Hot Off the Web- January 30, 2012

Personal Finance and Investments

In the WSJ’s “Can you sum up your investing philosophy in 10 words?” Jason Zweig provides his answer and some answers provided by a few prominent investors: “Anything is possible, and the unexpected is inevitable. Proceed accordingly.”  (Zweig), “If everybody wants it, I don’t. Avoid crowds.” (Sauter), “Other people are smarter than you think they are. Index.” (Siegel), “Control what you can: your savings rate, costs and taxes” (Phillips), “Save. Invest long-term. Compounding return builds. Compounding costs destroys. Courage! (Bogle). (My answer would be (similar, though not quite the same, as that given by Phillips) “Control what you can: spending, saving, costs and asset-allocation”)

In the Financial Post’s “Why boomer widows are financially at risk” Chris Taylor reports that differences in life expectancies between males and females and that 70% of the boomer women will outlive their husbands. A couple of key problems identified will be insufficient assets and inexperience in managing the assets. Recommended immediate actions include: start estate planning, prepare a complete list of accounts, password and contacts, delay Social Security to maximize its longevity insurance value, don’t rush to action on financial matters if you become a widow, and hire a professional. According to a widow who has experienced it, she says that “People running around without wills, without life insurance. They could lose everything, and it’s because nobody is talking about these things. We think that if we just don’t talk about it, it won’t happen to us.” A related story is CARP Action Online’s “The ‘If-Something-Happens’ binder”which pulls together a good list should someone “have to take over our affairs if we are incapacitated or when we die. Many of us know where to find our important documents, but fewer have put all the information down in one place, so that our family or the executors of our estate can locate it easily, if something happens.”

In SmartMoney’s “Is the 4% rule viable?”Glenn Ruffenach writes that if you’ve been following the withdrawal rate tug of war recently, you’d be right to be confused about what’s annual withdrawal rate should you be using for your retirement income to insure that your money doesn’t exhaust before you do. As recent papers suggested, is it either 1.8% (Pfau) or 7% (Williams and Finke) or (Bengen’s traditional) 4-4.5%. Ruffenach suggests that the lesson is that “Retirement planning — or rather, good retirement planning — is never really finished. Ideally, your particular plan is open to new ideas and research and, as such, is able to evolve.” Factors influencing withdrawal rates according to various researchers range from market valuation, risk tolerance, expected life-span, inflation and investment fees, but most significantly, as Bengen still indicates, 4% is a prudent staring point…just keep your plan open to some adjustments. (Just remember, predictions are difficult, especially about the future and every year is the start of your remaining retirement. Thanks to VP for recommending the article)

In the Financial Post’s “Do we have enough to retire?”financial advisor Jim Otar writes that there are two questions to consider: (1) how much income do you needs each year (sum all your annual post-retirement expenses subtract annual income in retirement from all sources like CPP/OAS/GIS, company pensions, etc; if the result is negative you are home free, whereas if positive then you must make up that shortfall from retirement savings) and (2) how much retirement assets do you need to finance you retirement (unless you know that you’ll live less than five years then Otar recommends that you create a plan that will last to age 95; to do that he provides an ‘asset multiplier’ which for a 65 year old couple is 28 that you have to multiply the shortfall by, to come up with the required retirement assets).  Otar’s ‘asset multipliers’ (32, 30, 28, 25, 22 and 18 for ages 55, 60, 65, 70, 75, and 80 respectively) are intended to deal with what he calls the three risks for retirement finance: longevity risk, market risk, and inflation risk. If you have less than the indicated assets you need to take some actions: retire later, reduce spending, continue part-time work, etc.  (For a 65 year old couple planning for a 30 year retirement the ‘4% rule’ is not far from 3.57% you get using Otar’s multiplier.)

In the Globe and Mail’s “How to beat the three villains that can steal your retirement”Norman Rothery writes that fees (2%), taxes (23%) and inflation can transform a TSX annual return of 9.4% since 1970 into 1.3%! “Put in dollar terms, instead of growing each dollar invested to $43.20 over the period, you’d only be left with $1.70 after fees, taxes, and inflation.” (The article also contains a great graphical representation of the message)

Real Estate

The November 2011 Canadian Teranet-National Bank House Price Index released the past week indicated that “Canadian home prices in November were down 0.2% from the previous month…The retreat came after two months in which prices had been flat from the month before, and is the first in the index since a brief correction during the three months ending November 2010. Prices were down in eight of the 11 metropolitan markets surveyed, one more than in October…The simultaneous monthly declines in Toronto, Hamilton and Winnipeg are noteworthy in that these three markets are considered tight.”

