Contents: Sustainable spending strategies, you own the stock or the stock owns you? investing in your health, with higher interest rates it’s time for annuities? Swedroe: absolute return=rip-off, timing of retiree downsizing? U.S. property ‘deals’ for Canadian snowbirds-Not, U.S. home prices strong but volumes slow, 401(k) with feedback, autopilot 401(k) outcomes improved but still inadequate, myRA better than nothing but not much, ‘coco’ bond risk understated, Kay: “the rich stay rich while the poor struggle”

Personal Finance and Investments

In the Financial Post’s “How to practice ‘sustainable spending’ in retirement so you don’t run out of money” David Pett discusses three withdrawal strategies in retirement: dollar amount adjusted annually for inflation (when spend rate is modest say 1% and portfolio growth is desired), fixed percentage of ongoing assets (appropriate when legacy is desired), and a hybrid- a modification of the fixed percentage but with a floor and a ceiling (if portfolio is modest relative to spending needs) which is recommended as the preferred strategy for most common scenarios. (For those interested in looking at some of the trade-offs between decumulation strategies you could peruse my “Vanguard GLWB vs. other decumulation strategies” blog post.)

In WSJ MoneyBeat’s “When a giant gain causes pain” Jason Zweig writes that ”If you have a small stake in a company, you own the stock. But if that stake suddenly grows enormous, the stock owns you.” Finance professor Meir Statman points to ‘regret’ as driving behaviour of people in such a situation; “So you need to figure out which will bother you more: selling the stock and then watching it go up even more, or not selling and then watching it go down.” To manage regret Zweig suggests that you might “consider selling, say, 20% in five equal installments at regular intervals.”

In the Globe and Mail’s “Retirement delayed: Build wealth by investing in your health” Rob Carrick discusses the importance of investing in your health and not thinking about that gym membership or pair of running shoes as an expense. He quotes a doctor’s rules for “retaining the flexibility to work longer” which include being “proactive about your health” and remembering that “disease is unpredictable”. So expecting to work well past age 65 is not a retirement plan which replaces saving for retirement. The article includes recommendations for health maintenance: exercise, weight control, hobbies, fruits/veggies and remembering to book that checkup with your doctor.

In the Financial Post’s “Annuities are looking cheaper, but are they cheap enough” Fred Vettese writes that with the increase in long-term interest rates, annuities in Canada have become about 7.5% cheaper since September 2012, and he notes that with each 1% increase in long-term rates there is about a 10% increase in annuity payouts. So he argues that “if your monies are invested in bonds right now, then you may as well not wait” because any increase in annuity payout as a result of interest rate increase will likely be offset by a reduction in the value of bonds held, and will end up with same annuity payout; furthermore if you wait you run the risk that “insurance companies may reassess their longevity risk” and of course rising interest rates are not guaranteed, especially if we get into a deflationary period. (There is at least one other factor that is worth considering in making the annuity decision, which is your age! As Mr. Vettese notes insurance companies calculate how much they pay you in an annuity by looking at your life expectancy, their expected returns and then make reductions for their expenses, profits and broker commissions. So unless the mortality credits (excess returns earned from those who die prematurely) exceed the expenses/profits/commissions which typically won’t be the case until sometime after age >75, holding bonds at age <75 may not be as bleak. Furthermore, annuities (like an all bond portfolio) expose younger retirees to corrosive effects of inflation, so you are just trading off longevity risk for inflation risk. Therefore those under 75, at least, might want to sharpen their pencils before they go whole hog into annuities.)

In ETF.com’s (new name for IndexUniverse) “The absolute return rip-off” Larry Swedroe writes that “The bottom line is that no one should invest in absolute-return vehicles, because they aren’t absolute-return vehicles, but relative return vehicles. They are just another way Wall Street has found to transfer money from your wallet to its.”

