Topics: Malkiel: bonds worst asset class, life insurance cash-value taxable, more reverse mortgages, GMWBs- No, annuities: Hartford exits and agent to jail, lifestyle inflation, advisor evaluation and messages, fiduciary, VIX index expensive protection, Canada’s synthetic ETFs safer? Canadian real estate investment??? US real estate bottom? OAS and MP/public-sector pensions to be hit? Poor retirement prospects, new retirement options: cruises-group homes-backyard cottages, inflation risk rising?
Personal Finance and Investments
Burton Malkiel in WSJ’s “What does the prudent investor do now?” writes that “Bonds are the worst asset class for investors. Usually thought of as the safest of investments, they are anything but safe today. At a yield of 2.25%, the 10-year U.S. Treasury note is a sure loser. Even if the overall inflation rate is only 2.25% over the next decade, an investor who holds a 10-year Treasury until maturity will realize a zero real (after-inflation) return. If the investor sells prior to maturity, it will likely be for less than the face value of the note if the inflation rate rises… A good way to estimate the likely long-run rate of return from common stocks is to add today’s dividend yield (around 2%) to the long-run growth of nominal corporate earnings (around 5%). This calculation would suggest that long-run equity returns will be about 7%—five percentage points more than the safest bonds.” Malkiel also argues that Shiller’s P/E ratio might suggest that stock valuations are high but “the average earnings over the past 10 years are likely to be well below the current normalized earning power of U.S. corporations”. The asset classes he thinks to be particularly attractive are: emerging market equities, real estate. In a low return environment “investment fees are more important than ever”.
Jamie Golombek in the Financial Post’s “Insurance can be taxable” warns that while life insurance proceeds upon death may not be taxable, but taxes may be due when taking cash value out of a whole or universal life policy, because “premiums paid in the early years of his policy exceeded the cost of insurance in those years, a capital reserve was created within the policy that generated investment income, which remained tax-sheltered while inside the policy.”
In CNBC.com’s “More seniors use reverse mortgages to raise cash” Mark Koba reports that there has been a 15% increase since 1999 in the percentage of 62-64 year olds applying for reverse mortgages. “…with job losses, higher debt and living costs, more and more of the ‘younger’ seniors are looking at reverse mortgages as a way to pay their bills and keep their homes…It shows the devastation some seniors have gone through since the financial downturn.” Those who (must) avail themselves of reverse mortgages appear to do so at an earlier age than the historical mid-70s. (Advisors recommend that you think of reverse mortgages as “last resort” scenario only; you can read my old blog on this subject at Reverse Mortgage.)
Rob Carrick, in his very short Globe and Mail video on GMWBs interviews Asher Tward in “Worried about outliving your savings?” who indicates that while guaranteed income stream for life sounds wonderful, GMWBs (as available in Canada) are not the way to go because of a combination of high fees and inability to invest aggressively enough (to get any realistic upside opportunity). See my analysis Vanguard’s U.S. only GLWB/GMWB product Vanguard GLWB vs. other decumulation strategies which includes some other approaches to withdrawal in retirement and discusses pros and cons of the available options; you might also be interested in an earlier analysis which discusses in more detail what’s wrong with such high cost guarantees at GMWB II- Guaranteed Minimum Withdrawal Benefit II. Also in the WSJ’s “Hartford says goodbye to annuities” you get a sense that the variable annuity with guarantees business might be a gusher of money for the insurance companies in good times but if a ‘1-in-a-100-year’ event comes along then insurance company not being properly hedged (or hedge counterparty being unable to pay) can have bad outcome for investor; the ultra-low current interest rates orchestrated by central banks just added pain by dramatically lowering insurance company returns. (So this re-enforces a previous suspicion that for the variable-annuity with guarantee buyer this product always has a no-win outcome; i.e. little or no upside opportunity when markets are flat or “good” and might not get paid if there is a systemic crisis. In fact some might reasonably ask whether insuring against rare but severe market events is even an appropriate insurance product in the traditional sense of insurance products…i.e. insuring an individual risk without actually taking on a systemic risk for the entire insured population (as in no or capped terrorism coverage).
