Contents: Steps to retirement income, reasons to rebalance, financial elder abuse, curing home bias with World ex-Canada Index ETF (VXC), preparing financials for death, estate planning is more than wills, retirement savings catch-up, ending embedded commissions, Tactical Asset Allocation= Market Timing, Canada healthcare limitations for seniors, financial plan necessary but insufficient without disciplined execution, Vancouver/Toronto/Calgary home price limits? Canadians 25% of international buyers of US homes, real estate investing is all local, Canada Pension Plan active investing comes with high cost, asset managers best positioned to generate effective retirement savings framework? Asset managers’ headline fees just the tip of the cost iceberg, cash from pensions may come with tax implications, biggest DB myth: its cost, DB pension may replace bonds in portfolio, emotions contagious for investors, if low growth rates explain low bond rates then stocks may be overpriced, justification for staying with stocks even if overpriced, robo-advisors leaving money on the table? smart beta may lead to ‘crowding’/price-bubbles/illiquidity, search for yield just a euphemism for ignoring higher risk? liquid alternatives: handle with care! financial challenges of single majority, experiences trump possessions for growing number of seniors.
Personal Finance and Investments
In WSJ’s “How to ensure adequate retirement income” Jonathan Clements’s recommended steps are: delay Social Security, cover your fixed costs (with Social Security, pensions, interest and dividends and for conservative investors a fixed annuity if there is a shortfall), add five year cash reserve for discretionary expenses, add growth opportunity to your portfolio, stay flexible by temporarily adjusting downward your discretionary spending if necessary.
Also by John Clements is the WSJ’s “Why you should keep your portfolio balanced” in which he explains the importance of ‘rebalancing’ as a way of making you a better investor. Clements discusses three benefits: it forces you to act (“create an overall portfolio plan”, de-clutter and drives you from ‘picker’ to ‘asset allocator’), risk control/management (rebalancing between stocks and bonds reduces risk, but rebalancing within asset classes can raise returns) and prevents you from jumping on bandwagons whether stocks rise rapidly or plunge suddenly.
In the NYT’s “Financial schemes against the elderly are increasing” Constance Gustke looks at how “Financial crimes against elders are taking a toll on lives and pocketbooks. And trusted caregivers — the friends and relatives who offer support and guidance — are often the ones at fault, according to legal and financial specialists.” The elderly are natural targets with relatively large accumulated assets, no debt, mortgage-free home and often accompanied by deteriorating faculties, while their caregivers who are under financial pressure due to debts, weak economy and poor income might find it irresistible to help themselves to some of the assets of the unsuspecting senior. The root cause of abuse is mostly money but the abuser, is of not who one might expect, could even be a child with power of attorney over the finances of the elderly. The article recommends prevention, specifically good oversight of the power of attorney who have been known to write themselves large checks, or transfer the home of the elderly to their name. Co-trustees for trusts and co-agents for power-of-attorney are part of good checks-and-balances. The article also recommends that one should “watch for caregivers who want to isolate the elderly person”. Once the fraud has occurred, it is only rarely reported and when the money is gone it’s usually unrecoverable.
In the Globe and Mail’s “An ETF to help Canadian investors avoid home bias” Tim Shufelt reports that Vanguard Canada has released a new ETF VXC, the Vanguard FTSE All-World ex-Canada ETF, as an easy way to avoid home bias that’s common among Canadian investors who typically have 59% of their stock portfolio allocated to Canadian equities even though Canada only represents about 4% of the world equity capitalization. Such a home bias comes with risks like heavy sector concentration in financial/energy/mining and an absence of “consumer, health care, biotech and to some degree technology” sectors. The author notes that while there are currency exposures and withholding taxes and the 0.25% expenses associated with this fund might be higher than its components, but this is mitigated by elimination of much of the transaction costs and taxes on capital gains associated with rebalancing. VXC “gives investors the chance to eliminate home bias with a single security”. (Worth considering, especially in tax-deferred accounts where replacing a number of existing securities with VXC alone can be accomplished without adverse tax consequences.)
