Hot Off the Web- March 10, 2014

Contents: retirement savings first, bank falls for scam, non-financial retirement risks, adviser questions, undisclosed stockbroker red flags, hidden camera shows advisers “lying or incompetent”, “easy money” is attraction to active investing, Milken: health and education better investments than housing, Toronto home sales and prices up again, income replacement percentage inappropriate for estimating retirement expenses, CPP cap hike simple and effective, dividend stock myths, 5-years of almost 0% interest and likely to continue? “smart beta” is all marketing and adds to your cost and risk, leveraged ETFs for retirees? life insurance as an investment? emerging markets ready to emerge again?

Personal Finance and Investments

In the NYT’s “Save for retirement first, the children’s education second” Ann Carrns discusses why “financial planners advise that if funds are limited — and for most people, they are — it is crucial to fund retirement first before contributing to an education fund… shortchanging yourself now to help pay for college can backfire. You may simply be increasing the likelihood that your children will have to support you later in life.”

In CBC.ca’s “BMO customer’s account emptied of $87K as bank falls for scam” Kathy Tomlinson reports that a BMO customer has been reimbursed after the “bank wired $87,555 of his inheritance money into the hands of a scammer”. The article suggests that the bank’s existing procedures were either inadequate or were not followed. (There is always a trade-off between security and convenience, but that call must be made by the bank, so long as the customer is made whole.)

In a WSJ interview “Beware of the non-financial risks of retirement’ Veronica Dagher interviews Dr. Bob Pokorski who identifies a long list of non-financial retirement risks (though each having financial consequences as well) that advisers should address in discussion with their clients. Many of the shocks can start even pre-retirement, such as: health issues, job loss, loss of spouse (death/divorce), taking care of adult parents and/or children moving back home, and sandwich generation responsibilities. Additional post-retirement shocks might include: health expenditures much higher than anticipated, longevity risk and chronic illness. The good news according to Pokorski is that despite fears of ending up in nursing homes, much of the care will likely be provided by families at home.

In ETF.com’s “11 questions to ask a potential advisor” Cinthia Murphy list question when looking for an adviser such as: (starting with the most important one) Will you manage all my assets as a fiduciary? What is your fee structure?  What is your personal compensation structure/incentives? Do you provide Investment Policy Statements for all clients? Do you provide written asset allocation and explain how that was arrived at? Rebalancing strategy? What action you took for clients in 2008/9? Can you share your personal IPS including asset allocation and investments?  

In WSJ’s “Stockbrokers fail to disclose red flags” Eaglesham and Barry report on an investigation following looses resulting in dealing with broker with an unreported history of “a bankruptcy, a tax lien, a court judgement for unpaid debt and a criminal guilty plea relating to a false report to law enforcement”. FINRA the industry’s self-regulator’s “BrokerCheck” website intended to disclose brokers’ professional history also require disclosure of “bankruptcies and criminal charges”, show no indication of a history of malfeasance for this broker. In fact upon further investigation by WSJ, by comparing databases containing 500,000 brokers against criminal and bankruptcy-court filings, the Journal found 1500 unreported bankruptcies from 2004 to 2012, and 150 with criminal charges. Statistics also showed that brokers with bankruptcy filings ended up with about 50% higher regulatory actions, terminations, criminal charges and customer complaints than average broker. Some of FINRA’s excuses are discussed in “Finra’s BrokerCheck comes under fire” including “carefully considering the balance between what investors need to know and what could be seen as a violation of advisers’ right to privacy”. (This clearly reinforces the need for tighter regulations administered by an independent agency, rather than an SRO. Financial industry self-regulation cannot and does not work.)

CBC’s “Hidden camera investigation uncovers ‘atrocious’ advice” aired last week on CBC Marketplace’s “Show me the money” (17 minutes segment) shows the result of hidden camera interaction with advisers at some of Canada’s banks and Investors Group, Dundee Wealth, Primerica and Edward Jones. Topics discussed raged from debt repayment vs. investing, borrowing to invest, risk, expected returns, fees/trailers, to educational requirements to become an advisor in Canada. The CBC called it atrocious advice; Banerjee commenting on CBC adviser interactions suggested that some of the advisers were “incompetent or lying”. (Isn’t it time to clean up the Canadian “advice” business by requiring fiduciary standard and minimum financial education/training requirements? It is long overdue, but powerful financial industry forces are at work making sure that government/regulators won’t rush into action.)

