Topics: Financial advisors add 1.8%, age 65 an obsolete threshold, living inheritance better, US house prices up but not all house price reports the same, Canada’s house market a slow-motion train-wreck? November vote on Florida constitutional amendments more bad news for non-homesteaders, pension/annuity or lump-sum? floundering PRPP, coming ‘tail-risk’ event? Gross: inflation coming- stocks favored, leverage is bad, risk-parity, financial repression continues.

Personal Finance and Investments

In WSJ MarketWatch’s “Are financial advisors worth their fee?’ Chuck Jaffe reports that, according to new Morningstar research, financial advisors (not brokers) add 1.82% per year before fees. They do this not by stock or fund picking, but as a result of efficiency gained due to  five financial planning decisions: “asset allocation, withdrawal strategy, tax-efficiency, product allocation (the use of traditional investment products versus guaranteed-income products), and “liability-driven investing” (which is investing with an eye toward an investor’s specific goals, needs and timeline)”. Also (not surprisingly) “Morningstar found that a “dynamic withdrawal strategy,” which Blanchett described as “going in once a year and, based upon market performance and market strategy, figuring out what is a sustainable withdrawal for that portfolio.” The second-most important decision involved making sure that allocation decisions were tax-efficient… It really is worth it to pay someone 1% a year to help me figure out how to do this stuff because [the 1.8%] is significant value that any [adviser] can achieve”. And by the way Boyd Erdman in the Globe and Mail’s “Brokerage business blues deepen” reports that “Quiet markets, nervous clients and rising costs are cutting profits for Canadian brokerage firms to the weakest levels in more than a decade. Figures from the Investment Industry Association of Canada (IIAC) for the second quarter show a huge plunge in the amount of money that brokerage firms are bringing in…. Decent bond trading results are buoying the largest firms to some extent…” (Perhaps the financial industry should consider a new business model; also bond trading costs are one of the significant black holes of Canadians investment costs that must be addressed.)

In the Financial Times’ “U.S. urged to consider rise in retirement age” Norma Cohen reports that the National Academy of Sciences in a report entitled “Ageing and the Economy” predict that by 2050 life expectancy at birth will be 84.5 compared to 47 years in 1900. The report also argues that “Although 65 has conventionally been considered a normal retirement age, it is an increasingly obsolete threshold for defining old age and for setting benefits for the elderly.” The increased labour participation at older ages would boost national output, would reduce time in retirement and lower the assets required to be accumulated for retirement.

In the NYT’s “From parents, a living inheritance” Ron Lieber discusses the importance/advantages/mechanisms of helping children while you are still alive rather than waiting to leave them an inheritance. He also mentions a model where families set up a pool that the next generation can borrow from interest free.

Real Estate

The just released July 2012 S&P/Case-Shiller Home Price Indices indicate that the 20 city index is up 1.6% during the month of July and 1.2% YoY. ““Home prices increased again in July,” says David M. Blitzer, Chairman of the Index Committee at S&P Dow Jones Indices. “All 20 cities and both Composites were up on the month for the third time in a row. Even better, 16 of the 20 cities and both Composites rose over the last year. Atlanta remains the weakest city but managed to cut the annual loss to just under 10%…Among the cities, Miami and Phoenix are both well off their bottoms with positive monthly gains since the end of 2011. Many of the markets we follow have seen some decent recovery from their respective lows – San Francisco up 20.4%, Detroit up 19.7%, Phoenix up 17.0%”

In WSJ MarketWatch’s “The devil in the housing report details” Quentin Fottrell compares the above Case-Shiller numbers and writes that they pale compared to the recently announced 9.5% YoY number from the National Association of Realtors. He indicates that historically the NAR numbers are higher. Specifically while the Case-Shiller number reflects price changes in the sale of same homes (i.e. implicitly adjust for the size of homes sold), the NAR numbers are derived only from the homes sold in the month so that “The result is that NAR’s numbers jump when homes at the high end of the market sell strongly, and larger and more expensive homes have lately been selling particularly well”.

