Hot Off the Web- February 27, 2012

Personal Finance and Investments

In the Globe and Mail’s “Understanding MERs, Management fees, and other costs” John Heinzl explains different components of fund costs and where you can information on these: management fee (which only covers what is paid to fund manager and mutual fund trailer fee paid to fund seller to cover ongoing advice to investor; note that front- and back- end loads, if applicable, are not included), MER (additionally includes administrative costs, i.e. day to day operating costs of the fund and HST) and TER (trading expense ratio, covers trading costs not included in the MER; the higher the turnover of the portfolio the more costs are eaten up by trading costs- an index fund typically has a very low turnover, hence low trading cost). The article notes that with ETF the “management fee covers the lion’s share of the fund expenses”

In AdvisorOne’s “Retirement isn’t about age: Merrill affluent survey”Janet Levaux reports that in a BoA-ML survey results indicate areas that affluent clients would like to discuss more extensively with their advisors include: financial planning for the possibility of living to 100, cash flow and liquidity in retirement, balancing short and long-term objectives, non-financial aspect of retirement, rising cost of healthcare in retirement. Not surprisingly investors consider longevity and future health care costs as the most difficult topics in planning financial futures. (I wouldn’t be surprised if Canadians would have similar concerns, including surprisingly even healthcare; as boomers age demand for health care will increase, which in turn will worsen accessibility and increase pressure to shift cost to users. I’ll never forget how shocked I was about 10 years ago when discussing retirement planning with a Canadian accountant he suggested that I allocate in my financial plan $15,000/year to heath expenditures; I would be much less shocked to hear that today.)

In the Globe and Mail’s “Ripping of grandma: How the elderly are vulnerable to fraud”Lauren Krugel discusses tricks used to rip off the elderly, including: emergency calls by from real and pretend grandchildren stranded on trips needing money “to get out of trouble”, boomers borrowing from their parents and then refusing to pay it back. “The three most common ways the fraudsters make the pitch is through cold calls over the phone, through a group of family and friends potential victims know and trust, and through advertising on TV, radio, newspapers or the Internet.”

Preet Banerjee in the Globe and Mail’s “Warning: Risk-profile ahead. Proceed with caution” writes that risk profile questionnaires must be mostly ineffective given the frequency with which investors abandon their plans when they can’t stomach risk. “The next time you are presented with a risk profile questionnaire, it should be accompanied by a lengthy discussion about risk. Otherwise, the results are worth the time you put into it: little.”

In the Globe and Mail’s “Don’t believe retirement doom and gloom” Rob Carrick interviews actuary Malcolm Hamilton whose crystal ball is clear on some topics (need for public sector pension reform, or that the most effective lever in retirement planning is not savings rate but retirement age- i.e. there is no retirement crisis so long as you stay in the harness until you die), but a somewhat more cloudy crystal ball on other topics (don’t worry because concerns existed in the past as well about insufficient savings that have never ultimately resulted in a retirement crisis, though currently future retirees will be affected by low interest rates, less lucky with housing prices and are more exposed to changes in government policy, the shift from DB to DC pension plans for those who still have one- you bet!). (But don’t let Nortel actuarial firm Mercer partner’s folksy style fool you, mutual fund fees are corrosive even if you are getting good advice on the average, DB pension plans are history in the private sector and future retirees in Canada are at serious risk with no credible pension reform tabled by the government (PRPP is not pension reform). And when I hear Mercer and actuary, I can’t help myself think of the actuarial profession who by their actions and/or inactions, likely due to their inherent conflict of interest, have contributed to the underfunding of DB pension plans, and they have not taken responsibility for their failure; furthermore the government has not taken the necessary steps to change the law to explicitly require fiduciary level of care by actuaries (and other pension professionals) toward the pension plan beneficiaries. Nor for that matter has government done anything to strip employers from their pension plan administrator role or enforce their fiduciary duties as sponsors toward plan beneficiaries- i.e. modify BIA/CCAA to raise priority of plan underfunding in case of employer bankruptcy. So “no retirement doom and gloom”? You be the judge.)

In the Globe and Mail’s “What does retirement really cost?” Roma Luciw refers to a (well worth reading) Research Magazine articleby Moshe Milevsky in which he suggests that an inflation indexed annuity can be used as 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.” (Using an inflation indexed annuity as a good measure for estimating cost of retirement makes sense, though you may not wish to implement it in that manner; for example for a 65 year old the ballpark cost of such an annuity is consistent with an annual withdrawal rate of about 4-4.5% from a balanced portfolio, but of course you don’t have to give up control of your capital, you don’t have the risk associated with your insurance company going broke (though have market risk), and you do have significant expected (though not guaranteed) residual assets after 30-35 years. By the way, there are no inflation indexed annuities in available in Canada. Furthermore, people would be better off with a much lower cost “longevity insurance” (mentioned further along in this week’s blog) which is also not available in Canada, though available in the US. So arguing that the inflation indexed annuity is the cheapest and safest is a little like beauty, even when available, it is defined by the eye of the beholder. The financial industry unfortunately has lost its way in its transformation from a mutual to stockholder organized corporations. The only innovations emerging from financial industry are so called “products” which usually come with high cost, high complexity and high opaqueness, and for the primary benefit of the seller of the “product”. Perhaps the coming battle between investment and insurance industries for boomers’ retirement assets will generate some competition and innovation in the financial industry. It would be about time.)

Real Estate

Reuters reports in “Home resales at 1-1/2 year-high, supply falls” that according to the National Association of Realtors “existing (US) home sales increased 4.3 percent to annual rate of 4.57 million units” in January, though “The tenor of the report was weakened somewhat by a sharp downward revision to December’s sales data to show only a 4.38 million unit sales rate rather than the previously reported 4.61 million unit pace.” (Some might say that “somewhat” in the previous sentence is perhaps an understatement, given the first reported 4.61M number in December.)


