Hot Off the Web– February 28, 2011

Personal Finance and Investments

FAIR Canada report just issued indicates that “Even though there are two compensation funds (CIPF and IPC) in Canada that compensate investors in event of insolvency of investment firms and mutual fund dealers, the funds only compensated 2% of the financial losses because most of the investment scams “. The report is “calling on the government to consider a total of four recommendations, chief among them being the implementation of a more unified national approach to fraud detection and prevention, prosecution and most importantly, investor compensation.” See “FAIR Canada releases report on financial scandals” “A decade of financial scandals” (Thanks Dan Braniff and Larry Elford for recommending the report)

In an excerpt reproduced in John Mauldin’s “Outside the Box” email of Ed Easterling’s new book “Probable Outcomes”, Easterling looks at 30 year periods since 1900 and a couple of different withdrawal rates (indexed with inflation) and concludes that with a 4% withdrawal rate 95% of the time retiree did not run out of money; however that was the case in only 76% of time in the upper quintile of P/E ratios over that period (P/E>18.7). Even worse, with a 5% withdrawal rate the overall success rate is only 75%, but now top quartile (P/E>18.7) has on 41% success rate, and second and third quartiles still only have about 70% success rate. The message is 5% inflation indexed expectation leave you with a significant risk of running out of money in retirement based on historical sequence of return rates; and even 4% is too much when P/E are high. (You know the definition of insanity? Doing the same thing year after year and expecting different outcomes. So no sane person would start with a fixed (4% or 5%) withdrawal rate continuously adjusted for inflation at the beginning of retirement and expect to make no midcourse corrections adapting to circumstances over 30 years; nevertheless this approach is a common benchmark in the financial planning industry so it is at least worth considering. My preferred approach is a systematic withdrawal of 4-5% of previous year’s year-end portfolio value which introduces a little more income volatility but automatically adjust for the natural growth/shrinkage in one’s portfolio and you never run out of money as indicated in GMWB IIwhich also compares results with other decumulation options.)

Richard Fullmer in the Russell Research report entitled “Mismeasurement of risk in financial planning”argues that risk defined as the “probability that the plan may fail (e.g. the individual runs out of money)” is a mismeasurement of risk, and “just as not measuring risk can be dangerous, so too can mismeasuring it”. Instead he proposes a more general measure of Total Risk= Probability*Magnitude which translates in this case to Shortfall Risk= Probability of Shortfall * Magnitude of Shortfall. He then looks at risk associated with different asset allocations (AA) and compares the risk as measured by the three measures: Shortfall Risk, probability of Shortfall and Magnitude of Shortfall. “…mismeasurement of risk may lead the investor to select an inappropriate portfolio” (AA). (Thanks to Ken Kivenko of Canadian Fund Watch for suggesting this interesting paper on risk measurement with some good insights…but as indicated before still not realistic because 3% annual inflation adjustment does not reflect actual behaviour of a reasonable individual and especially not that of reasonable financial planner over a 30 year retirement interval.)

In the Globe and Mail’s “Beware of tax traps when passing assets to family” Tim Cestnick discusses the right and wrong ways to pass the cottage to the next generation. He suggest a couple of approaches both triggering capital gain. The first approach is gifting which triggers immediate gain but sets receiver’s ACB at market value. The second approach is selling at market value and taking down payment with a promissory note (which could be forgiven on the death of the giver) or mortgage for the balance. Cestnick prefers this latter approach as it allows “taking advantage of the “capital gains reserve” provision in our tax law. This provision allows a taxpayer to pay tax on a capital gain over a period as long as five years when the sale proceeds are not fully collected in the first year.”

Tom Lauricella in the WSJ’s “A portfolio to keep income flowing” discusses the differences between portfolios for accumulation and decumulation. He suggests that even as pension funds are disappearing, we can learn from them because they have similar goals as individuals in retirement. “In both cases, the primary goal isn’t to make as much money as possible or “beat the market.” Instead, it’s to create a portfolio of investments that will allow you to meet specific obligations — no matter what happens in the markets. This may seem like a distinction without a difference. But it requires a fundamentally different mindset and approach than investing to maximize returns.” Pension funds (should but not always) use liability driven approaches (e.g. in search of minimizing company contributions many take on excessive risk with often disastrous effect on pensioners). He then discusses some of the suitable decumulation approaches: bond ladders (not practical at these low interest rates except for those whose assets are large enough to meet income requirements at current rates), 80% bond ladders and 20% stock funds, 60% stocks and 40% bonds and “simply consume 4% or 5% of what there is in the portfolio every year” if you can live with the income volatility (this is some call the endowment model which assumes you’ll live forever) and finally the use of annuities to hedge outliving one’s money a 15% allocation to annuities but preferably only in the mid-70s might be useful.

Real Estate

Canada’s December 2010 Teranet National Bank House Price indexshows a 0.3% in-month increase in the index; Ottawa was the only one of the six cities in the index which fell -0.4% during the month. The index showed a 12 month increase of 4.1%.

