Hot Off the Web- May 12, 2014

Contents: Conflict of interest, portfolio strategies, considerations on imminent retirement, Hybrid LTCI policies, retirement consumption, target-date funds, bonds are like stocks? housing: rent vs. buy? Yellen: US housing market risk, UK housing: still firing on all cylinders, self-made annuities? shared-risk pension plans, pension gives peace of mind in retirement, wealth tax inevitable? Sunstein: “Why Nudge?” rentiers not needed, regulators want access to our portfolios, stocks impacted by geopolitical crises? Demographics impact valuation.

Personal Finance and Investments

In InvestorNews’ “Why nixing money manager conflicts of interest is key to restoring investor trust”Trevor Hunnicutt reports that “only one third of investors believe their financial service provider is acting in their best interest”. The article also notes the need for full disclosure of compensation/fees and a full alignment of these with value received.

What Rick Ferri has to say in’s“5 ways to improve your portfolio”is not news but it summarizes well the keys to investor success: (1) risk tolerance driven asset allocation, (2) rebalance to target risk, (3) cost control, (4) tax management (“asset location, tax-loss harvesting, and withdrawal strategy in retirement”), and (5) discipline to execute.

In the WSJ’s“About to retire? Three big questions”Jonathan Clements recommends that you consider three critical questions: (1) phase of market cycle (at the current valuation level expect market return of only about 6% over next decade; so have at least a 5  year reserve and stick with 4% draw), (2) understand the after tax dollars from the 4% draw that you’ll have available to spend, and (3) what are your fixed (housing, utilities, food, insurance, phone, transportation, etc) and discretionary (travel, restaurant, etc) expenses in retirement which have to be covered (the fixed expenses are very hard to cut back so you try to minimize them if possible and have fixed expenses covered by pension-like income and the 4% draw).

In WSJ’s “’Hybrid’ long-term-care policies” Anne Tergesen has a great article comparing traditional vs. hybrid LTCI policies (hybrids: need large upfront payment, are “ideal for those with appreciated annuity or life policies”, are easier to qualify for by those with health issues if an annuity is included, but hybrids come with two layers of fees administrative and mortality as well as morbidity). But as the article notes the need for LTC is a 70% probability. So is this an insurable (i.e. low probability of occurrence with high financial impact) event? No, especially when you factor in other LTCI problems (high load factors, subjective benefit qualification criteria, etc)… Therefore, probably a superior solution would be to save for it! (By the way, if you can’t afford to save for it, you are unlikely to be able to afford to buy a meaningful amount of LTCI either. You might also find of interest a couple of Long-Term Care (LTCI) blog posts I did on LTCI, though not specifically on hybrid ones.)

In  the Journal of Financial Planning’s “Exploring the retirement consumption puzzle” David Blanchett indicates that “retiree expenditures tend to decrease upon and during retirement, “although retiree consumption basket is likely to increase at a rate (primarily due to the higher proportion of faster rising medical component of retirees’ basket) that is faster than the general inflation, actual retiree spending tends to decline in retirement in real terms” (about 3% drop at retirement, followed about 1% per year thereafter in real terms), though spending does rise again in the last few years of one’s life (i.e. ‘smile’ shaped.) . It is not clear whether the decreasing real cost in retirement is “by choice or need”; specifically whether retirees reduce their expenses to reduce the chance of “retirement ruin”. The author shows that compared to the constant real spending during retirement scenario the “probability of success over 30 years” increases for $25K/$50K/$100K spend levels by about 8-30% with increasing spending ($) levels in the initial withdrawal range of 4-5%/year .  The observed, decreasing (rather than constant) real spending during most of the retirement, would suggest that less retirement assets are needed and/or a 5% rather 4% initial spending can be accommodated without adversely affecting expected probability of  success over 30 years.

