Topics: Humans compelled to trade, wills after re-marriage, long-term care fears over-rated? withdrawal strategies, US/Canada home prices up, Toronto no bubble-maybe, pension changes? pension costs critical, do actuaries add value to pensions? retirement needs 25 years of safe assets? gold is insurance? disaster economics suggests portfolio insurance re-think? illegal acts essential to success in financial industry? economic models? America’s short-term thinking.
Personal Finance and Investments
Jason Zweig in WSJ’s “Why we’re driven to trade” discusses how “short-term thinking is deeply embedded in the workings of the human brain. New research suggests that in order to avoid trading your accounts to death, you must counteract some of the very tendencies that make Homo sapiens the most intelligent of all species.” The frontopolar cortex in humans “…is critical to such advanced mental functions as memory, exploring new environments and making decisions about the future.” In experiments with people with damaged frontopolar cortex they “based their choices primarily on the cumulative reward history, not on the changes in the most recent outcomes”, while “the healthy subjects appeared to be extrapolating their most recent experience into the future and choosing predominantly on that basis”. So we are designed to trade based on or most recent experience, but we must resist and instead “Every investing decision you make should be the result of a deliberate process.”
In the Financial Post’s “Will and marriage: Having one without the other” Thomas Grozinger writes about recent changes to statutory law in Canada relating to wills. It used to be that generally a marriage revoked pre-existing wills. “So, when a person died after their marriage without creating a new will, they would die “intestate” (without a will) and their surviving spouse would typically be the primary beneficiary of the deceased spouse’s estate… Under this new (Alberta and soon BC) legislation, marriage no longer revokes a prior will.” This opens a whole range of new cans of worms discussed in the article due to “the relative ease that individuals can cross not only provincial boundaries, but international ones as well, the issue of the validity of pre-existing wills takes on a whole new and more complicated significance.”
In the Financial Posts “Fear of illness in old age haunts our finances” Garry Marr discusses the impact of potential need for long-term care in the context required retirement assets for Canadians, where government-run nursing homes are available but some might prefer to die at home. Quoted actuary Fred Vettese argues that there is only a 6% chance (sounds low) of needing an assisted living situation. However he indicates that even if you can’t pay the $2,000/month for the government-run nursing home you won’t get thrown out, and if you have assets or retirement income “…you will have little use for (it) once you are under 24-hour care. Some people may also have a home to sell.” And there is no requirement for you to leave an estate to your children. You could buy a long-term care insurance policy, but for the wealthy it is unnecessary and for others Vettese argues that these are expensive; a do nothing approach might be more than adequate for the small chance that you’ll need 24 hour care.
And you can read my review/comments earlier this week on Blanchett, Kowara and Chen’s paper at “Optimal withdrawal strategy for retirement income portfolios”in which the authorscompare five retirement withdrawal strategies (under the constraint that the retiree considers bequests to be of zero importance) and define a measure of Withdrawal Efficiency Rate as a means to compare them. They conclude that the commonly mentioned/used “Constant Dollar” (first year 4% of original assets, than adjusted annually for inflation) is the least efficient of the five considered, while one targeting a constant probability of failure with withdrawals continuously adjusted for remaining longevity and factoring in the effect of return history is the best. This should not come as a surprise to readers, since as a practical matter it should be obvious that “spending regimes that dynamically adjust for changes in both market and mortality uncertainties outperform the more traditional approaches”.
The just issued CanadianTeranet-National Bank House Price Indexindicates that “The (seasonally unadjusted) June increase takes the index to a new high for the third month in a row. June was also the second consecutive month in which none of the 11 metropolitan markets surveyed showed a price decline from the month before. The monthly rise was 1.7% in Calgary and Ottawa-Gatineau, 1.6% in Toronto, 1.5% in Winnipeg, 1.4% in Quebec City, 1.3% in Edmonton, 1.1% in Montreal, 0.9% in Halifax, 0.7% in Victoria and Hamilton and 0.5% in Vancouver… The index is now at an all-time high in eight of the 11 markets surveyed, the exceptions being Victoria, Calgary and Edmonton.”
