Contents: Investors don’t know what they are doing, rising rate ETFs? dividend funds? financial literacy, long-term-care insurance, adjusted cost base (ACB), fiduciary questionnaire, Canada housing: prices flat but home sales up and Toronto condos flying off the shelves, U.S. housing: market slow start this spring, storm surge maps, take cash from pension to invest? participation rate higher than RRSP stats suggest, smart beta??? pseudo-math based fraud, Faber’s new value fund? robo-advice taking off, retirement spending management tips, Bert Hill: Canada trailing U.S. in pension protection, modern finance: mankind’s greatest innovation shaped by crises.
Personal Finance and Investments
In WSJ MarketWatch’s “Most investors have no idea what they’re doing” Howard Gold writes that despite his initial enthusiasm about DIY investing he has growing doubts having seen people make the same mistakes over and over again: chasing hot stocks, buying horrible triple-leveraged ETFs and frequent trading. “Not only do most individual investors not know what they’re doing; they seem incapable of improving. According to DALBAR’s 20th annual Quantitative Analysis of Investor Behavior “ Investors’ annual equity fund returns vs. S&P500 index were: 3.69% vs. 11.11% over 30 years, 5.02% vs. 9.22% over 20 years, 5.88% vs. 7.4% over 10 years, 15.21% vs. 17.94% over 5 years and 25.54% vs. 32.41% over 12 months. The primary reason is “terrible market timing” (buy high and sell low) which appears to be totally resistant to educational efforts over past couple of decades. DALBAR CEO suggests that industry stop talking in a language (beta, standard deviation, benchmark, etc) that means nothing to average investor and start focusing on ““ two basic concepts to investing that the man on the street will understand: capital preservation and opportunity. Will I lose money or how much can I make?” He thinks setting clear long-term goals and measuring success against them rather than using benchmark indexes would help investors keep their eyes on the ball.”
In WSJ’s “Are bond ETFs designed to insulate investors from rising interest rates a good idea” Joe Light argues that investing in such so called “zero or negative duration” ETFs they may not make much sense. Typically the funds “buy long term bonds but then “short” Treasuries or use Treasury futures to counterbalance losses when interest rates rose”. “Yet experts caution that some of the funds carry risks that investors may not anticipate (when economy weakens stock markets and interest rates fall, and bond funds are expected to rise, however these funds may stay flat or fall and thus not provide any diversification effects) and have costs that aren’t readily apparent (higher expense ratios, shorting costs, derivative costs which may even rise with interest rates).” (In addition you might recall in last week’s blog a reference to a Mark Hulbert article in which he indicates that historically bond fund returns were surprisingly good even in rising rate environments due to higher reinvestment rates compensating for declining bond prices.)
Jonathan Clements in the WSJ’s “The case for dividend funds in retirement”writes that the old rule “never, ever dip into capital…doesn’t work in our low-yield world”. Instead he gives seven reasons why using dividend paying stocks might require fewer capital encroachments; among these are: dividends are less volatile than share prices, dividend growth rates historically exceeded inflation, availability of good dividend funds and favorable tax treatment (for domestic dividends at least). (First of all it’s great to see Jon Clements back; I enjoyed reading his WSJ column for years before he left for new challenges. My concern with dividend funds instead of using a ‘balanced’ bond/stock portfolio is that without the bond allocation we lose its stabilizer effect; dividend portfolios tend to have limited sector diversification, and as noted earlier in this blog bond portfolio returns not as at risky as usually perceived. Personally, I feel more comfortable with systematic withdrawal approach from a portfolio of stocks and fixed income securities whose allocation is consistent with my (perceived) risk tolerance.)
In WSJ’s “Teaching financial literacy, starting with teens” Carolyn Geer discusses a financial literacy program developed by Carrie Schwab-Pomerantz jointly with the Boys & Girls Club, aimed at 13-18 year olds and funded by the non-profit Charles Schwab Foundation. Over half million teens have taken the course so far, and results appear to be encouraging. You can get a flavor of the curriculum at Money matters: Make it count . Schwab-Pomerantz’ also has a new book “The Charles Schwab Guide to Finances After 50” aimed at baby-boomers.
