Topics: Passive beats active, don’t die intestate, control: risk-level/asset-allocation and rebalancing, SS delayed-retirement credits, Canadian housing to fall? US housing up- but on the rebound? no pension relief to Canada’s corporations, spending in retirement, some CPP recipient more equal than others, no Paulson subprime mortgage related Goldman charges, StanChart villains- the lawyers? sell gold? backlash against the rich, Libor replacement needed now, why is America’s middle class broke? inflation to triple? Great Recession aftershocks? America’s debt at $222 Trillion!!!

Personal Finance and Investments

In the Financial Post’s “Fees are constant, performance isn’t” Michael Nairne reports that according to the latest (2011) S&P Indices Versus Active Funds (SPIVA) scorecard “the overwhelming majority of actively managed funds cannot outperform their benchmarks. Across all major equity categories, the vast percentage of actively managed funds in Canada underperformed their indexes. The dead weight of fees and expenses on returns is simply too great a burden in today’s highly competitive capital markets.” This is especially true over longer periods (five or more years) where the oppressive burden of fees is overwhelming. (Surprise? No. So why are so many Canadians continuing to buy/hold mutual funds?)

In the Globe and Mail’s “Where there is a will, there is a way to avoid a tax hit” Tim Cestnick explains why trying to save legal fees by avoiding preparation of a will is being penny wise and pound foolish. The outcome, more than likely, will be that the estate will be distributed according to a provincial intestate default, i.e. “that your estate may not be distributed in accordance with your wishes, and there could be more tax to pay than necessary”.

In IndexUniverse’s“Swedroe: Laddering Treasurys still works” Olly Ludwig interviews Larry Swedroe who has some insightful commentary well worth reading: forecasters (even smart ones) are mostly wrong, the financial repression is driving people into hedge funds and venture capital even though their histories should make people run the other way, stop worrying about things that you can’t control (returns) and focus on what you can control (level of risk you take, asset allocation and rebalancing), “When you have satisfied the “I must haves” and the “things I really like to have” then you should take some of the chips off the table” (not zero, but 20-30% of equity to the end of life), in Treasurys 10 year ladders are useful in balancing reinvestment and inflation risk, “the passive investing trend is clear but “ most of the alternatives that people are pushing certainly cannot be supported by the evidence. Hedge funds have been disasters on average. Venture capital has gotten somewhat better results, but it hasn’t gotten better returns than simple, risk-adjusted public equities like small value stocks. And there you have transparency, daily liquidity, daily pricing, and you don’t have that with private equity.”

In the WSJ’s “Social Security: More ways to time it to your benefit” Kelly Greene discusses the benefits of “file and suspend” strategy to Social Security which increases monthly payments later in retirement at the rate of 8% a year for each year you delay the start of benefits up to age 70. The article also discusses how these delayed-retirement credits affect spousal benefits, such as surviving spouses with lower benefits would get the same higher payments as the deceased spouse, including the delayed retirement credits, and other related Social Security topics.

Real Estate

In the Financial Post’s“Canadian housing prices to fall 10% over next few years: Scotiabank” Julia Johnson reports that according to a Bank of Nova Scotia report entitled “Canada’s housing outlook- Hot markets beginning to cool”a combination of “record home ownership” (70%, compared to 60% in 1961, is a rate which also signaled peaks in the US and UK)and “cooling housing market” will lead to 10% drop over next 2-3 years. Other economists suggest higher than 10% drops, with Vancouver (due to affordability) and Toronto (due to condo over-supply) being most vulnerable. Those who are most likely to suffer, according to Garth Turner, are boomers trying to harvest some of their accumulated net-worth with a significant proportion being in housing, and young professionals and couples already in the condo market. Affordability will also deteriorate with tightening of financing requirements and if interest rates increase for those with variable rates or coming to the end of their 5 year terms.

Nick Timiraos reports in the WSJ’s“Home prices climb as supply dwindles”that US home prices are up 2.5% year-on-year and 6% from previous quarter. Reasons for the price increase are limited inventory partly due to increasing conversions to rentals, lowest mortgage rates in 60 years driving up demand, distressed homes are being sold at higher prices, years of depressed levels of new construction, and many sellers are staying out of the market looking for higher prices. Price jumps at the low end of the market were particularly significant. Dampers on further price increases are difficulties to qualify for a mortgage, 3 million mortgages in “some stage of foreclosure or serious delinquency” and concerns about where the economy is heading.

