Topics: Banks=1: Customers= 0, group RRSPs: high cost and zero guidance, beating the index? arbitrary/insane US medical charges, ETFs OK, US home sales down and prices bottom, Florida home sales and prices up, reverse mortgages still NOT, CPP at 65 not 70, Nortel bankruptcy a pensioner disaster, pension fees high, bond buyers irrational? financial industry parasitic, muni bankruptcies, life-cycle saving and investing.

Personal Finance and Investments

In the Globe and Mail’s “Banks will win, customers lose under Flaherty’s new spat-resolution rules” Barrie McKenna writes that “Jim Flaherty is spinning his plan to overhaul the banking industry’s dispute-settlement regime as “tough” and “pro-consumer.”… (however) The upshot is that banks will be free to handle serious customer complaints using their own private ombudsmen, provided they follow some broad federal guidelines… The minister’s eight-paragraph press release doesn’t even acknowledge the existence of OBSI, which has handled thousands of complaints and secured millions of dollars in compensation in the past decade.”  (Sounds like a regressive step in Canadian consumer protection…just like the PRPP, another gift to Canada’s financial industry, at the expense of investors.)

In the Financial Post’s “How to add more cash to your pension plan” Ted Rechtshaffen laments the shift from DB to group RSP DC plans, but this $100B Canadian DC market he writes has two major problems: (1) insufficient guidance on investment selection and (2) people have no clue as to the cost of their plans, with many paying as much as 1.5-2.0% and more. In summary, very high fees and zero support.

In the Financial Times’ “It’s easy to only just beat a poor index” James Mackintosh re-states the by now well known (though not all investors have internalized its implications) fact that “managers on the average underperform the market; those outperform are no more likely to outperform in the future than other managers”. He then proceeds to quote some recent research from Research Affiliates, which indicates almost any strategy (and its opposite!) can outperform the market so long as one sticks to it. The reason is that the market capitalization weighted index is more heavily invested in the biggest companies. The problem is that the outperformance is just sufficient to cover trading costs. So, active managers can’t use this approach because they must also cover their management fees, and because these (non-market index) strategies might underperform the market for years and their investors wouldn’t stick with them.

From a Bird talk letter in the CSANews’ Summer 2012 issuethere is a reference to the LATimes’ “The bizarre calculus of emergency room charges”discussing the challenges of dealing with the U.S. medical system. It is truly eye opening article about the arbitrariness of charges which reinforces the essential need for travel health insurance before a Canadian crosses into the US and letting the insurance company negotiate the hospital bill, and by the way, separate physician bills; even those with a large deductible might be better off, except when they say they are un-insured, in which case the cost of services drops dramatically. He writes that “the calculus for medical charges in general is beyond comprehension, with outrageously high fees used as a starting point in a bizarre game of bargaining… This is the kind of insanity that exists when medicine and medical insurance are about private profit rather than public health”. (The article is eye opening; US medical system sounds bizarre!)

In IndexUniverse’s “Should you trust your ETF?” Paul Britt writes “Rate-fixing. Fraud. Money-laundering. Today’s hottest growth niche seems to be white-collar crime by financial institutions. Can you trust your ETF to steer clear of these shenanigans?” He then proceeds to discuss areas that might be of concern such as ETF short sales, securities lending, derivatives, ETNs and concludes that “The structural risks discussed here are real, but they’re clearly defined, and most importantly, manageable… While the wider world of finance is tainted by ethical lapses and worse, ETFs are designed to be transparent and, for the most part, that’s exactly what they are.”

Real Estate

In the WSJ’s“Yea! Home prices hitting bottom. Now, the bad news” Brett Arends writes that the bad news is for all the sellers, especially the Boomers who were counting on the sale of their homes to finance their retirements. Case Shiller Home price index indicates that inflation corrected prices are only up 16% over the last 25 years! His recommendation is: don’t hold your breath waiting for prices to rise, consider local and personal circumstances including the possibility that there may be ways to negotiate with your mortgage holder or in some states to walk away if that makes financial sense, and if you were planning to move or downsize explore how may still go on with your life.

