Contents: Year-end tax planning, U.S. ETFs for Canadians, cash under the mattress, downsizing? RRSP vs. public service pension, QE damages pensions and investment while smoothing distorts reality of deficits, Stones induced Social security reform and intergenerational warfare? understanding retirement income risks, target-benefit plans, “laws of competition do not apply under asymmetric information” due to agents capturing rents, demographics threaten boomer retirement, passing along values.

Personal Finance and Investments

In the  Financial Post’s “Year-end tax planning: Act now to save later” Jamie Golombek reviews some payments that must be made by year-end to get 2012 tax benefit (e.g. charitable donations), tax-loss selling (e.g. capital losses which can be carried back up to 3-year and forward indefinitely- but make sure it settles in 2012), and for those turning 71 in 2012 year-end is the deadline for the last RRSP contribution prior to RRIF or annuity conversion.  Golombek also points out that there is no deadline associated with TFSA contributions.

In the Globe and Mail’s “U.S. ETFs: To hedge or not to hedge?” Rob Carrick looks at some things to consider when buying  U.S. market ETFs: NYSE listed ETFs have impact on U.S. estate tax treatment whereas TSE listed ones don’t, buying US based ETFs in USD might incur currency exchange cost in your Canadian brokerage account (unless you hold USD in your account) as compared to buying low-cost Canadian dollar denominated version listed on the TSE (e.g. VFV and ZSP are mentioned),  buying the Canadian version of the US market ETFs dividends would not be subject to the 15% withholding tax due to Canada-US tax treaty, then of course the answer to the question “To hedge or not to hedge?” is less clear  in an environment when the US and Canadian dollars, rather than being at 0.65 CAD/USD exchange rate, are close to parity and thus have a lower likelihood of significant rise of the Canadian dollar.

In the Globe and Mail’s“Should you keep some cash under your mattress?” Preet Banerjee indicates that “having an emergency fund is one thing, but having funds you can access in any emergency is another”; considering situations when you couldn’t “access cash from an electronic account”: technical failure or natural disaster. His advice is to keep at least a few hundred dollars cash in the house in addition to the three month reserve in the bank. He also mentions that close to 10% of American families don’t have a bank account!

Real Estate

In the WSJ’s “Everybody says you should downsize. Everybody may be wrong” Anne Tergesen writes that “Moving to a smaller home is supposed to solve a lot of problems in retirement. But it doesn’t always work out that way.” The reality of downsizing to solve a retirement finance problem does not always work as expected: after paying for the new ‘smaller’ place there may be little cash left after transaction costs, the new place (condo) may come with higher ongoing maintenance/operating costs than the old house, children and parents miss the ‘old house’ with the associated memories or because the smaller new place offers less personal space or extra space if family member needs to be accommodated temporarily or for an extended period.

Pensions

In the Financial Post’s “The best RRSP money can buy” Fabio Campanella compares a public servant’s retirement against the option available to most other Canadians who nowadays don’t have access to a defined benefit plan. He compares an Ontario teacher’s pension to the aggressive Canadian saver who maxes out the permissible RRSP and then annuitizes upon retirement. The resulting pension/annuity is similar but the saver’s annuity is un-indexed and typically halves in purchasing power over retirement while the teacher’s is indexed, and the teacher’s pension cost is 50% of the saver’s with the rest being paid by the employer/taxpayer.

The Economist’s Buttonwood in “The pension squeeze- Finding the right rate” opines that the effect of the UK quantitative easing (QE) intended to increase investment has been to: drive down yield, drive up pension liabilities by 40-50%, force companies to up the pension contributions thus making less funds available for investment, contrary to intent of QE. The QE has also affected the average person by reducing the return on their savings, and by dramatically increasing the cost of their annuities. Yet companies are looking to the pension authorities to ease the pension contribution burden by requesting new smoothing techniques which might be advantageous in the short-term by may backfire once interest rates start increasing. And of course various ‘smoothing’ approaches also distort the reality of pension plan deficits. And on the same subject in the Financial Times’ “Smoothing won’t solve our pension problems” John Ralfe writes that “Smoothing pension assets and liabilities disguises deficits, but does not make them disappear.” And that “Smoothing pension assets and liabilities cuts both ways”, when interest rates rise, the then current rates will no doubt be demanded instead of the smoothed rates.