In the WSJ’s “Annuity case chills insurance agents” Leslie Scism reports that “an independent insurance agent was ordered to spend 90 days in jail on a felony-theft conviction for selling a complex annuity to an 83-year-old woman who prosecutors alleged had shown signs of dementia… The case underlines authorities’ continuing discomfort with “indexed” annuities, savings products that pay interest tied to the performance of stock- and bond-market indexes. Insurers guarantee that buyers won’t lose any of their principal but in return charge sometimes-steep penalties if investors withdraw their money early, for periods that can stretch beyond a decade.” (With low interest rates and fear of losing their capital it’s open season on retirees to be victimized by high cost and often illiquid guaranteed products like indexed annuities which guarantee capital or GMWBs which guarantee income stream; neither way is optimal for achieving objectives.)
In the Globe and Mail’s “Are you reining in your lifestyle inflation?” Preet Banerjee explains the difference between inflation that you can’t control (CPI changes) as compared to “lifestyle inflation” (i.e. ratcheting up you lifestyle or expenses on “wants”) which you can control. He says “I believe that one or two spending vices are okay. It might be travel, sports, home, fashion or fancy coffee beans. As long as you’re not spending beyond your means over all, you can indulge. The problem is that we want to indulge in everything.”
In the Financial Post’s “Weary savers get mixed signals from advisors” Linda Stern discusses the unprecedented level of fear among investors and how advisors can/do deal with them. The range of approaches is to some degree a function of what might suit the advisor’s interest: annuity, more active asset management (trading and hedging), options, bonds or just a “pep talk” to reassure “that scary times don’t call for different investing strategies, just for more hand holding… There’s always risk…If you want to do more than keep up with inflation, you have to take risks. And you have to be patient.”
Rob Carrick in the Globe and Mail’s “The art of evaluating your investment adviser” list topics your, at least annual, meeting with your advisor: “Material changes in your personal or financial life”, investment performance, “reassessment of your risk profile and asset mix”, advice on other services (insurance, retirement planning, charitable giving…)
In InvestmentNews’ “Goldman flap drives home fiduciary issue” Darla Mercado reports that last week’s very public resignation of a Goldman Sachs employee, “some advisers hope that (this)…will be a wake-up call for clients, getting them to demand better quality of service they receive from advisers…One thing this … will certainly do is make the idea of a client-first duty of care harder to ignore…” (We can hope that it will open the eyes of investors to the need of high level of diligence if/when they deal with a non-fiduciary “advisor”.)
In the Financial Post’s “Concerns grow over volatility-linked index” Ajay Makan writes that the rising popularity US equity volatility-linked products have lost money over the past year not just because of falling volatility, but also because the fund operators must buy increasingly higher volume of increasingly more costly VIX futures contracts. This approach of volatility hedging is only used retail investors (not hedge funds). “The VIX futures market is very thin. People on the other side of the trade know that the banks operating these funds have to cover their positions and can price accordingly.” Some of these funds have dropped 40-50% this year.
In the Globe and Mail’s “Canada’s ETFs safer than U.S.’s and Europe’s” Tim Kiladze writes that Canada already has tighter requirements pertaining to collateral associated with synthetic (swap-based) ETF implementations; e.g. no more than 10% exposure to a single counterparty. Blackrock proposed that only plain vanilla implementations should be classified as ETFs. (Frankly I don’t see why I would use synthetic ETFs for asset classes that I can access with physical-based plain-vanilla implementation of the index.)
In the Canadian context, Tom Bradley (“an active manager of stocks and bonds”) in the Globe and Mail’s “Real estate as an investment? Look elsewhere” writes nowadays income property is considered by many as superior to investing in the markets. He argues that a combination decreasing demand for property due to demographics, an increase in home ownership over the past 15 years from 65% to 70%, a pullback in the government’s excessive financing stimulus, has led to “the fundamental trends in favour of housing investment are getting tired, and in some cases reversing… cheap, abundant financing is transitory, while the price paid is forever…(and while) affordability indexes show that most housing markets in Canada are near their long-term averages… these calculations are based on current mortgage rates”. His conclusion is that “The distribution of potential outcomes looks asymmetrical to me – limited upside and plenty of possible downside… To invest in an asset class that is illiquid, has high holding and transaction costs and involves large amounts of leverage, I want a significant margin of safety.” And, in the Ottawa Citizen’s “Toronto condo sales slide 59% from last year” Garry Marr reports that “Builders call it “stability” in the housing market but sales in Toronto’s high-rise market, which includes the volatile condominium sector, saw a 59% decline in sales from a year ago…”
In the Barron’s “Ready to rebound” Jonathan Laing reviews the devastation in U.S. real estate over the past half decade with the Case–Shiller indices off 34% and some markets off as much as 50-60% (Las Vegas, Phoenix and Miami), but writes that “there are signs that the long nightmare for American homeowners is in its terminal stage, and that, maybe, just maybe, home prices will bottom and begin to turn by the spring of 2013—if not before…” The article suggests that a “bifurcated market has developed in which a pricing recovery is already under way in communities and neighborhoods far from the areas still reeling from past excesses of past excesses of subprime mortgages and predatory lending”. “The biggest impediment to a turn in the home market remains the so-called shadow inventory of some 3.671 million homes… This inventory sits atop a market for existing-home sales that this January reached an annual pace of 4.5 million units”, however a national home builders’ market index is “on a tear of late, rising five months in a row” and Shiller notes that, while he doesn’t know why, the” builder-confidence reading has been such a good leading indicator”.
