Hot Off the Web- September 10, 2012

Topics: High fees, protecting retirement assets, financial to-do list, investing a windfall, retirement portfolio needs risk, tax deferral? UK bans advisor commissions-fees only permitted for advice, Vancouver home sales plunge, pensions undamaged by QE, annuities? Unchartered territory for developed countries, ETF risks, gold standard? Entitlements corrupt? financial/economic documentaries.

Personal Finance and Investments

In a Consuelo Mack interview (a 6 minute video) with Charles Ellis and Mark Cortazzo  “Charles Ellis: Why fees are much higher than you think” Ellis explains why the perceived 1% fee (in the US but over 2% in Canada) is completely wrong way of looking the fees: 1% (of assets) is 15% (of 6-7% nominal returns) which compares less than favorably even with 5-6% real estate broker fees, graduated fee scale with 1% over $1M is not 1% but a “blended fee which is much higher”, “the model of paying higher fees for higher quality investment management no longer works” because so many smart people trying to beat the market” that pricing is close to “right” so it is essentially impossible to beat it or to figure out who might be able to beat it a priori.

In the WSJ’s“Making retirement assets last” Anna Prior writes that  to make assets last in retirement one should consider: (1) identifying the annual budget for fixed expenses and allocating a portion of the portfolio to these (even having liquidity to cover 3-5 years for these basics), (2) longevity consideration should include annuities and long-term care insurance (handle with care), (3) the longer your planning horizon the less you can withdraw annually (but the article assumes inflation indexed withdrawals and 3% real return, the former assumes no spending flexibility while the latter is anything but guaranteed) (4) “don’t be too conservative-bonds aren’t always your friends”, keep duration at about 5 years, (5) watch out for inflation, the “silent killer”, with historical average of 3.2% so asset allocation should include some inflation hedges like alternative assets nontraded REITs, long/short funds (WOW-more scary and potentially inappropriate advice) and (6) limit taxes with a tax-efficient portfolio; consider distributions in your 60s from accounts requiring minimum distributions at age 70 (in some instances for some individuals)

Rachel Louise ensign in the WSJ’s “Financial To-Do list for summer’s end” enumerates a summer’s end check list for your financial life: (1) create/review/update wills, financial/health power of attorneys, beneficiary designations (insurance and retirement accounts), (2) check insurance policies for adequate coverage, cost and need, (3) make sure to contribute to retirement accounts (especially to get matching contribution), and for Americans review (4) implications of tax rate changes in 2013 , and (5) charitable and family gifts, and others.

Carolyn Geer in WSJ’s “Should you wade in with a windfall?” reports that a new Vanguard study  shows that using historical data back to 1926 you have a long-term horizon you are better off diving in whole hog investing the lump sum rather than dollar-cost averaging (unless you are overly concerned about short-term losses). The report entitled “Dollar-cost averaging just means taking the risk later”confirms that, assuming that future will unroll about the same as the past, lump-sum investing out-performed dollar-cost averaging about two-thirds of the time, which is consistent with the return of stocks and bonds being higher than that of cash.

In the Globe and Mail’s “Younger retirees need some risk in their portfolios” Tom Bradley writes that the boomers are “leading the way into pension-less retirement”, their need to invest in assets that have a promise to provide returns in excess of inflation (i.e non-negative real returns) unlike is the case of low-risk (CD/GIC and cash) investments. He also makes some sensible recommendations like: get a financial plan, work longer, spend less, take more risk and focus on total return.

In the Journal of Financial Planning’s “Tax deferral: When does it make sense and when does it cost cents (or dollars)?” Roger Silk tackles that age old questing of when tax deferral makes sense or not. The default assumption that tax deferral always makes sense, only does so as long as” tax rates are uniform across income types (no difference between capital gain and other income) and constant over time…and client’s personal discount rate is lower than expected return on the assets”. The author looks at various scenarios and from which he generates some guidelines, when tax deferral makes sense (or not). For example, it might make sense to defer “ordinary income” if tax rates are not expected to rise significantly or tax bracket will not rise, deferring taxes while working in high tax states and planning to retire in lower tax state, higher future tax rates might suggest withdrawing from taxable accounts while rates are lower, variable annuities funded with after tax dollars can’t compete with capital gains in a deferred  (but not a high-turnover account), consider harvesting bond capital gains and reinvesting proceeds, etc. (Tax matters are pretty complicated.)