But in the Bloomberg’s “Home sales to factories point to second half weakness: Economy” Jamrisko and Chandra report that existing home sales dropped 5.4% in June to a “4.37 million annual rate, an eight-month low”. “Existing-home sales, which are tabulated when a contract closes, have strengthened since reaching a low of 3.39 million at an annual rate in July 2010. In the buildup to the subprime lending collapse and recession, purchases reached a peak of 7.25 million in September 2005.”

In Palm Beach Post’s “Palm Beach County home sales and prices up in June” Kim Miller reports that sales in the county were up 14% and prices up 7% over previous year; statewide sales were up 5.3% and prices up 8.2%, while nationally sales were up 4.5% (though in June sales were off 5.4%) and prices up 8%, according to the National Association of Realtors.

In WSJ’s “Rethinking reverse mortgages, Part 2”  Tom Lauricella writes, that despite increasing use of reverse mortgages, he reminds readers that their use may only be advisable as a last resort. The problems are numerous: (1) taking out a large lump sum can lead to spending it and eventually losing the home due to being unable to pay for taxes, insurance and maintenance, or (2) that the “borrowers fail to understand that even after the money is gone, the balance on the loan is still rising and eroding any remaining equity in their homes”, or (3) “A reverse mortgage feeds into our American desire to avoid the financial facts of life,” Mr. Quinlan wrote. “If I need money and have a lot of equity in my home, I should sell the home and downsize” and the newest problem (4) when one chooses not a lump sum withdrawal, but a “line of credit”-like option one ends up with variable rates, which can come back to bite you. So take the money as a lump sum or as a line of credit, you can end up with a losing proposition.

Pensions

If you are a Canadian then you have an interest in the Canada Pension Plan, you might be interested to read why I changed my plan to start CPP at age 70 in Took CPP at 65 instead of the previously planned age 70: What changed? blog posted earlier this week arguing that the combination CPPIB investment strategy changes from passive to active, potentially higher effective future taxes, less transparency in CPP asset valuation due to growing proportion of private (company and real estate) vs. public investments, uncertainty of actuarial forecasts and, should circumstances demand it, government’s ability to change CPP (target) benefits, drove my decision to take CPP at 65, rather than 70. Too many unknown factors all potentially exposing one to downside risk, with very limited upside possibilities. And, those who doubt that government pension benefits can be reduced should reflect upon the recently announced OAS changes or discuss this possibility with the citizens of Greece!

In the Ottawa Citizen’s “Why Nortel bankruptcy talks are stalled” Bert Hill explains clearly the reasons why Judge Winkler’s mediation efforts are very slow (to pensioners it feels like they have ground to a halt). The main culprits are: the UK pension guarantee fund (effectively the UK government) demanding its $3.1B flesh from the $9B Nortel assets, the bondholder who “snapped up the distressed securities for as little as 12 cents on the dollar now demanding $3B plus interest because the bonds are guaranteed by both US and Canadian assets”. Hill says that Nortel has refused to participate in UK regulatory proceedings which upheld the guarantee fund’s claim, while the US Supreme Court has rejected it; in the meantime the lawyers feeding frenzy at the trough of Nortel’s carcass continues. Hill writes that “The implications are terrible for 10,000 Canadian pensioners who are campaigning for the federal government to intervene, despite a long history of indifference.”  (The pensioners should be planning the rest of their lives assuming that the additional recoveries from the bankruptcy will be zero; any upside perhaps 10-15 cents on the dollar will be a pleasant surprise. The government never got its bearings right on (this and other) pension issues. Somebody is asleep at the pension policy wheel. Truly pathetic!)