In WSJ’s“Is the real-estate rebound for real?”Joe Light looks at indicators (house prices, builders’ stock prices, rents, REIT prices, new construction) which appear to suggest that a US real estate rebound might be under way. Furthermore single family home inventories are at six months, a 49 year low. However Robert Shiller is uncertain that house prices have bottomed.

Pensions

Unlike the U.S. (UK and Denmark) the Financial Post’s “Ottawa shrugs off pleas for pension relief amid massive shortfalls” Egan and Taylor report that Canadian Finance Minister Flaherty rejected requests for additional pension relief, i.e. additional time to make up DB plan deficits. “But the federal government, which provided companies with three rounds of pension funding relief between 2006 and 2010, has no plans to do the same again.” (After years of using aggressive investment strategies combined with aggressive actuarial assumption in order to minimize pension contributions, resulted in underfunded pension plans, the very low interest environment further aggravated the underfunded status of the plans. Now corporations are requesting additional relief from making required contributions to start making up the shortfall; but should that relief be granted and the corporation goes into bankruptcy protection in Canada, unlike in the US, the DB pension shortfall would be absorbed by the pensioners! It would be unconscionable for Canada to provide relief to corporations given that Canadian pensioners have neither pension guarantee funds (except a minimal one in Ontario) nor priority in bankruptcy. Minister Flaherty called it right; let’s hope he sticks to his guns.)

Jason Heath in the Financial Post’s “How much money will you spend in retirement?” tackles the eternal question of required assets/income to “maintain your desired standard of living” in retirement. Unfortunately he mentions the frequently employed percentage of pre-retirement income shortcut (e.g. 60% or 70%) rule of thumb, though he does redeem himself by noting that one’s individual requirements should really be determined by “examining your current spending”. He then quotes studies which indicate that: (1) relative to pre-age 65 decade, spending drops among retiree couples by 11% between age 65-74 and then another 11% at ages 75+; though non-married individuals only report 1% drop to age 75 and 10% drop thereafter, (2) the lowest quartile net-worth retirees had 22% drop in spending, while the highest net-worth quartile had only 7% drop, and (3) those in excellent health saw a 9% drop in spending while those in poor health had a 26% drop, (4) generally there is a 20% drop in spending between 65 and 75. (Not sure what these statistics indicate: cause or effect? I would stick with examining pre-retirement expenses and then adjusting them for puts and takes to account for costs of desired/expected retirement lifestyle.)

In the September 2012 issue of Zoomer Magazine, Gordon Pape answers a reader’s question in “Benefit Gap: Why not all CPP recipients are created equal”. The question was about why is it that a 65 year old in 2008 who started receiving CPP at that time and was then eligible for the maximum of $884.50/mo, is getting different amount $925.80/mo today than those who started receiving maximum CPP at age 65 in 2011 of $960/mo, i.e. a difference of $410/year. Pape, upon inquiring with Human Resources Canada, was told that this was not an error, but it was a result of differences in rates of wage increases (which determines maximum receivable CPP for ‘new’ recipients, based on maximum insurable earnings and thus maximum required contribution) as opposed to rate of CPI increases (inflation) which are used to annually adjust CPP benefits of ‘old’ recipients. So Pape elaborates that “If wages outpace price increases after you retire, your CPP benefit will gradually fall behind.” If the CPI increase exceeds wage increases (not what typically happens) then the opposite occurs. (Many might consider this a pretty bizarre situation, intended or not; possibly collateral damage from unnecessary “actuarial” wizardry and probably a big surprise to most Canadians. Sounds like it could use some application of common sense.)

Things to Ponder

In the WSJ’s “US Not seeking Goldman charges” Albergotti and Rappaport report that according to the Justice Department “”the burden of proof” couldn’t be met to prosecute Goldman criminally based on claims made in an extensive report prepared by a U.S. Senate panel that investigated the financial crisis. “Based on the law and evidence as they exist at this time, there is not a viable basis to bring a criminal prosecution with respect to Goldman Sachs or its employees in regard to the allegations set forth in the report,” the statement read… Goldman was accused of failing to inform investors that hedge-fund firm Paulson & Co. had helped choose underlying securities in the deal and was betting against it.” (Some might argue that if it wasn’t illegal, it should be; and even if it is not illegal, it certainly is immoral. It might even suggest the requirement for a fiduciary level of care for certain type of transactions.)

