Contents: Lower return expectations, Buffett to wife: use cheap and passive, free automated portfolio management, advisers enhance returns by up to 3%, passive beats active, testamentary trusts still useful, new tracking at border-crossings requires snowbird vigilance, Canadian home prices at record level but no bubble? U.S. wealth at record $80T but only $10T in IRA/401(k), apartments at 31% of U.S. housing starts, U.S. housing still affordable on average but not for entry-level buyers, ‘zombie’ homes haunt Florida real estate market, middle income retirees short-changed in uncompetitive UK annuity market-alternative decumulation strategies needed, principal-agent problems with asymmetric incentives, ‘smart-beta’ dangers, target-date glidepaths not the best, Bunds the new risk-free rate? “the map is not the territory”, dividend investing is not what it’s cracked up to be, Buffett’s genius explained, bubbles a consequence of institutionalization of markets, Klarman: timing of market drop from bubble territory unknown but coming, career opportunities result from aging population.
Personal Finance and Investments
In the WSJ’s “How safe are your investments, really?” Brett Arends discusses realistic investment expectations ( driven by lower interest rates, lower dividend yields, and higher current valuations) in an article that also includes an interesting chart of the real returns over (rolling?) 10-year periods since 1928 which indicates the best, median and worst periods returns to have been 218% (1988-1998), 63%, and -25% (1971-1981), respectively.
In the Financial Times’ “Warren Buffett tells wife: go cheap and passive” Chris Flood reports Buffett’s instructions to wife in will is 10% short-term government bond fund and 90% very low cost S&P 500 index fund. He then added that “long-term results from this policy would be superior to those attained by most investors, whether pension funds, institutions or individuals that employed high-fee managers”. A little more detail is available in “Buffett to heirs: Put my estate in index funds” to minimize frictional costs. (Thanks to AR for referring.) (Just remember, while these two portfolio components might work for many other American investors, the specific allocation to equities is a function of your risk tolerance, bounded at one end by how small a percentage of assets you need to draw per year to meet your retirement expenses (Mrs. Buffett<1%?) and at the other end what’s the highest stock allocation that you can tolerate even if there is a 40%-50% market drop so you can continue to safely draw each year enough (perhaps 4%-10% depending on your age) to meet your needs (given potential portfolio volatility and drawdown) yet still make sure that your assets last as long as you do and the income you draw meets your needs .)
Jason Zweig in the WSJ’s “The incredible shrinking management fee” discusses the trend to automated portfolio management and an example of a new one, WiseBanyan, which does it (build portfolios from ETFs) for free with the expectation “to make money by charging fees for additional services”. Zweig asks if “if money can be managed this cheaply, am I getting my money’s worth from my financial adviser?” He indicates that the ’advice’ might cost an average of 1% of assets, and in fact many don’t even give advice but just are “itching to beat the market” by selecting individual stocks and/or trying to time the market. Some individual financial advisers started charging a flat fee for advice $4500 and $7500 in his examples for planning and portfolio management independent of portfolio size. This is reasonable for a $1M portfolio but might be “prohibitive for clients with smaller balances”. Other online providers mentioned like Wealthfront and Betterment charge 0.25% and 0.15%, respectively. In fact, in InvestmentNews’ “Where young boomers prospects are going for advice” Joyce Hanson reports that traditional brokerages face dual threat from discount brokerages and robo-advisers (e-RIAs). 50% of boomers 50-59 are self-directed investors compared to about 40% in other age groups. Now not just e-RIAs and discount brokers are using scalable technology to “reach underserved clients without enough investible assets to fit” in traditional brokers’ business models, but traditional brokers are starting to use as well.
