Contents: Rebalancing, 401(k) plans, when to take CPP, Investment Policy Statement, financial literacy insufficient for better retirement outcomes, fiduciary, Toronto office condos, US housing starts up, FL foreclosures top US, collateral damage of state/city pension plans underfunding to hit employees and taxpayers, reducing bonds allocation, raging or raving bull? Vanguard index switch challenges

Personal Finance and Investments

Jason Zweig in WSJ’s “Winning it by trimming it” writes that according to William Bernstein “In typical markets and a basic portfolio, rebalancing—or trimming your winners and adding to your losers—can add 0.25 to 0.5 percentage points to your annual return… Rebalancing can get you a little more return and a little less risk with a minimum of effort.” He adds that “It is important to note that rebalancing is likely, but not certain, to work (e.g. Japan). If one asset does far better than all the others in your portfolio, then any money you move to the other investments will lower your returns… (and it’s difficult to do since) Rebalancing forces you to sell pleasure and buy pain—a bad emotional trade.” Rebalancing maintains your assets allocation (and risk level) and it can be done as infrequently as every couple of years.

In WSJ MarketWatch’s “10 things 201(k) plans won’t tell you” Elizabeth O’Brien’s list includes: no guidance on how much you need for retirement, “the system  isn’t working for employees or employers”, there is no fee transparency, “you’re losing years’ worth of savings to fees”, and “auto-enrollment alone won’t save you” (because defaults are set too low).

In the financial Post’s “The most lucrative time to draw the CPP” Jason Heath discusses the disadvantages of drawing CPP early i.e. before 65 (However there are potential penalties of drawing it late (>65) like: OAS claw-back, benefit increase resulting from post-65 start is not transferable to spouse, amounts drawn may be taxed at lower rate up to age 71 when you must start drawing from your RRIF/LIF/etc, and since CPP is a target benefit plan there is also a (low) probability potential for adverse benefit changes. You might also be interested in reading my recent “Took CPP at 65 instead of the previously planned age 70: What changed?”  blog.)

Last week I mentioned the importance/necessity of an IPS (Investment Policy Statement) discussed by Warren Mackenzie in his Canadian Money Saver  article, but some readers who don’t have the subscription to access article asked about an alternate IPS reference…so here is alternate link to the subject of IPS e.g. “Elements of an Investment Policy Statement for individual Investors” .

In a New IRPP study entitled“Can financial education improve financial literacy and retirement planning?”Sol Schwartz argues that “With respect to retirement planning, rather than attempting to improve the financial literacy of Canadians, governments should seek to better protect consumers of financial products and services.” Specifically he recommends that governments take the following steps: (1) “create an agency to better regulate the financial industry and protect consumers against risky products and services that are difficult to understand”, (2) “ensure the provision of expert, impartial third-party advice about retirement planning”, and (3) “redesign private pension plans using mechanisms that have been shown to improve financial outcomes such as automatic contribution-rate escalation”. (There is little doubt in my mind that: improved regulatory oversight is necessary for better consumer protection, fiduciary based financial advice is required  for retail clients, and urgent pension reform is long overdue; all these have been discussed previously at this website. If somebody tried to sell cars as defective as some of the financial ‘products’ being pushed, legislation would have been introduced long time ago, as it was for cars decades ago). (Thanks to Ken Kivenko of Canadian Fund Watch for bringing study to my attention. And by the way, I have no doubt in my mind that fiduciary level of care is a necessity for leveling the playing field between financial “advisors”/industry and clients, and real advisors will prosper with a fee-only business model in the fiduciary context. The sooner this and better regulatory protection of investors happens, the better. In the meantime caveat emptor!)

And speaking of the F-word (fiduciary) in “Is the fiduciary standard a joke?”  Allan Roth writes that despite advertisements by the CFP Board of Standards which ”trumpet their fiduciary duty…One ad states CFPs are ‘ethically bound to put your interests first”, and Allan Roth asks if this “Is it merely an advertising campaign, or is it real?”. After describing an incident involving a client, a couple of CFPs and the CFP Board, Roth concludes that “this incident makes the CFP Board look like it does not deserve the public’s trust, and that’s a serious problem.” (Thanks to Ken Kivenko for bringing to my attention.) By the way the CFP Board response/defense was given in WSJ’s “Why our fiduciary standard is no joke” which also includes further discussion in the Comments section of what might or might not have actually happened during this incident, but the CFP Board’s defense was that the incident originated prior to mid-2008 when the CFP Board made fiduciary standard effective. (This pertains to US CFPs. In Canada there is no claim of fiduciary responsibility by CFPs, as far as I am aware.)