In the WSJ’s “Home prices reflect strengthening” Nick Timiraos reports that according to Zillow US “Home prices in the second quarter rose from the year-ago period for the first time since 2007, according to a closely watched index, the latest indication the housing market is starting to recover.” (Well at least they look like they are bottoming.) “Nearly one-third of the 167 metropolitan areas tracked by Zillow posted annual price increases for the second quarter compared with the year-ago period… The Wall Street Journal’s quarterly survey of housing-market conditions in 28 U.S. metropolitan areas shows that inventories of unsold homes have fallen in every market and are down by more than 20% in two-thirds of those markets.”
But in the WSJ’s “New home sales dropped”Portlock and Morath report that “Sales of newly built homes in the U.S. fell in June to the lowest level in five months…New single-family home sales decreased by 8.4% from May to a seasonally adjusted annual rate of 350,000, the Commerce Department said Wednesday. June’s sales were the lowest since January but were up 15.1% compared to the same month a year ago.”
In the Globe and Mail’s “No Toronto condo bubble, RBC says” Tara Perkins reports that according to an RBC economist “…worries about the market are largely overdone…(because) record sales for new condos are picking up the slack that exists because fewer single-family homes are being built… Most condo units are finding occupants when they’re completed…” However “There are more condos under construction in Toronto than any other city in North America, and more residential building is taking place in the Greater Toronto Area than ever before.” The quoted RBC economist “expects condo prices to fall by perhaps 2 per cent to 7 per cent from their peak. He predicts that a two-tiered market could emerge, with condo prices softening while the market for single-family homes is resilient.”
But according Capital Economics as reported by John Shmuel in the Financial Post’s “Canadian housing looks to be in soft landing, but actually heading for a 25% crash”“There is always a stand-off period at the end of a housing bubble, when prospective buyers refuse to meet the price of sellers, who refuse to drop the asking price,” he said in a note. “Eventually it begins to dawn on sellers that the market has shifted and, as they become more desperate, they eventually agree to lower their asking price. But until that happens, any stagnation in prices can be misinterpreted as a successful soft landing.”
In the WSJ SmartMoney’s “Pensions facing more changes than you think” Alicia Munnell discusses proposed pension cuts in municipalities, which pre-crisis were thought to be impossible. The changes being discussed revolve around “the “pension wealth” of both current employees and retirees has been reduced. The most direct way this reduction has occurred for current workers is through increases in required employee contributions. Such increases were possible because, while constitutions and state laws preclude benefit changes, they usually place no restrictions on how much the state can ask the employee to pay… In some states, retirees have seen the reduction or suspension of their cost-of-living-adjustments (COLAs).”
Pauline Skypala in the Financial Times’ “Raising the issue of cost is crucial” discusses a new paper which argues that in the new UK pension schemes costs can eat up as much as 50% of pensions, contribution and transfer limits are also problematic, so is governance because “employers choose the pension scheme, and their choices “might not always be in the saver’s interest.”” (Are there some similarities here to PRPPs?)
And in Benefit Canada’s “Reflections on Canadian pensions”Malcolm Hamilton writes“Retirement plans are hostage to the economic environment in which they operate. Everything works in good times; nothing works in bad times. And nothing can be done about this.” (A better job at asset-liability management would have prevented much of the pension problems (but at a higher cost). So “nothing can be done about this” sounds like a self-serving statement aimed at protecting/excusing actuaries and their corporate clients from taking responsibility for years of underfunding pension plans by using aggressive and at times ludicrous actuarial assumptions at the expense of retirees’ pensions; to aggravate things, the retirees were promised DB pensions and were prevented from (partially or fully) contributing to RRSPs due to government mandated pension adjustment formulas while government regulators were looking the other way on funding of pension plans. If the actuarial ‘profession’ believes that “Everything works in good times; nothing works in bad times”, then actuaries add no value, and society doesn’t need actuaries.)
Things to Ponder
In IndexUniverse’ s “Bernstein: T-bills pack a special punch” Olly Ludwig interviews Bill Bernstein about his new book “The ages of Investing: A Critical Look at Life-cycle Investing” . In the interview he argues that: Bodie is essentially correct about the laddered TIPS for retirement portfolios, but still a couple of Samuelson’s students who came to the opposite conclusion recommend that young people should leverage 2-to-1 into equities using LEAPS are also right; except humans can’t execute this psychologically. He also says that “you really cannot rest easy until you’ve got 25 years’ worth of living expenses saved up in safe assets… I’m not even sure you need the annuity stream or the TIPS ladder. Just safe assets: short bonds. Short Treasurys generally keep up with inflation…(and) will hold its value when the whole world is going down the drain. And T-bills will do that.” (This perspective must be a real shock to a lot of readers.)