In CBCNews’ “Neil Macdonald: Why a U.S. style nightmare could hit Canada”  Neil Macdonald quotes Robert Shiller “that what is happening in Canada is kind of a slow-motion version of what happened in the U.S.” due to the combination high household debt (increasing from 75% of income in the 90s to 150% now), and debt concentrated in households which spend >40% of their income on interest charges. “That means those households are extremely sensitive to any sort of shock — be it a rise in interest rates, a drop in home prices, or, worst of all, job loss.” While the price drop may be less severe than in the U.S., “Shiller says Canadians do seem to be suffering from the same delusion that afflicted Americans: the notion that housing prices always rise.” Yet he studies house price data over the last century and “factor in inflation and depreciation” prices essentially stayed constant, even though there were occasional spikes resulting from “groupthink” but then when prices stop increasing they end up collapsing. He also points out that Canadians who must renew their mortgages every five years or less are much more exposed than Americans who have access to 30 year mortgages.

Of 12 constitutional amendments that Florida voters will be asked to vote on in November, four deal with property tax (none beneficial to the non-homesteaded). My interpretation of what is being done is unchanged from a year ago when the proposals were tabled. At the time I summarized my understanding in Florida’s nonhomesteader snowbirds shafted again by new property tax Bill 381 so whatever narrowing of the homesteaded vs. non-homesteaded  tax-load which has occurred during falling prices over the past six years will stop narrowing further if prices continue to fall, and in fact the non-homesteaders’ property tax load will start rising again if prices start increasing. (Plus ca change….)

Tim Cestnick in the Globe and Mail’s “Buying U.S. real estate? Beware of the dreaded estate tax” discusses some of the estate tax issues associated with Canadians buying US real estate, the uncertainty associated with the year-end expiry of the current $5 million (individual worldwide assets) exemption under the Canada U.S. tax treaty, and some potential solutions (e.g. joint names and non-recourse debt).

Pensions

In WSJ’s “Trading in your pensions” Ellen Schultz writes that “Deciding whether to take a pension in a lump sum or monthly payment can be a combination of self-analysis (“How much risk can I stand?”) and prognostication (“When will I die?”). But there are clues in one’s own behavior that can help make the choice easier… “. Before deciding to take the lump-sum and giving up the “guaranteed monthly paycheck” to accept the market, inflation and longevity risk that comes with it despite the encouragement of your investment advisor, consider that often continuing with the pension/annuity is the better answer. Considerations include: have you historically demonstrated that you can do the investment management (e.g. during the crash), have you bought (undesirable) “variable annuities and life-insurance policies that you don’t understand”, do you understand how much you can withdraw annually, do you want to leave an estate and protect a spouse (fair chance that one of you will live to 92+), and (in the US) even if employer goes into bankruptcy most (though higher earners may be exposed so cash may be more attractive) pensioners are 100% protected. On the same topic, in the Globe and Mail’s “Pension or lump-sum? Five questions you need to ask” John Heinzl lists the following questions: “How healthy are you?”, “How healthy is your pension plan?”, “How do you feel about managing money?”, “What is your risk tolerance?” and “Do you work in the public sector?” Answering: good, good, not good, low and yes, would push you toward sticking with the pension. (I am also preparing an in-depth blog adding my two-cents worth on the upcoming annuity vs. lump sum decision that Nortel pensioners in Canada will be making, to be released shortly.)

In the Financial Post’s “Pooled plans address a savings gap” Ted Menzies, who is the flag-bearer of the government’s floundering PRPP, makes a weak case for it, while C.D. Howe Institute’s Laurin and Pierlot in “Pooled pensions need tweeking” suggest that some tax changes and allowing mortality pooling decumulation products might save PRPPs. (Delivering Canadians into the waiting arms of the financial industry with a poor record for delivering value to customers is a fundamental flaw in PRPPs that is not mentioned; a new “mutual” construct with the implied fiduciary responsibility to the investors would go a long way to solve the PRPP problems.)

Things to Ponder

In the Financial Times’ “Investors fear imminent tail-risk event” David Oakley writes that according to a State Street investor survey some of “the world’s biggest investor fear a fresh market crisis will erupt in the next 12 months”. (Market prognosticators make fortune tellers look good? If you make enough predictions, some will eventually come true.)

