Hot Off the Web- October 31, 2011

Personal Finance and Investments

In the U.S. Vanguard has announced a GLWB (Guaranteed Lifetime Withdrawal Benefit) plan that can be attached as a rider (current annual cost of 0.95%) to their variable annuity offerings (total costs in the range of 0.5-0.6%). Guaranteed withdrawal rates are 4.5-6.5% depending on the age of the annuitant and whether the guarantee applies to an individual or a couple (joint). (These rates are about 2% cheaper than such products from other US providers probably 3% cheaper than what would be available in Canada. Readers of my blog know that I haven’t been a fan of GMWB-like products since their costs/fees essentially make the expected upside a triumph of hope over reality (e.g. see several year old blogs on GMWB I, GMWB II), but the new Vanguard U.S. product appears to be changing the landscape (and hopefully will eventually become available in Canada as well), and my preliminary calculations suggest that this Vanguard GLIB is an exception to my previous rule to stay away from such products. I plan to discuss Vanguard’s new product in an in-depth blog shortly.)

In the NYT’s “What to ask a prospective wealth manager”John Wasik writes that “Finding an adviser who already acts as a fiduciary — while not a fail-safe standard — offers better investor protection than the broker-dealer model. Generally, most fee-only C.F.P.’s (not in Canada), C.F.A.’s, lawyers and accountants who do personal financial advising have a written standard of care that combines a code of ethics with extensive pro-client guidelines…Do they charge for assets under management or an hourly rate for planning services, or both? Do they earn a commission on their recommendations?… In addition to preparing an investment policy statement outlining your financial goals and risk tolerance, a worthy adviser must have the ability to listen… ask for an adviser’s Security and Exchange Commission’s ADV Form, Part II. This document is supposed to list any potential conflicts of interest and specify how advisers are compensated… you will learn if the adviser is paid referral fees by financial product firms, information about their transaction costs and where they hold your assets. This last item is critical… You need a trusted third party holding your cash…”

The BMO Research Institute has a report entitled “Mind your taxes in retirement” which discusses some of the tax consideration differences for Canadians between working and retirement years. Areas mentioned include: the relatively better known advantages of efficient asset allocation among registered and non-registered accounts, and the less well known efficient management of withdrawals. Specifics discussed are the opportunities and potential impacts of: pension (traditional, CPP/QPPRRIF/LIF) splitting, OAS claw-back due to minimum RRIF withdrawals for large RRSPs and even Canadian dividend tax treatment, possible advantages of pre- age 71 conversion to RRIFs, even possibly the counterintuitive approach of paying more tax earlier to pay less later, the use of TFSAs even in retirement and a reminder of the impact of taxes in general on your expected income from accumulated RRSPs (the (1-T) problem). It might be worth your time to read this short report, as you might find something you overlooked, but as the report points out, the applicability of many of the opportunities are very specific to individual circumstances (and of course to uncertainties to future tax changes). The BMO Retirement Institutehas a number of other articles that you might also find of interest. (Thanks to Ken Kivenko for recommending the article.)

Todd Tresidder in “Are safe withdrawal rates really safe” provides a very good and accessible (though somewhat long) review of the of some of the literature on safe  withdrawal rates, pretty much focused around the initial 4% of assets then adjusted yearly for inflation. He critiques the approaches on the basis of the of their use of historical U.S. securities returns over assumed 30 year retirement intervals, and risks inherent on counting on their sacredness even if attempting use a valuation influenced initial withdrawal rate, non-U.S. security returns. He looks at some of the other flaws of the approach: the future no worse than the past returns/volatility, uncertainty of the impact of bad sequencing (e.g. the past 10 years), uncertainty about the ravages of future inflation, the impact of increasing longevity and the need to factor in the high (and growing) probability of at least one of a couple reaching age 100, the impact of non-zero fees/expenses. After a long winding road, he gets to his real point, which is that no sane individual would actually continue to spend at some fixed withdrawal rate adjusted for inflation until exhausting their retirement assets. The answer, of course, is a flexible spending rate. One approach(unfortunately) buried (but hopefully not lost) in a long list of potential ‘solutions’ mentioned, is the one based on a withdrawal of a fixed annual percent of current retirement assets each year. (Thanks to VP for recommending.)  (This has been both my personal and recommended approach. And one way to select the specific withdrawal percentage is to withdraw the expected long-term real return rate of the portfolio, which might be 3-4% for a low-cost balanced portfolio. A further fine tuning has recently been suggested in a Vanguard research report by Jacconetti and Kinniry entitled “A more dynamic approach to spending for investors in retirement”which includes a sensible ceiling and floor on withdrawal rates. Vanguard’s new GLIB offering might also be a good candidate.)

