Hot Off the Web- June 27, 2011

Personal Finance and Investments

In WSJ’s “Banking on yourself: Is it ever OK to borrow from your 401(k)?” Jason Zweig gives and example where it might, but there are risks associated with it (e.g. requirement for immediate repayment if you leave your job). This is the case in a legitimate spending need (obviously not a vacation) which might be met by a significantly lower interest rate by borrowing from the 401(k). “From your portfolio’s perspective, taking out a 401(k) loan is like adding a bond position: you are plunking down a chunk of cash in order to receive a steady stream of interest income. The difference is that the interest comes out of your paycheck, rather than from the issuer of the bond. “

In the Globe and Mail’s “Breaking the seal on the information vacuum” Rob Carrick reports that “Canada’s securities regulators…issued proposals to have investment dealers and advisors show you…actual dollar cost of fees and commissions you pay for investment products you own…(and) a meaningful summary of your personal rate of return.” In a survey of investors “Only 47 per cent said they wanted more detailed reporting on their investments than they’re getting now… This is what happens when you seal investors into an information vacuum: They don’t even know what they don’t have.” (Let’s hope that this necessary change is introduced ASAP to help improve the level of transparency on the costs (and returns) associated with investments. But I’ll believe it when I see it. By the way the similar is needed for the insurance industry, but I am not holding my breath.)

And speaking of not even knowing what you don’t have, in InvestmentNews’ “Report: Clients confused about standards and don’t care” the results of a J.D. Powers survey indicates that “85% of 4,200 full-service investors say they have never heard of — or don’t understand the difference between — the suitability and fiduciary standards…But investors don’t seem very concerned about the different standards. Among full-service investors whose financial advisers adhere to the fiduciary standard, 57% said that this increased their comfort level. Then again, 42% said that it decreased their level of comfort…Although clients appear confused about fiduciary standards, they do have a very clear idea of what they want from their adviser.” They want to get more frequently called by and clearer communication from their advisor, want phone calls returned within 24 hours. Considering investors’ confusion about what fiduciary standard means, it is strange that the pollster was quoted commenting that “The lack of investor enthusiasm about a single fiduciary issue might make firms consider whether it is worth the extra cost of meeting the higher standard, particularly for an imprimatur of which most clients are unaware”.(Frankly unless the surveyors explicitly spent time explaining to those called what fiduciary (vs. suitability) means, the survey has zero value, beyond the indication that investors don’t get meaning of fiduciary (e.g. see Fiduciary). Some might wonder if this was sponsored by the brokerage industry; but it was funded by JDP.) However in “Want to retain retiree clients? Put their retirement income plans on paper” Darla Mercado reports that “A survey by Fidelity Investments of 252 retirees and 252 pre-retirees who work with advisers showed that 81% of pre-retirees felt that a detailed plan is important, but only 18% of them had actually retirement income plans… Sixty-three percent of pre-retirees and 69% of retirees with details on their retirement income plans said they were “very satisfied” with their advisers.” (If you don’t have an Investment Policy Statement (IPS) ask yourself and your advisor, what constitutes the advice you are paying for?)

In the Financial Post’s “Good genes can be a curse”Jonathan Chevreau discusses the need for some kind of longevity insurance to deal with the risk of running out of money should you live too long. His recommendation based on various experts mentioned leans toward annuitizing at least some of the assets if you don’t have a DB pension, but if you do, it is better to wait until mid-to-late 70s when as Larry Swedroe is quoted as indicating that (as a result of increasing mortality credits with age) “It’s the only asset class that can get you in effect equity-like returns without taking equity risk.” And by the way, don’t bother with variable annuities, GMWBs. (Finally, more people are beginning to understand why GMWBs sold by many Canadian insurance companies are corrosive. This article unfortunately missed an opportunity to advocate for the need and value of pure longevity insurance, readily available in the U.S. but still not so in Canada.)

In the Globe and Mail’s “A painful lesson in when stop-loss orders don’t work”John Heinzl explains that “With a straight stop-loss order, when the stock reaches a predetermined price, the order converts into a market order. This means your broker will sell the shares at the best available price. The problem is, it could be well below the trigger price if there are no other bids on the books… To avoid this, whether you’re trading ETFs or stocks, it’s important to include – as you did – a limit price with your stop-loss order.” But placing the limit price too close to stop price might leave your security unsold in a fast falling market.

In Canadian MoneySaver’s “Assessing investment performance”Scott Ronalds provides some pointers to what he calls the muddy and neglected” but very important task of performance measurements. Among his suggestions, Ronalds includes the need to look at performance as an annualized number, compare performance to an appropriate benchmark covering the identical start and end period, and be particularly careful as a shift of even a month can make significant difference in the outcome. He also says that you should not chase performance, as recent good/bad performance is often followed by bad/good performance, and as suggested by Warren Buffett your bias should be towards inaction.