In the Financial Post’s “Phantom mortgages haunting homeowners into foreclosure”Michelle Conlin describes how some homeowners found ” that mortgages they thought were dead and buried are springing back to life, sometimes haunting them all the way into foreclosure… The problems grew from a lot of sloppy recordkeeping that began during the housing boom, when Wall Street built a quick-and-dirty back-office operation to process mortgages quickly so lenders could sell as many loans as possible… These “robosigners” became a national sensation in the fall of 2010 when it was revealed that they faked titles, forged documents and backdated affidavits so they could make up for the bypassed procedures and foreclose on properties… In some cases, mortgages that were supposed to die off in a refinancing are popping back up, while in others, the loans were paid in full. Homeowners who pay off their houses through bankruptcy programs are also falling prey.” (A truly surreal state of affairs in the US mortgage world.)


In the Financial Post’s “Major changes coming to Canada’s pension system” Kennedy and Press report from Davos that Prime Minister Harper signalled “major transformation” including in the retirement pension system. While Mr. Harper was not specific, some suggest that increasing OAS from 65 to 67 is a clear target given that unlike the CPP, the OAS is an unfunded program. The government is planning “Making better economic choices now. And preparing ourselves now for the demographic pressures the Canadian economy faces.” “We have already taken steps to limit the growth of our health-care spending over that period,” said Harper. “We must do the same for our retirement income system.” (The article is worth reading in full as it also discusses other areas that are targeted for changes like energy, immigration, science, and trade. The Globe and Mail also has an article on the subject “Prime Minister Harper unveils grand plan to reshape Canada”. You might also be interested in reading Adrian Humphrey’s take on this in the Financial Post’s “What the #!%*? Stephen Harper rethinks retirement funding”. So Canadians will be getting pension reform after all, and though we don’t have any specifics as yet, the indications are not what Canadians were looking for.)

In the WSJ’s “Are pension forecasts way too sunny?” Jason Zweig writes that stock return expectations used by some major companies which are often as high as 12-16%. Even in this very low interest environment (with typically 50% bonds and 50% stock mix), “median expected rate of return on pension-plan assets at companies in the S&P 500 has dropped from 9.1% a decade ago to a still-high 7.8%… Corporations aren’t the only bulls. Among major public-employee pension plans, the median assumed return is 8%… Now consider the projected overall return of 7.1% at Berkshire Hathaway’s pension plan, which is overseen by Mr. Buffett. The Berkshire plan has about 30% of its money in bonds.”

In the Financial Times’ “People are right to be angry over pensions”Michael Skapinker writes that over the past decade the final salary pension plans open to new recruits dropped from 88% to 19% in the UK, while among the US Fortune 100 companies it dropped from 89 to 13. Today new employees at best have access to DC plans. Companies closing these plans argue that growing longevity and tighter regulatory environment make these plans too expensive to continue. However Skapinker notes that none of these companies mentioned the contribution holidays they often took for years as a factor in the current state of affairs. Companies often chose bankruptcy as way to wiggle out of pension obligations (e.g. Nortel). Skapinker argues that when companies want to shut down pension plans which are effectively contractual agreements the courts should provide protection to employees. In the context of the credibility crisis in capitalism, the subject of a whole series of Financial Times articles in the last couple of weeks, he writes that “…that the rich will be fine, regardless of success or failure, while dutiful employees face a life of insecurity. Final-salary pensions have probably had their day, but the way companies are burying them is not doing them much credit.”

Things to Ponder

In the Globe and Mail’s “Will my portfolio earn double digit returns? Likely not”John Heinzl discusses historical total real returns in US and Canada of about 6% for equities and 2% for bonds. Today the capital market expectations are more in line with 5.75% nominal return for a balanced (50:50) portfolio. “After deducting estimated inflation of 2 per cent and fees of, say, 1.5 per cent (which is less than what many mutual fund investors pay), we’re left with a real return of… 2.25 per cent for the balanced portfolio. Taxes would take another bite out of these returns… There are several lessons here. The first is to keep your fees as low as possible. The second is to invest a portion of your portfolio in equities which, though volatile in the short run, are still the best-performing asset class. The third lesson, Mr. Bender said, is that investors “have to start being more realistic about what their portfolio is going to do.”” (If you are a DIY investors there is no reason why fees would not be <0.3% leaving you a much more tolerable expected 3.45% real total return on the balanced portfolio.)