On the same topic of generating income in retirement, Karen Blumenthal in the WSJ’s “Funding the post-pension retirement” discusses the challenges of the pensionless  boomer generation in figuring out how to generate regular income in retirement. Earlier generations used the combination of income from bond ladders and stock dividends, but new solutions are being sought in the current environment.  Consideration suggested: buy pure longevity insurance (sorry, not available to Canadians), consider fixed annuities (which are now available in many 401(k)), variable annuities (with or without guarantees, but costs are critical, in the U.S. consider Vanguard’s products), use the 4% rule (but don’t go on auto pilot), consider managed payout funds but with poor markets you’ll have to manage with lower income and Steve Utkus, head of the Vanguard Center for Retirement Research, “taking money out of an account that is going down is very paralyzing to some people.” Another sign that the search for ‘new’ lifetime income products is on aimed at the growing number of market scarred boomers who are looking for ‘guaranteed’ income streams, is the growing list of companies claiming breakthrough innovation in the field. For example, in “Lifetime income options grow” Hartford claims that “The income shares concept “was the most powerful element in our design,” said Ms. Harris, who created the offering that the company has patented. Hartford Financial chose a deferred fixed annuity to insulate participants’ retirement income from market risk, she said. The income benefit is guaranteed by Hartford Life Insurance Co.” (Thanks to CFA Institute Financial NewsBriefs for recommending article.) (The cost of unit is a function of age and prevailing interest rates. This sounds good in principle, but how much does it cost to buy a unit and what T&Cs?…can you choose units which start paying income at age 85?) Tom Lauricella discusses in WSJ’s “Target-Date funds shortchanging investors”is concerned that many of the target-date funds don’t really deliver retirement income, yes many fund companies are categorizing them “retirement income”. The reason is simple. Target-date funds are really asset-allocation funds with age-dependent asset-allocation (risk) glide-path. Their real focus is total return, and if you need more income you can always sell some shares in the fund.

In WSJ’s “Why value will beat growth” Jack Hough writes that “Long term investing favours value stocks. The cheapest one-10th of U.S. stocks relative to projected earnings have outperformed the most expensive one-tenth by 9.1 percentage points a year on average since 1968, according to Brandes Investment Partners, a San Diego money manager. But growth stocks sometimes reign for years at a time… Mr. Magnuson and Ms. Subramanian agree that investors should buy now, however: value stocks with fat dividend yields.” (One considering such a strategy might be careful with sector concentration.) But Dan McCrum in the Financial Times’ “Value fund believers struggle to keep faith”writes that “Value investors’ adherence to stock-by-stock analysis is being sorely tested by markets that rise or fall in concert with the latest swing in sentiment. Since the 2007 peak, value funds have been outpaced by their growth counterparts.”

In WSJ’s “Financial acumen declines after 60”Robert Powell refers to a recent study indicates that while “our confidence in our financial decision-making abilities rises with age…the cores on a test measuring knowledge of investments, insurance, credit and money basics fell about 2% a year starting after age 60…” (I haven’t seen the questions, so I can’t judge their effectiveness in assessing financial acumen, however) Powell, who is editor of newsletter Retirement Weekly, recommends that you: shouldn’t assume it won’t happen to you, “set up a retirement income plan where you where you don’t have to make complex decisions as you age” and “consider annuitizing your income, preferably in a straightforward annuity-type product or a mix of annuity and investment products. Consider also passive investments that automatically rebalance”.