In the Financial Times’ “Belief in easy money boosts active funds” Pauline Skypala writes that “fear and greed narrative that seems to guide much investment thought and action and leads people to suspend disbelief in the hopes of getting rich quick.” She argues further that despite all the contrary evidence, the “easy money” story which “lies at the root of the strong preference for an active approach to investment management over a passive one displayed by most investors” continues to capture the imagination of retail and institutional investors. (This continues to be the ultimate triumph of hope over reality.)

 

Real Estate

In WSJ’s “Housing policy hurts the middle class” Michael Milken argues incentives created by the US government (mis)led  Americans “to think of homes as investments, not just shelter” to the point that “median net worth (presumably excluding housing) of American adults ($45,000) is now one of the lowest among developed nations (Australia $220K, France $142K, Greece $54K)” .The subsidized mortgages led to: “the largest housing price bubble in American history”, “Misguided economic priorities” and “damage to the environment and public health”. Milken concludes with his view that “Investments in quality education and improved health will do more to accelerate economic growth than excessive housing incentives”.

In the Globe and Mail’s “Toronto home-sales gains bolster view of resilient Canadian market” Tara Perkins reports that Toronto area home sales during February were up 2.1% compared to previous year and average prices were up 8.6% or 7.3% using a more apples-to-apples comparison. The article also notes that Pimco warned (see also “Pimco takes more bearish stance on Canada”) that it expects Canadian prices to drop “10-20% in real terms over next 3-5 years”, primarily driven by expected (?) rise in mortgage rates; Deutsche bank opines that “Canadian home prices are 60 per cent too high, and declared that it believes Canada is the most overvalued housing market in the world”. However in the Globe and Mail’s  “Here’s the problem with Pimco’s negative view of Canadian property” Brian Milner writes that “going by Pimco’s recent track record, it’s not something I would take to the bank.” But then Milner also notes that assorted other prognosticators like Nouriel Roubini and Mavid Madani also view Canada’s housing market as a bubble. (Then of course, as the old saying goes- forecasting is difficult especially about the future.)

By the way according to the Financial Post’s “North America’s top 20 housing markets: Vancouver, Toronto, Calgary among most expensive on continent” Vancouver, Toronto and Calgary are numbers 1, 4 and 6 respectively (though ranking based on U.S. median and Canadian average prices).

 

Pensions and Retirement Income

In CNNMoney’s “You’ll spend less as you age” Rosato and Wang report that retirement readiness may not be as dire for Americans as many suggest because: the 70-80% pre-retirement rule of thumb may be 20% too high, income replacement target is a function of income with 85% needed by those making $40K and 60% by those making $100K, retirees’ spending does not increase with inflation as they age. The article (sensibly) suggests that instead of worrying about an income replacement rate, a better approach is to actually look at the expected expenses in retirement separating musts from wants. (This is not new, but it still worth retelling: replacement rates are largely irrelevant, specific spending expectations based on pre-retirement spending adjusted for changes like expenses discontinued (e.g. retirement saving) and new expenses started (travel and/or condo for snowbirding, and higher healthcare expenses no longer covered by employer) are the way to understand retirement needs; and expenses for many can be higher in retirement that pre-retirement.)         

In the Globe and Mail’s “CPP cap hike would help retirees most” Janet McFarland reports on a new study which argues that “A simple reform to increase the cap on Canada Pension Plan contributions would lead to results that are almost identical to more complex reform proposals being touted by some provinces… The report concludes it is difficult to use CPP as a tool to increase retirement income for lower-wage earners, but says CPP reform is more effective for those earning more than $50,000 a year.”

Things to Ponder

In U.S. News-Money’s “7 myths about dividend-paying stocks” Dan Solin discusses the “misconception among investors may be the value of investing in dividend-paying stocks” by listing myths such as: “dividends hold up in bad markets”, “dividend paying stocks outperform the market”, “dividend paying stocks provide adequate diversification”, “dividend paying stocks are a substitute for bonds”, and others. In summary: dividend paying stocks are stocks so they are riskier than short-term bonds, to increase returns it’s better to increase allocation to stocks because the bond allocation is there to reduce volatility, if market tanks all stocks will likely be affected and dividends will likely be reduced/eliminated.

