Contents: Deferred annuities, safety of cash? not so ‘independent advisers’, only 15% trust their advisers, estate planning errors, yield vs. dividend growth, LearnVest’s objective to disrupt advice industry with affordable financial planning, best discount brokerages in Canada, US home prices up but sustainability questioned, misguided cult of home ownership, BlackRock’s new retirement index CoRI, Canada’s pension reform not only non-existent but even its objective is undefined, inflation/deflation, deep vs. shallow risk and its mitigation.
Personal Finance and Investments
In the WSJ’s “Should you buy retirement income” Anne Tergesen discusses deferred annuities which typically a 55 year old may purchase and start receiving lifetime income at age 65. The article notes that those whose Social Security plus pensions are insufficient to cover their retirement income needs might be candidates. But the article notes that given the current ultra low interest environment, it would be advisable to execute the intended purchase in stages, try to get one with inflation indexed payouts. The downsides mentioned include: exposure to insurer insolvency, giving up control to a significant chunk of one’s assets. Some policies allow deferral periods as long as 40 years (i.e. longevity insurance type coverage. I am still waiting to have these available in Canada; if priced fairly they are the right product for those looking for pure longevity insurance.)
In the WSJ’s “Retirees face high stock prices and low bond yields” Brett Arends writes that in an environment of expensive stocks and very expensive (low interest rate) bonds, perhaps the best place for retirees’ money is cash/money-market funds or short-term CDs. And by the way for Canadians, Larry MacDonald in the Globe and Mail’s “Inflation-beating cash account deserve a share of your portfolio” recommends considering CDIC insured high-interest savings accounts at Peoples Trust and Canadian Direct Financial which pay between 2 to 3%. (Though I haven’t seen anything close to that in my travels.) But in InvestmentNews’ “Vanguard analyst: Cash isn’t king” Jason Kephart quotes a Vanguard analyst who warns that while “cash means principal protection, financial advisers would be missing out on yield while they waited to time their way back into the market” (historically a highly improbable task to execute well, even by experts). In a hypothetical worst case scenario of a 300 basis point rise in rates, this would lead to a 13% drop in year one, but with reinvested interest the loss would drop to 8.5% by end of year two and to a total return of 6.3% by end of year five. Vanguard analyst Phillips notes that “You have to think about the likelihood that rates continue to go up, making cash the true loss avoidance vehicle you think it would be…”
The WSJ’s “More investors seek ‘independent’ advisers-but ‘independent’ has multiple meanings” warns that while investors need advice from independent adviser, not all “independent” advisers are the same; there are three types of “independents”: brokers (who are required to sell to client products “suitable” to their needs), Registered Independent Advisers (RIAs who act as fiduciaries, i.e. must work in the client’s best interest) and those wearing both of those hats. Things to consider are: fees (0.5-1.75% of assets under management for RIAs vs. commissions for brokers), conflicts of interest of brokers are obvious but the article notes even RIAs can have potential conflict whereby they might not recommend insurance products as they would reduce the assets under management, and those wearing both hats might have the potential conflicts of both. (If I needed an adviser, I would lean toward an RIA who has fiduciary responsibility to the client, works exclusively on a fee-only basis and preferably on a fee for service basis, selling no products and not working for a company selling products.) And by the way, in InvestmentNews’ “Investors have little trust in their advisers- fee structures are blamed” Michael Shagrin reports that just 15% of investors trust their advisors primarily because “they don’t believe the fees they are paying are commensurate with the return on their investments.” Advisors fail to deliver on “performance, unbiased and high-quality advice, and transparency — a mirror image of their positive expectations”. Other survey findings are that: investors’ highest allocation was to cash at 37%, and 40% of them “didn’t know whether their adviser is held to a fiduciary standard”.
In the Globe and Mail’s “Estate planning: Learning from the mistake of celebrities and others” Tim Cestnick lists things not to do in estate planning which include: dying without a will, specific bequests (can backfire when tax considerations are not factored in properly), choosing an old executor (who might die shortly after you) and others.
In Forbes’s “Forget yield—Dividend growth is the metric that matters for retirement income” Richard Sizemore runs through the numbers to argue that “When building an income portfolio, accept a lower payout today in the interest of generating a far bigger payout tomorrow. As in so many other areas of investing, delayed gratification has its rewards.”
In the NYT’s “A start-up aims to bring financial planning to the masses” Tara Siegel Bernard reports LearnVest is looking to disrupt the ‘advice’ industry by arguing that “financial advice shouldn’t be a luxury”; they are trying to deliver that advice by a combination of ”technology and bona fide certified financial planners” at an affordable price. Instead of charging the usual $1,000-3,000 for a financial plan “LearnVest charges $399 upfront fee and $19 a month, or $608 annually”. What is different here, from some other technology based online companies in the same general space, is LearnVest’s focus on financial planning first. They analyze the clients’ spending and generate a customized financial plan including: debt elimination, savings plan for child’s education and retirement saving targets. The service also includes ongoing feedback mechanism to monitor/notify if client falls off the wagon; they also specify an overall target asset allocation to stocks and bonds without naming specific funds at this time. The firm hopes to “revolutionize financial planning for the masses”. The company is a Registered Investment Advisor. (By putting the horse(financial planning) before the cart (investment management) where it belongs, they got the priorities the right way around, and I hope they succeed in creating better outcomes and perhaps even change the ‘advice’ industry.)