In InvestmentNews’ “Advisers can add 3 percentage points to clients’ net return” Liz Skinner reports that in a Vanguard whitepaper ( Putting a value on your value: Quantifying Vanguard Advisor’s Alpha by Kinniry, Jaconetti, DiJoseph and Zilbering) they suggest that depending on individual circumstances, advisers may add value as behavioral coach (up to 1.5%), asset allocation strategy (up to 0.75%), cost effective investments (up to 0.45%), rebalancing (up to o.35%) and decumulation strategy (up to 0.7%). Vanguard notes that these adds shouldn’t be considered as annual but more as intermittent adds.
In the Globe and Mail’s “How do CIBC mutual funds stack up against its index funds?” Andrew Hallam’s message is that fund cost determines outcome and (even) CIBC’s own (expensive at about 0.4-1.2%) index funds outperform its (even more expensive) active funds, with some bond fund exceptions. (But the lesson should be that there are even cheaper index funds (at about 0.1%) than CIBC’s, so you should be buying those to get your fair share of the available market returns.)
In the Financial Post’s “Despite budget changes, testamentary trusts still useful” Jamie Golombek writes that even with the latest changes to testamentary trust (removing tax bracket advantages) there are still benefits which might justify them, such as: means to manage inheritance of minor, using it as a vehicle to receive a life insurance benefit, trustees can control timing and distributions to young (and/or irresponsible) beneficiaries and particularly useful in case of incapacitated beneficiaries, or as a way to specify that the income of some portion of the inheritance is to go to a surviving spouse during her lifetime by remainder to go to children upon spouses death.
In the Financial Post’s ”Border shakeup could have tax consequences for snowbirds” Julius Melnitzer reports that starting June 30, 2014 “Travellers will be required to swipe passports when they enter and when they depart each country. Canada and the U.S. will share information.” The consequences can be serious, including: loss of provincial healthcare for Canadians, Canadians could lose residency status requiring payment of exit tax, snowbirds staying too long in the U.S. could be deemed U.S. residents for tax purposes and be subject to tax on world income there”. (On the surface it makes no sense why the Americans would want to discourage Canadians from spending more time in the U.S., should they want, unless perhaps they might have concluded that they could collect a lot more in taxes from Canadians who stay past 6 months are deemed to be U.S. residents for tax purposes? In any case, Canadians snowbirding in the U.S. better pay attention and file their 8840s or else they’ll be liable for fines now that they’ll be tracked.)
The February 2014 Teranet-National Bank Composite House Price Index was up again 0.3% MoM and 5.0% YoY, to a new record. During the month of February, Vancouver and Victoria were up 0.9%, Montreal was up 0.7% Calgary was up 1.1% why Toronto was slightly off -0.1% and Ottawa was down -0.8%. For the year Vancouver was up 7.7%, Calgary 9.6%, Toronto 6.1%, Montreal 1.9% and Ottawa down -0.6%.
In the Globe and Mail’s “Why doomsayers are wrong about Canada’s housing market” Tara Perkins discusses how “a key measure, used by economists, underestimates the degree to which rents have been rising in the market. That inflates what is known as the price-to-rent ratio, feeding into fears that the market is overheated.” So while the housing market is definitely stretched due to the ultra-low mortgage rates, “the most bearish diagnoses of the market have been relying on flawed (price-to-rent ratios) uses of data”.
In Bloomberg’s “U.S. wealth hits record, typical savings plan is still ‘Buy a House’” Mark Gimein reports that U.S. household net worth is up $3T to $8oT, but you must look to the components of which about $20T is household real estate, $20T is pension entitlements; the pensions break down further to $10.6T (IRAs and 401(k)s), $3.1T private pension plans, $8.5T in government pension entitlements and the balance in life insurance. So the article notes that effectively only $10.6T (13%) of $80T household wealth is in IRAs and 401(k)s which are “the key instruments of middle class wealth accumulation”. Note that the $8.5T government pension entitlements cover just 14% of U.S. workers! The article also contains a troubling chart showing the “Median Net Worth of Households: 2000-2011” which shows an essentially unchanged picture over that period, in which “ (1) private sector workers save fairly little, and (2) the main way of accumulating wealth is to buy a house.” (Also not mentioned that if/when the baby boomers start cashing in their homes en mass, the prices they are to be getting will be under strong downward pressure as supply-demand picture changes.)