Michael Kitces in “What happens if you outlive your safe withdrawal rate time horizon?” challenges arguments that Bengen’s 4.5% (inflation adjusted) is not conservative enough. He says that “The bottom line is that while safe withdrawal rates ratchet spending down to the point where a retiree can survive a terrible sequence of returns (and/or a substandard period of total return), in the overwhelming majority of cases, the outcome is not nearly so dire. In point of fact, most of the time the safe withdrawal rates approach is a path to significant wealth accumulation, and/or an adjustment period several years into retirement where spending can be increased to account for rising wealth. Nonetheless, for retirees who do not want to ever face the risk of cutting their spending, safe withdrawal rates provide a rising-floor approach that allows for spending or wealth to rise, without anticipating cuts. But while it’s the conservative measure needed to protect in bad markets, be cognizant that in “merely average” – not to mention, good – markets, your client’s greatest problem may be what to do with all the extra money.” He finds the fact that historically in 55 instances of 30 year retirement periods since 1926, 96% of the time the individual still had assets in excess of 100% of the original nominal dollars; there was only one instance of running out of money and two other cases of have less than the starting nominal assets. (Thanks to VP for recommending article.)

In WSJ SmartMoney’s “10 things life insurers won’t tell you”the list includes: insurance cos. won’t track down your family in case of your death, term is what you need (unless your estate plan needs insurance to work), higher premium is paid not just by the unhealthy and smoker but also by some “pilots, mortgage-defaulters and lousy drivers”, insurance cos. rarely have to pay, etc

In the Financial Times’ “Rob Arnott: Fundamental pioneer” Pauline Skypala writes about Arnott’s message that “there are advantages in constructing indices using fundamental measures of a company’s size, such as earnings, dividends or sales, rather than market capitalization… It is one of several alternatives to market cap weighting, including equal weighting, which dates back to the 1960s, and minimum variance, around since the 1980s… He believes fundamental indexing is superior to the market cap weighted approach because it is a reflection of the investment opportunity set offered by the broad economy. It weights companies by their economic footprint rather than their market capitalization… “To add value we don’t have to analyze companies or forecast the future, as long as we have a disciplined strategy that can capture a superior risk premium.”” While critics suggest that his approach is just a value and/or small cap tilt, Arnott counters that additionally “two-thirds coming from “the dynamic contra trading against the market”, whereby “we trim whatever is most newly beloved and use the proceeds to top up whatever is newly feared and loathed”.” He plans to extend the fundamental index to bonds where it may be even more applicable. And on the same topic, in WSJ’s SmartMoney’s “Index funds that do what they should” Reshma Kapadia discusses the arguments between traditional low-cost broad capitalization weighted index vs. new ‘improved’ indexes which Bogle says are driven by businesses “in which salesmanship trumps stewardship, and marketing trumps management. That’s where the money is.” The traditional index funds “do little but buy and hold steady concentrations of the stocks of a given index…For that straightforward service, they typically charge a rock-bottom fee… A great many of the newer funds are adding an unfamiliar ingredient to the mix — strategy. The maneuvering ranges from the modest (merely changing the way that equity holdings are weighted in the portfolio) to the downright ambitious (using derivatives or borrowed money to bet against Japanese stocks or the Dow). And it is these funds that are suddenly drawing a significant — and fast-growing — share of investor money…Over the past decade, just over half of active equity fund managers underperformed their benchmarks, according to Morningstar. “It’s naive to assume that [any of the new adjusting index funds], using freely available data, have stumbled onto some sort of free lunch that the thousands of active managers in the industry have not,” says Kinniry… (and even) Jason Hsu, chief investment officer of Research Affiliates (Arnott’s firm), readily acknowledges that his firm’s special-sauce indexes won’t perform well in every type of market… “This is not a be-all and end-all strategy,” cautions Hsu. “Investors should diversify.”… The strange upshot is that in many of these new offerings, investors are trading away the very qualities that made the originals such a wonderful idea in the first place: simplicity, low cost and freedom from that irresistible temptation to chase the herd.” (Some problems are that this form of (active) management doesn’t work in all environments, costs more (fees/transaction/taxes) and is not as scalable as cap weighted indexes.)