In the Globe and Mail’s “Preparing for death: Tips on how couples should plan their finances” David Friend discusses how to plan/prepare for the very common scenario that the husband dies, and he managed finances/investments. Some are diagnosed with a terminal illness and still have time to prepare but others “have delayed even the most rudimentary outline of what would happen if they were to die suddenly”. The article mentions: wills, appropriate beneficiary designations for retirement accounts, ensuring account access maintained (i.e. not frozen and knowing account numbers/passwords to access them), consolidation of information (bank/investment accounts, insurance policies, other assets, and their location), contact info for accountants/insurance/lawyers/ financial planners) and take necessary steps for smooth transfer of financial responsibilities-including the appropriate portfolio for the surviving spouse. The article also suggests “having a friend or relative as a sounding board for major financial decisions” after the passing of a spouse; the decision still remains with surviving spouse.
On the same subject, the NYT’s “There is more to estate planning than just wills” notes that the “information that family and friends will need when a loved one dies goes far beyond those much-talked-about documents”. Erik Dewey put together a free online book entitled “The Big Book of Everything” (both in PDF and excel format) and Mark Gavagan wrote “12 Critical Things Your Family Needs to Know.” The article also touches upon the trusts (their necessity and lack their of), wills, living wills and durable health care power of attorney, and power of attorney (finances). “But it’s not enough to write these up and put them in a drawer, or even worse in a safe-deposit box where no one has access to them. They should be scattered as far and wide as possible — your spouse, your children and your doctors…” Also mentioned are password and account names, health history, “how your house works” and perhaps a letter to family and friends to be read after your death. (Thanks to MF and EF for recommending. Great article which digs into the next layer of how to make things easier for those left behind.)
In the WSJ’s “How to Play Catch-up on Retirement Savings” Walter Updegrave has a “catch-up list” to consider if you didn’t save enough and you are approaching retirement with less than at least 5-7x salary. The list includes: increasing savings significantly (adding a further 5-10% of salary), working longer than planned, postpone taking social security, working part-time in retirement, and more likely a combination of these.
(It’s amazing; apparently there are still people who own mutual funds J!) In the Globe and Mail’s “Unfinished business: It’s time to end embedded commissions” Tom Bradley writes that “Canada is on the verge of making meaningful headway in advancing clients’ understanding of their portfolio…as the CSA will require by July 2016 that investment dealers clearly disclose, at least annually, everything the client has been charged (commissions, management fees and administration charges) and provide a full reporting of investment returns.” While this is progress, it is insufficient; the CSA must also “eliminate embedded compensation, or what’s commonly known as trailer commissions – an arrangement whereby the financial adviser receives a portion of a mutual fund’s fee (usually 1 per cent for an equity fund) as long as the client holds the fund”.
In ETF.com’s “Beware Tactical Asset Allocation” Larry Swedroe referring to Morningstar studies calls Tactical Asset Allocation (the attempt to improve performance as compared to a benchmark allocation by adjusting asset allocation periodically according to “economic and/or market (technical) indicators”) just “Market Timing by another name”. He concludes with the observation that “…the next time you are tempted by the tactical asset allocation strategy….(remember the) Bottom line: big fees, poor results. In other words, TAA is just another game where the winners are the product purveyors, not the investors.”
In the Financial Post’s “Canada doesn’t have our back: free health care only goes so far, especially for some seniors” Melissa Campeau looks at the flawed view that Canadians don’t have to worry about health and long-term care costs as they age as these are covered by the Canadian health care system. The article discusses “limits of the Canada Health Act and the merits of advanced care planning”; specifically the limits of (non-homogeneous) drug coverage across Canada, lack of timely access of “non-emergency” medical procedures, the cost of home-care and often only partial coverage to even basic long-term care facility. The article notes that planning is required to make sure that funds are allocated as part of the retirement planning process. A care planning advocate notes that while nobody in Canada will be completely “stranded by the system”, but planning is required for those who want some level of independence and choices. Often family and friends provide much of the care needed by elderly but that comes with steep “physical and emotional cost” and impairs “caregiver’s ability to generate income”. (While numbers are tossed around for various costs, this sensitizing article to the need for Canadians to plan for cost of care in old age, could be significantly more powerful if it included some guidelines for fund allocation required to meet these needs. One way to start thinking about the numbers might be a guesstimate of $3000/yr for medical/dental/drug costs as part of the annual retirement budget, and a reserve of about $150,000 for long-term care per person, although when the second of a couple ends up in long-term care the cost is not fully incremental as the regular household expenses will no longer be required when (s)he enters a long-term care facility.)