For those trying to compare online Canadian brokerages (as I have been recently), a good place to start is MoneySense’s “Canada’s best discount brokerages” which recognizes that investor needs differ and groups investors into types/buckets. Brokers are then evaluated/ranked according to the different needs of each customer type. For those really looking to change to or add a new online brokerage to work with, the $2.99 is well spent to get you the detailed report mentioned in the article. (Thanks to Ken Kivenko for recommending.)
The May 2013 S&P Case Shiller Home Price Indices indicate that 20-city U.S. index increased 2.4% over April, and 12.2% over May 2012. “The strongest YoY gains… (were) San Francisco home prices rose 24.5% followed by Las Vegas (+23.3%) and Phoenix (+20.6%). New York (+3.3%)… (while) Cleveland (+3.4%) and Washington DC (+6.5%) were the weakest… the eastern Sunbelt cities, Miami and Tampa, are lagging behind their western counterparts.” In Florida Miami and Tampa are up 14.2% and 10.9% YoY, and 2.6% and 1.8% MoM, respectively. Miami prices in the index are now back to January 2004 levels and are up about 20% from the April 2011 trough, but still 41% below the December 2006 peak.
Commenting on the Case-Shiller numbers, Nick Timiraos’s WSJ article “Home prices jump, but headwinds build” notes that Case-Shiller numbers may overstate the increase since foreclosures tend to sell at a significant discount to market and they were over-represented in the data set in the past few years, and as foreclosures become a smaller portion of the homes changing hands that will further amplify the perceived price increases. Recent prices were also driven by pent-up demand, buy-to-rent purchases and low inventories (with banks holding back inventory to help drive prices up.). The article also notes that “rising mortgage rates, potential more supply threaten pace of gains”. In Forbes’ “Home prices post another big gain in May, best boost since 2006” Steve Schaefer quotes Zillow economist Gudell who called some of the Case Shiller 10% over three-month price increases “not normal, not sustainable and, frankly, not very believable” and he added that homeowners shouldn’t “assume that the Case-Shiller figure means their own homes have increased sharply in value. And a Sun-Sentinel article by Shanklin and Owers in “South Florida home prices predicted to drop” report that according to a Core Logic forecast Fort-Lauderdale and Miami prices are expected to drop YoY from first quarter of this year by about 2.6%. (I resonate with the cautionary notes, as I haven’t as yet noticed any of these dramatic price increases in my neighbourhood.)
In the Financial Times’ “The cult of home ownership is dangerous and damaging” Adam Posen argues that both the US and UK are overdoing it with their schemes encouraging home ownership. He argues that the government policies driving up home ownership rates cause misallocation of resources in the economy and add risk to individuals’ finances when “home equity is their primary financial asset” and it is a “highly volatile, difficult to price asset, which is subject to disaster risk both idiosyncratic and general”. Posen adds that aggressive promotion of home ownership is actually regressive since it favours those young people from middle and higher income families who can get down-payment assistance, they “perpetuate an influential lobby” for the housing industry, “discourage economic flexibility” and thus lead to higher unemployment.
Pensions and Retirement Income
BlackRock introduced this week CoRI Retirement Indexes and filed to issue bond funds corresponding to these investable indexes. According to Index Universe’s “BlackRock joins the hunt for the white whale of retirement income” the funds come with target-maturity dates from 2015 to 2023 aimed at pre-retiree 55 to 64 year olds and can be used “to calculate how much estimated income an investor will get from his or her retirement savings or the amount of savings a client needs in order to generate a particular amount of income… The indexes provide the estimated cost of providing $1 of future annual inflation-adjusted lifetime income starting at age 65.” In the WSJ’s “BlackRock rolls out index to make inroads in retirement income market” Greene and Lauricella indicate that according to BlackRock these CoRI funds could be used “within their target date funds” and used as part of the income generation strategy. At BlackRock’s website you can access the “CoRI Retirement Income Planning Tool” and get a flavour of how this is supposed to work. For example for the CoRI index for a 60 year old today is $16.16, which indicates the amount of money one needs to have at age 60 to generate $1 of lifetime income starting at age 65. i.e. $1,000,000 at 60 would generate $61,881 annually starting at age 65. The index is generated from complex proprietary calculations involving inflation, risk, interest rates and life expectancy. The index values change daily to reflect changes in the factor driving the indexes and they are intended to converge with/to annuity prices. The funds are not intended to guarantee anything. (I haven’t as yet read about CoRI indexes beyond the articles mentioned here, but at a minimum these might turn out to be another indicator on one’s retirement planning dashboard.)
