Topics: Target-date funds, executor warning, taxes and asset allocation, pension or lump-sum? saving OBSI, covered call strategy-not, bonds: bumps ahead for individuals but pensions buy more for ALM, assisted living, fiduciary standard, debt in retirement, global real estate, multiple personal use homes, Shiller unsure about housing recovery, target benefit plans, Canada’s annuity industry, trader vs. investor, next five years? wealth taxes spreading, gold? boomer longevity?
Personal Finance and Investments
Earlier this week I posted an in-depth blog entitled “Target-Date Funds a passing fad? Problems and solutions to using TDFs as a 401(k) default or option”. Essentially since target date funds (TDFs) became available as a permissible default or an option for 401(k) accounts, their popularity has been exploding, with predictions that within a decade 50% of 401(k) funds will be in TDFs. But some are raising valid concerns about the suitability of these supposed “one decision” “low/no maintenance” funds as a default 401(k) investment vehicle or even as a retirement investment vehicle in general. The collateral damage of the simplicity of TDFs is the potential resulting complexity created elsewhere due to: glide-path variability, cost, fit in overall portfolio, risk tolerance variability among individuals and over time, and tax efficiency. If you’re using or thinking of using a TDF you might wish to look at some of the collateral complexities associated with their simplicity.
In the Globe and Mail’s “Executors beware- it’s not an easy job” Noreen Rasbach warns that being named an executor may seem like an honour and a sign of trust and respect, but it comes with “a pile of work” (she includes a reference to an RBC checklist) and potential liability for any mistakes. “These considerations, the experts agree, mean that people should take great care in whom they choose as an executor, and prospective executors should consider very carefully if they want to take on the role.”
In Morningstar’s “When taxes collide with your asset allocation” Christine Benz discusses the complexities associated analysing effective asset allocation when one starts to factor tax consideration and the importance to do this especially in retirement. Specifically the difference in handling of assets in taxable, tax-deferred (401(k)/IRA/RRSP), non-taxable/tax-free accounts (Roth IRA/TFSA). The author also notes that this is more important activity for retirees than pre-retirees because far from retirement it is difficult to predict what assets will look like in the various pots at retirement and because at/in retirement “tax-adjusted withdrawals become’ real. “An even bigger wild card in your tax-adjusted asset allocation analysis is that we don’t even know what income, dividend, and capital gains tax rates will be next year, let alone in the decades ahead.”
In the Globe and Mail’s “Perusing the fine print on pensions” Larry MacDonald discusses some of the pension vs. lump sum decision such as: required return on capital if one lived to age 85 to break even with the pension income, the timing of the a cash or pension decision, loss of post-retirement benefit if any, handling of longevity risk, and importance of a bequest. Other related decisions mentioned are timing of start of CPP, splitting income from pensions in general including CPP. The use of an advisor is also recommended given the complexities of a pension vs. lump-sum decision.
Tom Lauricella in the WSJ’s “Speak for yourself while you can” looks at the importance of “communicating your wishes about health care and a funeral, information about things like finances, your will and what to do with the family home” to your kids while you are still in a position to be able to do so. Children are often not even aware of parents’ assets that may be available to care for them, and/or end up going to the state as unclaimed assets. An explanation of how assets were allocated in the will, and why, might also be appropriate while one is able to do that.
Ken Kivenko is perturbed by the proposed External Banking Complaints Bodies to effectively replace OBSI. In his letter to Finance Minister Flaherty he thinks it is wrong “allowing Federally Regulated Banks to choose their own external complaint bodies to hear consumer complaints made about them. Canadian financial consumers will not be well-served by a hodge-podge of industry-hired so-called “independent” complaints bodies which are supposed to resolve disputes between bank clients and financial businesses. Lack of a truly impartial complaints body for bank customers to resolve complaints will no doubt be harmful to all Canadians, especially seniors, new immigrants and the infirm. OBSI is in place and reasonably well-equipped to serve consumers as an independent, unbiased complaint body. OBSI should be nurtured, not demolished. There is no need for this new regulation. Please withdraw the proposed regulation and the underlying legislation.” (You can read his complete submission to FCAC here and encourages all Canadians to provide their comments to the Minister of Finance and the FCAC.)
