Topics: Elder financial abuse, US reverse-mortgages may be better but are they good enough? are target-date funds safe? rent or buy not just a financial decision, tightening mortgage rules imminent in Canada? Nortel bond-holders $1.25 while pensioners $0.15? good ideas in OECD pension report, pension fees, post-war parallel of “financial repression” and being on the cusp of “equity cult”? volatility the wrong risk measure and other issues.

Personal Finance and Investments

In the Financial Post’s “Financial abuse of elderly getting worse” Garry Marr reports that a new US survey indicates growing level of financial abuse of the elderly, with 84% of the experts agreeing that the situation is getting worse. “Another finding was 96% of respondents say potential problems with mental comprehension make seniors vulnerable…” Seniors are natural target because they tend to have accumulated assets for retirement, natural prey to scammers promising unrealistic higher returns accompanied by low-risk. Canadian situation is similar. Coincidentally, I got from Larry Elford an article “’Pink Slime’ investment sales techniques? Nine broker tricks you should know” in which he illustrates an example of elder financial abuse orchestrated via: misrepresenting salespeople as advisors, piling fees-upon-fees often invisible to the client, false titles, and others. He writes that “Any one of these tricks has the potential to cut your retirement in half, over the long term, while placing the other half into the hands of the trusted financial industry.”

In the WSJ’s “Advisers reverse thinking on reverse mortgages” (also see US federal website at FHA HECM) Tom Lauricella writes until recently,” …they (reverse mortgages) were the Wild West of retirement planning. High upfront costs, poor disclosure and dodgy sales pitches made them an option that many advisers avoided. Now, with the introduction of reverse mortgages backed by the Federal Housing Administration in late 2010, more financial planners are adding them to their tool kit.” However when you read the article you still get a sense that what advisors are saying is only slightly less negative than before: “”It’s a tool…but it’s something that people need to be careful with…”, “retirees should be wary of brokers pushing higher-fee reverse mortgages”, other suggest they should be used only on a standby basis to limit having to sell risky assets when market tanks”. (I haven’t looked the current costs and available rates today, but I would still consider this an option primarily when all other avenues have been exhausted; see my somewhat aged blog Reverse Mortgage on this subject.)

In NYT’s “Target-date funds not equally safe” Ron Lieber looks the wide differences in risk aimed at a specific age group contained in target-date funds; examples he provides aimed at 63 year olds range between 63% stock to 63% bond allocation. The difference in these funds are a result of philosophical difference between employer or fund managers whether they are concerned about assets and their buying power having to last possibly 30+ years at one extreme to being concerned about big market dropped just before retirement which would prevent retiree from taking commuted value to meet some expected expenditure or from buying an annuity with the expected income level. (See below in the Pension sub-section of this week’s blog a reference to OECD recommendations for a safer TDF glide-path.)

Real Estate

In the WSJ’s “To rent or buy? That is not the question” Kathy McLaughlin and her husband have been arguing for years about the financial wisdom of buying vs. renting. However upon some reflection they realized that “we thought we had been arguing about one thing but were actually arguing about something else.  It had nothing to do with whether it’s empirically smarter financially to rent or own. Instead, we were fighting for what is emotionally important to us. Alejandro wants to own title to a home, so that no one can ever tell him he needs to move. And once I buy a house, I want to feel proud of it, not ripped off by it. “(Of course buy vs. rent is not just a financial decision, whether it’s you primary residence or a winter escape, there are emotional factors that cannot be clearly eliminated.)

In the Globe and Mail’s “Flaherty preparing to announce tighter mortgage rules” Reuters quotes an unnamed official as saying “Finance Minister Jim Flaherty is expected to announce Thursday that mortgage rules will be tightened in an attempt to cool a heated housing market.  The maximum amortization period of mortgages will be cut to 25 from 30 years and the minimum down payment required will increase to 20% from 15%…” (Announcement is expected today)