Jonathan Chevreau in the Financial Post’s “More choice for ETF investors”discusses arrival of Vanguard and PowerShares on the Canadian ETF scene. The advantages of the Canadian listed ETFs is that “they can provide versions of their existing foreign funds hedged back into Canadian dollars, as well as create new equity and bond ETFs specifically for the domestic market”, (also for estate consideration for those otherwise holding U.S. versions of these funds.) PowerShares offerings include fundamental indexing (discussed in the previous paragraph). However, the proliferation of ETFs in both U.S. and Canadian markets to smaller and smaller niche areas is not in the interest of ordinary investors. “As ETFs depart from low-cost broad-based market exposure, investors will be tempted to trade more often, usually to their detriment, Hallett warns.”

The new BMO Retirement Planning issue of their InSite newsletter has a couple of articles that you might find useful on the subject of ‘Estate Planning’  (discussing wills, executors, probate, trusts, tax and other considerations in inheritances) and ‘Expense ’in Retirement’ (increasing and decreasing elements, and effect of inflation)

In the Financial Post’s ”Making the most of CPP”Andrew Allentuck looks at some of the complexities of deciding when to start CPP. (But it is even more complicated than described there; some reasons why it’s even more complicated are: (1) that not everyone’s objective should be to maximize the expected take from CPP. For many the objective should be to maximize the annual CPP take should they live much longer than life expectancy at age 65 (i.e. longevity insurance, and also not addressed is the implication of how survivor benefits are handled in case of a couple (i.e. should one or another or both be taking early or late CPP? Bottom line: you’d think that an organization like the CPP which spends almost $1B a year on “administrative costs” would be able to create some spread sheet or customized reports for individuals to help with the decision!?!)

Real Estate

In WSJ’s “Home resales fell in May” Zibel and Bater report that sales of previously occupied U.S. home sales fell 3.6% from previous month to the lowest level in six months, a seasonally adjusted annual rate of 4.81M. Inventory was 3.72M or 9.3 months of supply at May sales rate. But in Palm Beach Post’s “Palm Beach County home sales up 26% in May”Kimberley Miller reports that “Palm Beach County’s sales of existing homes continued to surge in May, increasing 26 percent from last year and fetching the highest median sales price seen in six months. At $214,100 for a single-family Palm Beach County home, May’s price was an 8 percent increase from April, and the highest since October, although it was still 9 percent below May of last year. May also was the third consecutive month where Palm Beach County’s home purchases surpassed 1,000 with 1,115 sales, according to a report released Tuesday by the Florida Realtors. May’s housing inventory was down to an eight-month supply from 15 months last year. Statewide, home sales were less robust last month, increasing 3 percent from 2010 and mostly even with April.” But “Prices are still under a downward pressure,” Hunter said. “It’s certain we will continue to see a flow of bank-owned property released onto the market for the next couple of years.”

In the NYT’s “Why the reverse-mortgage isn’t going away” Ron Lieber writes that despite the fact that in the past week Bank of America and Wells Fargo have declared that they are stopping new originations, and despite that reverse mortgage are not “the best income-generating product for retirees…it will almost certainly become a necessary last resort for a nation full of increasingly strapped older people.” The banks are not supposed to look at credit ratings, since they essentially provide you the reverse mortgage based on “your age, prevailing interest rates and the amount of equity you have in your home”, and the government acts as the mortgage insurer. However the borrower is responsible for taxes and maintenance on the property, and if the borrower is unable to pay those expenses, the lenders (banks) are worried that they’ll have to foreclose on the elderly with collateral damage to the banks’ reputations. (So it’s not a great deal for the borrower, and the more reputable lenders are leaving the market, yet reverse mortgages will be needed according to Lieber because eventually retirees will run out savings and won’t be able to live on (even unreduced) Social Security. This doesn’t sound very encouraging.) Also in the WSJ is Kelly Greene’s “Reverse mortgages: Who needs a bank?”where she explores options by which in families with well-off adult children can avoid reverse mortgages and their associated high costs, the children can “either buy the house outright or set up a private reverse mortgage…or set up a revolving credit for the parents backed by their home equity…There are risks: The child funding a reverse mortgage could fall on tough times and stop paying. Or the parents’ house could fall in value, leaving the children holding an asset worth less than they have lent against it”.


In the Financial Times’ “Honest truth about contributions” Pauline Skypala writes that in the UK “nearly double the money (is) being paid into DB schemes than into DC plans (by both employer 17% vs. 8%) and employee (5% vs. 4%) and there are serious concerns about the inadequacy of the likely retirement income levels resulting from DC plans. Skypala says that “There is a real need for better, and more honest, communication on the subject of just how much money it takes to build up a big enough pot to buy or provide an income that replaces even half of salary. “ She adds that less saving will lead to less capital available to fuel the economy. (The impact of the boomer generation’s pension crisis is still coming, and with Canada’s systemic failure of pensions for middle-class private sector workers is like a train crash in slow motion and the governments are just sitting on their hands in inaction.)

