Contents: Prescribed rates, equity-indexed annuities? what do P/E ratios mean? Palm Beach County home prices up YoY but down QoQ, South Florida 43^rd in home price increase from through, second home ownership declining and discriminatory property tax practices spreading, coastal flooding risk mitigation required in Miami/Tampa/Vancouver, Canada’s large pension plans struggle, 60% of Ontarians without workplace pensions, Swedroe: other risk measures, Siegel: CAPE is pessimistic, active management of equity portfolios a bust but bonds may be different.

Personal Finance and Investments

In the Globe and Mail’s “Taxes: What the prescribed rate is and why matters and how you can save on tax” Tom Cestnick writes that the “Prescribed rate” is 1% until October 1 when it will rise to 2%. This is calculated by Revenue Canada as the “average 90-day Government of Canada T-bill for the first month of the prior quarter”. If you make loans to your spouse or under 18 children and charge the prescribed rate (which s counted as income to you), then income resulting from that loan will be considered as their income for tax purposes. If you make a loan at the current historically low rate of 1%, that rate will stay in effect for the duration of the loan.

In the WSJ’s “Fixed indexed annuities merit caution” Leslie Scism writes that fixed annuities have a tax-deferred interest component while (equity-) indexed annuities “link annual interest to a stock-market benchmark”; buyers are protected against market losses but upside is capped and typically dividends are excluded from the payout calculation. Critics warned that these are: “juiced up bank CDs”, some insurers didn’t specify a priori that penalty fees will apply for withdrawals “even a decade after purchase”, guaranteed minimum income levels can be purchased for extra annual fees, and most disconcertingly hedge funds are moving into this market buying up annuity sellers which might lead to increased risk of bankruptcy given the buyers’ high return expectations.

In the WSJ’s “Price-earnings ratios aren’t always what they seem” Mark Hulbert explains why “P/E calculations based on differing views of earnings paint competing pictures of the market”. The price of securities is known precisely at any moment of time but earning are in the eyes of the beholder or perhaps it depends on what point one is trying to make. Earning can be based on future earnings estimates or trailing 12-months earnings and the results are dramatically different. The article notes that both P/Es are about 25% higher than the 1871-2013 median respective P/Es. And typically “forward-looking P/Es are about 24% lower than those based on trailing earnings”. (If interested in the topic you might also want to read my short blog on the subject “P/E ratio– it can be confusing and misleading”)

Real Estate

In the Sun Sentinel’s “July home prices rise, but market may be cooling” Paul Owers reports that according realtors association median home prices for Palm Beach County for July are $249,000 which is 15% higher than year ago but “Despite the annual increase, the median actually has declined each of the past three months after climbing to $265,000 in April — a possible sign that the once-blistering market is settling down.”

In the Palm Beach Post’s “South Florida ranks mediocre for housing recovery compared nationwide” Kim Miller writes that South Florida came 43^rd place rank among highest increase in house prices from the through. “South Florida had a 7.6 percent unemployment rate and 43 percent of homes underwater. Distressed home sales made up 43 percent of purchases, although foreclosures were down 57 percent. Home prices were up 40 percent from the bottom, while cash sales made up 64 percent of the market.” (Some really strange numbers in the table included in the article.)

In the Financial Times’ “The second home curse is overblown” Emma Jacobs discusses second homes in UK and France and notes that higher tax regimes are being contemplated on overseas homeowners since “Second-home owners are the scourge of country life. Gastropubs, boutiques and delicatessens catering to fickle metropolitan tastes, it seems, are a poor replacement for affordable housing and a vibrant community. The ungrateful wretches.” But they may not have to worry, as the article notes “second-home owners find it increasingly hard to justify the luxury…in the past two years there has been a decrease in the number of buyers and increase in sellers.”

