Contents: ‘To’ vs. ‘through’ retirement strategies, ETF definitions, high market values? home investors: buy-to-flip morphs into buy-to-rent, IMF’s macroprudential advice for Canada’s housing, Nortel allocation trial, can workers really self-prep for retirement? don’t leave free money on the table, managing pensions not just about assets, scammers capitalizing on new UK pension flexibility, demographics to drive slower Canadian economy, anchorless retirement living, no retirement apocalypse but $1M is not what it used to be, actuarial pension delusion.

Personal Finance and Investments

Tom Lauricella in WSJ’s “Dueling strategies for your retirement funds” covers again the ground applicable particularly (though not exclusively) to target-date funds and whether the intent of the strategy is to cover the lifecycle ‘to’ vs. ‘through’ retirement. He defines the difference in intent to be “The “to” refers to preserving savings for an expected retirement date; the goal is to get “to” that date without last-minute harm to your nest egg. Generally this means cutting back sharply on riskier investments—namely stocks—in the years leading up to retirement, even if it reduces the potential for growth. A “through” strategy means tilting a portfolio to keep increasing savings well into, or “through,” retirement. That means higher allocations to stocks and other riskier investments despite a bigger risk of losses.”

In the Globe and Mail’s “Investment fees: You’re going to pay ‘no matter what you’re doing’” Guy Dixon reviews again the various forms of compensation for ‘advice’ and suggests that whether you like/see/know it or not you’ll pay 1-2% a year. The compensation mechanisms discussed include: commissions, front-end and/or trailer fees/MERs, fee-only for work they do and fee-based (some percent of assets). (The 1-2% per year mentioned is too expensive for advice, and look for an adviser who is prepared to do the work on a fiduciary or client’s best interest basis.)

In ETF.com’s “Ferri on exchange-traded confusion” Rick Ferri discusses the structural differences and corresponding tax implications of the “five basic exchange-traded product (ETP) structures: open-end funds, unit investment trusts (UITs), grantor trusts, limited partnerships and exchange-traded notes. You might also be interested in a somewhat related article in ETF.com’s “Smart ‘Beta’ 6: A better definition” in which Elizabeth Kashner categorizes “smart-beta”  funds to a much greater level of granularity according to “what funds actually do” or fund strategy rather than the “name” on the fund.

In WSJ’s “Stocks: Are you nervous yet?” Jason Zweig, given the strong market advance in the past year, discusses different measures of market valuation and its implications on future returns. Some of the numbers mentions current Price-to-(next 12 months of)Earnings ratio is 15.3 for the S&P 500. MSCI World ex USA index had in 2007 a 27.2 P/E ratio against average earning over the previous five years compared to 19.2 now. US stocks delivered “annual returns of 10% and up, after inflation—when investors buy them at less than 14 times their long-term dividends, adjusted for the cost of living.” But it was 1942 the last time US stocks were that cheap; whereas since 1987 92% of the time the US market has been trading at >35 this P/D ratio measure which suggests 3-4% real returns for the next decade. Foreign stocks are cheaper by the various measures and are ‘expected’ to outperform.

Real Estate

In the WSJ’s “Housing investor settle into a holding pattern”  Whelan and Dougherty report that after the home “buying binge” investors appear to be shifting tactics. The original plan was to keep buying fire-sale priced property and eventually sell at a profit. However prices have appreciated faster than expected, making it more difficult to buy at fire-sale prices, so they settling into “generating steady income from tenants” by running a rental business. (To me the whole think doesn’t add up. If prices accelerated “so much” then why not sell and move to the next opportunity? Are there no buyers at the current home price point created by investors? Can large corporations profitably run disjoint/individual rental properties profitably? If investors try to bail out, what will happen to US  home prices?!? If flipping strategy didn’t work as originally advertised, why would we believe the same people that the rental one will work better? Time will tell. Perhaps buyers who want to live in the home will get another chance soon?)

