Contents: The 4% rule-NOT, retirement risks, “just like CDs”-NOT, home equity funded retirement, adviser conflict of interest with own firm products, fixed income asset class expands in retirement portfolio, Canadian homes 20% overvalued? Toronto home prices stable while sales off 15%, DC a lottery but longevity insurance can help, CPP survivor benefit skimpy, retire later, retirement planning stages denial-anger-bargaining-depression-acceptance, stealing from our children and grandchildren, China property opportunity and bubble.
Personal Finance and Investments
In the WSJ’s “Say goodbye to the 4% rule” Kelly Greene writes that it’s getting harder to make sure that your nest egg will no exhaust for your entire lifetime. In the article she writes that William Bengen’s 4% rule (i.e. first year retirement taking 4% of assets and increase dollar amount by inflation each year thereafter) “has been thrown into doubt”. The article explains that there are four scenarios that could undermine this rule: big market drop early in retirement, “dismal stock returns”, “hostile bond markets” and/or “rampant inflation”. Greene suggests alternatives like: (1) using fixed annuities (SPIAs) instead of bonds in creating a 50/50 annuity/stock portfolio as suggested by Wade Pfau, (2) use IRS’s age-based “required minimum withdrawals from individual retirement accounts” defined as 1/(life expectancy) with life expectancy tables available at “Appendix C of Publication 590 at irs.gov” but you’ll have to tolerate higher income volatility, or (3) “peg your withdrawals to stock valuations” for example as per Kitces’ rule from a 60/40 stock/bond portfolio of “if the PE10 is above 20…4.5% in first year…if between 12 and 20…withdrawal would be 5%…if below 12 you can pull out 5.5%” adjusting initial dollar amount for inflation annually. (Lots of ideas here, but the article tables alternatives which were proposed at different points in time, e.g. Pfau’s annuity/stock portfolio was proposal was quite recent (though was also explored about a decade ago by Ameriks if I recall correctly) factoring into assumptions at least some of the devastation of the past five years or so, while Kitces’ rule appears to have been proposed pre-2008 crash so it offers even higher starting withdrawals than the “4% rule”. My usual comments of any approach that assumes that you start with some dollar amount in retirement and adjust for inflation for the next 30 years still stand; i.e. “forecasting is difficult, especially about the future” and 30 years is an eternity. The implicit adaptability of withdrawals implied by the IRS minimum withdrawal rule probably has the best chance of success among these alternatives, as it adjusts annually to current reality: amount of current assets and remaining current life expectancy. Furthermore, one might also wish to consider a more flexible approach which factors in the reality of higher spending needs/desires early in retirement followed by a gradual decrease in needs until a rapid increase the last couple of years before death reflecting higher health-care related costs. Personally, I’ve been advocating the use of the “proportional 4%” rule whereby you can take 4% of current assets each year, which if sustainable could even leave a residual estate; if not, you can always switch to the IRS based withdrawal rule which allows larger and larger annual percent withdrawals as one’s life expectancy decreases. It just shows you that Richard Hamming is right “computing is for insight not numbers”.)
In the March/Aril 2013 issue of the CanadianMoneySaver’s “Have you addressed the risks to retirement income?” Greg Dowdall describes the five retirement risks to consider as: longevity, inflation, asset allocation (taking on too much or too little risk), withdrawal rate (too high), and health care and other benefits (pressure of demographics).
In the NYT’s “Beware of investments promoted as ‘Just like a C.D.’” Carl Richards warns that driven by the “double whammy” of less money and lower interest rates after the crash investors feel driven to find investment “solutions” to help recover more quickly, such as investments that “will grow fast” and/or “pay higher interest” (i.e. yield chasing). But don’t fall into the trap when somebody offers you alternatives that pay 7% when CDs pay 1.5%, because “risk and expected return are still — and will always be — closely related…when someone comes to you offering an investment that’s “just like a C.D.,” but it pays 7 percent, guess what: This investment is NOT just like a C.D. If it was just like a C.D., it would pay you what you expect a C.D. to yield…the answer isn’t to hope that a dubious, new product someone sells you will solve your problem. The odds are high it will only make things worse.” (Well put; many might be hurt by the current “yield chasing” going on.)
In the Globe and Mail’s “What is funding retirement through home equity is your only option?” Preet Banerjee explores options to help house rich but income (and other asset) poor retirees benefit from current high Canadian real estate prices: downsize to smaller home, sell and rent, get a home equity line of credit, take out reverse mortgage, rent out part of your home. Banerjee concludes that nothing works like planning ahead: “The sooner you can get started with a real financial plan, the more choices you will have”. (Remember that ‘real’ advice is not about investing, it is about financial planning.)
