Hot Off the Web- June 9, 2014

Contents: Can I afford to retire? no free-lunch with dividend funds, new LTCI options? reverse mortgage use up in Canada, pay down mortgage vs. retirement saving, rent/buy/upsize/downsize, PBC: condo sales slump, fixing the 401(k), reduce mandatory RRIF distributions, Calof: Nortelers have right to remaining assets, UK-PPF pension insurance premiums adjust for default risk, Europe moves to negative rates, index construction, Silicon Valley to invade insurance/finance, frontier markets, Seasteading: libertarian utopia.

Personal Finance and Investments

In the Globe and Mail’s “Three simple but vexing questions that sum up retirement” Ian McGugan figures that one must consider three questions to answer “can I afford to retire?. These are:” how much do I need?” “what returns can I expect?” and “what will government provide?” His answers for a “working couple with a combined income of $100K” are: somewhere between $2.8M, if you assume real 2.5% return, 70% income replacement rate and OAS/CPP, but only $600K, if you assume real 4% return, 50% income replacement and $25K/yr in OAS/CPP for the couple. (Not a very satisfying answer, especially since no risks were discussed as yet. Next week the article will look at risk management issues. Hopefully the key retirement risks: longevity, market and inflation will be addressed. Also might be worthwhile to consider an assessment of post-retirement expenses based on pre-retirement ones rather than worrying much about income replacement rates. At the end of the day flexibility/adaptability around expense management will be needed to manage the realities of current circumstances and live within one’s means. So it is really first and most about expenses, estimating and controlling them.)

In WSJ’s “No free lunch in dividend funds” Jason Zweig discusses dividend funds “pitched…as a way to get higher returns and lower risk than the stock market” and how they outperformed for a couple years. But “a good idea turns bad when too many people try it at once, and those with unrealistic expectations are the first to panic at the slightest disappointment”. “Dividend funds tend to be less diversified than the stock market as a whole, tilting heavily toward large companies and electric utilities… So when the market heats up on the prospects of improving economic growth—as it did in 2013—dividend-paying stocks are left behind.” (It’s at least in part a value vs. growth tilt, so you’ll pay when growth is ‘in’.)

In the WSJ’s “For the chronically ill, a lump-sum option” Anne Tergesen describes the trade-offs between what a 60 year old might be able to buy for $150K/ year: a pure LTCI policy, a life policy with accelerated death benefits or a hybrid life/LTC policy. (Good luck trying to figure out which one is “better” in some sense, and even more so whether the 60 year old needs any life insurance at all or whether LTC insurance makes sense especially since it does not meet the very-high-impact  low-probability event for an insurance product.)

In the Financial Post’sReverse mortgages rising fast to deal with retirement shortfallsGarry Marr reports that according to Canadian Home Income Plan (CHIP) reverse mortgages are up about 26% over last year and expect about 3000 such mortgages to be issued. (Last time I looked at these, they didn’t make financial sense, if you really need the money you should sell house, rent basement, etc see my Reverse Mortgage blog post. I doubt that this makes sense for vast majority of retirees.)

In the Globe and Mail’s “Saving for retirement should trump rush to pay off mortgage” Rob Carrick argues that instead of obsessing over paying off the mortgage and pouring any excess cash into the mortgage, a better financial balance is achievable by putting those excess funds toward retirement savings. (Makes sense after all you don’t want all your eggs in the house-basket; you need a better balance. But, I always believed/practiced/encouraged paying off mortgage first/quickly on the basis of high risk-free return that one achieves by this move, and the dramatic release of pressure on meeting expenses by reducing this large fixed expenses. Of course that this assumes one has already taken full advantage of any employer match on retirement accounts. I guess one could also look at rent vs. buy, how much house one needs and whether the house is intended as one’s retirement fund. These may be part of getting the balance right.)

Real Estate

In the Financial Post’s “Buy, rent, upsize or downsize? How o make he best move in today’s housing market?”Jason Heath looks at the pros cons of each of these moves and sensibly concludes that “There is no one-size-fits-all answer to life’s financial questions.” Heath also notes that whatever choice is selected it “could (will?) have a profound impact on your financial situation for years to come”.

In the Palm Beach Post’s “Palm Beach County condo sales slump but prices still climbing” Kimberly Miller writes that PBC condo sales “been in a three-month slump, dropping 11 percent in April from the same time last year as higher prices and low inventory chase investors from the market.”

Pensions and Retirement Income

Anna Prior has a great article in the WSJ entitled “How to fix the 401(k)” in which she points to the few simple fixes that would bring significant benefits to participants. Those mentioned are: simplified fee disclosure, low-cost index funds, nudge features (auto-enroll, auto-escalate), guidance by fiduciaries, and a national 401(k) plan for small business. (Wonderful article pointing to simple fixes: the only items I would add are a “longevity insurance” option at age 65 with lifetime income starting at 85, and a good feedback report indicating recommended savings level necessary to achieve a selected retirement income objective.)

