Contents: Rebuilding financial industry trust, mutual fund fees, 401(k) inadequacies, sell or hold before US capital gains tax increase? longevity insurance taking off in US, 15 year mortgage at 2.56%, Canadian house prices moderating, US house prices increasing, PRPP is DOA, Swedroe: passive investing winning despite Wall Street resistance and consumer ignorance, like Taj Mahal’s builder the rent-seeking financial industry won’t survive much longer.

Personal Finance and Investments

In the Financial Post’s“Time to restore trust in the financial industry” Jason Heath argues that government’s push for “financial literacy” programs is at a significant disconnect with the interest of Canadians. More promising approaches would be those addressing some of the major flaws in Canada’s context for the financial industry: (1) “Canada is one of the only countries in the world without a national securities regulator”, and (2) “regulators seem to be reluctant to impose a fiduciary standard on financial advisors which would require them to act in the best interests of their clients”. “Nanos Research poll that found that 77% of Canadians rate doctors as having high or very high levels of honesty and ethics — compared to stockbrokers, in last place, with 18%.” (In another recent European survey of customer satisfaction, the financial industry even lagged the usually much maligned used car salesmen.)  “For the average Canadian, fees are too high, the industry is too complicated and people don’t know who to trust or where to turn for advice. It seems to me that everyone responsible for financial services consumers has a responsibility to restore trust. And if that means instituting a fiduciary standard, despite the criticisms, so be it.”

David Pett discusses business models for advisors in the Financial Post’s “Mutual fund fees face scrutiny” .  He writes that “Today the majority of Canadian advisors earn their living from “trailer fees” embedded in mutual funds so quietly that many investors believe the advice is free… (but) a growing number of advisors have shifted their structure to charge a flat percentage of the amount invested — generally 1% more or less, depending on the portfolio size and allocations. Some advisors choose to provide advice only, for a flat fee, leaving the perhaps more sophisticated investor to execute the transactions themselves… Approximately 55% of advisors are now fee-based in the U.S., say studies conducted by The Vanguard Group Inc., while in Canada, the percentage is closer to 20%…People are very distrustful of financial institutions and advisors and the commission-based model is fraught with more conflict than fee-based, mostly because it is less transparent.” Other countries have banned commission based mutual fund sales and Australia announced reductions in “commission-based income”.  “The Canadian Securities Administrators, meanwhile, is preparing a consultation paper examining issues related to investment fund fees such as the lack of investor understanding and potential conflicts.” (Ultimately, radical changes are required in Canada’s financial industry’s business models to a: fiduciary level of care, a visible/explicit rather than hidden/commission based compensation model, a training/knowledge based qualification standards for using an “advisor” designation, as well as value for money by the provision of real financial advice.)

In WSJ’s “Your paycheck or your 401(k)?” Karen Blumenthal looks at the reasons why auto-enrollment into 401(k) plans is insufficient for an adequate retirement nest eggs (due to low (3%) default contribution levels) and the tug of war between plan providers who are pushing for higher (6%) initial contribution level and employers who might have to make higher matching contributions. Blumenthal recommends: maximizing contributions all the way to permissible levels, minimizing fund and other costs (if target-date fund is the default and cost is above 0.5% implement your asset allocation from low cost index funds), and don’t touch the accumulated assets under any circumstances.

With the anticipated hikes in US capital gains tax rates, Jason Zweig writes in the WSJ’s “Make the tax man wait” that the easy answer to the question “would you rather pay lower tax now or a higher tax later?” might not necessarily be the right answer. The pressure will build to sell before year end and perhaps buy same stock back immediately thus resetting the cost basis. But Zweig writes that “Which choice is right for you depends primarily on three variables: how long you plan to hold the investment, what rate of return you expect to earn and how much the capital-gains tax rate goes up.”  The longer you want to stay invested, the higher your anticipated return and the lower the rise you expect in the capital-gains rate” the more likely that staying put will lead to a superior outcome. For those planning to sell within a year, selling now makes sense. Paul Sullivan in the NYT’s “More costly than higher taxes: Rash decisions” discusses the same topic with mostly similar recommendations.

In the WSJ’s “Postpone annuity payments for years” Anne Tergesen writes that “A growing number of insurers are rolling out a relatively new breed of deferred annuity that allows policyholders to boost income by postponing payments for several years. Economists say it can make sense to put a small portion—for example, 10% to 15%—of your nest egg into such a policy upon retirement to protect yourself from running out of money from age 80 or 85 on.” (In the US not only is the uptake for longevity insurance is increasing, but more companies are offering these policies. In Canada you these are still not available. Pretty unbelievable. We not only have the most expensive financial industry in the developed world, but we also a very uncompetitive one from a product offering point of view. I’ve been writing about these products for about six years e.g. “Longevity Insurance”   and been researching them for about a decade (though at current interest rates you are more likely to get $0.65/yr starting at age 85, rather than the $1/yr mentioned in the blog) , but Canadian insurance companies prefer to take most or all of your assets for an immediate annuity, rather than start offering longevity insurance which would only need you to spend 10-15% of your assets for longevity risk coverage.)

