Contents: Things to mess up retirement, unexpected death of spouse running finances, the permanent portfolio, accumulation vs. decumulation, US vs. Canadian listed Vanguard ETF considerations for Canadians, Canadian house prices/sales up again-overheating? CPPIB reports subpar Q2 pension plan return, US-DOL driving toward fiduciary requirement for IRA providers, fiduciary and investment losses 23% of available 401(k) risk premiums, pension plan longevity risk: a red herring, bond trading platform coming? US expat tax reporting a “most fatuous regulation”, (but) look before renouncing US citizenship for financial reasons, CAPE high at 23.8 but consistent with 3% real return next decade, American doctors’ fee-for service needs cultural shift similar to Wall Street.

Personal Finance and Investments

In the WSJ’s “Five ways you can really mess up your retirement” Brett Arends lists some of the ways: starting Social Security too early, overspending early in retirement, spending without a budget, “not making a nonfinancial plan”, and moving without proper preparation/test-drive.

In the Globe and Mail’s “Unexpected death leaves wife to plot course for future” Gail Johnson looks at  the situation of a recently widowed lady whose husband left a complex portfolio of assets which she now has to untangle to insure that she’ll have sufficient retirement income. The specifics aside (available data and recommendations, which in this case are incomplete at best) this article tables a much too real situation of many who are unprepared when the spouse in charge (and it’s not uncommon to have just one) dies leaving the unfamiliar/inexperienced/financially un-inclined spouse (usually, though not always, the wife) to create/execute muddle through; this can be a serious problem even when the passing spouse leaves behind adequate resources. (Preparation and suitable contingency planning are a must; many of us are guilty of failing to do this adequately. This is also on my mind.)

Andrew Hallam in the Globe and Mail’s “The Permanent Portfolio: The only investment plan you’ll ever need” describes the “permanent portfolio comprised of 1/4 gold, 1/4 stocks and 1/4 long-term bonds and 1/4 cash; the investor is only required to rebalance once a year back to the target asset allocation. The returns were10% during the 80s, 7.7% in the 90s 7% in the decade starting in 2000; in 2010, 2011 and 2012 returns were 12%, 13.3% and 6.8%. The author notes that given the current unusual environment he guesses that “you could do better with a diversified portfolio of stock and bond indexes. But my pessimism has a familiar ring. As I’ve demonstrated above, things never look good for the Permanent Portfolio. It just seems to work.” (Perhaps???)

In Journal of Investment Consulting’s “The fundamental differences in accumulation and decumulation” Richard Fullmer pulls together the differences between the accumulation and decumulation phases in one’s lifecycle and the impact on the appropriate investment strategy in each stage. Fullmer looks at differences in 7-dimensions of accumulation and decumulation which are: time horizon (known/controllable vs. unknown/uncontrollable), investment goal (future wealth vs. cash flow and bequest), risk measure (wealth variability vs. sustainability of income and bequest variability), cash flow (regular contributions vs. regular withdrawals), timing of returns (dollar cost averaging good vs. bad, e.g. sequence of returns risk early in retirement), and inflation (mitigated by incomes rising with inflation vs. un-indexed cash flow purchasing power seriously corroded by inflation (e.g. fixed annuities)). Fullmer’s bottom line is that investment strategy must be customized to personal goals of each individual in the context of his/her circumstances which then drive the relative importance of wealth (bequest) vs. cash-flow (the case for most people) goals, each requiring different investment strategies. (The exceptions include the very wealthy and those who have secure ‘real’ (indexed) pension incomes covering 100% of their needs, i.e. those whose spending represents an insignificant part of their wealth) (Well worth reading. Thanks to Ken Kivenko for recommending.)

In an article discussing new Canada based Vanguard ETFs “How to assess five new Vanguard ETFs?” Andrew Hallam notes some generic considerations for Canadian investors. He notes that “Over long periods, hedged funds may underperform their non-hedged counterparts by a percentage point or more each year. “ And while “Vanguard’s U.S. listed ETFs are still cheaper… Outside of a tax-sheltered account, the uncertain rules of U.S. estate taxes could provide your heirs with an unexpected uppercut. There’s also the added cost of converting Canadian dollars to greenbacks every time you make a trade.” In the Globe and Mail’s “The smart way to invest across the border” Larry MacDonald also discusses the pros/cons of hedged vs. un-hedged, US- vs. Canadian- listed ETFs. He also mentions withholding tax issues, US estate tax considerations.

Real Estate

The July 2012  Teranet-National Bank Home Price Index shows that Canadian home prices are up 1.9% YoY and 0.7% MoM; the 0.7% in-month increase in July “may seem substantial, (but) it is somewhat below the seasonal norm”. Toronto, Ottawa, Montreal and Vancouver showed YoY increases of 3.4%, 0.9%, 1.1% and -2.0%, respectively; the corresponding in July increases were 1.3%, 0.3%, 0.0% and 0.3% respectively.

In the Globe and Mail’s “Canada’s housing market still running hot” Tara Perkins reports that Canada’s housing market continues to show “surprising resilience” which is “renewing concerns that it could be overshooting”. Vancouver, Toronto and Calgary showed YoY increases in sales of 40%, 16% and 17%, respectively; however Montreal and Ottawa had 2% lower sales than previous year. There is some speculation that the Minister of Finance might take additional steps to cool the market if it continues to show strength; “average home prices were up almost 5 per cent year over year in June, and we suspect the gain was closer to 6 per cent for July”.

Pensions and Retirement Income

In the Globe and Mail’s “CPPIB not bothered by  lacklustre quarter. In long-term” Tim Kiladze reports that CPP return was (nominal) 1.1% in the second quarter. The 5- and 10-year annualized returns are 2.9% and 5.0% respectively, compared to long-term target return of real 4.2% annual return.   The CPPIB news release indicated that asset allocation is 49.5% equities (31.8% public and 17.7% private), 33.6% fixed income, 11.1% real estate and 5.8% infrastructure.