In a just released C.D. Howe Institute report “Outliving our savings: Registered retirement income funds need a big update” Robson and Laurin point to a broken minimum withdrawal requirement in RRIFs, which do not recognize the increased life expectancies and radically lower returns today compared to 1992, when federal government bond rates were much higher and indicated life expectancies about 3 years lower. They write that with the federal budget almost at a surplus it is time to reduce or eliminate minimum withdrawal requirements. (If you actually built a simple spread sheet you would notice an alarmingly high depletion rate of your account. As a minimum, the mandatory withdrawal requirement should be halved at least till age 85 to help preserve sufficient funds should an annuity be contemplated at that time. Taxes would not be lost to government, just deferred.)

In the Ottawa Citizen’s “The strength of Nortel was its people” Jonathan Calof, who just completed a study on Key Lessons Learned from the Demise of Nortel, weighs in on the continuing saga of the Nortel allocation trial and concludes (correctly according to my biased view) that “Nortelers have the right to the majority of the remaining assets” as they were the source of all the value created by the company.

In the Financial Times’ “Pensions lifeboat scheme adjusts levies” Josephine Cumbo reports that a quarter of UK companies running DB pensions face a significant increase in the required Pensions Protection Fund premiums because of a “radical overhaul of the way it assesses the insolvency risk… more focused on the specific risks of companies with final salary schemes than on the broader corporate landscape”.  (I am not sure whether the insolvency risk referred to is company insolvency risk or to the risk to the PPF associated with a default on the underfunded state of the company’s pension plan; but if this drives companies to maintain a close to fully funded status in their pension plans, than it is all good.)


Things to Ponder

In the Financial Times’ “Draghi in battle to head off deflation” Claire Jones reports that the ECB, in an effort to counter the perceived deflationary threat, rolled out negative interest rates on excess bank reserves parked overnight with the central bank, and special incentives (“cheap loans”) to banks to lend to small businesses. Should these measures fail to achieve desired levels of inflation the bank will next move some form of QE (buying asset backed securities.)

With index based investing growing by leaps and bounds more articles are discussing how indexes are constituted.  In WSJ’s “A big-name index is No. 2 in returns”Tom Lauricella discusses the differences in composition between the Russell 2000 Small Stock Index and the S&P SmallCap 600; the interest was triggered in this case by the increased use of the indices to create ETF products around them and the significant outperformance by the S&P index. The two indices differ in allowed capitalization range (S&P is more truly SmallCap only while Russell includes some MidCaps and MicroCaps) and S&P includes a “profitability screen for its index. (It might also be interesting to what degree actual supply and demand factors affect the performance/volatility of the indices.) The importance of understanding the differences between the coverage spaces of indices is discussed in’s “Dear Mrs. Buffett, about that index fund” where Elisabeth Kashner argues that by recommending the Vanguard’s S&P 500 ETF (VOO) rather than Vanguard’s Total World Stock Index (VT) Mr. Buffett might be shortchanging Mrs. Buffett a number of ways. The S&P 500 index and the corresponding ETF “omits midcaps, small-caps, foreign companies and firms that have short-term earnings struggles”. Berkshire Hathaway portfolio also includes a number of public companies which are not in the S&P 500 either due to size, failure to meet S&P’s profitability screen, they’re foreign based or just because “S&P’s index committee passed them over”.

In the Telegraph’s “The Silicon valley of fear” James Titcomb discusses the threat that financial and insurance companies face from Silicon Valley technology companies which “want to eat our lunch” according to JPMorgan’s Jamie Dimon. The article notes the small probes being launched by technology companies, likely in preparation for a major assault. (It couldn’t happen to nicer guys than the financial and insurance people; bring it on Silicon Valley!)

In the WSJ’s “Investors rewarded for trek into little known markets” Dan Keeler reports that “While the MSCI Emerging Markets Index has been essentially flat since the start of 2013, the MSCI Frontier Markets Index has shot up by more than 50%… (also) research showed that frontier markets’ stock indexes were significantly less volatile than emerging markets and slightly less bumpy than even developed markets.” Despite individual countries being quite volatile, in aggregate frontier markets’ lower volatility is attributed in part to being less exposed to the global financial system, but as more asset flow into this space with ETFs, the volatility is likely to increase.

And finally, in Bloomberg’s“For libertarian utopia, float away on ‘startup’ nation”  Edward Robinson looks at “The Seasteading Institute, an Oakland, California–based group… The five-year-old organization is pursuing an ambitious aquatic mission: to develop floating microcountries that will dwell in international waters with the same sovereign status enjoyed by cruise ships. Think secessionist, do-it-yourself nation-building meets the 1995 post-apocalyptic science-fiction stinker ‘Waterworld.’” ” This isn’t the mother of all tax dodges (Americans pay taxes on their world income even if they reside elsewhere)… (but) something more audacious. Settling on the sea offers a way to opt out of an overregulated society…”


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