The press release entitled “Canada’s Premiers are committed to fair and inclusive society” at the conclusion of the July 24-26 Canadian Premiers’ get-together in Niagara-on-the-Lake made only cursory mention, under the Retirement Income heading, of the thinking on where pension reform might be heading. The release mentions the importance of the subject and their (continued) intention to consider options for a phased-in and fully funded enhanced CPP/QPP and PRPP. They also expressed concerns about the increase of OAS/GIS eligibility age from 65 to 67. Unfortunately nothing specific was mentioned on any of these topics.
In Benefit Canada’s “Directions for pension reforms: At the crossroads?” Murray Gold argues that before we can determine what form pension reform should take, we need to first answer the question of: “What is it that we want from our pension systems?” Earlier traditional DB workforce pensions were aiming to replace 70% of the pre-retirement income (of course these type of pensions are increasingly extinct in the private sector, the new baseline for pension plans is the CPP which replaces 25% of YMPE assuming that you put in your requisite close to 40 years of work. But until we know what we want we are not in position to determine what reform is required, and given that pensions are long-term commitments, Mr. Gold indicates that we must be ready to then bear the costs and risks associated with them. (His point is well taken, much of the years and years of, so far, pointless discussion of pension reform has taken place without a stake being placed in the ground as to what objective we might like to achieve. Any meaningful/realistic percentage of pre-retirement income or expenses would quickly indicate that a gradual phased-in fully-funded expanded CPP is not a solution to a meaningful pension for those near or already in retirement unless they are in the bottom third of Canadian income levels. But that’s not news, it’s just an indication how much talk there has been on this and what total lack of progress has been achieved to date. So Canada’s Finance Minister and the provincial Premiers are continuing to fiddle while Rome is burning. What a shame.)
The Economist’s “The Unsteady States of America” warns that “It is not just Detroit. American cities and states must promise less or face disaster.” The article compares Greece as the source of the European financial contagion, to the potential of Detroit becoming the source of an American one. It calls Detroit “a flashing warning light on America’s fiscal dashboard”. Only discontinuance of accounting tricks which hide the true extent of the financial problems will lead to the required action to correct the crisis. If/when the federal government will pitch in; the help should not go the “local governments or investors who should have known the risks. But they should help pensioners (some of whom don’t even qualify for Social Security) left stranded through no fault of their own”. And by the way John Dizard has a thoughtful article in the Financial times entitled “Detroit default exposes lie of phantom returns” in which he discusses the coming battle between public sectors unions arguing that “pensions and healthcare benefits are middle-class right guaranteed explicitly by the Michigan state constitution, and should not be subordinated to Wall street and the rich, i.e. the bondholders. However, the beneficial owners of most of the bonds are also middle class” and the federal court will have the final say. If the federal court agrees with the unions, muni-bond markets will disappear. He also notes that the Supreme Court has already ruled that social security benefits, unlike Treasury bills and bonds, are not full faith and credit obligations of the federal government.
Things to Ponder
In The Economist’s “Deflationary pressures build” Buttonwood discusses that deflationary indications in Europe, Britain and the US yet we had ‘tapering’-driven increase in bond rates; and despite the governments’ money printing excesses QE did not yet lead to inflation. Buttonwood writes “it all looks a bit Japanese to me”.
In Bloomberg’s “The $7 trillion problem that could sink Asia” William Pesek opines that “The more Asia adds to its holdings of U.S. debt, the harder they become to unload. If traders got even the slightest whiff that China was selling large blocks of its $1.3 trillion in dollar holdings, markets would quake. The same goes for Japan’s $1.1 trillion stockpile. So central banks just keep adding to them. Pyramid scheme, anyone?”
And finally, in WSJ’s “’Shallow Risk’ and Deep Risk’ are no walk in the woods” Jason Zweig discusses the difference between “shallow risk” (“a temporary drop in an asset’s market price” which may be deep and prolonged but still temporary) and “Deep risk” (“an irretrievable (permanent) real loss of capital, meaning that after inflation you don’t recover for decades- if ever”). The article is based on William Bernstein’s forthcoming book “Deep Risk: How History Informs Portfolio Design” in which he identifies inflation, deflation, confiscation and devastation as the four sources which can irreversibly destroy one’s assets. There is not much you can do about devastation/war/anarchy, foreign real estate offers some protection against confiscation (but unlikely to work well in Florida where non-locals’ assets can get confiscated locally by imposition of discriminatory property taxes), “the best insurance against deflation is long-term government bonds” while it exposes you to inflation risk, which in turn is best protected against with a “globally diversified stock portfolio with an extra pinch of gold-mining and natural resource stocks”, which in turn expose you to massive shallow risk (high volatility); and volatility in turn exposes you to the ultimate deep risk of selling your stocks after they have (temporarily) crashed. (As usual, a thought provoking article from Jason Zweig.)