Jason Zweig in the WSJ’s “Look who is locking horns over retirement accounts” discusses the much anticipated new fiduciary rules US Department of Labor which would require that “brokers and other securities professionals would act solely for the benefit of their clients when advising on individual retirement accounts (IRAs).” Financial industry and its lobbyists have launched a frontal attack against the expected changes calling them “destructive”,  will lead to “chill all kinds of activity”, “conflict free relationship doesn’t work in practice”, “if brokers can’t have any conflicts like earning higher fees on some investments than on others, then they no longer will be able to afford handling small accounts”.  Zweig quotes Assistant Secretary of Labor Phyllis Borzi that that there are lots of fiduciaries operating today and they are doing so profitably and (true) “advisers have a responsibility to work for the clients’ best interests and not their own”. Zweig recommends in the meantime that you ask your ‘adviser’: “Do you or your firm earn more money for recommending this investment? Can you suggest a simpler, cheaper way of accomplishing the same goal? (All in all, what we hear is the industry attempt to cast the usual FUD, fear-uncertainty-doubt. The evidence is overwhelming; the time has come for real advisors to operate at a fiduciary level of care.)

In Yale Law’s “Measuring Fiduciary and Investor losses in 401(k)s” Curtis and Ayres studied “the relative costs to investors of limited investment menus, fund- and plan-level expenses, and investor allocation mistakes”. Return reductions are categorized as: “Fiduciary losses” which are “attributable to plan fiduciaries” and represent about 10% of available risk premium, and “investor losses” which are “attributable to mistakes that investors make in choosing how to allocate among menu offerings” and represent about 13% of the available risk premium. “Taken together, these losses consume about a quarter of the optimal potential risk premium.” Large plans typically have lower fiduciary losses than small plans, but there are huge variations among small and large plans. Most telling note of the researchers is that “A portfolio consisting of only retail share classes of Vanguard index funds incurs lower fiduciary losses than 90% of plans in our sample.” (Thanks to MK for recommending.)

In Benefit Canada’s “What longevity risk” by Calvin Jordan is the first sensible article on the subject of the impact of increasing life expectancy, suddenly discovered by the Canadian Institute of Actuaries, on pension plans. He writes that this is not about risk but about cost, “longevity risk has to do only with mortality improvements that are different than expected”, why hedging it at pension plan level makes little sense, projections of increasing longevity can/are/should be built into ongoing plan costs. “We should not allow the hedge sellers to confuse us on this point and let longevity risk divert our attention from the more significant pension issues.”

Things to Ponder

In The TRADE News’ “Electronic bonds platform nears completion” Richard Henderson reports that “An industry initiative to create an electronic bond trading platform led by Deutsche Bank and supported by key buy and sell-side firms may take shape as early as October… the platform would begin in Europe, but will aim to become a global fixed income trading platform”. (Hopefully if it really gets rolled out in North America as well, it will make bond trading less opaque.)

The Economist’s  Buttonwood in “The most fatuous regulation” compares his 4-page annual tax return to Her Majesty’s Revenue and Customs with his American expat spouse’s “forest-worth of paperwork” including the balance on her London transport electronic ticket balance. After reminding readers that the American Revolution started as a tax revolt, Buttonwood concludes that the IRS is a “mindless bureaucracy, pure and simple”. And by the way in InvestmentNews’ “Is renouncing U.S. citizenship financially favorable?” Liz Skinner writes that “some Americans are giving up their U.S. citizenship to save on taxes. But many more just want to be relieved of the paperwork aggravation that holding on to their U.S. passport demands…(but) the new exit tax rules make it such that you are effectively taxed on your (global) estate at the time you give up citizenship…(i.e.) framed to discourage citizens from giving up their citizenship for financial reasons” Robert Keats observes that the restrictions that come with giving up U.S. citizenship are so onerous that once understood lead to few abandoning the mother ship for financial reasons alone. (Perhaps that explains while even though the number of people giving  up their US citizenship is up dramatically to 1,800, that is still just 1,800 of 6 million expats still holding on to their citizenship.)

In the Financial Times’ “The CAPE of less hope” John Authers looks at Robert Shiller’s Cyclically Adjusted price/Earnings multiple which according to a new Merrill Lynch report is the only one out of 15 valuation metrics which indicate that U.S. stocks are expensive (but not dangerously so). Critics argue that the problem with CAPE is that the past 10 years includes an unprecedented period of real earnings fall since 1871. Shiller argues that earnings have increased so much that they may be unsustainable. Still he notes the current CAPE of 23.8 “suggests that CAPE at this level is consistent with average real returns over the next decade of about 3 per cent” (nothing to sneeze at in the current environment).

And finally, in the Financial Times’  “America’s doctors, like Wall Street, need a cultural shift” Gillian Tett argues that the American “’eat what you treat’ system can tempt doctors to offer excessive treatment”. US doctors’ compensation is 60% higher than industrialized world average, with 2/3 being paid on a fee-for service basis rather than practices elsewhere of base salary (plus private practice income) and capitation. Tett notes that “it can create cultural patterns not dissimilar from those seen on parts of Wall Street: just as an “eat what you kill” bonus system has encouraged financiers to do unnecessary deals and trades, an “eat what you treat” medical system can tempt doctors to offer excessive, duplicate treatments”. (She does not mention the higher liability insurance costs as drivers of doctors’ compensation. However she is still correct that the context will to a large degree determine human behaviour. So ideally, you’d want to create the compensation context to drive the best outcomes for the least cost.)