Hot Off the Web- April 7, 2014

Contents: Aging brain, investment fees, why ETFs cheap, simple US portfolio, skip LTC insurance, foreign withholding tax in Canada, soft landing for Canadian housing, inadequate data to assess state of Canada’s housing, reverse mortgages affect heirs, pension reform: not “Big CPP” and not “Little PRPP”, what replaces UK’s discarded mandatory annuitization? annuities come up short again, are markets rigged by HF traders? retirement happiness formula, inflation and interest rates in Canada, corporate bonds deliver more, junk bonds don’t diversify, financial crises: past and future, who is this “suitable” for?

Personal Finance and Investments

In WSJ’s “Finances and the aging brain” Jason Zweig discusses how new research explain how “even sophisticated investors…can end up victims of financial predators” due to aging individuals’ tendency to want to “maximize positive emotions and social interactions…(being) more determined to block out negative experiences…leads older people… to pay more attention to those who make them feel content…and more likely to neglect warning signs…” “Highly intelligent retirees…with no signs of dementia…find it harder to distinguish safe investments from risky ones…” Furthermore, individuals who are declining cognitively, continue to remain self-confident “even if they lost their reasoning capacity”. Among expert recommendations are: force yourself “not to make a lot of fast decisions”, “monitor financial health of parents”, watch for any new relationships, and make sure to involve spouses, advisers and accountants before committing to major changes.

In the not news but worth retelling repeatedly category, Preet Banerjee in “Your lifetime investment fees could easily top $100,000” estimates that with a set of assumptions he describes, the investing fees might add up to over $170,000 with annual investment management fees of about 2.0%, but would reduce to just over $130,000 at 1.25% and $32,000 for a DIY investor with 0.25% costs. In the example used the annual retirement income for the DIY investor would be almost double that for the investor burdened by the 2.25% fees.

In’s “3 reasons why ETFs are so cheap” Cinthia Murphy discusses the reasons why ETFs are so inexpensive because of their: (1) unique creation/redemption process by authorized participants (AP), (2) being more tax efficient than mutual funds because in mutual funds upon redemption the fund incurs capital gains which are distributed among all fund holders even those not involved in sale whereas for ETFs only selling units are affected, and (3) the Vanguard low cost pressure.

In WSJ’s “A portfolio that’s as simple as one, two, three” Anna Prior writes that for the average investor less is more. Simple (US based investor) portfolio mentioned is one composed of 3 funds (also available as ETFs: Vanguard Total Stock Market Index (40%), Vanguard Total international Stock Index (20%) and Vanguard Total Bond Index (40%), rebalanced annually. If you really want to include international bonds as well, you could use Vanguard Total International Bond Index for half the bond allocation.

I just came across a one year old article in Forbes entitled “Dodge the Long-term care insurance mess” where William Baldwin looks at LTCI and concludes, that despite much of the advice you might be getting to “protect your family from the devastating costs of nursing homes”, these policies may not be in your or the selling insurance companies’ best interests. “The economics of old-age insurance are sufficiently poisonous to injure both parties to the transaction… both sides of a deal can come away losers. It’s a bit murky just when a policyholder is sufficiently disabled to be entitled to collect. If a benefit worth $50,000 is at stake, it makes sense for the insurer to spend $45,000 on medical exams and claims adjusters fighting the claim and for the applicant to spend $45,000 pursuing it. Longevity insurance would be a choice for most. (I reached much the same conclusion in my Long- term Care Insurance (LTCI- I)and Long-Term Care Insurance (LTCI) II- Musings on the Affordability, Need and Value: A (More) Quantitative View blogs.)

Given that tax season will shortly be behind us, Canadians might consider in the future factoring in the impact of withholding taxes associated distributions from foreign securities/ ETFs in taxable and tax-deferred (e.g. RRSP) and non-taxable (e.g. TFSA) account depending on whether the ETFs are US or international based and whether the underlying securities/ETFs are U.S. or Canadian listed. This complex topic is discussed in Dan Bortolotti’s MoneySense article entitled“Foreign withholding tax: which fund goes where”and“The true cost of foreign withholding taxes”

Real Estate

In Maclean’s“Odds are on a soft landing for Canadian housing market”Stephen Gordon argues that “An outright U.S.-style crash is not impossible, but it is less likely than the soft-landing scenario.” He then proceeds to look at the evidence, arguing that Canadian household could deal with 20-25% increase in mortgage costs especially given that the increased interest rates would come at a time of increased inflation and incomes.