In the Financial Post’s “Financial planners should create financial plans” Jonathan Chevreau reports that 61% of Canadians between ages 45 and 64 don’t have a financial plan, Furthermore after attending a Certified Financial Planners’ conference, he was “was surprised to hear that even CFPs don’t routinely create comprehensive plansfor their clients”. (This is a pretty pathetic state of affairs, but then doing a real financial plan takes significant effort and expertise that many ‘advisors’/fund-salesmen are not interested in doing since they are not qualified to do it, and it is relatively painful and low-margin work compared to collecting trailer fees on mutual funds.) Chevreau also commented on the discussion pertaining to the need and the difficulty of implementing a fiduciary standard of care by advisers, given Canada’s multi-jurisdictional context.

In the Financial Post’s “How to invest like the Canada Pension Plan”Jason Heath writes that CPP’s approach to portfolio management might be a suitable model for other investors. “Perhaps most important is that the CPP’s “primary approach to equity investing is to create a portfolio that replicates the composition of major stock markets. Replicating broad market indexes is a cost-effective approach for a long-term investor.” It seems the CPP has taken a predominantly passive approach to equity investing, much to the chagrin of the broader investment community’s focus on active management.”

In the Globe and Mail’s “Time for Canadians to stand up for investment ombudsman”Rob Carrick writes that survival of OBSI, “formed by the banks in 1996 after the federal government threatened legislation forcing the creation of an dispute-resolution service for bank customers”, is under threat because banks are opting out in favour of other dispute resolution venues, and there you don’t hear an input/uproar from the investing public, the regulators or the minister of finance. “Criticisms of OBSI from within the financial community focus mainly on the way it calculates losses. Simply put, judgments in favour of investors are too high.”

Real Estate

The August 2011 Canada’s Teranet National Bank House Price Indexwas up 0.9% over previous month. “Six of the 11 metropolitan markets surveyed were also at all-time highs. The monthly increase equalled or exceeded the national average in four markets: Toronto (1.6%), Winnipeg (1.3%), Hamilton (1.0%) and Ottawa-Gatineau (0.9%). The rise was 0.7% in Calgary, 0.6% in Vancouver and Edmonton and 0.3% in Montreal. Prices were flat from the month before in Victoria and Quebec City and down 0.2% in Halifax.” YoY gain was 5.4% and “The rise from a year earlier exceeded the national average in Vancouver (9.9%), Winnipeg (7.6%), Quebec City (6.7%), Toronto (6.2%) and Montreal (5.6%). It was below the national average in Ottawa-Gatineau (3.9%), Halifax (2.9%), Hamilton (2.4%) and Calgary (0.8%).”

In the WSJ’s “Home prices show sector still ailing” Mitra Kalita reports that “U.S. home prices inched 0.2% higher in August but declined 3.8% on an annual basis, according to a closely watched index released Tuesday. Ten of the 20 cities in the S&P/Case-Shiller composite index also posted gains in August, signaling some improvement in the battered real-estate sector.” And IndexUniverse’s “Case-Shiller: Glimmer of hope for housing” comments that “Earlier this year, the market retested 2009 lows and has since stabilized just above those levels, but hasn’t moved by much more. Compared with last year, however, the hole seems to be getting shallower.” You can read the entire report at the S&P Case-Shiller Home Price Indices.

In the Globe and Mail’s “Listings website pries open property data vault” Steve Ladurantaye reports that “ has partnered with property valuation company Centract Settlement Services to make local market information available to anyone with a Web connection. By entering any address in the country and providing a few additional details, such as the number of bedrooms and bathrooms in a house, a user can get an instant price estimate.” (Very simple to use and the price range provided appears to be in the right ballpark, a (wide) +/-15% range. It would be nice if they eventually added the actual prices and number of homes sold in the neighbourhood in the past year.)

In the Financial Times’ “Foreign investors look to US property” Raval and Abbrizzese report that “Of the total foreign investment into the US from 25 countries, more than 80 per cent came from five; Canada – which accounted for a third of activity – the Netherlands, Switzerland, the UK and Israel.”


