only earn outsize profits, but also we reduce the rewards for unethical practices.”

And finally, in WSJ’s “The scales can lie: Hidden fat” , Ron Winslow reports on a recent Mayo Clinic study that “people can face health risks from ‘normal weight obesity’. “People don’t have to be overweight to have excess body fat. Instead, these people have a higher ratio of fat to muscle tissue than do people with low body fat.” BMI is not a good indicator either. “High body fat among normal-weight men and women was associated with a nearly four-fold increase in the risk for metabolic syndrome—a cluster of abnormalities including elevated blood sugar and blood pressure. This syndrome is common among people who are obese and is an increasingly important precursor to diabetes and cardiovascular disease.” To reduce heart risk requires increasing the percentage of lean muscle mass…That underscores the importance of exercise in maintaining cardiovascular health—including weight lifting and other resistance training, which helps build lean body mass.” A healthy diet is insufficient; “if you only restrict calories, you risk losing an equal amount of body fat and lean muscle tissue and thus you could end up weighing less without significantly reducing the percentage of body fat.” (…and the struggle continues…)


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