In the Globe and Mail’s “Vancouver near top cities threatened by rising sea levels” Dene Moore reports that according to a new report  in a few decades annual cost of coastal flooding (partly due to rising sea levels, but also due to “increased intensity and frequency  of storms”) may be $1T/year and Vancouver is one of the high risk cities and that mitigation planning must start now. “The list of 20 cities most at risk, based on average annual losses due to floods, is topped by Guangzhou, Miami, New York, New Orleans, Mumbai, Nagoya, Tampa-St. Petersburg, Boston, Shenzen, Osaka-Kobe and Vancouver.” (As usual, Florida is asleep at the wheel.)

Pensions and Retirement Income

In the Financial Post’s “Your pension: Is now the time to take the cash instead?” Ted Rechtshaffen suggests that given the current historic low interest rate environment serious consideration should be given to taking the cash (commuted) value of the pension and perhaps in a few years, when interest rates are higher (and you are older) you can still but the same income stream at a much lower cost. He mentions six factors to consider: expected personal longevity (impact of health, family history), required return rate to outperform the pension factoring in life expectancy (if breakeven >5% pension is likely better), employer/sponsor health (will they be around to pay when you are an old pensioner?), how important is cash-flow flexibility to you, do you want to leave an estate, tax implications (not entire cash value can be sheltered in a LIRA/RRIF/RRSP). Rechtshaffen concludes with “The bottom line is that the pension decision is among the most important financial choices you will ever make. Take the time and get the information you need to make the right decision for you and your family.” (He is right. This will be a tough decision for many Nortel pensioners when windup will occur likely next year.)

In the Globe and Mail’s “Pension funds struggle to beat their benchmarks” Tim Kiladze reports that Canada’s huge pension plans are having difficulties to meet their targets, but both CPP and Caisse de Depot et Placement du Quebec argue that the focus should be on the multi-decade potential rather than quarterly returns. (Time will tell whether the active pension fund management can beat the markets, and more importantly achieve the targets necessary to cover real pension liabilities.)

In Benefit Canada’s “Do Ontarians have enough to live on in retirement?” Helen Fetterly writes that according to a recent survey of Ontarians which indicates that: 64% are worried about inadequate income in retirement, 82% of those with DB and 57% of those with DC plans are confident that they’ll have sufficient assets to retire on, and” 60% have no workplace coverage at all”. (Pretty sick for a country like Canada, and pension reform continues to recede on the horizon.)

Things to Ponder

In IndexUniverse’s “Beyond volatility as risk metric” Larry Swedroe discusses risk measures and notes that “volatility risk hasn’t been rewarded- the highest volatility stocks produce the lowest returns”. But investors care about other types of risk as well: timing of risk (stocks with relatively poor performance during “bad times”), adverse distribution of returns relative to normal distribution (e.g. fat tails) and “black swans”; these must all be compensated for with appropriate risk premiums. “The bottom line is that if you have the stomach for the occasional large loss and the discipline to stay the course, you can earn above-market returns. Unfortunately for most investors, that’s easier said than done.” Or do as Buffett suggests is “buy when there is blood on the street”, which can best be executed if you “have a well-developed plan that doesn’t take more risk than you have the ability, willingness or need to take, and rebalance as required”.

Larry Siegel in the Financial Times’ “Don’t put faith in CAPE crusaders” argues that “The (Shiller CAPE) ratio’s pessimistic predictions are based on biased data”. The biased earnings data is as a result of: 1990s accounting changes requiring “companies to charge large write-off when assets they hold fall in price”, false assumption that currently higher than historical profit margins are unsustainable (however the higher numbers are a result of higher proportion of foreign profits with lower tax rates, and higher proportion of technology stock in the index), companies have locked in the current low interest rates for a long time and it is even possible to have an expansion of P/E ratios in the future if inflation and interest rates stay low.

And finally, in IndexUniverse’s  “Star stock pickers are harder than ever to find” Cinthia Murphy writes that that active management appears largely ineffective in equities though active managers continue to play an important role of creating the “market mechanism that allows long-term investors to profit from the foolishness” of traders. Active bond fund management appears to offer more promise because bonds are less standardized and more opaque in general.