Brettell and Johnson in the Financial Post’s “Today it pays to owe money, while savers suffer”discuss the impact of the extreme low interest rate environment on retirees/savers. The governments are pursuing a low interest strategy to try to kick-start the economy and to minimize the carrying cost associated the governments’ debts. “The low rates policies are being pursued in preference to raising taxes and making even steeper cuts in spending, which would be unpopular and would cause more damage to already fragile economies… There are also signs of more tax policies geared to keeping money in a particular country. Some even foresee overt capital controls being introduced to prevent people and companies from investing money offshore… In economic policy circles, holding interest rates below inflation to ease debt levels and limiting capital mobility is known as “financial repression,” and it can go on for years, even decades.” The article also discusses what ultimately will be the negative effect on the economy of the ‘financial repression’ of low interest rates on the growing proportion of retirees in the population who will be unable to maintain their spending. “Investors waiting for a “great eruption” of inflation are a bit like the proverbial frog being slowly boiled alive without knowing it… “It’s not going to be hyperinflation, default or depreciation,” he said. “It’s going to be forcing savings into the government bond market. It’s happening every day but the market is kind of ignoring it. But the theft is underway.””

In the Financial Times’ “The world’s hunger for public goods” Martin Wolf defines ‘public good’ as “non-excludable” (non-payers cannot be prevented from enjoying its benefit) and “non-rivalrous” (one person’s enjoyment does not detract from another person enjoyment). Examples of ‘public goods’ are economic stability, “security, science, a clean environment, trust, honest administration and free speech”. He argues that “So its need for public goods – and goods with public goods aspects, such as education and health – is extraordinarily large. The institutions that have historically provided public goods are states. But it is unclear whether today’s states can – or will be allowed to – provide the goods we now demand.” Also that many of the public goods today are global like: the economy, security in a nuclear world, crime/counterfeiting/piracy and pollution. “The more global the public goods the more difficult it is.”

The Economist’s “The IMF’s growth forecasts” reports that the IMF expects “world economic output to slow to 3.3% in 2012, against an estimate of 3.8% for 2011. This is 0.7 percentage points lower than the forecast it made in September. Emerging markets account for around half of global economic output but, given the continued process of deleveraging across the rich world, the IMF expects them to contribute over 80% of world GDP growth in 2012.” (The article also contains additional country GDP statistics.)

In SmartMoney’s “The real problem with global bond markets” Brett Arends writes that “Global bond funds are taking needless risks, but a new set of indexes unveiled today aim to fix the problem”. Arends writes that global bonds are in a bubble because “the global bond markets are set up in order to lend the most money to the countries which are already most in debt, regardless of their future ability to pay. And they will lend the least to those who have the best future prospects.” “The issue, Mr. Arnott says, is that most global bond market indices are basically weighted by the capital value of national bond markets. The countries with the biggest bond markets make up the biggest weighting in the global indexes. Sound sensible? Hardly. “In bonds,” he says, “cap weighting means that you weight bonds in proportion to a borrower’s debt.” A moment’s thought makes you realize that this is upside down of what an investor actually wants”. Arnott suggests that “Instead of weighting countries according to their debt levels, the new Citi RAFI bond indexes will weight them using four factors: Gross domestic product, energy consumption, population, and resources. Used together, Mr. Arnott argues, these offer a reasonable proxy for a country’s ability to repay its obligations, today and in the future.” Two new indexes have been tabled, one for developed and one for developing countries. Mr. Arnott recommends more emerging market bonds, because ”emerging markets account for 45% of world GDP but only 10% of world sovereign debt.”

In Bloomberg’s “Days of easy money are over for fund managers”Alice Schroeder writes “Wall Street, it often seems, is exempt from the laws of economics. Most active money managers produce worse returns than an index, such as the Standard & Poor’s 500. But making enough money to look respectable to clients has been relatively easy as long as falling interest rates boosted the value of most asset classes. What’s more, new competitors constantly enter the business, yet rarely discount fees to gain market share. Instead, funds rely on investors to chase the latest high-performing manager, like gamblers who ignore their losses while seeking a hot slot machine. This has given the business a pricing umbrella that shelters it from competition. From the owners’ standpoint, all this has been fabulous. They work in a business that produces abnormally high profits and forgives incompetence, a rarity in modern capitalism… But after a couple of decades in which asset managers floated along in ease and splendor, economics is now grinding down the business. The easy money is going away. Investment management is in the early stages of a historic transformation. Like most tectonic shifts, it probably will take years to fully develop.” Pressure is building for declining fees and from growing headwinds due to likely a reversal of three decades of declining interest rates and tolerance for high leverage; falling interest rates and leverage were key drivers of high asset valuations and customers’ historical high tolerance for high fees.

And finally, in the Economist’s “Worth all the sweat”reports that “As doctors never tire of reminding people, exercise protects against a host of illnesses, from heart attacks and dementia to diabetes and infection.” And now you can add anti-ageing to the list “A few anti-ageing zealots already subsist on near-starvation diets, but Dr Levine’s results suggest a similar effect might be gained in a much more agreeable way, via vigorous exercise.”


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