But, in the Globe and Mail’s “Dangers lurk in dearth of solid housing data” Tara Perkins reports that Canadian housing economists are getting more outspoken about the inadequate housing data available from government agencies like CMHC and OSFI. CIBC economist Tal released a report entitled “Flying Blind” noting that “the gap between the importance of the real estate market to the economy and the lack of publicly available information on it is mind-boggling.” The article notes the special importance of the unavailable data compared to the US) “as economists and policy-makers try to determine just how overvalued Canadian homes are, and what should be done to ensure the market is healthy.” Missing data includes: value of mortgage originations, their distribution by credit score, nonconforming loans and their delinquencies, foreign buyers’ share of condo market, etc. (So the decisions about the state of Canada’s housing market based on inadequate data might be erroneous?)

In NYT’s “Pitfalls of reverse mortgages may pass to borrowers’ heirs” Jessica Silver-Greenberg discusses how homes with reverse mortgages can become “bitter inheritances: the same loans that were supposed to help the elderly parents stay in their houses are now punishing their children out.” Heirs find out that bureaucratic mazes are set up by lenders in order to withhold all available options to settle the outstanding loan. According to federal rules, “Lenders must offer heirs up to 30 days from when the loan becomes due to determine what they want to do with the property, and up to six months to arrange financing. Most important, housing counselors say, is a rule that allows heirs to pay 95 percent of the current fair market value of the property.”


Pensions and Retirement Income

In the Toronto Star’s “Helping Ontario workers build retirement nest eggs” Keith Ambachtsheer reminds readers about Canada’s private sector pension crisis “only a fifth of Canadian private sector workers are members of an employment-based pension plan today. As a result, many of them are likely to face sharp reductions in their standard of living when they retire in the decades ahead” and he suggests that Ontario consider something in-between the “Big CPP” and the “Little PRPP”, which he argues both have significant drawbacks, some of which he proceeds to outline. He proposes instead an Ontario Supplementary Pension Plan for which he “suggests a pension target to replace 60 per cent of middle-income family earnings, and estimates it would take an additional 6 per cent of pay contribution rate (above the 9.9 per cent CPP contribution rate) to achieve it. As in the CPP, the additional 6 per cent would be split 50/50 between employees and their employers. It would be phased in over a number of years.”

In the Financial Times’ “Baby boomers put annuity market on trial”Pauline Skypala discusses the impact of the UK announcement that it is doing away with the current compulsory annuitization of accumulated pension funds at retirement. She discusses the impact “severe injury to the annuity market…(but) few will mourn it, as it is widely regarded as a failure”. But she notes that “Killing off annuities leaves a gap, though. No other product reliably insures against outliving your savings.” Concern is expressed that UK pension system becomes too focused accumulating wealth rather than generating income. (Of course you don’t have to worry about generating income if you haven’t accumulated any wealth. One solution to lifetime income generation is to consider the use (where available as in the US) longevity insurance (to secure an income stream starting at age 85, bought at retirement for not more than 15% of one’s assets) with the rest of assets decumulated with a systematic withdrawal plan till age 85 or beyond…unless you “know” that you won’t live to 85. The other approach might be to just create a low cost balanced portfolio which you tap using a sensible systematic withdrawal plan.)

In Journal of Financial Planning’s “Lifetime expected income breakeven comparison between SPIAs and managed portfolios”Frank, Mitchell and Pfau compare “total expected lifetime cash flows between single premium immediate annuities (SPIAs) and managed portfolios” and concludes that “that assets should be retained and managed in the markets longer than conventional wisdom suggests before the purchase of a SPIA”. Factors mentioned as “that encourage annuitization include being older, having greater longevity relative to peers, aversion to holding equities, and higher portfolio fees”. The authors also include, breakpoints based on market conditions on the annuitization decision. Based on current conditions they conclude among other things that: (1) “Other than in the most pessimistic market expectations and risk aversion situations, managing a portfolio makes sense at all ages”, (2) “The current low interest rate environment suggests that encouraging the purchase of SPIAs prior to age 80 may be misplaced.” (3) “SPIAs may be appropriate if retirees demonstrate a tendency as spendthrifts. In these situations, managed portfolios may not be appropriate to ensure lifetime income.” They remind readers that the annuitization breakpoints presented, but the methodology is likely the more lasting contribution. They also note “research is needed to look into possible combinations of partial annuitization over time and/or the use of longevity annuities (deferred income annuities or DIAs), which do not pay out unless a later age is reached”. (Well worth reading, lots of pragmatism and real life considerations factored into the paper. By the way in my “Vanguard GLWB vs. other decumulation strategies” you can readily see that in March 2011 context even simple decumulation strategies like proportional withdrawal, i.e. taking say 4.5% from a balanced portfolio each year, most outcomes are superior to annuitization; annuities might pay more at the beginning but if you die young you lose your capital and once you get past about 15 years into retirement you not only lose your capital but systematic withdrawals will likely lead to higher real income. Annuities are just trading off longevity risk for inflation risk; so they might make more sense in a no inflation world?)