Kiran Stacey in the Financial Times’ “Miliband attacks pension groups over fees” reports that British Labor leader attacks pension industry on their high fees for services and call this the next Libor crisis: “People can see half the money they put in being lost in fees and services. It is a massive, massive issue that is coming down the track.” He demands that pension providers “to state clearly how much their services will have cost by the end of a pension’s lifetime” and if elected he even threatened to cap maximum charges.

Things to Ponder

Pauline Skypala in the Financial Times’ “Books to enlighten bond buyers” refers to The Invisible Gorilla film which demonstrates how humans are so focused on their ”assigned task” or “current thinking” that they fail to see/respond to new inputs. She quotes Knudsen that the current investment world’s invisible gorilla is the ““state-guaranteed loss of purchasing power” for buyers of government bonds”, and who argues that investors are not thinking/acting rationally. The end of the bond bull market has been predicted for some time. Also since 2000 equity P/E dropped from 30 to 10-12 and dividends have been increasing, yet investors still prefer bonds.

The Economist’s Buttonwood in his “Conard or canard?” blog commented on Edward Conard’s book “Unintended Consequences” writing that he doesn’t buy Conard’s arguments (that we shouldn’t be taxing more heavily the highest earners since they are the source of the nation’s overall prosperity and that the very talented 1% deserve their high pay for their enormous contribution) given that the last decade had an annualized growth rate of 1.6% compared to 3.6% in the more egalitarian 70s. Buttonwood adds that “The last decade saw the culmination of the focus on finance, which was the fastest way to get rich; talent was allocated to “the most valuable investment opportunities” for the individuals concerned, but not for the economy as a whole.” (My comments on the book last week were along the same lines “I’d have to agree with his (Conard’s) perspective on not having confiscatory taxes on those who are innovators/entrepreneurs and make money by bringing value to the population a large…however this does not apply to the financial industry, where ‘innovation’ tends to be mostly for new ways to fleece the unsuspecting/uninformed customers.”)

InvestmentNews’ “Buffett says muni bankruptcies are set to climb as stigma lifts” reports that according to Warren Buffett, the reduced stigma associated with municipality bankruptcy will lead to its accelerated actual use, as well as use as a  threat in negotiating with unions. The crisis is aggravated by generous wages and benefits (including pensions) granted during years of windfall muni tax revenue increase resulting from housing bubble; yet investors continue to be drawn to municipal bonds due to their tax-exempt status and dearth of other fixed income alternatives. Examples where a state and municipality have been renegotiating contractual agreements are mentioned in “Alabamans in prepaid college plan may have to settle for less”and“Palm Beach Gardens faces unfortunate pension reality”

And finally, in the Journal of Financial Planning’s “Financial Planning: A look from the outside in” Paula Hogan discusses what she calls the Bodie Merton Samuelson theory of Life-Cycle Saving and Investing (LCSI). Hogan explains: (1) the centrality of human capital in LCSI which leads to “life planning as central to the (financial) advisory mission…life planning focuses on values clarification and goal specification”, (2) that “People care most about their lifetime standard of living, not portfolio wealth”, i.e. focus is on income not wealth, emphasis on risk management in general and longevity and inflation risk in particular, and “the need to smooth consumption”. The implications of these principles on financial planning practice suggest that: advice is client rather than portfolio centric, advisor must find a way to help client separate needs from wants (i.e. with life planning “client discovers and implements the optimal level of earning, saving, investment risk-taking, and spending”), the assumption that stocks are safe if you have a long horizon is flawed (e.g. see my Time Diversification: Stocks are less risky over the long-term??? (Not!) blog), a plan should be architected so that needs are covered with “lifetime inflation-protected income”, derivative strategies have a place in managing risk, it is not portfolio appreciation that’s key but what is floor and upside with specified risk parameters, each goal should be matched with a specific investment allocation based on risk capacity not willingness to bear risk (more of an ALM strategy), advisor role is to optimize human capital and “safely smooth consumption over time”, and insurance is not an expense but a source of income should there be “a disruption in your personal life”. (A thoughtful and thought-provoking must read for all those calling themselves financial “advisors”.)