In ETF.com’s “Don’t invest without discipline” Larry Swedroe writes a “well-thought-out” financial plan is necessary, it is insufficient if it is not accompanied by the disciple to execute it. The article discusses the difference between strategy and outcomes, and how results are insufficient to judge performance without considering “the costs of the alternative”, the persistence of (market, size, value, momentum) risk premiums, and the frequency of when one or all four premiums were positive in a month.
In the Globe and Mail’s “Home price surge in Calgary, Toronto, Vancouver ‘can’t go on forever’” Michael Babad reports that Sal Guatieri in a BMO report sees lower price gains and “slower sales and residential construction starts” and wonders “how long can they (price gains) continue to eclipse the rise in incomes”. “The longer it does, the greater the risk of a correction.”
FloridaRealtors’ “Profile of International Home Buyers in Florida 2014” new report has some interesting statistics such as: of all US home purchased by international investors 25% buy in Florida, Canadians represent 32% of international buyers (Europe 24%, Latin America/Caribbean 23%, Asia (mostly China) 10%), and more interesting statistics. (Thanks to AR for recommending.)
In the Financial Post’s “The key to real estate investing? It’s all local” David Kaufman argues that you can’t “lump all real estate investments into one bucket”. The article discusses categorization of real estate: type (residential, office, industrial, and commercial), sub-categories (e.g. residential into single-family homes, multi-family, condo, and apartment) and further sub-sub-categories. But even more important may be the geographical considerations. “Without a powerful macro force that affects all of these situations simultaneously (such as a sudden and extreme increase in interest rates), the simple answer to these questions is that real estate is, in fact, local, whether it is by geography, type, investor or capital structure.”
Pensions and Retirement Income
In the Globe and Mail’s “Report questions Canada Pension Plan Investment Board’s ‘active’ investing” Bill Curry writes that a new Fraser Institute study “is questioning the merits of the Canada Pension Plan Investment Board’s (CPPIB) increasing use of “active” investments to boost returns”. The study also argues that the CPP is not low cost as it is perceived when you add to the $490M 2012-13 operating expenses the “additional $782-million for external management fees and $177-million on transaction fees” are included. “The report said these total costs have grown from 0.54 per cent of assets to 1.15 per cent of assets over the first seven years that the new investing approach has been in place.” (No doubt that to many, cost and ‘active investing’ are not the only concerns; there are additional concerns associated with investments in private (vs. public) markets where valuation is more subjective and liquidity is much lower.)
In the Financial Times’ “Fund houses, unto pension breach” Sophia Grene writes that while investment managers are paying more attention to risk management since the financial crisis, but much of it has short-term focus with “volatility the main proxy for risk”. But a more relevant risk for most is “the risk of failing to accumulate enough money to meet their aims, usually a reasonable retirement income”; i.e. are you saving enough for retirement in a world of lower returns, increasing life expectancy and increasing dependency ratios? Grene argues that the asset management industry is in the best position “to developing an effective retirement savings framework” given its clout and expertise. (While that may certainly be true theoretically, the industry as constituted has lost the trust of its clients by continuing its rent-seeking ways and fighting tooth and nail the fiduciary standard of care. With the exception of Vanguard, is there another financial institution that can claim to be operating in the best interest of its clients? We need the financial industry reconstituted into Vanguard-like mutual corporate structure before the practicality of Grene’s proposal can be realized.)
And just to drive home the point that the asset management industry may be in the best position to develop an “effective retirement savings framework” has not earned the trust of society to do so is another article in the Financial Times’ “Investors’ headline fees ‘only a fifth’ of total” Steve Johnson writes that according to research result by one UK’s largest pension funds “Headline fees charged by asset managers may be as little as a fifth of the total amount siphoned off from investors”. The article notes that “the industry… is structured for the service providers rather than the providers of capital” with private equity and venture capital funds being some of the worst.
In the Financial Times’ “Warn consumers of pension tax traps” Josephine Cumbo reports that pension industry insiders urge that the potential tax implications must be considered by their customers when they chose to take the cash rather than the pension.
In the Financial Post’s “The biggest myth about defined benefit pensions is how much they cost” Fred Vettese notes that while unions are fighting the replacement of DB pension plan with target benefit plan “that looks just like a defined benefit plan but strips away the guarantee”, but what the unions prize even more than the guarantee is “the artificially low price that is placed on the guarantee. If employers reflected the true cost of defined benefit plans when negotiating the wages of unionized workers, few workers would want such a plan.” Vettese also adds how ironic it is that unions (who are opposed to target benefit plans) still are pushing for an expanded CPP which is a target benefit plan.