In the Financial Post’s “Homes more affordable, but not for long”Derek Abma reports that according to an RBC report “the affordability of home ownership (in Canada) improved in the final three months of last year for the second straight quarter. However, it warned that this reprieve — the result of lower mortgage rates and little rise in home prices — is temporary.” The report adds that the expected Bank of Canada rate hikes and corresponding increases in mortgage rates will erode affordability, but not necessarily derail the housing market.

The December 2010 S&P Case Shiller Home Price index was released the past week and it indicates a decline of 3.9% and 4.1% during the fourth quarter of 2010 and relative to 2009, respectively. “We ended 2010 with a weak report. The National Index is down 4.1% from the fourth quarter of 2009 and 18 of 20 cities are down over the last 12 months. Both monthly Composites and the National Index are moving closer to their 2009 troughs. The National Index is within a percentage point of the low it set in the first quarter of 2009. Despite improvements in the overall economy, housing continues to drift lower and weaker. The 10-City and 20-City Composites were down 0.9% and 1.0%, respectively, from their November levels. They are now only 3.9% and 2.3% above their April 2009 troughs, respectively. Back in July 2010, they were +7.9% and +6.9% above the troughs, respectively. This reinforces the fact that the latter half of 2010 has been marked by a drop in home prices across the nation.” With the exception of Washington DC and San Diego, the other 18 cities in the index declined during 2010. If interested, here are  some other interpretations of the last Case-Shiller numbers “Home prices in 20 US cities fall 2.4% from year earlier” “Fundamentals to reassert themselves” “Home prices slide despite recovery”

In the WSJ opinion piece“Waiting for hurricane Charlie (Crist)”the topic of ex-Florida governor Crist’s hurricane insurance house of cards is discussed “Floridians can thank the former Governor. In a mere four years, he crippled the private insurance market and socialized taxpayer risk into two public institutions: Citizens Property Insurance Corp., an insurer, and the Florida Hurricane Catastrophe Fund, a reinsurer. They are structured to fail under pressure.”  “All Americans will pay if Florida doesn’t reform its insurance market.” (This is not the only achievement of ex governor Crist. Under his tenure even more of Florida’s property tax load was shifted to out-of-state property owners with the increase of homestead exemptions from $25K to $50K, and allowing portability of exemptions when a Floridian moves.)

In WSJ’s “Home sales rise as prices fall” Barkley and Bater report that “Existing-home sales unexpectedly rose last month, though a drop in prices to their lowest level in nearly nine years suggests the housing market continues to search for a bottom.  Demand for used homes increased by 2.7% to a seasonally adjusted annual rate of 5.36 million in January, the National Association of Realtors said Wednesday…Despite a strong finish last year, with a 12.5% jump in existing-home sales in December, the housing market remains a weak point in the economy. Last year was the worst year since 1997, with about 4.9 million homes sold, according to the NAR…the 2010 sales figures, representing a drop of 4.8% from the previous year, may have actually been even lower because of miscounting by the Realtor group.” “In January, home resales were also higher than in the previous year for the first time in seven months, up 5.3%.  Still, the median sales price for an existing home fell to $158,800, the lowest level since April 2002. That is down 3.7% from the year-ago median price of $164,900 and well below the median of $168,800 in December…Distressed properties accounted for about 37% of sales last month…”

In WSJ’s “Housing: Is it time to buy”M.P. McQueen reports that “Correlations are still quite high by pre-1997 standards, but they are weakening. In the first quarter of 2009, for example, median prices for existing-home sales declined from the previous year in 134 of 152 metropolitan statistical areas, according to the National Association of Realtors. By contrast, in the fourth quarter of 2010, median prices rose in 78 markets, fell in 71, and were unchanged in three. David Blitzer, chairman of the index committee at S&P Indices, says the breakdown in correlations “is a positive sign we are moving out of the boom-bust cycle.””


In a Canadian Life and Health Insurance Association sponsored (and no doubt paid for) survey of Canadians, it claims that “PRPP support ‘virtually unanimous’: CLHIA”. (But I suspect most would put little credence on any industry sponsored survey. This is all about how the question is framed and what answer you are looking for. By contract, in the recent CARP survey asking whether you trust private sector to deliver a low-cost pension to Canadians only 29% replied in the affirmative…and  if they were properly  informed about the implications of a private sector plan, I have no doubt the  affirmative percentage would be even lower.)

In the LATimes’ “The pension haves vs. the have-nots”George Skelton  looks at the psychology  of how “The long-term erosion of private-sector workers’ security fuels resentment over generous public payouts… they’re merely a symptom, it seems to me, of a gradually declining lifestyle for working stiff Americans — blue and white collar, college educated or not… It’s sort of an American civil war between government and non-government families… Can the substantial disparity between public and private sector retirement benefits be sustained much longer? We think that it probably cannot… Actually, free enterprise employees should be rooting for government workers in hopes that at least some retirement security can be retained in America. Perhaps ultimately it will wend its way back into the private sector. But human nature doesn’t function that way. You don’t need to be an economist or a psychiatrist to see that Americans are battling over pieces of a smaller pie.”