In Dealbook’s “Selling the Home Brand: A look inside an elite JPMorgan unit” Craig and Silver-Greenberg report that JPMorgan has “…a sales-driven culture that is unusually aggressive, even by Wall Street standards…While financial advisers at other firms are typically free to offer a variety of investments, JPMorgan pressures brokers to sell the bank’s own products…” (‘Advisers’ required or ‘strongly encouraged’ to push own firm’s product have potential serious conflict of interest and would find it very difficult to act in the client’s best interest as discussed in my Fiduciary – Response to “CSA Consultation Paper 33-403 – The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty When Advice is Provided to Retail Clients” blog.)
In IndexUniverse’s “Malkiel preps Wealthfront for bond bust” Olly Ludwig reports that Wealthfront CIO Burton Malkiel is adding to the bond portion of the firm’s portfolio, traditionally composed of Treasury and agency bonds, five new asset types: “municipal bonds, corporate bonds, emerging market bonds, dividend growth stocks and Treasury inflation-protected securities”. “Wealthfront’s radical business aims to replace human advisors with computer algorithms that enforce the verities of responsible investing as a matter of course, including portfolio diversification, rebalancing, minimizing taxes and, not least, limiting fees.” And Malkiel believes that “software can handle routine tasks like rebalancing automatically, and the complexity required to implement continuous tax-loss harvesting, without adding a lot of cost. Software also takes the emotion out of investing…”
In IndexUniverse’s “Dare to be dull” Cinthia Murphy interviews investment advisor Allan Roth who argues that you should “Dare to be dull”. The biggest mistake investors make are related to “expenses and emotions”. He advocates “broad asset allocation” using indexing, no market timing for example by trying to chase after yesterday’s winners, value investing (but considers fundamental indexing an active strategy), committing to and sticking to an appropriate asset allocation with regular rebalancing. “…rebalancing is the one contrarian view. It can make you buy when people are selling, and it can make you sell when people are buying.” (I follow a similar approach.)
In the Financial Post’s “Canadian home prices overvalued by about 20%: Fitch” Barbara Shecter reports that “Canadian home prices are overvalued by about 20%, according to Fitch Ratings… (but the US experience based model may not be fully applicable to the Canadian context, so) despite the valuation, it doesn’t expect prices to fall by the same amount because of the effects of inflation and price momentum… Moreover, the drop in Canadian home values would depend on “a number of factors such as government support and credit availability” and the decline in prices “could be as low as 10%”.
In the Financial Post’s “Toronto housing sales drop 15%, but no relief yet for home buyers” the Canadian Press reports that “The number of homes sold last month in the Toronto area was down about 15% from the same time last year… The lower sales volume continues a months-long trend in Toronto…. (however) the average transaction price last month in the Greater Toronto Area was $510,580, up from $510,249 in February 2012.”
Pensions and Retirement Income
In the Economist’s “Life is a lottery” Buttonwood, referring to a new OECD report, discusses how the retirement income of individuals with a DC plan is a pure lottery. For a 5% annual saving over a 40 year working life invested in a 60/40 stock/bond portfolio one ended up with 50% income replacement rate in the US if they retired at the “height of the dotcom boom” and only 20% if they retired 10 years later. In the UK the gap was even greater at 70% in early 90s and 35% now, while in Japan late 80s replacement rate of 70% has fallen to 10% today! His conclusion is that 5% savings is way too low, lifecycle funds would be better than 60/40 portfolios as they tend to reduce stock exposure as one is nearing retirement. Saving 10%/yr for 40 years only gives you 30% income replacement with 92% probability according to the OECD simulation. Unlike the UK where people tend to annuitize on retirement, in the US typically people take the pot of money and try to manage it themselves. Buttonwood writes “They have a good reason for doing so – there are some high-charging opaque (annuity-like) products – but the result is that they risk running through their savings before they die. One answer is to use part of the pot to buy a deferred life annuity that kicks in at, say. 85. This is a lot more flexible than tying up all your capital in a fixed-rate annuity straight away, and of course, the rate on a 85 year old’s annuity will be a lot better than that of a 65 year old. The risk, of course, is that the individual does not live till 85. But think of the investment in a different way – as longevity insurance.” (That sounds pretty sensible to me, as I have been a long advocate of longevity insurance; see Longevity Insurance- What does it buy you? or a CPP version of it in Pure longevity insurance payout option in CPP would reduce retirees’ longevity risk.)
In the Toronto Star’s “This retiree’s $22.75 Canada Pension Plan shock” Adam Mayers explains the surprise of an individual that upon the death of his wife, found that the increase of his pension (survivor benefit) amounted to $22.75 even though his wife was receiving $1053/mo before she died. According to the HRSDC which administers the CPP “The rationale for establishing a limit . . . reflects the principle that no person should receive a combination of pensions that is greater than the amount payable to an individual who made the maximum contributions to the Plan throughout his or her working life… The benefits are not intended to replace a second source of household earnings or the retirement income of a dual-earning family…” (In fact one of the reasons I took CPP at 65 instead of the planned 70 is because any increase resulting from delaying my CPP start would not be transferable to my wife should I die first; I describe other considerations as well in my Took CPP at 65 instead of the previously planned age 70: What changed? blog.)