Real Estate

In the WSJ’s “When should retirees downsize homes?” Tom Lauricella reminds readers that “For most people, their house is their biggest asset. It’s also their biggest expense. But when it comes to retirement planning, a house often falls to the bottom of the list involving changes in later life… But for many retirees, it can pay to downsize sooner rather than later.” Lauricella makes a compelling argument that the “house discussion” needs to be front and center in retirement planning discussions. Owning a house might appear cheaper because rental makes costs explicit but ownership costs can be both volatile and leave some costs invisible (for a while). Moving also gets harder with age. Downsizing and/or renting also frees up capital to enhance retirement income. (I suspect the message is that if the house asset is expected to be needed for retirement income, selling it sooner is better than later.)

In the Globe and Mail’s “Can snowbirds still find a property deal in the U.S.” Shelley White explores the draw experienced by Canadians to snowbird living in southern U.S. destinations. She notes that according to the NAR in the year ending in March 2013 “Canadians have accounted for 23% of the $62B foreign real estate purchases in the US… Florida garnered 39 per cent of Canadian purchases, followed by Arizona with 24 per cent and 8 per cent in California.” The article explores whether with (about 20+%) increase in U.S. real estate prices in the past two years, combined with the (about 10%) drop in the Canadian dollar in the last couple of months, “prospective snowbirds are wondering: Can I still find a deal?” Various conflicting expert opinions are quoted, including the recommendation that you should rent first in and near where you are considering to buy. (But if you are looking for a “deal” I suggest you explore seasonal renting instead of buying, especially in Florida. From personal experience in Florida for well over a decade the cost of ownership is significantly higher than the cost to rent the same property, once you factor in property taxes (non-homesteaders’ rates in Florida), condo fees, insurance costs, assessments, not even counting the loss of the puny after-tax income that you could have earned on the funds that you have sunk into buying the property (if you borrowed it’s even worse). This was true even in years when property taxes were the lowest and there were no assessments. So if you are looking for a ‘deal’, then rent; the only rewards that come to snowbird property owners are psychic ones.)  If you are still determined to buy you should also read Shelley White’s “Five things to consider before buying snowbird property in the U.S.”

The November 2013 S&P Case Shiller Home Price Indices showed healthy YoY increases of 13.8%, composites declined -0.1% MoM but were still up +0.9% on a seasonally adjusted basis. “Average house prices were now back to mid-2004 levels… the peak-to-current decline for both Composites is approximately 20%. The recovery from the March 2012 lows is 23.0% and 23.7% for the 10-City and 20-City Composites.” The Sunbelt cities were up with Miami +1.4%, Tampa +0.2%, Phoenix +0.3% and Las Vegas +0.6% MoM; on a YoY basis the first three were up about 16% while Las Vegas 27%.

The WSJ’s Timiraos and Hudson in “U.S. housing market hits headwinds” indicates that existing  home sales contracts fell during December 8.7% and housing construction declined in Q4, likely due to the 24% increase in home prices from recent bottom and 1% increase in mortgage rates to 4.5%.

Pensions and Retirement Income

In WSJ’s “How to fine-tune your 401(k)” Kelly Greene discusses the much overdue topic in retirement plans: feedback! Greene notes that despite what appears as massive asset accumulation in retirement plans, “many workers are at risk of being unable to replace a substantial portion of their preretirement income”. Feedback is finally here in 401(k)s in the form of: estimates on how much they’ll need to retire, recommended savings rates to achieve certain income replacement rates, how much others save in similar age groups, encouragement to save more (auto-enrolment and auto-increase in contributions). Employer sponsored retirement finance education programs are being offered which also cover not just savings, but also cost-effective investment, and understanding current and retirement expenses. Hopefully the advice comes from fiduciaries who are required to act in employees’ best interest. (This is a good overview article; and especially great to see growing use of feedback to help achieve retirement objectives.)