In the Financial Times’ “Five years at 0.5 percent” Jonathan Eley looks at the impact of five years of low rates and QE. He declares government as winners for forcing a low interest environment allowing them to finance cheaply their massive debts, and mortgage borrowers are benefiting greatly. He declares “older people” as losers for 400,000 people in the UK annually having locked in their savings into annuities at historically low rates and other retirees having to live with 1-2% interest on guaranteed investments. He also suggests that governments having appointed central bankers favorable to low rates might mean that these low rates might become “semi-permanent”. In the Economist’s “Five years on” Buttonwood also reflects upon the historic low rates over the last five years and he also argues that it’s all about the government debt burden which needs near-zero rates to keep it serviceable. (i.e. this is all about wealth transfer from creditors to debtors.)

In Bloomberg’s “Smart Beta ETFs beating S&P 500 index capture record cash” Alexis Xydias that S&P beating “smart beta” returns have drawn $43B last year for a total of $156B currently. But Rick Ferri calls smart beta a marketing tactic and that the only this you’re guaranteed to get is higher costs and more risk. In reality “smart beta” is just value and small/medium cap tilt; so if that’s what you want why pay the high cost of “smart beta” when you can buy a value and small/medium cap capitalization indices. In ETF.com’s “The extra risk of equal weighting” Ferri illustrates the problem with equally weighted funds of unequal capitalization and concludes this is a search for the “free lunch” and writes that “The frenzy around so-called Smart Beta strategies sometimes leads to the idea that everyone can outperform the market by using alternative weighting strategies. It’s just not true. The laws of economics cannot be overturned. Investors earn a market return less cost. Everything else is marketing.”

In WSJ’s “Leveraged ETFs for retirees?” Anna Prior reports on a Financial Engines research paper by Watson and Scott in which they explore the benefits of a portfolio with an 85% allocation to TIPS and 15% to triple-leveraged ETFs. (This sounds similar to the Zvi Bodie proposal some years ago with high TIPS allocation (90%) but using long term call options (LEAPS) to leverage the relatively smaller (10%) risky portion of the portfolio.) The article notes that when the market trajectory is mostly upward this works well, but the problem with leveraged ETFs is that over longer periods of time  they don’t necessarily perform in the same way as the leveraged multiple of the benchmark they track when there is significant volatility associated with the benchmark. The authors are still researching the approach. (I have to think about this some more, and perhaps wait to hear more about the progress of this work before I’d be ready to seriously consider.)

In the Journal of Financial Planning’s “Analyzing the Value of Life Insurance as an Investment” Jordan Smith writes that if you: are prepared to forgo the access to your premium dollars for life (lock in for life), you believe that you can continue paying the premium indefinitely (which you must to preserve death benefit), NLG (n lapse guarantee policy purchased exclusively for the death benefit) policy has typically zero cash value (i.e. zero liquidity), and you are not worried about the life insurance company going bankrupt then according to the illustration in this paper you have an opportunity to beat a an alternate investment with a pre-tax return of 6%/year and blended 28% state/federal tax rate until the crossover point (or “the point where alternate investment is projected to exceed the policy’s death benefits”) which occurs a couple of years after life expectancy. (This might sound good, but I am not convinced given the lapse rate that typically occurs over a 40 year period that one would be expected to continue paying the premium; or if we are looking to a 40+ year period you might consider investing at least the first 30 years 100% in stocks which would likely lead to a significantly higher return. If you need the life insurance you might consider this as one of the options; if you don’t, then focus on your investment options which will likely have equal or better outcomes without all the restrictions/risks that come with such a policy.)

And finally, in the WSJ MoneyBeat’s “Emerging markets look appetizing…again” Jason Zweig notes that according to recent research considering decades of data, emerging markets have not out-performed developed ones, but due to much higher volatility they have “tended to do stunningly well over shorter periods when investors neglected or rejected them”. Listing the four stages that ideas pass through: “worthless nonsense”, “interesting”, “true, but quite unimportant”, and “I always said so”, Zweig wonders if emerging markets which were in “I always said so” phase in 2012 are now approaching the “worthless nonsense” phase, and therefore it might be time to “get seriously interested”.

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