In the IMF working paper “With great power comes great responsibility: Macroprudential tools at work in Canada” Krznar and Morsink conclude that “Despite the moderation in the (Canadian) housing market, high household debt and elevated house prices remain key macroeconomic vulnerabilities. If house prices were to drop sharply, accompanied by severe recession, bank solvency stress tests suggest that recapitalization needs would be manageable (IMF, 2014c). If the housing boom were to reignite, the Canadian authorities could take additional macroprudential measures. The international experience suggests that—in addition to tighter LTV limits and shorter amortization periods—lower caps on DTI ratios and higher risk weights could be effective. Over the medium term, the authorities could consider structural measures to further improve the soundness of housing finance, such as working with provincial regulators to strengthen prudential lending guidelines, applying the same prudential oversight to the CMHC as private mortgage insurers, and increasing the role of the private sector in mortgage insurance. Over the long run, the authorities could consider eliminating the government’s role in mortgage insurance, as was done in Australia. Any changes to the structure of mortgage insurance should be made gradually over time, to avoid any unintended consequences on financial stability.” (In fact I was wondering whether in our current demographic context, it would make more sense for the government to act as an insurer of pensions rather than mortgages.)

Pensions and Retirement Income

Nortel Allocation Trial: For those interested in following the Nortel Allocation Trial taking place simultaneously in Wilmington and Toronto you could read daily summaries available at the Koskie Minsky website . (Good luck to pensioners; so far the score is pensioners-0, lawyers-10)

In the Financial Times’ “Saving for retirement is the new cool” Sophia Grene writes that the need for saving for retirement is given nowadays, she takes a critical look at the implications of the shift of emphasis to individual savings, specifically the risk that retirees “despite doing everything by the book, they still end up in poverty at the end of their lives”. With the risk shifted from sponsor to the individuals, the risk mitigation techniques like target-date funds and their glide-paths, are insufficient to insure that workers are saving enough for retirement. Questions are being raised that perhaps it’s more important to start focusing on expected wealth shortfall using liability driven techniques, than obsessing about risk-adjusted returns.

In the Financial Post’s “‘Money on the table’: How Canadians are missing out on defined-contribution pensions” Barbara Shecter reports that many Canadian workers are not taking advantage of the “free lunch” being offered by participating in their employer’s DC plan. The article notes that while there is a dearth of available stats on the subject, some employers/sponsors are routinely paying out only 40-50% “of available matching funds to employee plans”. The article also notes that auto-enrollment feature of pension plans introduced in the US over past decade have boosted participation significantly. Some employees indicate that they need the funds to meet day to day expenses, while other invest in their own RRSPs or use funds to pay off their mortgages. (Perhaps a good strategy to consider is to at least participate sufficiently in the DC plan to pick up all the “free money”, and use the rest of the funds to pay off mortgage as fast as possible.) Also in the Financial Post is Ted Rechtshaffen’s article “Here’s why you should show your group pension plan some love” in which he also encourages people not to leave the matching  funds on the table and notes that other mistakes to watch for include: investing too conservatively, not monitoring portfolio and its cost.

In the Financial Times John Authers interviews Ronald Ryan why US pension funds are still underfunded after 5 years of significant market gains in “Mitigating the pension crisis” ; the problem lies in the precipitous drop in the interest rates which drive up the value of liabilities. This has created a “contribution crisis”. Increasing interest rates would be a great way to save the pensions according to Ryan.  He recommends the use of a liability index based on present value of liabilities and the drive asset allocation based on the gap between current assets and liabilities; for a heavily underfunded pension fund you might want to increase allocation to risky assets while for fully funded pension fund dial back on risk or perhaps and immunize the portfolio against interest rate changes. Next he recommends close monitoring of changes in growth rates of both assets and liabilities, and how to get to fully funded status, rather than almost exclusive focus on assets and return-on-assets only. (Of course adding more risk to underfunded plans after the markets have appreciated significantly may not achieve the desired result, just as pilling into bonds after interest rates dropped won necessarily work well. Again time will tell.)

The unscrupulous scam artists are always ready to separate you from your savings, and a good signal to stay alert is when you are being offered something for ‘free’. In the Financial Times ’“Watchdog warns on free pension review” Emma Dunkley reports that with the UK move away from mandatory annuitization of retirement assets and “requiring that retirees receive free and face-to-face guidance”, many are being cold-called by people claiming to act for the watchdog. The concern is that many as a result of the “more flexible access to their pension could be led into unsuitable investments”.

Things to ponder

Barrie McKenna in the Globe and Mail’s “Aging population will put brakes on economic growth”  writes that a new report from BMO, predicts for Canada (much like Japan’s 90s) a demographics/aging driven: lower growth rates, lower investment, lower productivity, lower unemployment, lower than previously predicted interest rates, and lower balanced portfolio returns of just “5.6 percent a year in the next 10 years compared to 7.8 percent a year over the past two decades”.