Amin Rajan in the Financial Times’ “Retiring on autopilot can lead to hard landing” addressing the same subject of retirement plans increasingly being the responsibility of the individual, opines that encouragement to “work longer, save earlier, save more and spend less- and leave the rest to “nudge economics”… helps but it is not enough”. The automatic enrolment with life-cycle fund defaults have helped, but the ideal model envisaged of having the “employee as a planner…is at odds with reality”. Rajan notes that individuals don’t adjust their asset allocation with changing circumstances, don’t have the proper understanding of retirement planning and investments, are prisoners of their inertia (for good and bad), and while enrolment is up they save only 6-8% rather than 17% likely needed. He recommends an approach that involves four stakeholders: asset managers (better life-cycle funds), plan members (more financial literacy, higher savings rates), plan sponsors (improved autopilot features, educational offerings) and financial advisers (goal based financial plan, regular reviews and mid-term corrections, and risk management of contingencies).

In Bloomberg’s “The ‘mirage of success’ shimmering in your 401(k)” Ben Steverman reports on a new player HelloWallet (joining others in this space like Wealthfront, LearnVest, Betterment and Personal Capital) in the online financial advice space. Calling itself a “financial wellness service,” HelloWallet will become an option for the almost 4,000 defined-contribution retirement plans that Vanguard runs, potentially making its tools available to 3.5 million workers. The article notes that people need a lot more advice than they are getting and includes some interesting observations: even as the 401(k) balances grow “64% of plan participants are accumulating debt faster than they are accumulating savings” and the while advertising focus is on returns, for half of the 401(k) marketplace 96% of their balance is a function of their contributions and employer matches”. (those are eye opening stats.)

In the WSJ’ “Obama signs order for retirement accounts” Tergesen and McCain Nelson report that new Roth IRA-like myRA investment vehicles will help workers who don’t have access to traditional retirement accounts save for retirement. Contributions will be voluntary, using after-tax dollars, sensible for younger/lower-income workers, “investment gains and withdrawals are tax-free”, only investment option available will be variable interest rate Treasury bonds, accessible via payroll deduction and will be required to be rolled into an IRA when $15,000 is accumulated. But the Bloomberg editorial “ MyRAs won’t fix a broken retirement system” opines that this will do little to get more low earners save but might help spur the “the discussion about how to fix a broken retirement system”. (Nearly a decade old intensive talk about imminent pension reform in Canada has done nothing to move pension reform forward; perhaps Americans are more effective at following up talk with action.)

Things to Ponder

Given this interest rate starved world, I can’t resist including the Financial Times article entitled “Investors sound warning on ‘coco’ bonds” in which Christopher Thompson discuses “coco” bonds (which are also called reverse or contingent convertibles , because under some specified conditions your bond can become a prescribed number of shares in the issuing bank.) With coco bond interest rates of 7-8% on investment grade European banks compared low single-digits for similar banks, these can be very enticing; but investors should consider themselves warned that these bonds can act more like equities under certain circumstances. While 7-8% sounds very attractive but the risk associated with them is misunderstood; e.g. “coupon deferral is either at management or regulator’s discretion” as they are designed to “ensure bank creditors absorb some losses and avoid the need for taxpayer bailout”.

And finally in the Financial Times’ “The world’s rich stay rich while the poor struggle to prosper” a cranky John Kay writes a Dear Bill Gates letter in which he explains why (what he interprets as) Mr. Gates’s criticism of his book The Truth about Markets: Why Some Nations Are Rich But Most Remain Poor is wrong. Kay explains his use of 2001 measures of country wealth (market value per capita output and average consumption of inhabitants) based on which the countries of the world show a U-shaped distribution with 20 rich countries, very few in-between countries usually on the way to joining the rich, but even countries with incredible growth like China and India “are still desperately poor countries by the standards set by Switzerland and Norway”. Due to globalization “the centers of major cities now appear similar” but Kay notes that “you do not have to venture far (from Nairobi, Shanghai or Mumbai)…to see sights unimaginable in Norway or Switzerland”. Mr. Kay argues that Bill gates used inappropriately the “distribution of household incomes across the world” rather than “distribution of average incomes across states” as a measure. And beyond the major cities little has changed in the past 10-years because of the failure to establish or operate effectively the necessary “economic and social institutions” which allow countries to “operate near the technological frontier”. (Specific arguments aside, I’d venture to guess that the poorest quartile in the world is better off than a decade ago, but perhaps not by as much as that would have been possible by the superior institutions envisioned by Kay.)