In the Palm Beach Post’s “Palm Beach County home prices lag U.S. average” Jeff Ostrowski reports that “Palm Beach County homes are selling for a hefty discount below the national average, a price correction that marks a sharp reversal from the boom-time premium commanded by properties here… It’s a trend that has housing experts predicting Palm Beach County prices could bounce back – but only after the area’s flood of foreclosures and short sales recedes… In 2005, Palm Beach County prices spiked, reaching a premium of as much as 19 percent over the national average. During the crash, Palm Beach County homes have sold for much less than the national average. The gap has been more than 20 percent since late 2010.”
In the Financial Post’s “Tories poised to launch daring cutbacks to public pensions in federal budgets” Mark Kennedy writes that next week’s budget is expected to hit: OAS by moving eligibility from 65 to 67, “gold plated” Member of Parliament pensions will be reduced-or perhaps tinkered with- to provide cover OAS reductions, and public service pension contributions will likely increase toward 50% of cost level. The article also suggests that the government hasn’t as yet got its messaging right as to the “necessity” of the OAS changes. (While these might be necessary changes, they are just changes at the margin since none tackle the real pension reform to deal with the systemic failure of Canada’s private sector pensions. And on the subject of messaging/selling needed changes, Gillian Tett in the Financial Times’ “Investors must get a grip on ‘granny tax’ rows” writes that a new book by Robinson and Acemoglu entitled “Why nations fail” discusses two measures of social cohesion that determine whether a society prospers (“Is there a centralized power structure that can implement decisions?” and “Is this government system sufficiently “inclusive” to create “buy-in” from the poorer masses?”))
Things to Ponder
In WSJ’s “New retirement resorts” Kelly Greene that for many retirees, just as assisted living facilities replaced nursing homes, these in turn are being replaced by permanent cruises, spas, group homes in the home country or foreign countries and cottages in adult children’s (or parents’) backyards used as separate living quarters. Many of these new options might even be more economical than similar quality traditional assisted living facilities.
In the NYT’s “After the storm, the little nest egg that couldn’t” ….discusses the meager resources and limited income many of those in or approaching retirement can expect as a result of: poor market performance, low interest rates, fewer with DB pension plans, low savings rates, increasing longevity. The article includes a reminder that you need $750,000 for $30,000 annual draw at the 4% rule of thumb. It also suggests to: delay start of Social Security, diversify and keep costs low.
Also in the NYT, in “A forecast for low returns, and advice for investors” Paul Sullivan writes that advisor to the wealthy Jean Brunel argues that “the classic link among the return premiums for bonds over cash and stocks over bonds still holds, but they are substantially lower because of the low interest rates set by the Federal Reserve. Here is how it works. The return on cash is typically the expected rate of inflation plus some real interest rate that is derived from the rate a central bank sets to promote growth. The return on bonds is cash plus some additional amount to account for the duration of the bond. The return on equities is the bond returns plus some premium for the risk associated with stocks. He noted that cash typically had a return of 4 percent, putting bonds at 6 percent and stocks at 8 to 9 percent. With cash now yielding zero, that has lowered bonds’ return to 2 to 2.5 percent and stocks to 5 percent. The problem, as he sees it, is that too many people are stuck on the old numbers…the easiest strategy is to spend less…other option… is for people to rigorously practice mental accounting — one of the main tenets of behavioral finance. By putting money in various fictional baskets or buckets, people can become more comfortable about the money they have. As long as the money for the next five years is safe, the thinking goes, clients are less apt to touch the money meant for after that.”
And finally, inflation concerns are on again? A couple of Bloomberg articles suggest that vigilance might be appropriate. The “Fed’s Bullard see price threat from G-7 delaying price policy” and “Canada February core inflation rises fastest in three years” .