In the Globe and Mail’s “A race for yield measured in nanoseconds” Dan Hallett writes that people reaching for yield by using ETFs utilizing a covered call strategy might not quite as promising as it sounds: “Covered call writing involves buying stock and selling call options “against” that stock position…. In other words, this strategy negatively skews the risk-return profile. Covered call writing strategies are promoted as a source of income with less risk than owning stocks outright. But adherents to this approach are giving away too much future upside in exchange for current income. The amount of forgone upside may well dwarf the extra income over time… because covered call strategies often focus on more volatile stocks – because premium income correlates with volatility – these strategies sometimes suffer more damage during bear markets.” (Thanks to Ken Kivenko for recommending.)
In InvestmentNews’ “Vanguard to bond-holders- Bumpy ride ahead”Jason Kephart reports that Vanguard “cautioned investors about lower returns and heightened market sensitivity from the traditionally staid fixed-income asset class… With such low yields — high-quality bonds are generating less than 3% these days — there’s no cushion to counteract any short-term rise in interest rates. Of course if you are a pension plan the situation is somewhat different. According to the Financial Times’ “U.S. pensions snap up 30 year bonds” “Long-term debt is particularly attractive to pension and retirement funds as well as insurance companies… This is a risk management exercise by pension plans to immunize their liabilities and not try and seek outperformance”
In WSJ SmartMoney’s “10 things assisted-living homes won’t tell you” Jim Rendon writes that “Moving to a residential-care facility is difficult enough — even before you account for the hidden fees, untrained caretakers and misleading marketing.” Their growing popularity is due to: lower cost than nursing homes, more freedom and less institutional environment, however they are less regulated, have no national standards, staff is less trained, and there is fewer staff especially at night. Some of the 10 things that you are not told are: they are short term solutions, you can be evicted at will, you will be milked for any ‘extra’ services, basic rates are negotiable, staff may not be adequate or competent to deal with dementia patients, it’s not the decor that counts but the level of care offered (one measure of which is staff-to-resident ratio), these are for-profit businesses rather than a charity so treat it accordingly, no ratings are available, etc. (Quite an eye opener; while the focus is the U.S. context, much of the discussion is applicable in Canada.)
You might be interested in watching a short video interview with Glorianne Stromberg onFiduciary Standard she hits the nail straight on the head. It is time to act in Canada now on requirement for fiduciary relationship now for anyone who calls themselves advisors explicitly or implicitly! (Thanks to Ken Kivenko for recommending.)
Jason Heath in the Financial Post’s “Debt in retirement: It works for some” argues that while ”It’s important to consider rules of thumb, it’s wise for the average Canadian to be mindful of our rising debt levels, but debt in retirement, whether pre or post-retirement, needs to be a personal decision.” He gives a couple of examples, both cases where the person happens to own and have significant capital in a house or a cottage, where the retiree should not feel guilty taking a loan to allow enjoyment of those assets a little longer.
For those interested in global real estate trends and like to look at them in a graphical for “The Economist house-price indicator” might wish to peruse data about 20 countries: house price index, real prices, price-to-average income ratios, and price-rent ratios since 1975.
In the Financial Post’s “When one home isn’t enough” Garry Marr tackles the increasing trend to multiple home ownership, what are the drivers, the implication of carrying unused property for most of the year, whether it makes any financial sense to do so, is it ego or convenience driven, is it perceived as a property investment (buy income generating property instead). These considerations are even more important when somebody is about or has committed to another footprint for which they don’t understand the full cost and end up being unable to afford.
In WSJ’s “Is this the end of the housing bust” Not so fast, says Shiller”Joe Light quotes Robert Shiller who “isn’t convinced we’ve crossed into safe territory just yet. His reasoning? The home-price rebound, if that’s what it is, doesn’t yet have momentum …Momentum is the tendency for prices to keep moving in the same direction. It exists, but is a relatively weak force, in the stock market. In the housing market, though, it’s proven to be a reliable predictor of where prices will go in the future.“ Shiller is concerned about the invisible inventory overhang, still high unemployment; Shiller would become more of a believer that we have turned the corner, if home prices continued to increase over the next six months.