In a sign of things to come (?), Vauhini Vara reports in the WSJ’s “California proposes to curtail workers’ benefits” that “California Gov. Jerry Brown on Thursday unveiled what would be one of the nation’s widest-reaching pension overhauls, a proposal that would raise the retirement age and shift more investing responsibilities to public workers. The 12-point plan includes meshing a 401(k)-style component into newly hired workers’ retirement plans, raising the age at which some future employees retire to 67 from 55 now and boosting pension contributions for current workers. Labor groups immediately expressed disapproval…(however according to some critics) “The governor’s proposal is more substantial than I expected, particularly with regards to new employees, but it doesn’t go nearly far enough” because the biggest changes wouldn’t apply to current employees.”

In the Globe and Mail’s “Pension plans not accounting for longer life spans” Tara Perkins reports, in the understatement of the of the last decade (at least) that “A number of Canadian pension plans are not putting aside enough money to account for the risk that people will live longer than expected”. The story goes on about insurance companies peddling protection against longevity risk. (I have difficulty seeing how a pension fund expects to get reasonably priced insurance against such longevity “risk”, where most of the “risk” (and cost) is already known. As to insuring against ‘catastrophic’ increases of longevity (i.e. a discontinuity caused by a medical breakthrough), one might question any insurance company’s ability to pay such a claim. It is not news, but just part of the sand that Canada’s systemically failed private sector DB pension castles are built on. Under-accounting for longevity risk is all part of the actuarial profession’s conflict of interest which led to the underfunding of plans based on aggressive/ludicrous actuarial assumptions, aggressive investment practices, inadequate regulations/regulators and lack of protection when bankrupt companies have underfunded pension plans. The solution to the growing longevity is simple, if one desires a real solution: risk-sharing with beneficiaries, not buying insurance against what is already a well documented phenomenon/trend; longevity insurance should be focused on the larger of the risks, that of the individual, not of the cohort which can be borne by the individual members of the plan (if sponsor is unable/unwilling to deal with it).)

Jonathan Chevreau reports in the Financial Post’s “Canadians working longer as Pension freedom Day approaches 67” that Towers Watson developed a new DC retirement index which “tracks the performance of a balanced portfolio of a DC plan member who has contributed to the plan from age 40 to 60. At that point, an annuity would be purchased but its value and monthly payout would depend on the performance of the plan over those 20 years…(then) “pension freedom” (is defined) as the point when an individual who stops contributing to the plan at age 60 can first purchase the benchmark annuity.” Since December 2009, “pension freedom”, according to this index, has retreated from age 60 to 67 due to a combination of lower stock markets and lower interest rates.

Things to Ponder

You might find Daniel Kahneman’s three-part Bloomberg article “Bias, blindness and how we truly think, Part 1”, “Part 2”, “Part 3” and “Part 4” an interesting read on the subject related to behavioural finance. It discusses the role of optimists and optimism in our lives, the relationship between mind and matter (reaction to a change in wealth, how we take a gamble, utility theory which explains “why poor people buy insurance and why richer people sell it to them”, the flaw of utility theory in its lack of a reference point), the human brain designed to give priority to bad news (loss aversion, reference points in evaluating the good/bad behaviour of merchants, employers and landlords), “caring for people often takes the form of concern for the quality of their stories, not for their feeling… In intuitive evaluations of lives, peaks and ends matter, but duration does not… elimination of memories greatly reduces the value of the experience”.

A number of inflation related articles might be of interest to you: Bloomberg’s “Inflation peaking in U.S. as most prices tumble” which suggests that we may be seeing slowing inflation, The Economist’s “Hard times” which looks at the changes in American’s spending patterns as a result of inflationary pressures and the Financial Post’s “Nightmare scenario: U.S. deflation risks rising” that worries about “moribund job market and potentially steep drop in inflation could push the United States into a downward spiral of falling wages and prices”. And, in the Financial Post reports that “Prem Watsa maintains hedges on economic concerns” Watsa “compared the current environment to the 1930s depression or Japan’s recession in the 1990…In those time periods, government bonds were the ones that benefited an investor…”

Last week I referred to the high U.S. misery index (the sum of inflation and unemployment). This week in the Globe and Mail’s “Will an oil-driven misery index defeat a U.S. president” Jeff Rubin explores its impact on next year’s Presidential election. Some good news for the President and the market is that U.S. GDP grew in Q3 at a higher than expected annual rate of 2.5%. However, not everyone believes the GDP numbers. Alan Abelson in Barron’s “Animal spirits rising”quotes John Williams as suggesting that “GDP is the most “heavily biased, heavily guessed at, heavily politicized and most worthless” measure of the economy foisted on us poor peasants by the powers that be.”