In the Sunday Times’ “Thousands of financial advisers face ruin” Iain Dey reports that over 3,000 UK advisers will be out of business shortly, as effective January 1st they will not be permitted to accept sales commissions for financial products. “Those who want to continue selling pensions, life assurance and other investment products will also have to pass tough exams and prove that their books are in order.” (Sounds like US and Canada investors could benefit from this type of reform. Thanks to CFRS advisor Jim Murta for recommending.)

Real Estate

In the Financial Post’s“Vancouver home sales plunge, posting second worst August since 1998”Garry Marr writes that according to the Vancouver real estate Board “sales of detached, attached and apartment properties were 1,649 in August, a 30.7% drop compared to the 2,378 sales in August 2011 and a 21.4% decline compared to the 2,098 sales in July 2012. It was the second worst August since 1998 for sales and 39.2% below the 10-year average… yet we continue to see relative stability when it comes to prices (off 0.5% from previous year and 1.1% from July)… (the) sales-to-active-listings ratio sits at 9% (compared to 19% in march0 which puts us in a buyer’s market”. Another Financial Post article indicates that “The Toronto Real Estate Board reported Thursday that sales of existing homes in the greater municipal area fell 12.5% from last year, although the average price of $479,095 was 6.5% higher.”


In the Financial Times’ “QE damage claim rebuffed” Robert Cookson reports on a challenge of the UK pension industry’s claim that it is being damaged by QE (extremely low interest rates). However, John Ralphe argues that the negative effects of QE on liabilities is counteracted by its positive effects on “bolstering financial strength of sponsors”, ”boosting equity (and bond) prices” in the pension plan portfolio; the net effect being “neutral or slightly positive”. (So much for the argument that the reason that pension plans (like Nortel’s) were underfunded, was as a result of falling interest rates rather than systematic employer under-contribution to the plans.)

In the Financial PostFred Vettese’s“Annuities: The best financial product no one really wants”and Jason Heath’s“What if you live to 101?” they both tackle the ‘advantages’ of annuities for protecting against longevity risk (running out of money before one dies) and not having to manage one’s portfolio, yet both indicate minimal uptake of annuities; and at least Vetesse is doubtful that he would personally buy one. Some options suggested by Vetesse include: annuitizing (after age 75) assets not allocated to bequests and reserves, or annuitizing 50% of one’s RRIF and leaving the balance invested in equities. Heath’s article, triggered by the C.D. Howe report (on which I commented in the pensions section of my Hot Off the Web- August 27, 2012 blog), reviews the report but indicates that “Retirement planners like myself may talk to clients about annuities to “cover the bases,” but I haven’t had a client actually buy one in years. While it might be a good idea in theory, in practice, buying an annuity is a little like buying a 20-year government bond and locking in today’s record low rates.” (Heath’s point about locking in the 20 year government bond rate not being very attractive in today’s environment is a key argument against annuities, however the counter to that would be that if you buy annuities you also get the mortality credits which start having some net value after age 75; of course not everyone might choose to invest one’s portfolio into government bonds exclusively, either.)

Things to Ponder

In the Economist’s“We live in remarkable times” Buttonwood column referring to a new Deutsche Bank report indicates that interest rates are at all (recorded) time (i.e. hundreds of years) lows, developed countries have a tendency to run budget deficits most of the time (likely due to the welfare state), so the endgame is unpredictable with possible outcomes of: hyperinflation, or Japanese stagflation, and little progress in deleveraging. So Buttonwood concludes with “if they can’t cope with shrinking credit, balanced budgets or higher interest rates, then modern economies have truly entered a new, and not very appealing, era.” (Scary!)

On the subject of deleveraging, in the Financial Times’ “The trend that cooled America’s plastic passion” Gillian Tett reports ‘that while public sector debt has exploded in the past five years, deleveraging is under way”. There are 23% fewer credit cards than at the 2008 peak and their outstanding balance 23% below the 2008 peak. America’s overall consumer debt dropped $1.3T to $11.4T in June, mostly due to a drop in mortgage debt. Tett concludes that these trends demonstrate that monetary policy has limits (pushing on a string) and the apparent behavioural shift in attitude toward credit.