In the Financial Times’ “Who are the true villains of the StanChart tragedy? Frank Partnoy looks at the charges against Standard Chartered which suggest that the bank was hiding $250B of transactions involving the Iranian government to side step western governments’ attempt to economically coerce Iran into dropping its nuclear program. It appears that incriminating internal bank correspondence suggests that the stealth effort at the bank was devised and directed by the bank’s attorneys; the attorneys who in the past were supposedly standing on guard and “thinking more about ethics than efficiency”.  Similar sentiments are expressed in John Plender’s Financial Times article “StanChart is a reminder of banking’s insatiable greed” as he writes that this is a “…challenge to the legitimacy of capitalism. It is hard for people to tolerate historically high levels of inequality in difficult times when they can no longer perceive any moral link between effort and reward at the top.” (Sounds like banks are rotten to the core; what we need is a banking self-regulatory organization to correct the problem. J)

In the Financial Times’“Cash out of gold and send kids to college” Peter Tasker writes that despite all the financial instability gold is now behaving “like a ‘risk-on’ asset, rising and falling in sync with stock markets”. He argues that this is due to gold still being “within spitting distance” of its 1981 all time high. Total gold in existence has value greater than the “combined capitalization of the German, Chinese and Japanese stock markets”. According to PricedInGold.com gold is at “120-year high (at least) relative to US house prices…at a 74-year high relative to US wages, at multi-generation highs relative to wheat, coffee… A bull market of this scale requires widespread distrust of other financial assets, of the banking system, of capitalism itself”. Tasker argues that just about everything has become somebody’s asset class and thus expensive, though he sees value in European and Japanese equities, and “solid blue chip equities purely on the basis of dividend yield”.

In the Financial Times’ “The backlash against the rich has gone global” Gideon Ranchman discusses the worldwide (most pronounced in the west but also in other countries including China) increase in antagonism against the rich triggered by a combination of much larger gap between the rich and the rest compared to a generation ago (e.g. in US richest 1% share of national income increased from 8% in 70s to 24% in 2007) and the reduced standard of living of “ordinary people” as a result of the Great Recession. He sees a coming “end of an era of lower taxes, deregulation and rising inequality”. He concludes that the cost will be paid by the “merely well-off” who are less mobile and less well advised than the super-rich.

Reuters’“Libor system has ceased to work”reports that “The Libor system as a measure of interbank lending costs has ceased to work since the financial crisis and a fix needs to be found to support existing contracts based on the rate, Bank of England governor Mervyn King said on Wednesday. (So everybody agrees that the Libor was set so that banks minimize their cost of borrowing on the backs of savers/lenders, so the fix is coming when?)

In the Washington Monthly’s “The hole in the bucket” Phillip Longman discusses how despite an unprecedented obsession with personal finance, we got to a situation where so many of America’s middle class are broke? The answers include: demographics, reductions in windfall Social Security payouts, disappearance of private sector DB pensions, even where DB plans survived the lifetime single employer required to maximize benefits was history, introduction of voluntary DC plans with inadequate savings rates using a self-directed approach to investing with “the sharks of wall Street” with residual returns further “eroded by hidden fees”, tax subsidies benefiting primarily the wealthier segment, and debt accompanied by “predatory lending”.

In the WSJ SmartMoney’s “Arnott: Inflation will triple” Jack Hough quotes Robert Arnott warns that even though inflation has dropped to 1.7% in the year ending June compared to 3.5% the previous year and the long-term average of 3%, inflation rate has “an 80% chance of topping 5% within five years”

In the Financial Times’ “Brace for an era of crisis aftershocks” David Rosenberg writes that due to the massive collapse of baby boomers’ net worth they are still in the process of resetting their expectations (when they can retire and what lifestyle they’ll be able to afford). The result will be “profound and enduring changes that will prove to be intensely disinflationary and foster a prolonged period of ultra-low interest rates, bond yields and expected returns in the public capital markets”

And finally, in the Bloomberg’s“Blink! U.S. debt just grew by $11Trillion”Laurence Kotlikoff writes that the true measure of the US government fiscal gap is obtained by factoring in both “official” (e.g. servicing Treasury  bond obligations) and “unofficial” (e.g. food stamps) spending commitments. Based on the latest Congressional Budget Office forecasts the fiscal gap has increased from $211 Trillion to $222 Trillion. “When fully retired, 78 million baby boomers will collect, on average, more than 85 percent of per-capita gross domestic product ($40,000 in today’s dollars) in Social Security, Medicare and Medicaid benefits. Each passing year brings these outlays one year closer, which raises their present value…Closing the gap using taxes requires an immediate and permanent 64 percent increase in all federal taxes. Alternatively, the U.S. needs to cut, immediately and permanently, all federal purchases and transfer payments, including Social Security and Medicare benefits, by 40 percent.” (Ouch…it is amazing how the worse the deficits are, official or otherwise,  the lower the interest rates are!?!)