Ian Salisbury in WSJ article “Targeting fees in target-date funds”he mentions an interesting metric of the impact of fund fees paid by investors for target-date funds common in U.S. company 401(k) plans. Fund fees range from 0.18% to 1.68% in the funds mentioned. “Investment fees “can take a big chunk … out of a person’s return,” says Robyn Credico, a senior consultant at employee-benefit consulting firm Towers Watson. Her research suggests a salaried worker earning $125,000 a year and saving 12% of his salary every year between the ages of 25 and 62 in a target-date fund with a 0.2% annual fee would end up with roughly 12 additional years of retirement income than a similar worker in a fund with a 1% fee. The calculations assume investors withdrew 70% of their last year’s pay each year in retirement, including Social Security benefits.” (Wow…if that doesn’t make you pay attention to fees than nothing will…and this is also a warning to and a threat of the latest Finance Minister Flaherty proposed Canadian private sector run PRPP).

Things to Ponder

In a WSJ article “In Argentina, a different sort of inflation fight”Taos Turner reports that the government is cooking inflation numbers. According to the government figures annual inflation is 10.6%, whereas economist suggests it is closer to 25%. (Can’t imagine respectable developed country government doing the same?!? J)

Conflict of interest is everywhere and we must watch for it very carefully. In the Financial Times’ “Accounting advisory fees: independence must be assured”there is discussion of the accounting profession’s challenges (or more correctly the investor public’s challenges in reading financial reports). The conflict discussed is between the auditing and consulting sides of accounting firms where in pre-Enron debacle period 50% of the revenues were consultancy based; but consulting was scaled back following the Enron debacle. Consultancy is coming back in full force and “The new growth in consulting raises the old question: will auditors sign-off on dodgy accounts to preserve the firm’s high-margin advisory fees?”

For your amusement (and education) Michael Lewis in Bloomberg’s “All you need to know about why things fell apart”does a tongue-in cheek explanation of the causes of the financial crisis.

Jason Zweig in WSJ’s “Once bitten, twice bold: Who is buying stocks now” writes that we now have a “Contrarian indicator alert: It looks as though many of the retail investors now getting back into stocks are the same people who bailed from the market just before the start of a historic bull run.”

Doom and gloom predictions abound in the papers.  Some examples are James Mackintosh’s “A scary reality lurks beneath the fantasy”, Brett Arends’s “Why stocks tanked (It’s not just Libya)” also David Rosenberg’s “No free lunches in debt fuelled bear market”. (And no doubt, there are many reasons to worry; upheavals in Egypt/Libya/Yemen/Tunisia, not to speak of the even greater long-term threats from Iran/North Korea/Pakistan, food and oil price increases, concerns about cyclically overvalued markets, the list is endless. You might hear predictions of imminent major stock market pullback from some prognosticators for years, and sure enough eventually a significant pullback will occur and they will proclaim victory. Others are perpetual bulls. But as the saying goes forecasting is very difficult, especially about the future. Instead the more sensible approach is to build the (long term) portfolio strategic asset allocation based on ones risk tolerance, implement investment with very low cost assets, and stop worrying about the last expert’s pronouncements. Following perma-bears, perma-bulls or those who change their forecasts more frequently than you change your socks, might be entertaining but it is unlikely to get you to your goal. Thanks to VP for suggesting the topic.) By the way Dow Theory Letters’ Richard Russell in “Rich man, poor man (The power of compounding)” writes that “For the average investor, you and me, we’re not geniuses so we have to have a financial plan. In view of this, I offer below a few items that we must be aware of if we are serious about making money.” The items he offers, in addition to the key financial plan, are: (1) the power of compounding, (2) don’t lose money, (3)  don’t spend more than you earn, save and compound it intelligently, (4)  focus on value: stray from basic compounding only when investment offers safety, attractive return and potential price appreciation (Thanks to MB for suggesting article.)

William Hanley in the Financial Post’s “Gen-Y will be fatter, poorer than you”writes that “today’s children may be destined to be worse off financially than their parents and grandparents” and “…our kids may have a shorter lifespan than we do”. Hanley says that there is a “link between our debt crisis and our weight problem”; that link is being unable to say ‘no’. “”Just say no” might be a fitting motto for a generation perhaps willing and able to forge better futures at all levels.” Then say no to “unlimited junk food”, “electronic babysitters”, “more (personal) credit” and “to more government debt”.

And finally, a  Jay Leno Tonight Show quote reprinted at the AARP website “Here’s a surprising thing. It was in the ‘Wall Street Journal.’ A survey found 61% of people are afraid of outliving their money more than they are of dying. The other 39% have already outlived their money and have faked their own death to avoid creditors.”  (Thanks to Dan Braniff of CFRS for bringing quote to my attention.)


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