In LA Times’ “Mortgage rates drop to record lows” Adolfo Flores reports that average rate in the US for 30 and 15 year mortgages dropped to 3.31% and 2.63% and average fees were at 0.7 points. 5 and 1 year ARMs are at 2.74% and 2.56% with fees at 0.6 and 0.5 point fees. (Of course this should trigger a look at possible refinancing savings for those with mortgages. However, it also makes one wonder what the interest rate expectations are when one can get 15 year mortgage at 2.63% and the impact on the housing market)

Real Estate

Canada’sTeranet-National bank House Price Index for October 2012 showed continued deceleration in annual rate of increase were down for the month in 7 of 11 metropolitan areas. “In Montreal 12-month inflation has decelerated in 10 of the last 11 months, in Toronto in each of the last six months, in Winnipeg in each of the last four months…Prices were down from the month before in seven of the 11 metropolitan markets surveyed. For Quebec City (−0.9%) and Victoria (−0.6%) it was a third straight monthly decline. Toronto was also down 0.6% on the month. For Ottawa-Gatineau (−0.4%) and Montreal (−0.3%) it was a second consecutive monthly drop. Prices were also down in Calgary (−0.2%) and Halifax (−0.1%) and flat in Winnipeg, even if the resale markets in these three regions are considered tight. Prices were up 0.1% in Vancouver, 0.3% in Edmonton and 0.4% in Hamilton.”

In WSJ’s“Housing market posts gains” Nick Timiraos reports that “Existing homes sold at a seasonally adjusted annual rate of 4.79 million units in October, the second-highest level of the year and up 2.1% from September… (and) a 10.9% gain from a year earlier… inventory levels of homes for sale have fallen in all 28 metropolitan areas tracked in the realtors’ survey.

Pensions

A number of articles this past week discuss the impending DOA of Canada’s PRPP. Barbara Schecter in the Financial Post’s “Pooled pensions struggle for footing” declares that the most optimistic view of the state of the PRPP is that it is in limbo but others believe it is dead. “So far, none of the provinces have passed legislation that would empower or require employers to offer the federally mandated pooled pensions to their employees.”    Ontario was reconsidering the expanded CPP model (even though I have reservations about it, there is no question that it is superior to the currently proposed PRPP). The article elaborates on the perspectives of various sources as to why the PRPP is not a good solution as currently proposed; only the financial industry is still desperately pushing for it and waiting for the PRPP money to pour into their coffers. For example in the Financial Post’s “How Canada can become a retirement role model”where George Lewis, group head of RBC Wealth Management and Insurance, calls Canada’s banks sound and are in position of leadership in the world. He then proceeds to add some FUD (fear uncertainty and doubt) about the Old Age Security, about too many eggs in the CPP basket already and then moves in for the kill “It is critical we act now to stop this slide and rebuild participation in workplace Registered Pension Plans, through the introduction in all provinces of a Pooled Registered Pension Plan or “PRPP”.  (Even if there are OAS and CPP concerns, that doesn’t make the PRPP a credible pension reform.) He calls the PRPP an essential part of Canada’s “retirement seawall” and calls the “introduction and implementation of PRPPs as the single most important addition and solution to Canada’s retirement savings shortfall.” And he concludes by saying that “We have been a world leader in retirement planning. We have always been one step ahead of the curve.” (Sorry, Canada’s retirement system, except for the lowest income quartile individuals, is in shambles.)  In the Financial Post’s “Terence Corcoran: Who is killing the PRPP pension fix?” Corcoran might agree that the PRPP is DOA, but he says that “The blame, at this stage, appears to fall on a host of big-planning  redistributionists — unions, CARP, consultants, local politicians, government pension executives — who spent the last year or more sticking daggers in the PRPP concept…” (Unfortunately, the opposition to the PRPP is well earned. After waiting for pension reform for years, it offers little or nothing to anyone but Canada’s rent-seeking financial industry. Mr. Corcoran might find it interesting to read my take on the PRPP in the “PRPP: An agreement to kick the can down the road and deliver more fees to Canada’s financial industry” blog. Canadians deserve better, they deserve real pension reform.)

Things to Ponder

In IndexUniverse’s“Swedroe: Zero expense ratio ETFs inevitable” Olivier Ludwig interviews Larry Swedroe. Swedroe says that “there’s no army that’s strong enough to defeat an idea whose time has come, and passive investing is an idea whose time has come. However, the trend moves very slowly… because we’re fighting a very entrenched enemy in Wall Street, as well as the financial media”. “This is worst of times for them because they’re getting squeezed out, and all they’ve got left is 1) the ignorance of consumers and the hope that they can keep them ignorant; and 2) on the higher net worth side, what in my experience is mostly ego-driven investing… (who) want to be members of this special club that’s entitled to the “Goldman Sachs Treatment.”… But of course, these high-net people get the biggest screwing of all.”

And finally, after a visit to the Taj Mahal John Kay wrote in the Financial Time’s“The monumental folly of rent-seeking”that Shah Jahan the ruler/builder of the Taj Mahal who was a great example of a rent-seeker with taxation levels equivalent to 40% of GDP to “to support a lifestyle of exceptional ostentation and self-indulgence”. Rent-seeking is defined as “…the accumulation of a fortune not by creating wealth through serving customers better but by the appropriation of such wealth after it has already been created by other people.” “Whenever the balance shifts too far in favour of appropriation over creation, we see entrepreneurial talent diverted to unproductive activity, an accelerating cycle in which political power and economic power reinforce each other.” The “overblown” financial industry today is the foremost example of where the “burgeoning trade in existing assets has overwhelmed the creation of new wealth”. Kay concludes that the most important lesson from the rent-seeking excesses of the Mogul empire is that it only lasted two generation. (Sounds like an important message for the financial industry and the governments which allow the continued excesses on the back of the rest of the economy.)