In the WSJ’s“Target-Date funds: Same retirement year, very different results” Veronica Dagher discusses target-date funds which are now a staple of 401(k) investors who have now $644B invested in them, but reminds readers that just because two funds are aimed at the same retirement years, it doesn’t meant that they have the same performance (or asset allocation or glide-path). (While target-date funds are conceptually a great idea intended to keep things simple, in reality things can get quite complicated as they are more expensive and more difficult to integrate with one’s overall portfolio, risk tolerance, differences in providers’ views on appropriate allocation, glide-path differences, and whether they are intended to continue only to vs. through retirement, depending on planned decumulation strategy, as discussed in some of my previous Target-Date Funds blog posts.)    

In the Globe and Mail’s“Fixed income’s new reality: bonds are like stocks”Tom Bradley discusses how the bond investment world has changed in the past 20 years, and while he agrees that the current low interest environment necessitates changes to the lower risk approach of 20 years ago, he warns of the consequences. “          A mistake too many investors make is substituting aggressive fixed-income funds for their GICs (CDs for American readers) and bond ladders.” Aggressive means: high yield or junk bond funds, leveraged funds, emerging market debt, and similar constructs, which clearly come with a lot more like risk that GIC /CD or government bond ladders, as these generally behave more like (and are highly correlated with) stocks; they are also a lot less liquid and more likely to default than government bonds. “Most importantly, we have to recognize that high yields are only good if they fully compensate for the additional risk and complexity.”     By the way David Berman in the Globe and Mail’s “Shocker: Bonds are beating stocks” point out bonds’ outperformance of stocks so far in 2014 “ The iShares 7-10 Year Treasury Bond ETF has returned 4.3 per cent this year, outperforming the 2.4 per cent return for the SPDR S&P 500 ETF” for a long list of reasons including the demand for the bonds which drove 10-yer rates from over 3% to 2.61%.                                                                                                                                                      

Real Estate

In WSJ’s “The new math of renting vs. buying” Annamaria Andriotis reviews the evolving scene of making the rent vs. buy decisions. She refers to a Deutsche Bank study on 54 cities and how they rank according to the ratio of what a new renter to a new buyer would pay (and the impact of the assumptions on which the study is based on). Initial cost aside, pros to buying mentioned include: ”essential step in a successful life”, potential to tap home equity when needed and lower housing costs in retirement if mortgage paid off. Pros for renting include: often cheaper even for the same house, down-payment and cost difference might be invested in the market with higher return than in the house, renting is a good way to save for down-payment for those wanting to own. Those expecting to stay five or more years get an edge in buying.

In the Financial Times’ “Yellen warns on US housing market risk” Robin Harding reports that the Federal Reserve Chair expressed concerns about disappointing housing activity so far this year. She also indicated that while labor market improved significantly, increased geopolitical risk and investors’ “reach-for-yield” are areas of concern.

However UK house prices are still firing on all cylinders, with ratio of prices to first time home buyers’ earnings has risen past 8 as noted by the Economist’s Buttonwood column “The same old song” in which he seems to argue that the solution might be to address supply shortfall as a result of planning laws constraining development. Then the interaction between the financial markets and the economy takes over and keeps ratcheting prices up…until the eventual crash.


Pensions and Retirement Income

In’s“Investing trick: Build your own annuities”Allan Roth argues that “advisers don’t need to turn to annuity products to allay clients’ fears about market losses”. He proposes three alternatives to consider as a means to reduce costs associated with insurance products: (1) instead of an “equity indexed annuity” buy a 10-year compound 3.3% FDIC insured $100K CD for $72K and invest the $28K in Vanguards Total US Stock Market Index ETF (VTI), (2) instead of an immediate or deferred “income annuity” consider delaying Social Security which is a more cost-effective approach or take  Sexauer and Siegel’s TIPS plus deferred annuity approach, and (3) instead of “variable annuities” which are just more expensive mutual funds tied together with “worthless guarantees” use a low-cost portfolio to accumulate assets and then consider the TIPS plus deferred annuity mentioned in (2) for decumulation.

In BenefitCanada’s“Shared risk pension plans pique employers’ interest” Yaldaz Sadakova discusses the newly fashionable (so far for discussion only) target-benefit pension plans which: share risk between employee and employer, are a half-way house between DB and DC, eliminate the surplus “problem” and more importantly the contribution holiday problem, preserve deduction at source feature of DB/DC, force closer monitoring of plan health and introduce the flexibility to increase contributions or reduce benefits if returns are lower than expected. And in the Globe and Mail’s“Ontario and federal pension plan pitches: Why both are smart policy” Rob Carrick argues that a point of both the federal and provincial proposals is that they both are “retirement programs where savings are deducted at source”.