In Benefit Canada’s “TB or not TB: Is target benefit the answer” Manuel Monteiro looks at the growing disappearance of DB plans, the problems with the DC plans which are increasingly replacing them especially in light of the very low current fixed income returns, and argues that TB (target-benefit) plans would be a better answer than DC. TB plans deal with sponsors’ concerns about DB (uncertainty of plan cost) while addressing shortcomings of DC plans like: professional investment management, pooling longevity risk, more likely choosing lifetime benefits to cash-out and better individual retirement planning given the understanding of the resulting likely ‘pension’.
In a just out C.D. Howe report entitled “Annuities and your nest egg: Reforms to promote optimal annuitization of retirement capital” Norma Nielsen writes that boomers in their shift from accumulation to decumulation “must balance present financial needs against longevity risk”. (In the next week or so, I plan on providing some comments on this report which looks at primarily looks at regulatory changes required by the financial industry to better serve Canadians with annuities.)
Things to Ponder
In the Financial Times’ “Investors must rediscover their patience” Woolley and Vayanos write that traders and momentum buyers dominate short-term market prices rather than investors who make decisions based on fundamental corporate value. What’s even worse is that often investors find this so irresistible that they often get on board with momentum players pushing prices even higher. The authors lament this state of affairs since ultimately “it is cash flows that will be needed over future decades to pay pensions and insurance claims and to run charities”. This leads not only to misallocation of capital, but for investors with long horizon the impact of “the interaction between mispricing and the asset owner’s time horizon” can lead to “always buying after prices have started to rise and selling after they have started to fall”. The authors’ suggested approaches to fix the problem include: limiting turnover, replacing market cap benchmarks with GDP “growth in countries in which liabilities will be paid” based benchmarks, and longer performance evaluation periods.
The Financial Times’ Lex column entitled “Credit crunch- the next five years” writes that the past five years since the start of the financial crisis have been much like the five years after the Japanese bubble burst (around 1990). If we are to replay over the next half decade Japan’s following five years, we are in for little growth, flat stock market and bonds will be the best investment. (Pretty dismal outlook if we are replay that.)
For those wondering about trends in taxation might want to take note that in WSJ “Germany’s wealth grab” article about German opposition legislators pushing to re-institute a 1% wealth tax. The article notes that France has just raised its wealth tax, Italy has re-introduced a real estate levy and Spain has recently introduced a tax on those with assets in excess of 700,000 euros.
In the Globe and Mail’s “Gold expected to pull out of the slump” Pav Jordan writes that while Q2 demand for gold was down 7% overall, with a 38% drop from India, 7 % drop from China and 15% decrease from jewellery sector, these drops “were hugely offset by central bank buying at levels not seen since the 1960s, with the end of the gold standard.” (Why are they buying? Do they know something the rest of us don’t?) Also, for what it’s worth “Paulson, Soros make big bets on gold”.
And finally in the Globe and Mail’s “What if baby boomers don’t live forever” Stern and Heavey discuss the conflicting views about extrapolating the last century’s longevity improvements to the next century and the implications of the outcomes on Social Security, Medicare and society in general. Those who believe that the trends should not be extrapolated, like public health professor Jay Olshanksy, argue that “boomers, beset by factors like elevated rates of obesity, cancer and suicide, could reverse or at least slow the increase in human life spans… If you look at the health status of the baby boom versus the generation that just preceded them, they are in worse shape…” “Prof. Denney notes a “huge increase” of 30 years in U.S. life expectancy from 1900 to the 2000s. But he and fellow researchers see a mere three-year increase over the next 50 years, with improvements in longevity concentrated among the well-to-do, while poorer people will not share in the same benefits.” By the way, the current projections that Social Security will be exhausted by 2035 and benefits will have to be cut to 75% are based on extrapolation of the longevity trends of the last century.