Things to Ponder

In’s“The good, bad and ugly of high frequency trading” David Nadig discusses Michael Lewis’s new bookon high-frequency trading“Flash Boys”writes that things are a little more nuanced than the “rigged market” view (see last Sunday’s CBS 60 Minutes segment) but he argues that “there is a societal good here, but there’s also a problem”.   He agrees that gaining/using insider information is wrong, there are bad actors who take advantage of speed for personal gain but much of this has little impact on ETF investor (the buy-and-hold kind). Also, David Merkel in his Seeking Alpha piece“The stock market is rigged! The stock market is not rigged!” has some recommendations on what to do and not to do when trading and concludes that “the markets are not rigged. They not efficient; we don’t know what that means. The markets are highly competitive, and that makes them tough.”

In WSJ’s The Experts column William Bernstein provides the formula for Retirement Happiness in “A simple math formula for retirement happiness” which is “Retirement Happiness = [How Much You Dislike Your Job] X [How Badly You Want to Do Something Else]” …So if you still enjoy your job or if you don’t have an alternative in mind, one of those terms is zero, so don’t quit.”

In the Globe and Mail’s “Inflation comes to Canada (and that’s good)”David Parkinson reports that in “the past three months (December through February) alone, industrial prices have jumped 3.1 per cent” driven by rapid increase in raw material prices, and it is just a matter of time before wholesalers and distributors will be passing those increased costs on to consumers. But interest rate increases are not imminent as Canada’s CPI is still well below Bank of Canada’s 2% target. On the same subject, in the Financial Post’s“Bank of Canada expected to lag Fed in rate hike timing and pace”Jonathan Ratner reports that Scotia Bank economists argue that “There have been two exceptions in recent times when the BoC hiked ahead of the Fed, but Scotiabank believes neither is a compelling case for the risk of a repeat.” (If they are right a US hike would provide adequate warning signals for Canadian bond investors who plan to exit before rate hikes, but more importantly condemn seniors/savers to be collateral damage in the continued ultra low interest rates of the “financial repression” while simultaneously getting pounded by inflation.)

In’s “Tilt to corporate for more yield” Olly Ludwig interviews John Bogle who indicates that investors should consider to “work around the overweight in government debt” with “paltry bond yield” which now characterizes the (US) Total Bond Market Index” by adding corporate debt in retirement account and tax-free municipals in non-retirement account”. Other topics discussed include: a federal fiduciary standard-which he doesn’t believe will happen in his lifetime, indexing-continues to mean cap weighting, market timing- don’t be out of the market, bond index-is wrong, bond returns are essentially coupon yield while stock returns are dividends plus earnings growth, so with a corporate heavy 50% bond and 50% stock portfolio one might expect 5% annual return.

Also on bonds is’s “Not all bonds diversify” where Anthony Parish reminds readers that while most investors understand that bonds are used “to offset the risk of their equity holdings”, but some forget that “just because an investment is “fixed income” doesn’t mean that it provides much diversification versus equities”. He mentions specifically the high yield bond ETFs (HYG, JNK) which are highly correlated to, though somewhat less volatile, than stock market returns. (Sensible advice!)

In the WSJ’s “The next financial landslide” Al Lewis chronicles the various financial crises we’ve had over the past 30-some years: 1980s savings-and-loan, 1987 market crash, 19997 Asian financial crisis, 1998 LTCM hedge fund, 2000 dot-com and 2008 crisis. The story is always the same in broad terms “High rollers amass debt until they can’t pay it off, and then they default, setting off a string of insolvencies that can be stopped only by putting taxpayers at risk. Systemic fraud is exposed in every crash, but little is done about it.” He recommends a new book by Bob Ivry: “The Seven Sins of Wall Street: big Banks, Their Washington Lackeys and the next Financial Crisis”. Ivry calls it “predatory greed” and quotes Jamie Dimon’s answer to his daughter’s question on “What is a financial crisis?”, that “It’s something that happens every five to seven years”…are we due for one?

And finally, Larry Elford’s short (2-minute) but to the point videoabout the “suitability” standard and whether serves your interest-NOT.


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