In the Financial Times’ “A case for the 6,000-year-old gold bubble” John Plender writes about gold that Buffett hates it as it is “a wholly speculative investment which yields no income”, yet central banks, after decades of sales have become recent buyers. In a world of fiat money (i.e. its value is derived from people’s belief in it), probably the same psychology probably applies to gold (a fiat currency, especially compared to useful commodities). Even so, gold’s advantage is that (unlike paper money) “it is very costly to increase the supply” and it seems like a good store of value because while government bonds offer negative real yields, then “non-income producing gold” doesn’t sound too bad. The biggest threat to gold price would be when governments “address fiscal deficits and debt”; gold is an insurance against government not doing that.
In the Financial Times’ “Bond yields and disaster risk premia” Gavyn Davies writes that central banks’ actions might not fully explain the current ultra-low interest rate environment. He refers to a recent paper from Fulcrum which suggests that the “economic disaster risk premium” priced into bond markets explains the gap, and that also explains the unusually high equity risk premium. If (some) government bonds have essentially zero risk of default and if they are used as insurance against the risk of economic disaster, then as the perceived risk of disaster increases, so does the price of insurance. Gillian Tett, also commenting on the same Fulcrum paper, in the Financial Times’ “We have entered the world of disaster economics” explains the anomaly of US/German government bond yields falling even though CDS (default risk insurance) prices suggest that their default risk is increasing by arguing that perhaps: either the CDS market overstates the default risk or it is due to the investors’ fear of a “disaster”. If “disaster” is defined as 10% drop in GDP then there were 58 disasters in the 20th century but only 2 of these were in the second half of the century. Tett argues that “…assets have two functions: they can produce returns, but they also offer protection. When disaster risk is low, investors stress the former; when the risk rises, they focus on the latter” (at least in countries with low default risk). The implications might be that disaster risk’s influence on asset prices “may not be a short-term phenomenon” and that “the financial world may need to overhaul its investment framework”. Portfolio theory focused on the return maximization function of assets because it was developed during a period of relative absence of disasters, but it may now require modification to factor in its “insurance against disaster” role as well. (i.e. are some asset valuations now shifting from an investment to insurance framework?)
In Huffington Post’s “Illegal conduct is critical to the survival of the securities industry”Dan Solin writes that “How ironic that the industry that wants us to trust it with our funds can’t manage its own money and is rife with illegal conduct. While you and I may find this difficult to understand, Wall Street executives “get it.” In a recent survey, a quarter of Wall Street executives viewed wrongdoing as “a key to success.” Sixteen percent indicate they would engage in insider trading if they knew they would not be caught. Almost a third said they felt pressured to “compromise ethical standards or violate the law.””(Thanks to Ken Kivenko for recommending)
In the Economist’s “Muddled Models” Buttonwood discusses why economics is called the dismal science: economic predictions are of little or no value. Reasons mentioned include: economists suffer of physics envy-unlike particles in physics we “humans change our behaviour and we watch the news”, economy is complex and not possible to do comparative real-time side-by-side experiments, economists model that which they can-not that which it is, economic assumptions (e.g. supply-demand, rational expectations, utility maximization) not valid (e.g. housing), and also because economic models are neglecting “behavioural economics”. He concludes with “A functioning modern economy needs respect for property rights; a government that is able to collect taxes and offer a social safety net; banks that allow the payment system to function; markets that allow businesses to raise capital and so on. Once those essentials are in place, whether the right top tax rate is 40% or 50%, the right interest rate is 1% or 5% is largely a matter of trial and error, and of political acceptability.”
And finally, from the Economist 2011 Buttonwood Gathering, Tom Kaplan’s“Short-term thinking in America” video (<3 min.) is well worth your time. Kaplan ridicules the US’s inability to act except in reaction to a shock/crisis (debt or dollar)…calls Americans “incapable of proactive thinking”, Martians might considered them idiots for not having developed an energy policy after the last 40 years of having been voluntarily engaged in history’s largest transfer of wealth “often to countries which despise everything we stand for”, “This is the only generation in this country that has effectively said “what the hell have my children and grandchildren done for me lately”” and more…he concludes with the question “does this country have the political will to do that which it has to in order to leave behind a better world?”…spend the 3 minutes to listen…it really makes one think deeply about where we’re going.