In the Globe and Mail’s “Living in retirement: It’s all about pensions” Joyce Wayne’s blog chronicles her personal (and friends’) retirement journey, and opines that dominant factor is ability to retire is having a DB pension, especially a public service one. Other sources of a comfortable retirement mentioned were: inheritance, personal savings and the luck of having real estate in Toronto or Vancouver. Her bottom line: her DB pension gave her “peace of mind” about finances.


Things to ponder

In the Financial Times’ “Tory tax on property is perfect for the Piketty age” Janan Ganesh discusses how growing inequality has not necessarily been totally bad since it was accompanied by a rise in “the absolute quality of life of ordinary people”. “A country can be equal and dismal. Markets bring wonders as well as stratification.” Yet he endorses a shift of taxation “from income to assets”, and he sees a tax on property as inevitable.

In the Financial Times’ “’Why Nudge?’ by Cass Sunstein” David Brown reviews Cass Sunstein’s new book “Why nudge? The Politics of Libertarian Paternalism” in which he defends against criticism by some that the concept of “’libertarian paternalism’ was pure oxymoron“, he argues that “the state has the right to meddle with individuals’ choices if doing so increases our well being.” If you believe that “you should be free to get fat, smoke and retire poor – he wants you to read this book.” (Sounds interesting!)

In the Financial Times’ “Wipe out rentiers with cheap money” Martin Wolf writes that the ultra-low interest rates can last a lot longer than expected (e.g. Japan) and “cautious savers no longer serve an economic purpose”, “large shifts of income from net creditors to debtor was observed”. Winners were government and non-financial corporations, while losers were insurance companies, pension funds and households. Wolf argues that “cautious rentiers no longer serve a useful economic purpose…what’s needed…are risk taking investors. So he argues that the financial repression is good and predicts that will continue.  But the Economist’s Buttonwood column disagrees in “Who are you calling a rentier?”. (These thoughtful articles are worth a read. There is no question that retirees are struggling with low interest environment, much of the recovery is driven on their backs as wealth is being transferred from savers to debtors; the question is how badly will seniors driven into riskier assets will be further damaged if/when interest rates rise and/or the market tanks. The other question is whether investors’ assets driven into riskier areas will result in economic benefits or just more asset bubbles. Time will tell.)

In WSJ’s “Get ready for regulators to peer into your portfolio” Jason Zweig reports that FINRA “which overseas how investments are sold…proposed… an electronic system that would regularly collect data on balances and transactions in brokerage accounts.” The debate is between FINRA which argues that this would revolutionize how regulators do their jobs and could make it harder for unscrupulous brokers to bilk customers” and critics who it could endanger the privacy and security of investors’ confidential data”.

In the WSJ’s “What an international crisis could mean for stocks” Mark Hulbert looks at the DJIA’s “reaction to selected past geopolitical crises” and concludes that you should “Remain calm and don’t sell. If you are bold you could even use it as a buying opportunity.” On the average the change in value from day-before to day-after was -6.7% for 51 “biggest geopolitical crises since 1900” was more than recovered by +8.9% average change over then following six months. Quoting an investment manager “Historically markets do best when their prospects improve from being horrific to being merely humdrum…(and) there always is a crisis somewhere, and crises usually are correlated with countries whose stocks already are out of favor.”

And finally, John Dizard in’s “Spanish property advice from the plague” discusses the impact of demographics on valuation of Spanish housing as an illustration of the importance of demographics in setting valuation expectations. Known 2013-2023 demographic data indicates that the number of Spanish residents of ages 25-29/30-34/35-39/40-44 will drop -28%/-39%/-37%/-15% respectively; the last comparable drop of 25-40% was about 650 years ago during the Plague. He adds that given that the 95-99 year old population will double over the same decade, he wonders who will be paying for their support!?! By the way “It took at least half a century for European property prices to recover after the 14th-century plague.”


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