In the Globe and Mail’s “Ontario pension ruling hovers over restructurings”Jeff gray looks at the uncertainty created by the recent Indalex ruling on  how pension underfunding priority is treated in case of employer/sponsor bankruptcy. The Supreme Court of Canada will review the decision in June. While the circumstances were different in the Nortel case, the issue of priority of pensions in case of employer bankruptcy increased visibility of the issue. In a recent BC ruling, DIP funding maintained its priority unlike in the Indalex ruling. (The Nortel situation does not involve DIP funding and Nortel did not restructure but shut down, so the situation is dramatically different. I am not trying to create hope in the mind of Nortel pensioners, since the judge in that case was specifically hostile to any change in priorities in favour of pensioners, and in fact forced pensioners to accept very severe terms in last year’s settlement agreement. Only a retroactive change in the BIA/CCAA bankruptcy law could help Nortel pensioners at this time; while not impossible, it is highly unlikely given that the current government has expressed no interest in righting this wrong.)

In InvestmentNews’ “Longevity insurance promising but higher rates would help” Darla Mercado writes that “The Treasury Department and the Internal Revenue Service like it, as do many estate-planning experts. Now all that is needed for longevity insurance to grow from its tiny sales base is for more financial advisers to warm to the product: deferred-income fixed annuities. The Hartford Financial Services Group Inc., MetLife Inc., Symetra Life Insurance Co. and New York Life…”  are mentioned as companies offering these products, but the article notes that in a very low interest environment like now it is difficult to make them attractively priced according to the article. (While that may well be the case, imagine then how unattractive an immediate annuity is. Canadians don’t have to worry about the pricing of these products as they are still unavailable in Canada’s uncompetitive insurance market. Longevity insurance is a great mechanism to ameliorate the impact of rapid disappearance of (the lifetime income stream that came with) DB pension plans and a key element of real Pension Reform: It’s not rocket science-)

In the Financial Times’ “Pension gap spells trouble for muni bonds” Gillian Tett discusses the pension driven muni bond time bomb: lack of info transparency, no mark to market of portfolio, 8% return assumptions in a 2% 10-year Treasury market, etc. According to Robert Merton there is a minimum of $4T underfunding in state pensions alone; also state pension liabilities have been growing annually at 4-5% a year recently. The pressure is building for replacing “budget fantasies” with a “rendezvous with reality”. When this happens it will be a time of reckoning for muni bond investors and state pension plan beneficiaries.

In the Globe and Mail’s “Finley to make the case for adjusting Old Age Security” and “Ottawa aims OAS reform message at young” are indicating that the government is refocusing its message on OAS changes away from retirees and those close to retirement, who the government suggests will not be affected, to the young. The message is now positioned: “…the total cost of benefits will be increasingly unsustainable for tomorrow’s workers and taxpayers,” she said. “And it’s the next generations of Canadians who will have to shoulder the burden.” (As I indicated in my recent OAS vs. Pension Reform? blog, the still undefined but apparently contemplated increase of OAS from age 65 to 67 in nothing but a diversion from the lack of progress on the essential pension reform to address the systemic failure of Canada’s private sector pensions.  A two year delay in the start of OAS should have minimal impact for those 15+ years from retirement, as they would have adequate time to plan for the likely changes.)

Things to Ponder

In the WSJ’s “Is ‘derisking’ even riskier”Jason Zweig warns that “When you “de-risk,” be sure you understand whether you are eradicating risk—or just replacing old risks with new ones.” However in the article one expert Fran Kinniry of Vanguard warns that instead of de-risking more than likely investors are instead re-risking when they: make a significant shift out of stocks into bonds, or replacing an investment in the S&P 500 index with sector or real estate or emerging market or commodities/hedge-equity funds. And “Finally, if you reach for yield today through longer-maturity or lower-quality bonds, you may be sorry tomorrow.”

In the Financial Post’s “Brace for debt shock, Bank of Canada warns”there is a report about the Bank of Canada’s concern about the 153% household debt to income ratio and its warning that “debt-laden Canadians could face a “significant shock” if housing prices fall… “The evidence indicates that a significant share of borrowed funds from home-equity extraction was used to finance consumption and home renovation… rising house prices can facilitate the accumulation of debt. Households could, therefore, experience a significant shock if house prices were to reverse…” Bank of Canada “urged consumers not to borrow above sustainable levels, as interest rates will eventually begin to rise again”.

And finally, in Financial Advisor’s “Shakeout Ahead” Andrew Gluck writes about the as yet unrecognized threat facing advisors from commoditization of some of the financial advice and online wealth management services. In addition he notes that there is “an intellectual and academic assault on the value added by financial advisors is taking shape”. Similarly in InvestmentNews’ “Advisors blind to threat of direct investing, survey shows”Andrew Osterland writes that “Direct-investment platforms (Vanguard, Fidelity, Schwab, TD Ameritrade) are becoming a more formidable competitive challenge for investment advisers — a challenge of which many of them may not even be aware… The direct firms now serve a wide range of clients, including high-net-worth and advice-seeking clients… One of the big drivers of the growth in the direct channel is the ramp-up of programs that provide advice to investors. Managed-account programs at some of the larger companies, for example, offer ongoing investment management for a fee and financial planning, and may even have estate attorneys on staff for consultation”. (I suspect advisors should be more concerned about the “direct investment platforms” than the online wealth management services, in the space of their target customers. Those advisors who have the expertise and inclination to also provide financial planning and low-cost execution services with a fiduciary level of care will, not just survive, but thrive when the cost of the advice is commensurate with the value delivered.)


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