The WSJ’s “New-home building is shifting to apartments” reports that the “share of new homes being built as rental apartments is at the highest level in at least four decades”, with single homes dropping to about 69% from 87% in 1993 and 80% in 2007. Multifamily rental apartments now represent 31% of total housing starts. Part of the reason might be found in another WSJ article “Surging home prices are a double edged sword” which indicates that while U.S. home prices look fairly valued relative to incomes compared to historical average, “housing looks less affordable for many entry-level buyers”. Average monthly mortgage payment as a share of household income is25% for first-time buyers compared to average of 20% for other buyers.
In Palm Beach Post’s “Abandoned homes haunt Florida’s housing market” Kimberly Miller reports that “Florida’s real estate market remains haunted by decaying and abandoned properties even as new foreclosures slow and home values rise. There are 54,900 ‘zombie’ homes are foreclosed homes “lingering in the process for years, many of them vacant with neither homeowner nor lender taking responsibility for maintenance and upkeep”.
Pensions and Retirement Income
I plan to have a blog post in a few of days discussing two very different decumulation approaches for those of you who, like I, are junkies for decumulation strategy papers.
In the Financial Times’ “’Democratize drawdown’ says Nest” Josephine Cumbo discusses the available decumulation options in the UK to “savers on low to middle incomes”. The article notes that with serious questions about “the value of money offered by annuities…Nest (the national pension scheme) is exploring alternatives to annuities “such as income drawdown and multiple (phased) annuitization” usually only available to wealthy individuals. They note that that the typical “cliff-edge” purchase of a single-life annuity doesn’t feel right…” the article notes that there are 400,000 retirees each year in the UK and a better value must be found for them than delivered in the non-competitive annuity markets. Nest is looking for a low-cost decumulation option with some downside protection which would allow even retirees with small balances “to delay annuity purchase while keeping their funds invested”. (Notice the concerns: uncompetitive annuity markets, annuitizing too early, which create opportunity to develop some approaches for superior outcomes by the use of phased annuitization and low-cost decumulation strategies with some downside protection. Great ideas for those in search for pension reform in Canada; in fact it is something that Nortel pensioners who will have to make a lump-sum vs. annuity decision this year might also want to contemplate.)
Things to Ponder
In the Economist’s “Heads they win…” Buttonwood explains the principal-agent problem with asymmetric incentives, whereby the agent participates when there are gains, but pays nothing if there are losses. A roulette analogy does a great job explaining how the agent is incentivized to take more risk with the principal’s money; this was the case in 2008 with the bank bailouts where we had a “privatization of profits, and a nationalization of losses” and in hedge funds where managers take 20% of profits but do not participate in loses.
In ETF.com’s “The smart-beta trap” Dave Nadig looks at what can go wrong with “smart-beta” investments as “with every new invention comes new dangers”. He lists four potential dangers: false alpha (better mousetrap or just different/more risk?), crowding (people pile into things that seem too good to be true), tracking (to maintain cap weighting you have nothing to do but “smart” strategies require continuous adjustment), and trading (niche products don’t usually trade well: lower liquidity, higher spread).
In the Globe and Mail’s “The stock-bond mix: Conventional wisdom doesn’t necessarily apply” discusses a couple of new papers on best portfolio stock-bond glide-path during accumulation. In the first paper, Arnott, Sherrerd and Wu in “The glidepath illusion” argue that moving from stock-centric to bond-centric portfolio is not the best approach to achieve the objective to maximize real value of nest egg, while minimizing uncertainty around the prospective income” which can be derived from it in retirement; “rebalancing to a static mix beats gradual shift to bonds” (e.g. 50:50 stock:bond allocation) and a bond-centric to stock centric glidepath was even better. In the other paper by Javier Estrada “The glidepath illusion: An international perspective” considers outcomes in 19 countries and reaches the same conclusion internationally; again traditional stock-centric to bond-centric approach was worst, but the complete opposite bond-centric to stock-centric was significantly superior to constant mix approach. Generally the alternatives to traditional glidepath did have higher risk at retirement but the surprises were mostly upside, because earlier larger gains. (Surprising results!)