Things to Ponder
A couple of articles in the Financial Post are arguing for deferral of retirement past age 65. In Fred Vettese’s “Don’t retire at 65 if you like your work”, which is an excerpt from his recent book with Bill Morneau, he argues that “Retirement planning is focused too much on how and not enough on why… your decision about when, how, and where to retire is as important, in its own way, as the original career decision you made all those years ago”. He also explains the close connection between your standard of living before and after retirement and your retirement age. In Ted Rechtshaffen’s “The pope retired at 85- maybe you should too” he writes that increasing numbers of Canadians would like to retire later because they like their work or because are compelled by financial needs. Rechtshaffen argues that “people should work for financial reasons… (but) once you pass the point of financial freedom… That choice is all about whether you are happier working or not… For the Pope and Raul Castro, their freedom 85 day may look very different than the retirement date for you. But the days of the gold watch at 65 appear to be well behind us.”
For a somewhat different (perhaps even healthier?) perspective of retirement planning see Paul Brown’s NYT article entitled “The five stages of retirement planning angst” where he takes the reader, in a manner analogous to Kubler-Ross five stages of grief, through the parallel five stages of one’s retirement planning. Brown’s reaction to being told that they’ll eight times his and his wife’s income to retire in anything close to the retirement they would like was the same sequence of: denial, anger, bargaining, depression and acceptance. He concludes with “I am not arguing that you should give up on saving money for retirement. Rather, I think that you should try to save as much as you can, but that when you have done all that you humanly can do, accept it.”
In Bloomberg’s “Druckenmiller sees storm worse than ‘08 as seniors steal” Katherine Burton reports that one of the best hedge fund managers around warns the youth of America: “Don’t let your grandparents steal your money… the mushrooming costs of Social Security, Medicare and Medicaid, with unfunded liabilities as high as $211 trillion, will bankrupt the nation’s youth and pose a much greater danger than the country’s $16 trillion of debt currently being debated in Congress… I am not against seniors. What I am against is current seniors stealing from future seniors“. (Very compelling arguments for doing something now, before we irreversibly become a burden on our children and grandchildren.)
In WSJ’s “Money lessons from ‘Downton Abbey’” Kelly Greene discusses financial lessons from Downton Abbey pertaining to: estate planning, risky/concentrated investing, out-of-control expenses, business succession planning, medical directives, etc.
And finally, watch two segments on CBS 60 Minutes March 3, 2013 edition on mainland China’s unbelievable real estate opportunity (the ‘mogul’ story) and ‘bubble’ segments. And by the way in the WSJ’s “Property curbs weigh on China” Daniel Inman reports that past Monday Shanghai index and property developers fell 3.7% and 9.3% respectively with “China’s decision late Friday to try to slow house price rises, with the government imposing higher down payments and mortgage rates, and stricter enforcement of a 20% capital gains tax on property transactions. Any slowdown in China’s property market may curb demand for global commodities, and potentially cool spending and growth in Asia’s biggest economy“. (Think about the opportunities in China, and risks to the world should China implode.)
Regarding when to retire
“A couple of articles in the Financial Post are arguing for deferral of retirement past age 65. In Fred Vettese’s “Don’t retire at 65 if you like your work”, which is an excerpt from his recent book with Bill Morneau”
my (not original) view is retirement should not be a switch — at whatever age. Rather it should be a change of focus, not only financially but in all your lifestyle choices… You move away
– FROM “I HAVE to do this to survive/save/build contacts/build network for career, friendship” etc.
– TO “I WANT to do this… etc.
You’re right…that’s what is so wonderful about “retirement”…regards…
I continue to enjoy your weekly compilations …much good information for us retirees!
I have a question regarding the 4% rule (and others). Assume a $1000M portfolio consisting of quality dividend stocks producing $50M in annual income. Does the 4% rule assume annual reductions of $40M, excluding dividends which results in $90M annual reduction; or does it assume annual reductions of only $40M inclusive of diviends?
The “traditional 4% rule” assumes that you take $40M in Year 1 of retirement from your initial $1000M capital…at the end of Year 1 the Total capital may have grown (decreased) due to Capital Gains (Losses) and/or Dividends…but in Year 2 you would take the $40M Year 1 withdrawal amount and increase it by inflation, say 3%, and take $41.2M…each year the withdrawal is further increased by inflation, independent of the available capital in that year…”the proportional 4% rule” which I mention in my comments on the article is different, whereby one takes each year 4% of the then available capital each year… Hope this answers your question…all the best…Peter