In the Ottawa Citizen’s “Nortel could have blossomed at RIM”Bert Hill discusses the already two and half year old bankruptcy protection court proceedings whereby creditors are still cooling their heels, while the courts are trying to decide a fair allocation of the proceeds of the  $4B or so  asset sales among claims ranging from $11B to $24B. Hill also writes about the differences in the way US and Canadian courts are addressing the most vulnerable of creditors, the pensioners and long-term disabled. The Canadian judge already cut off life and health insurance and LTD payments at the end of 2010, whereas the US judge just assigned separate representation for pensioners and LTD recipients while Nortel continues to make those payments. (Pathetic, especially since Canada, beside Portugal, appear to be the only OECD country with no protection for pensioners if sponsor becomes bankrupt with an underfunded pensions.)

In the Financial Times’ “Big firms suffer large asset falls’’ Steve Johnson reports that he massive drops in assets managed by investment managers for UK pensions were primarily the result of “the seismic structural shifts underway in the market, with many of the losers specialising in active management of equities, an area that has fallen in popularity as many pension funds have switched to passive, index-tracking investment, while a wave of de-risking has seen many others sell equities for bonds or switch to lower risk liability driven investment.”

Things to Ponder

John Gapper’s Financial Times article “The price of Wall Street’s black box”is well worth reading. In it he discusses Walls Street banks’ frenzied lobbying against SEC’s proposals to force derivatives trading onto exchanges for transparency. “They do not want the black box of fixed income and derivatives trading, which has provided so much of their profits for so long, to be exposed to plain view…The behaviour, revealed in the JPMorgan and Goldman cases, is a product of the conflicts of interest embedded in how integrated Wall Street banks work. As they say in Silicon Valley, it’s not a bug – it’s a feature. That feature is inherent in most of what banks do, but the opacity and complexity of credit derivatives – especially mortgage-related securities such as collateralised debt obligations – let deception, overpricing and ultimately fraud flourish. From this black box came the bulk of revenues and bonuses… Their (CDO’s) complexity meant that only a few professionals could grasp them – most “sophisticated” investors went by credit ratings. For investors…the information asymmetry between professional and customer makes it easy to pad the bill.” (With opacity enhanced by complexity, added to knowledge/information asymmetry gives the financial industry a license to coin obscene profits at the expense of its unsuspecting customers, under the oversight of dozing regulators and governments.)

Richard Milne in the Financial Times’ “Asset prices and US economy diverge”quotes Jim Reid that “You have to question why asset prices have done so well when the economy hasn’t. Where do markets go from here when there is no stimulus?” Some argue is that asset prices can be justified by low interest rate environment and the growing corporate profits. Others worry that “Looking beyond that to 2012, many investors are becoming less convinced that the huge difference between the performance of developed economies and financial markets can persist.”

In the Globe and Mail’s “Beware the distortions of too-low interest rates” Tom Bradley warns about effects of the current manipulated low interest rates. He says that while this is good for borrowers (governments, mortgagees) it also helps hedge fund managers and Canadian home owners. “This Fed subsidy serves to transfer wealth from the lender to the borrower. Bill Gross of Pimco describes it well. “The artificial yields, in effect, act as a tax on savings, undercompensating asset holders and transferring the haircut benefits to the debtor nation”…people saving for retirement, or already living off their investments, are being stolen from. Returns from their bond portfolios won’t be adequate to live off of going forward, let alone keep up with inflation. To attain a reasonable amount of income, they’re forced to take more risk”. Low interest rates push up prices of financial and real assets. One must be careful when buying such (artificially expensive) assets and “make sure that the valuations on our assets make sense, not just today, but in non-artificial times as well”. The WSJ opinion piece entitled “Of wealth and incomes” looks at the same topic and asks whether the Fed QE2 impact really helped overall or not. The wealth effect worked to and extent, but the money flow also resulted in increases in the price of commodities (energy and food in particular), resulting in “what economists call “income effects” or change in consumption resulting in change in real income” (more money siphoned off by food and energy result in less for other spending). “The wealth effects have helped everyone but especially the affluent. The income effects have been felt most acutely by the poor and middle classes for whom food and energy are a much higher proportion of income…Could these income effects have also hurt economic growth by offsetting the wealth effects…?” And, in WSJ’s “’Did it work?’”Al Lewis also asks this question about QE2, and he concludes that “People forget that we are not so much recovering from a recession, but from a debt crisis brewed in a cauldron of deception and fraud. At some point, we have to wonder whether all this monetary and fiscal meddling is merely continued economic folly. No matter how long our jobless, house-poor, consumer-hobbled recovery slogs on, we’ll be constantly reassured that trillions from the Fed and the U.S. government spared us from another Great Depression. But what if we are just trillions more in the hole and still face an inevitable malaise? Can fate be changed? Or did our leaders just bloat the balance sheets and prolong the pain? Maybe all the economy really needed was a wider acceptance of its failures and time to mend.”