In the WSJ’s “Mistakes to avoid when shopping for long-term-care insurance“ Anne Tergesen discusses the difficulties in making the decision to buy or not to buy long-term-care insurance. But for those who decided that LTCI is for them the mistakes mentioned are: waiting too long to buy (more expensive each year), using price as the primary selection criterion, “overlooking shared benefits” and hybrid policies, “underestimating inflation” and most importantly “failing to read the fine print”. (If interested in the subject consider perusing my LTCI blogs entitled Long- term Care Insurance (LTCI- I) and Long-Term Care Insurance (LTCI) II- Musings on the Affordability, Need and Value: A (More) Quantitative View)
Canadians who are still in the midst of preparing to complete your 2013 tax returns in general and specifically the new T1135 Foreign Investment Verification form, might want to refer to“Adjusted cost base”and “Calculating adjusted cost base for US-listed ETFs”which explain how to handle Adjusted Cost Base (ACB) calculation. John Heinzl also had a couple of good ACB articles in the Globe and Mail in the past couple of weeks entitled “The ABCs of tracking your ACB”and“More fun with ACBs: Your questions answered” .
And here is an example of a “Fiduciary questionnaire”that you might consider trying on your current or prospective adviser. It will require some fine tuning for the Canadian context, but it’s not too difficult to change. (Thanks to Ken Kivenko for recommending.)
The March 2014Teranet-National Bank House Price Index was flat from February. MoM increases were recorded in Calgary (+1.4%), Vancouver (+0.6%), but Montreal was off (-1.8%), while a seventh consecutive month of decline was observed in Ottawa (-0.6%) for a 3.5% cumulative drop over the period; Toronto and Quebec City were flat for the month of March. YoY increases were recorded in Toronto (5.8%), Calgary (+9.7%), Vancouver (7.6%); however Montreal (-0.7%), Ottawa (-1.2% and Quebec City (-2.4%) declined YoY. The 6-City National Composite was up 5.0%.
In the Financial Post from Reuters’“Canadian home sales jump in March as buyers come out of hibernation”Andrea Hopkins reports that, according to the Canadian Real estate Association, sales during March were up compared to February by 1.0% and 4.9% compared to March 2013. CREA’s home price index increased 5.2% YoY.
The Toronto condo market also continues to fire on all cylinders according to Tara Perkins who reports in the Globe and Mail’s “Toronto condo sales soar despite concerns of a crash” that according to various real estate industry sources “Sales of new condos in the Toronto area last month hit the highest level ever for the month of March… The number of newly constructed units in and around the city that found a buyer last month reached 2,496. That’s more than double the number from a year earlier and significantly above the average 1,753 units that sold in the month of March over the past ten years.” Average condo prices were up 1% at $437K though price per square foot dropped to $548; the benchmark condo size in March was under 800SF compared to 900SF five years ago.
In the WSJ’s “Housing market slow to hit its spring stride” Dougherty and Timiraos report that in the U.S. “A flurry of recent housing data suggests that the market’s spring selling season is getting off to a slow start, a worrisome sign after a winter of expectations that warmer weather would rekindle growth.”
In the Palm Beach Post’s “Storm surge graphics to be issued this year” Eliot Kleinberg reports that the National Hurricane center will start showing surge maps…where surge could occur and how high above ground the water could reach in those areas…Scientists have said even in a minimal storm, water would cover most or all of barrier islands and the mainland right along the Intracoastal Waterway, and in a Category 5 storm, the ocean could rise up to 10 feet above normal in coastal Palm Beach County and up to 15 feet on the Treasure Coast.”
Pensions and Retirement Income
In the Globe and Mail’s “Tempted to withdraw cash from your pension to invest? Don’t be” Guy Dixon discusses advice from financial planners and advisers when you are considering withdrawing the funds from your pension plan and invest it yourself. The topic is particularly of interest for pension plan beneficiaries concerned about “pension solvency and shaky companies”. The answers tend to be: there is no generally applicable advice, this is “one of the most difficult and riskiest financial moves”, depends on “when they retire, their health, their lifestyle, their plans for their estate”, very complex subject (locked-in plans, minimum and maximum annual withdrawal requirements, rules vary by company and province), watch out as you might be moving from a low cost pension plan to a high cost investment plan, investor’s ability to manage portfolio and withdrawals is critical, adviser’s recommendation to take the cash may be tainted by a conflict of interest, and indexed pension plans are particularly attractive.
In the Financial Post’s “Why our RRSP participation rate is much better than it looks” Fred Vettese argues that while according to government stats “only 24% of tax filers made an RRSP contribution”, when you look under the hood of those not contributing and remove those who shouldn’t for various reasons, that 24% rises to 80% and even 88% if you include TFSAs. (But, this is a good new-bad news story, even if participation rate is higher than indicated, I suspect the real problem is that the people who save don’t save enough to maintain their standard of living in retirement.)
Things to ponder
In the Financial Times’ “Is ‘smart beta’ the latest magic money-tree?” Pauline Skypala calls “smart beta” a marketing label rather than an investment strategy descriptor and warns that “returns could decline as more money flows into the strategies…(because) the premiums they offer could shrink”. But product providers counter that the excess return generated by the strategies is a result of the “rebalancing they force”. Skypala says that investors must understand factors driving return, risks and value delivered for higher costs but “be prepared for disappointment as…smart beta could turn into plain beta, at a higher price…there is no magic money tree”.