In Bloomberg’s “A retirement experiment: Sell house, pack passport, keep moving” Ben Steverman discusses a new book “Home Sweet Anywhere: How We Sold Our House, Created a New Life, and Saw the World” by his adventurous retirees who did just that. (Thanks to long-time reader MF, for referring this article, who with his wife has done this exact maneuver for years but, as he pointed out to me, just hasn’t written a book about it; yet he could have, based on the unbelievable pictures that he’s been sending me for years chronicling their fabulous travels.)

In the Financial Times’ “Hard sell: why fund managers underperform” John Authers discusses how fund managers fail not because they don’t buy the right stocks, but because of their “terrible timing” of when to sell them. “Disposition effect” is the name that behavioral finance experts call the trait whereby “people happily took far greater risks to avoid taking a loss than they would to expand a profit”. “Selling for an underperformance, or especially for a loss, involves admitting a mistake, and crystallizing it forever.” Some managers combat this problem by not recording or referring to the cost assets in the portfolio, to prevent cost from influencing selling decision.

On one corner is Bloomberg’s “The retirement apocalypse that isn’t coming” where Ben Steverman argues that much of the retirement “catastrophes foretold by many experts, the media and financial firms” are but “scare tactic that’s moved the tone of Us savings and retirement conversation from a constructive call to action to an alarmist frenzy”. The article discusses the not as dire as advertised state of Social Security and Medicare, the falling cost of 401(k) plans, growing access to financial education and opportunity for boomers to still make changes (higher savings and lower spending) which will improve outcomes; also lifetime income products are increasing becoming available.

In the other corner is  InvestmentNews’ “1M is not what it used to be” where Matt Sirinides writes that “when it comes to living comfortably in retirement, that target symbol of wealth is past its prime…One million dollars in 1960 — around the time when having $1 million took hold in the popular imagination as a symbol of ultimate wealth — had the buying power of approximately $8 million dollars today”. The article also looks at what advisers consider the greatest “challenges when creating a stable retirement plan for clients” (low asset levels, longevity, emergency withdrawals…), “most important financial considerations” (health care expenses and debt elimination), “most important variable when establishing a retirement plan” (required savings levels for retirement and (achievable) retirement lifestyle). If inflation continues at the 2.78% of the past 30 years achieving $1M of assets will be even less adequate an achievement for gen X and Millennial couples who will be retiring in 2035 and 2055, respectively.

And finally, in “Actuarial pension delusion” (55 minute video) non-pension actuary Gene Dziadyk of http://www.avenueDconsulting.ca describes pensions as follows (I mostly paraphrase): DB is a monstrosity that was being peddled by actuaries as being cheaper than DC, now TB (target-benefit or shared-risk) is being peddled as such but it is even worse solution than DB, a DB pension just represents already earned deferred wages but managed by employer using fraudulent accounting and overseen by weak regulatory systems, there is no such thing as employer contribution as all contributions are employees’ fair wages, DB creates risk where there was none before: employer risks added are interest rate and longevity risk, while employee risk added is employers’ credit risk, in addition to added risks there are also new added costs (actuaries, lawyers, regulators, etc). Target-Benefit (TB) is now trumpeted as the new solution to DB problems. A high profile actuary who previously was peddling DB plans to employers now is quoted as arguing that “promising benefits with no relation to investment performance has put many DB plans in deficit or bankruptcy”; these are the same actuaries who were asleep at the switch and who created the current DB crisis (by enabling the fraudulent accounting). With the proposed TB (shared risk) plans to replace existing DB ones, DB plans are just turning into expensive DC plans. Dziadyk calls this DB morphing into TB, “bait-and-switch” with the employer in good times accessing surplus or taking contribution holidays, while in bad times employee/pensioner can take a benefit cut and/or increase contributions. TB could become a Ponzi given current demographics. He argues that DC is the right answer with employees’ money invested in the market via his own account. He is also looking to government to secure “legacy pensions” which he defines as already earned benefits. (No doubt that Nortel pensioners whose fate is being determined by Toronto/Wilmington court proceedings, would resonate at least with the last point; but it’s not to be.)