In InvestmentNews’ “’Titanic’ battle over deflation about to sink long bonds: Gross” Dan Jamieson reports that according to Bill Gross “…we see inflation moving to perhaps 3.5%,” he said. That scenario “tilts you toward the equity side, I suppose,” Mr. Gross said. “Tilt toward [Treasury inflation-protected bonds], shorter-duration [bonds], tilt to developing countries, tilt to real assets. I’m not a gold bug … but if the Fed prints another trillion or two, they will have debased the currency relative to gold [or to] assets that can’t be produced at that rate.”” Gross is also flogging his new BOND ETF which has outperformed the Barclays US Aggregate Bond Index for 7% and he expects to continue to outperform it by 100-200 bp because of its small $2.7B size it can be more nimble.

In the WSJ’s “Borrowing against yourself” Jason Zweig referring to a new research paper by Jacobs and Levy, discusses emboldened investors who are tapping into now easily available relatively cheap margin loans perceived to be not that risky. Zweig warns that “When you use margin, you merely appear to be borrowing from yourself. Instead, you are borrowing from one of the most unstable and unreliable lenders imaginable: Mr. Market, that personification of investors everywhere, sometimes euphoric, sometimes miserable, never predictable. If Mr. Market trashes your investments in a sudden panic, your margin debts may be “called,” forcing you to sell some of your assets to sustain the minimum account values you committed to under the terms of the loan. By definition, margin calls are most likely to come just as the prices of the holdings you borrowed against are in free-fall.” So while according to portfolio theory if you’re diversified then over the long run you’ll be OK, except with leverage you might be wiped out before the long run arrives. CFA institute’s private wealth director Steven Horan “urges investors to think of “aspirations” as another form of leverage. If your spending needs or goals exceed the money you are likely to have for funding them, then you are implicitly leveraged, he warns.” So instead of taking more risk to try to make up for the asset shortfall, they would be better advised to take less risk and reduce expectations.

In the Financial Times’“Investors rush for ‘risk parity’ shield” Dan McCrum writes that many underfunded pensions are looking to “risk parity” approach to save their undiversified portfolios which took a hit during/after the crash. While previously they abandoned the relatively safe asset-liability management approach to portfolio construction and loaded up on lots of stocks (and other equity-like assets), now are rebuilding portfolios based on risk parity principles; risk balancing approach advocates equal risk allocation to each asset class. The problem is that such portfolios historically would have been about 20% stock and 80% bond and thus not only does risk parity make the portfolio less risky, would also has lower return. Some might even consider such a portfolio more risky, at this time, at the end of “a 30-year bull market for fixed income”. You can also read Yahoo’s “Risk Parity investing: A new allocation model is here”  (Thanks to VP for the recommending the article; but I would not rush into this new must be better world.)

And finally, in the Financial Times’ “Hedge fund skeptics warn on ‘QE Infinity’” Sam Jones writes that most money managers generally agree that QE3 will brighten the outlook for stocks, commodities and gold, but some hedge fund managers are concerned that the Fed’s actions are a “disaster waiting to happen”; each new QE has less effect, there is no resolution of the outstanding issues with the can just being kicked down the road, weaker dollar will affect European economies, and the fed’s “inflation fighting credentials” are being lost.The Economist’s Buttonwood column in“Keeping it real” also discusses the “diminishing returns” of another round of QE; but “Mr Woo sees QE3 as being ineffective in the sense of driving down real yields or the dollar. Of course, it can work in a different way by driving the price of risky assets and improving consumer confidence.” In the Globe and Mail’s “Financial repression and the making of bubbles”Brian Milner quoting various experts reports that QE in US, Europe and Japan “has precious little to do with growth. If monetary stimulus were the answer, the Japanese economy would surely not still be stuck in neutral after years of unprecedented pump-priming. What the central banks are about, some economists and financial historians have concluded, is financial repression – a concerted effort to keep real interest rates below the level of inflation for long periods in order to reduce mountains of public debt and keep the costs of funding it under control.” Also that “financial repression” “…will probably find renewed favour and will likely be with us for a long time… Once governments dig themselves into enormous debt holes, they have two basic paths out of the mess, short of defaults. One is high inflation, which wipes out the creditors. The other, more palatable route is financial repression, in which “you slowly confiscate their wealth”. (Financial repression is trying to save the economy on the backs of retirees.)