Bloomberg’s “Fed can’t save U.S., so politicians must”opines that “Bernanke is running out of bullets… recovery that, two years after it began, remains “frustratingly slow” and too weak to make a meaningful dent in joblessness anytime soon.” The opinion piece discusses fiscal stimulus options available to politicians like: $1T of public works and corporate tax credits for adding jobs. “Realism and clarity are what taxpayers, businesses and markets need from the political system. An agreement in principle on what part of society — retirees, workers, employers, homeowners, consumers — ultimately will pay to fix the government’s finances, either through cuts in services or higher taxes, would go a long way toward restoring confidence. It should include mechanisms that guarantee the fix will happen, yet allow some leeway if the economy worsens.” (So far, with the artificially repressed interest rates, retirees/savers have been paying, perhaps it’s time for a new set of victims!?!)

And speaking of who pays and who get hurt, based on UK statistics according to the Economist’s “Who suffers from inflation” Buttonwood indicates that “The characteristic of recent inflation is that it has been concentrated on food and energy, two items which absorb a higher proportion of the spending baskets of the poor than of the rich. As a result, lower income households tended to experience higher inflation rates than higher income groups over the last decade. The worst rates of all were suffered by the single pensioners. The trends seem to have accelerated; the poorest quintile suffered an inflation rate of 4.3% between 2008 and 2010, the richest 2.7%.” He then adds that with the latest U.S. numbers “The US inflation numbers out today illustrate the theme. The headline rate is 3.6%, well above the 10-year bond yield, indicating that real rates remain negative across the spectrum. Now the Fed may focus on the core rate (at 1.5%); that number excludes food and energy, but the poor spend more proportionately on food and energy.”

In the Financial Post’s “Supreme Court of Canada offers guidance on disclosure obligations” Julius Melnitzer reports that “Canada’s capital markets are welcoming a Supreme Court of Canada decision that goes a long way to helping issuers determine the scope of their disclosure obligations”. The case argued the “proposition that while investors need to be informed, they don’t instantly get the right to sue simply because they happen upon some piece of information that wasn’t disclosed”.  “The Supreme Court has sent a message that if issuers act reasonably and responsibly in determining what is material, they don’t have to risk being sued if an investment goes sour…”  (So issuers can breathe more easily, but what about the customers of these securities? Remember the Rosens’ “$windler$”)

In Washington Post’s “With executive pay, rich pull away from rest of America” “For years, statistics have depicted growing income disparity in the United States, and it has reached levels not seen since the Great Depression. In 2008, the last year for which data are available, for example, the top 0.1 percent of earners took in more than 10 percent of the personal income in the United States, including capital gains, and the top 1 percent took in more than 20 percent. (The top 10% took about 50% of income, leaving the other half for 90% of the population.) But economists had little idea who these people were... Now a mounting body of economic research indicates that the rise in pay for company executives is a critical feature in the widening income gap.” The article contains some interesting graphics of the trends of income distribution in the U.S. and other countries.(Referred by the CFA Institute Financial NewsBriefs)

And finally an interesting piece on how technology can help improve health (somehow twisted into a discussion on the class divide), is Peter Orszag’s Bloomberg article  “Orszag: Wi-Fi scale adds to America’s class divide”. He writes that all the new technology now available to easily collect and store personal health information “may wind up exacerbating the growing gap in life expectancy between people with high levels of income and education and those without” New Wi-Fi connected scales, blood-pressure meters and pedometers automatically transmit and record daily readings on your computer. Emergency ID bracelets can collect/store same in addition to allergies, blood-type, and emergency contacts.  Statistics indicate that “Among 50-year-old men, for example, those in the highest education group are now projected to live almost six years longer on average than those in the lowest education group — and this differential has been rising sharply.” Longevity gap between counties of highest and lowest life expectancy has increased from 12 to 15 years, and much of it is explained via health and exercise behaviour. (It’s an interesting article discussing new personalized health technologies which might be expensive today, but no doubt will dramatically decrease in price and become accessible to individuals at most income levels, eventually spreading the benefits widely. It’s puzzling/bizarre why the focus of such an article needs to be ‘class inequality’ rather than the health benefits of new technology?)

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