In the Financial Times’ “When pseudo-maths adds up to fraud” Steven Foley reports that in a new American Mathematical Society paper “entitled Pseudo-Mathematics and Financial Charlatanism, they make the case that the vast majority of claims being made for quantitative investment strategies are false”. While Bailey, Borwein, de Prado and Zhu (apparently) don’t name names (and I haven’t as yet read the paper) the targets are: technical analysts, managed futures funds and ‘smart beta” strategies.
In ETF.com’s “Meb Faber: Own the most beaten down stocks” Cinthia Murphy interviews Meb Faber about his new book “Global Value: How to Spot Bubbles, Avoid Market Crashes, and Earn Big Returns in the Stock Market” and new Cambria Global Value ETF (GVAL); Faber suggests that this fund could replace your entire foreign stock allocation. The fund invests in 100 stocks of the world’s 11 most undervalued developed and emerging countries. Think of the portfolio as the “Terrible 11”—teeming with heightened expected returns and poised to bounce back up.” He uses CAPE as the value metric but he notes that “value metrics play out over one to 10 years, and on shorter time frames, markets are driven by sentiment and price moves. And the only difference between a market trading at a CAPE of 46 and a CAPE of 5 is simply what people are willing to pay for stocks. And that’s purely a sentiment-driven metric.” Many of the cheapest markets are a result of market losses of 40-80% due to “terrible geopolitical headlines”. While “investment is the only area where when things go on sale, everyone runs out of the store”, but cheap doesn’t mean that it can’t get cheaper.
In the NYT’s “Financial advice for people who aren’t rich” Ron Lieber reviews the new push “to provide personalized advice and appropriate investments at a reasonable price to customers who are not rich” with the use of robo-advisers. Lieber includes a chart comparing prices and services being offered. Services offered by some not only provide asset allocation and rebalancing using passive ETFs but also include safe monthly withdrawals, tax-loss harvesting, and Vanguard even includes a financial plan.
The NYT’s “Tips to manage spending in retirement”discusses the 18 risks which have to be managed in a retirement plan, the challenge of people “connecting a pool of money that they can’t understand to a time period they can’t quantify”, using a “time segmented” approach whereby people are asked to think of money lasting a number of separate successive decades each with a specific separate account: “the first 10 years, the next 10 and so on… this creates a long-term focus and matches assets with current and future liabilities”. Another approach proposed by Russell Investments uses “funded ratio” (FR) concept similar to that used by pension funds; this is discussed in”Adaptive Investing: A responsive approach to managing retirement assets” and in “Your model to successful individual retirement plans” . The objective of this approach is “to serve as an effective annuity deferral strategy, managing longevity risk by setting ending wealth target > Russell’s estimated future cost to purchase a simulated immediate lifetime annuity”. Monitoring FR one gets a sense of how one is doing against the retirement target (FR<1 below target, FR>1 above target) and appropriate asset allocation as a function of funded ratio (FR<1 growth assets<20%, FR=1.25 growth assets=50%, FR>1.5 growth assets=80%) and largely independent of age, as age is implicit in FR calculation. (This sounds interesting and worth a deeper dive which I haven’t as yet done.)
In the Ottawa Citizen’s “The more things change: 44 years in politics, business and the joys of journalism”Bert Hill includes, in his parting article, that “We have a wonderful social safety-net in Canada but we trail far behind the United States in regulating and insuring private pensions as legions of retirees of Nortel and many failed natural resource companies know all too well.” (He was one of the few Ottawa columnists who helped keep the private sector pensioners’ plight and Nortel pensioners’ in particular, visible. Bert’s column will be much missed, not just by pensioners who are victims Canada’s private sector pension system failures resulting from corporate greed and incompetence, professional self-dealing in the pension industry, regulatory incompetence and inadequate pension protection by Canada’s bankruptcy laws, but by the entire Ottawa technology community.)
And finally, the Economist’s“The slumps that shaped modern finance” peruses the history of financial crises and observes that “finance is not merely prone to crises, it is shaped by them. Five historical crises show how aspects of today’s financial system originated- and offer lessons for today’s regulators.” The article starts out arguing that mankind’s greatest innovation is the financial contract because it “acts as an economic time machine, helping savers transport surplus income into the future, or giving borrowers access to future earning now. It can also act as a safety net, insuring against floods, fires or illness.” Then notes that it terrorizes when bubbles burst and asks if following the 2008 crash “the right things are being done to support what is good about finance and remove what is poisonous.”