Real Estate

With Canadian real estate starting to slow down from the earlier frenzy, especially in Toronto condo market, here are a couple of articles which might suggest some confirmation of the slower trend. In the Financial Post’s “Toronto developer puts new spin on condo craze with plan to sell to business” Garry Marr reports that some Toronto developers are trying to expand from residential into office condo space aimed at commercial activity. The 600-1800SF units mentioned are selling at an average of $830/SF. In another article “Data on condo speculators prove elusive” the Globe and Mail reports that “An effort to get more information about the influence of some speculators in Toronto’s condo market has collapsed after developers refused to take part, leaving policy makers in the dark. Urbanation Inc., a data-research firm, has pulled the plug on a survey that it had tried to conduct, with the support of Canada Mortgage and Housing Corp., to quantify how many “assignments” (pre-delivery flipping) are taking place in the market.” The article suggests that developers are withholding the info to protect some flippers who fail to report the capital gains resulting from their activity. (Another reason might be is to limit the visibility of the volume of speculative activity.)

In Bloomberg’s “Buffett’s new CEO calls housing gain the ‘Start of something good’” Noah Buhayar reports that Berkshire Hathaway’s Johns Manville CEO is quoted saying that “a pick-up in housing starts shows that the U.S. real estate market is reviving”. Housing starts increased to an annual rate of 872,000, up 15% in September. “It’s still off of a very low base, but we really believe that this is a start of something good…”

In Palm Beach Post’s “Florida keeps top foreclosure ranking” Kimberly Miller reports that “Florida maintained its leading spot nationally for foreclosure activity last month with a filing rate more than twice the national average…one in every 312 Florida homes received a foreclosure filing in October… Florida kept the top ranking even as its new foreclosure filings dipped 19 percent compared to last year… Following Florida in the top five foreclosure rankings are Nevada, Illinois, California and Arizona.”

Pensions

In the WSJ MarketWatch’s“Public pension funds face vast shortfalls” Robert Powell writes that due to coming changes to deal with the $1.4T pension shortfall in state and municipal pension funds, beneficiaries better start thinking of ways ”to generate some extra income or cut costs to meet your living expenses”. Reducing/capping benefits for existing/new employees, increased employee contributions, later retirement dates, elimination of COLA and reductions in retiree health benefits are among the restructuring approaches under way or contemplated. He adds that taxpayers as well should be ready for “reduced municipal services—closing hospitals and school cuts, for instance,—or an increase in taxes, or both”. Powell refers readers to a new Boston College Center for Retirement research report “State and Local Pensions: What Now?”

Things to Ponder

In the Financial Post’s “Why wealthy investors are cutting back their bond holdings” Michael Nairne discusses the reason why pension plans and wealthy families are starting to reduce their investment-grade bond allocations. The reasons include: <2% yield on 10 year Canada bond is effectively negative real yield, history suggests that “long-term return prospects for bonds are modest”, 10-year Canada bond has duration of 8.4 (i.e. a 1% rise in interest rates results in a 8.4% drop in value of bond), the “tax-drag” in non-registered accounts further reduces returns, and serious inflation would kill bonds’ real return.

In IndexUniverse’s “David Kotok: Extraordinarily bullish” Kotok argues that with President Obama controlling appointments to the Federal Reserve (FOMC) “We expect this low-rate environment to translate into very aggressively rising stock prices in the next few years. We expect high-grade bond interest rates to remain low and perhaps go lower… We expect real estate to commence and accelerate a recovery.“ For another perspective on the effect of continuing the financial repression (QE) you can listen to a short video from the Economist’s Buttonwood conference at “Other voices”; here David Einhorn explains with his jelly doughnut analogy why QE is now past the point of diminishing returns, and has now become a drag on the economy. The explanation is that the ultra low interest rates are now causing people to hoard savings (i.e. reduce spending), and this is true for both those in accumulation stage (they are driven to save more because of lower returns) and those in decumulation stage (they have lower income due to low rates and therefore must to spend less).

And finally, in the Financial Times’ “Index switch hits Vanguard” Chris Flood writes that Vanguard’s index switches  from MSCI to FTSE have led to a stop in the inflows into VWO (e.g. Vanguard’s emerging markets ETF had $1M inflow in October after averaging $1.3B/mo previously); iShares’ ETF EEM received $1.3B inflow in October. Some investment managers “question if the cost savings are worthwhile in view of the potential disruption to their portfolios” while others require board level policy change since currently specified benchmark is MSCI. (Investors have every right to be angry that iShares EEM’s 67bp MER has not been reduced; Blackrock is taking advantage of long-term taxable investors with large capital gains embedded in EEM who are effectively locked in unless they are prepared to pay the capital gains tax now. Of course Vanguard, in its relentless pursuit of lower cost, may have underestimated/ignored the collateral damage that investors and investment managers will have to incur due to portfolio realignments and to the additional complexity in portfolio construction; but then of course, it may be just their way of “encouraging” investors to do portfolio implementation with a single vendor (Vanguard)…it might work given how upset some existing iShares investors are, but only time will tell.)