In USA Today’s “Financial ‘train-wreck’ looms” John Waggoner interview John Bogle about his new book “The clash of Cultures: Investment vs. Speculation” . Bogle expresses concerns about: ETFs being used for speculation (by individuals not just institutions), lack of requirement of fiduciary standard by brokers and insurance salesmen, use of non-standard (i.e. not cap-weighted) indexes or commodities/currencies, the coming 401(k) “train-wreck” (i.e. inadequate retirement savings and allowing funds to be removed before retirement), expecting that money market funds won’t break the dollar, or that something might go wrong with a “technology-driven system”. In the Financial Times’ “Bogle and nostalgia for the old days” Pauline Skypala also looks at Bogle’s new book which she says covers: that costs matter, the importance of fiduciary duty and stewardship (i.e. U.S. mutual fund managers with their short-term focus abdicate the responsibilities as owners by not exercising their voting power in the interest of shareholders). Bogle states of the fund industry that “Conglomerate ownership is “the single most blatant violation of the biblical principle that ‘no man can serve two masters’”” and he advocates that the fund industry must return to the ‘mutual’ model, with Vanguard being the only one remaining as such (though he thinks that Vanguard might also be failing in the area of voting practices).

John Gapper in the Financial Times’“Protect the virtue of exchange traded funds”calls ETFs“among the biggest and most useful innovations for the retail investor since the advent of mutual funds”, but identifies some concerns such as: ETFs being used by institutions “to short the market, or to hedge and trade in opaque ways”. While ETFs democratize investing there are risks such as: institutional trading might destabilize the market value of an ETF relative to NAV, individual investors are tempted to actively trade rather than invest, the difference between synthetic and physical ETFs, and very narrow/esoteric ETFs.

In the Financial Times’ “New dollar standard is only fool’s gold” Neil Collins, triggered by the Republican platform proposing a commission to look into a link between the dollar and gold, and he argues that this matter is a lot more complex than it seems at first sight. Issues mentioned include: how to set the price of gold at which the central bank is prepared to sell unlimited amounts (“pitch it too low, and there’s a run on Fort Knox. Pitch it too high, and otherwise productive efforts are diverted into digging for more”), nobody really knows how much gold is in Fort Knox, a paper currency does fine until politicians start running the printing presses and then “it’s the gold standard that goes, not the spending plans”.

In the WSJ’s “Are entitlements corrupting us? Yes”Nicholas Eberstadt writes that “the federal government has become an entitlement machine. As a day-to-day operation, it devotes more attention and resources to the public transfer of money, goods and services to individual citizens than to any other objective, spending more than for all other ends combined.” The entitlement burden is $7200/American of $29,000 for a family of four! Until 1960 the government primary responsibility was “some limited public services and infrastructure investments and to defending the republic against enemies foreign and domestic, but by 2010 entitlements became two-thirds of federal spending”. Americans have shifted from “fierce and principled independence“  and seeing themselves as “accountable for their own situation through their own achievements” to where the US is almost at a point where “more than half of all American households receive and accept transfer benefits from the government”; “The taker mentality has thus ineluctably gravitated toward taking from a pool of citizens who can offer no resistance to such schemes: the unborn descendants of today’s entitlement-seeking population.”  William Galston in“No, they’re part of the civic contract” counters that an aging society is just naturally shifting resources from building schools to hospitals/nursing homes, the situation is aggravated by disappearance of pensions, and today’s economy is growing a lot slower than 60 years ago. He furthermore argues that what we are seeing in not dependence but interdependence (i.e. an “intergenerational compact”). Galston agrees that the US will have to figure out how to pay for or reform entitlements, but he argues they are not responsible for fostering a culture of dependence. (While he agrees that, dependent or interdependent, one must still figure out how to pay for the entitlements, when he compares Social security to an annuity, the arguments get really stretched since the payments from the former are fully funded by contributions of a cohort while the latter are partially funded at best, like Social Security; of course income tested programs discussed in the article like Medicaid and low-wage workers’ supplements are also funded by current taxes.) If you are interested in the subject you might also be interested to read the Economist’s “Rethinking the welfare state-Asia’s next revolution” which discusses the threats and opportunities facing “Countries across the continent (of Asia which) are building welfare states—with a chance to learn from the West’s mistakes”.

And finally, for finance video junkies, the “9 Documentaries that’ll change the way you think of money, investing”offers a list of “thought provoking financial and economic documentaries…for insight in the world of money”.


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