In the Globe and Mail’s “Mobius takes a swipe at derivatives” David Parkinson reports that long time emerging market investor Mark Mobius argues for the need for reining in derivatives (by standardization and move to an exchange for transparency), return to Glass-Steagal (enforcing separation between investment and commercial banking) and dramatic increase of average investor’s allocation to emerging markets as way to improve their diversification (emerging markets represent about 30% of global investable markets yet average investor may have allocated 3-8% of their portfolio, and these countries have lower debt, higher reserves and faster growth.) But Gillian Tett in the Financial Times’ “Dodd Frank’s long-distance paper chase”laments that we are at risk of moving from “CDO cubed” to “complexity cubed” with the bill, whereby “complex financial products are colliding with complex reform processes run by leaders with complex (or unstated) reform goals”.

In the Financial Times’ “Fashion for currency hedges outdated” John Plender argues that (as often in financial matters) appearances can be deceiving, and currency hedging intended to reduce the effect of volatile currency exchange rates, seem to do so only in the short term. Over the long term, research show that hedged portfolios don’t have lower volatility or better returns. In fact he argues that hedging just exposes investors to a new source of risk: “betting on real interest rates at home versus overseas”. (I tend to think of foreign currency exposure, which comes with international/geographical diversification,
as another (useful) source of diversification. Of course it didn’t always work in my favour as the Canadian dollar was getting stronger, but that can be mitigated by doing some currency exposure matching of investment income and expense matching.)

Jason Zweig in WSJ’s “When funds lend stocks, who gains?” looks at where the benefits flow when your fund (e.g. ETF of mutual fund) lends securities to earn extra income. The problem is that it is very difficult to figure out who is making how much from securities lending. In fact a new study noted significant differences in income from securities lending among similar funds, suggesting possibly that “The people managing your money may sometimes be managing it more to benefit themselves than to benefit you” and that “when a fund uses an agent that is part of the same company that runs the fund, the returns to investors from securities lending are 70% lower than at funds that use other lending agents.”

Gillian Tett asks “Is there a shadowy plot behind gold?”in the Financial Times article by the same title. The issue relates to whether central banks are manipulating downward the price of gold to prevent the public from knowing its real price and therefore realize that “our currencies, such as the dollar, are a sham”. Tett suggests that protestations to the contrary by bankers might be taken with a grain of salt due to: (1) a combination of murky commodity markets, opaque central banks and “western rhetoric about “free” markets is often hypocritical”, and (2) western voters are frightened by the “unpredictable and mysterious nature” of the economy, which drives them to search for “plots” and “scapegoats”. She says that these accusations are unlikely to go away while the economy remains unstable or until the “gold price really soars”.

And finally, in the Financial Times’ “The big questions raised by anti-capitalist protests” Martin Wolf writes that the current protests are not a sign of “resurgent leftwing politics”, but it is a movement that is raising valid concerns about the role that macroeconomics should play in the post-crisis era, whether  what we really have is an “insider form of capitalism” which exploits and creates legislation for insiders to prosper i.e. a system in which “political influence is decisive”, and determination of what is an “acceptable level of inequality” because “any inequality is corrosive if those with wealth are believed to have rigged the game rather than won in honest competition.” And The Economist’s Buttonwood in “The great debate”writes that the key issue is “How to deal with an age of deleveraging without blighting the lives of millions of people though long-term unemployment… (and suggests that) one should not be too ideological about the issue; to recognise, for example, that America might have more flexibility to deal with the problem (because of its reserve currency status) than Britain or Greece.”


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