In the Financial times’ “Growing old, Stones-style” Gillian Tett after attending The Rolling Stones’ “50  and Counting” show and watching them and their audience in their 70s and 80s dancing to their music, asks whether given the energy displayed by them despite being well past current pensionable age, it is time for retirement reform? Specifically, would it not make sense to increase Social Security eligibility age given that longevity has increased dramatically over the last 50-70 years and Social Security wasn’t designed to pay for a “30 year retirement after a 25 year career”?  She also notes however that in the US (unlike in UK and Europe) the longevity of the bottom 50% of income earners increase just 1.3 years since 1977 while the top half’s has increase 6 years, so an increase in retirement age might be indefensible as it would hurt the poor; a better solution might increase in payroll taxes. But Tett thinks both might be needed but that we are likely heading to an “intergenerational fight” given that the solution might require the young to pay for the old. (Of course we know that such changes immediate evoke fighting words to protect senior entitlements even if our children and grandchildren end up paying for them.)

In the Financial Times’ “When you’re 64, will your nest egg be big enough?” Loren Fox discusses how US investors saving for retirement have a mixture of concern about their ability to eventually be able to retire comfortably and yet a sense of overconfidence when they actually retire about the adequacy of their savings to support them in retirement. The reason Fox writes is due to a lack understanding of the retirement income risks which include: continued low interest rates, retiree risk tolerance, market volatility, expectation of high withdrawal rates which will lead to exhaust savings before death, expectation that they’ll be able to work part time and reduce their spending, longevity risk and of course the risk of insufficient saving rate during working years.

In Benefit Canada’s “Can target benefit plans work?” Fred Vittese looks at Target Benefit Plans (TBP), which “are generally regarded as superior to DC arrangements since longevity risk is pooled and the intractable problem of educating a diverse population on myriad investment options is neatly circumvented by having one common fund”. While expert commissions in several provinces have endorsed TBPs, provinces have not been forthcoming with enabling legislation and whether that legislation “will allow for retrospective application”.

Things to Ponder

The Economist’s Buttonwood discusses in “Market failure” why the mysterious phenomenon of market momentum is not arbitraged away as expected. The conclusion in a recent report by Woolley and Vayanos is that investors are using agents (professional managers) to manage money, and moneys removed from those who underperform are then placed with those who have previously outperformed. Thus prices depart fair value until the process is reversed by a shock. The authors of the report also write that “Agents have learned that financial markets do not function like goods markets, and that the usual laws of competition do not apply under asymmetric information. Moral hazard, complexity and opacity all help them capture rents. They also benefit from mispricing, volatility and the proliferation of products. The costs and fees of intermediation go hand in hand with pricing inefficiencies in contributing to the erosion of the returns on savings”. The Financial Times’ “A new paradox found in markets theory” discusses the same report which also suggest that owners focus on “long-term fundamental value-based approaches to investment and finding more stable benchmarks linked to gross domestic product growth”

In Macleans’ “Attention boomers: Why demographics threatens your retirement” Stephen Gordon writes that “One of the more worrying aspects of population aging is its effect on the prices of assets that many people are counting on to support them in retirement.” So Boomers trying to all sell their houses to buy condos and trying to sell their shares accumulated over their working years may result in outcomes incompatible with expected impact on retirement finance. (If I recall correctly Jeremy Siegel addressed this concern about shares almost a decade ago in his “Stocks for the Long Run” and concluded that we shouldn’t be worried because the emerging market demographics will save us as their younger population’s demand for shares will absorb developed counties’ excess supply. Sounds good and hope it works out.)

And finally, in the WSJ’s “Before passing along valuables, passing along values” Robert Powell discusses the “burgeoning effort in estate-planning circles to ensure that life lessons are passed on to loved ones” and steps being taken to “encouraging and helping older adults to share their stories and values before they die, and teaching adult children and grandchildren how to tap their parents’ and grandparents’ thoughts”. One Cornell University project with its YouTube channel provides access to reflections “from hundreds of older Americans on more than a dozen subjects, including careers, marriage and parenting”. (Not a bad idea. In fact over the past several months I’ve been recording and transcribing my 92-year old mother-in-laws life experiences (hopefully never to be re-experienced by future generations) for the eventual benefit of our children and grandchildren.)