In the Economist’s “The new risk-free rate” Buttonwood asks whether the definition of risk-free is changing away from Treasury bonds to German 10-year bunds with widening yield gap (Bunds 1% lower than Treasury), lower inflation, both budget and current account surplus and a properly functioning government unlike in the U.S.
In the Financial Times’ “Economic abstractions conceal the real contours of human life” John Kay discusses a new book by Alan Greenspan entitled “The Map and the Territory” in which “he argues that the economist’s assumption of rationality is inadequate to describe human behaviour, and that banks that are too big to fail are too big”. Kay notes that the title of the book likely finds its roots in a 1920s book by a polish philosopher Korzybski who said that “the map is not the territory”. Its applicability to economics is that no economic model can describe “the world as it really is”. Kay also writes that this explains why economists suffer “physics envy” (where models also don’t describe the world as it really is, though work much better than in economics where human behaviour rather than inanimate objects are modeled) and if economics is to be a science…those who practice the subject must identify truths that are similarly independent of time, place and context.
In ETF.com’s “Investor madness and dividends” Larry Swedroe continues with reasons why dividend investing is not all that it’s cracked up to be: capital gains are often taxed lower than dividends and you can control the timing and size of the payout by creating self-made dividends. He also points to one of the most successful models in finance, the Fama-French four-factor model, where the factors are: “beta, size, value and momentum”; if dividends would be an important factor the model would not be explaining over 90% “of the differences in returns of diversified portfolios”. Furthermore since “60% of U.S. stocks and about 40% of international stocks don’t pay dividends”, dividend portfolios are less diversified than those which don’t screen for that.
In ETF.com’s “Unpacking Warren Buffett’s genius” Larry Swedroe discusses the drivers behind Warren Buffett’s outstanding performance which he summarises as strategy not stock picking, specifically starting with cheap capital from his insurance investments for leverage followed by the usual factors which explain most of his outperformance: market (beta), size, value, momentum and betting against beta (lower beta, low volatility stocks) and high-quality (“stocks that are profitable, stable, growing and with high payout ratios”) and high caps.
And by the way, in the Financial Times’ “Why markets are inefficient and what can be done about it” John Authers discusses new research which suggests that the incidence of bubbles and market inefficiencies has increased as a result of institutionalization of markets. Essentially “funds holding an asset suffer poor returns…lead to outflows, which force them to sell that asset, creating momentum…as assets flow out of a fund, so all assets it hold will tend to drop in price…eventually allows value effects to prosper”. The momentum effect leads to bubbles. The researchers suggest some possible solutions.
In the Financial Times’ “Klarman warns of impending asset price bubble” Miles Johnson quotes respected hedge fund manager Seth Klarman noting that while he doesn’t know the timing “When the markets reverse, everything investors thought they knew will be turned upside down and inside out… Anyone who is poorly positioned and ill-prepared will find there’s a long way to fall. Few, if any, will escape unscathed.”
And finally, in the NYT’s “An aging population also poses opportunities for retirement careers” Kerry Hannon discusses emerging fields of employment opportunities to servicing the needs of the over 65 U.S. population which is about to double from 41M (2010) to 86M (2050). “This aging population is spurring new fields and job openings for those in their 50s to 70s to care for those who are 80 and older.” People want to stay/age in their homes, thus creating a host of opportunities for servicing this “age in place” market. Opportunities mentioned include: massage therapists, fitness trainers, financial planners, dietitians, personal assistants, home decorators, drivers, etc…