Pensions

I had a chance to do a quick skim of the 200+ page OECD report which I mentioned in the last week’s blog “OECD Pensions Outlook 2012”. It has some very interesting graphs/tables and good recommendations for those with a more in-depth interest in the workings of pensions. Items I found of particular interest were: (1) comparative income replacement rates in OECD countries on pp. 163, 168, 169, 170, 204, 205, 206, 207 (confirming that Canada does well relative to other countries for low income Canadians, but performance deteriorates rapidly for those earning >1.0-1.5x average income; also Canadian numbers appear to be assuming that average income Canadians contributed at the maximum level for the full 35 or so years to be eligible for the maximum benefit, unlikely to be true for many. Given that average CPP payout is closer to $7,000 than the max of close to $12,000, the average and higher income replacement rates would likely be even lower than indicated.), (2) the relationship between replacement-rates/contribution-rates/contribution-period on p.167 (an eye-opener), (3)  the link between low cost and reduction in pension on p. 175,  (4) a recommended approach for DC plan default is a combination of (variable) “programmed withdrawal” with a deferred annuity (longevity insurance) bought at retirement  on p.184 (this is close to what I’ve been advocating though so far have failed miserably in getting any mindshare), (5) a recommended default for DC plans to have an asset allocation glide-path of (high) fixed equity allocation until 10 years before retirement, but then a rapid reduction in risky assets to zero on p.180 (coincidentally I got a note from Ron Surz this week who advocates a very similar default 401(k) glide-path for target date funds-see his Safe Landing Glide Path ; if you think about it a little this actually make sense, a default of constant high risk to age 55 and then reduce risk to a very low level approaching retirement. This would allow better predictability for those individuals who would like to take the cash value and/or annuitize, but would still allow those who are more risk tolerance the option to add risk elsewhere in the overall portfolios.) and (6) some level of inflation protection. (This confirms that, from what we know so far about it, Canada’s PRPP is completely out of step relative to some of these and other progressive recommendations; OK, auto-enrollment is included, but that is it.)

By the way the PRPP train appears to be leaving the station. Great West Life has announced a website for Quebec based employers on VRSP (Voluntary Retirement Savings Plan), the Quebec version of Canada’s PRPP. (I searched for specific funds available and all-in costs associated with them, but I haven’t been successful in locating this info at the website as yet.)

In the Financial Times’ “Control pension fees if nothing else” Pauline Skypala looks at the critical factors affecting public pension systems in different countries, and concludes that these include: elements of luck (not very useful factor to drive action, but sure is nice to be lucky), maximizing returns must be accompanied by risk management especially where “individuals shoulder all risks”,  individuals can control (in some cases) contributions to such public system, but only the government and those running these systems can control (investment, administration, etc) costs . (We still have no indication in Canada what PRPP costs will be like, not that the CPP costs are that low given a fund of that size.)

In my “Nortel bondholders poised to get $1.25/dollar while pensioner might get $0.15/dollar?” I encouraged all Nortel pension fund beneficiaries and other ex-Nortel employees with claims against the Nortel estate to respond to NRPC’s request for action.

An example of foreign creditors trying to encroach on the Canadian (and US) estate can be seen in totaltelecom’s “Nortel continues fight against $3.1Bn UK pension claim” Jacqueline Palank reports that Nortel is asking the bankruptcy judge to throw out the $3.1B claim of the UK pension plan as they have not provided adequate supporting documentation for their claim over the past three years. Nortel proposes that unless adequate documentation is provided by July 31, the claim should be dismissed. The US Supreme Court will be deciding on June 21 whether to hear the case about who should be responsible for the plan shortfall. (Sounds like the mediation process now under way is not close to satisfactory resolution.)

Things to Ponder

In the Financial Times’ “Parallels with the post-war era” James Mackintosh compares people’s preference for investments despite current “financial repression” driven low interest environment with the post-war era when there also was an aversion to stocks. She notes the “striking parallels” between now and then. However that turned out to be “the start of the “cult of equity””. But there are also some differences like, even though last decade equity performance was dismal, the past 20 years returned 6% real. (History may not exactly repeat but at least rhymes.) He notes that “With the most secure government bonds paying less than inflation, even as government debt soars, investors are not being rewarded for holding bonds – let alone for their increased risk.”

And finally, in IndexUniverse.eu’s “Using the wrong risk measure” Paul Amery rants about volatility being an inappropriate risk measure, “smart beta”, market timing, CAPM and its associated unrealistic assumptions, fat tails and the need for financial system reforms. (There is no black and white, just “shades of grey”.  And financial modeling is not about predicting the future but just about exploring scenarios; quoting Richard Hamming: “computing is about insight, not numbers”.)