In the Globe and Mail’s “Got a defined benefit plan? Lighten up on bonds” Rob Carrick discusses the reduced need for bonds when they factor in any defined benefit pension plan that they may have, if the employers’ pension plan is well funded. If Canadians’ OAS/CPP and defined benefit pension plan together generate sufficient income to cover 50-70% of pre-retirement salary “then there’s a case to be made for avoiding bonds and focusing on stocks in an RRSP or TFSA”, subject to the investors’ risk tolerance (at least the willingness portion of risk tolerance).
Things to Ponder
In WSJ’s “Can peers burn holes in your portfolio?” Jason Zweig notes that “for investors, emotions can be contagious… (and) now is the time to immunize yourself against the risk that a sudden selloff will infect the markets—and you—with panic”. New research has shown that “people aren’t merely trying to conform to the crowd, their actions may have been shaped by shared attention”. In conclusion is suggests that “the investors you follow may be as important to your returns as the investment returns”.
In the Economist’s “One market must be wrong” Buttonwood refers to a long-term asset returns study by Deutsche Bank which points to what many would consider a surprise: “current 2% US inflation rate is above median since 1790”, “deflation was quite common at the global level in the 19th century, but has not occurred since 1933” due to “modern central banking and fiat money”. Furthermore, “if secular stagnation has set in, then yields could stay low for longer” than now anticipated due to demographics (working age population growth dropped from 7.3% (1995) to 2.1% (now)) and lower participation rates. However if low bond rates can be justified by secular stagnation, then the implication might be that the “equity valuations are not justified”; Deutsche Bank’s assumptions for asset class real returns are negative for the next decade for equities, bonds and property, with equities and property being the poorest performers.
But Brett Arends in the WSJ’s “The Case for Sticking With Stocks-No matter the price” quotes three reasons given by Andrew Smithers on why “investors with long horizons should maintain a minimum of 60% in stocks”: historically stock returns are higher than alternatives, “overvalued stock markets often become even more overvalued before correcting back down”, and market timing (moving to cash and the trying to re-enter market at a lower point) is emotionally stressful and almost impossible to execute.
In ETF.com’s “Robots leave money on the table” Elisabeth Kashner looks at the selections of ETFs used by robo-advisers and she discusses what she calls “all the pieces” of their ETF selection process like “opportunity costs, holding costs and trading costs”, and suggests that they picked low expense ratio funds, sacrificing coverage or tax efficiency”. (It’s worth a read just for getting an insight in the complexities of building a portfolio using ETFs from different vendors who implemented different indexes. However I am not sold by her arguments because what is missing is the qualitative element of trust that ETF originators have gained or lost over time. For example she suggests BlackRock (IEMG) ETFs over Vanguard VWO because it contains small caps (true). But BlackRock introduced IEMG when it already had an Emerging Market ETF EEM, and had no doubt more in mind than offering a better mousetrap to its investors, i.e. adding small-caps and reducing expenses to 0.18%. BlackRock’s EEM at an expense ratio of 0.67 and Assets=$44B is pulling in almost $300M (!) in fees per year, but was rapidly losing the battle for new funds flow to VWO which is currently charging 0.15% and has $69B in assets; so by introducing IEMG with expense ratio of 0.18%, it was clearly aimed at stemming the asset flow loss to VWO. EEM investors were left stuck with 0.67% expenses or 0.5% higher annual fees, yet unable to dump EEM without major tax costs as most no doubt had significant unrealized capital gains. So BlackRock chose to do what’s good for BlackRock rather than what’s good for its customers; in fact who knows what IEMG fees will be in the future as unrealized gains (hopefully) build up in it. In investment management trust is everything, and many investors who understand the importance of fiduciary level of care, will lean toward an asset management firm structured as a mutual rather than a public corporate entity whose objective is profit maximization to management firm’s shareholders.)
In the Financial Times’ “Smart beta approach plays to the crowd” Steve Johnson opines that that while market cap approaches allocate new money inflows “to individual stocks in relation to size, so additional inflows raise all boats, but do not distort relative valuations”, smart beta allocates new money “into the stocks that score highest by whatever filter is being used”. This, warns Johnson, can lead to ““crowding” in favoured stocks, which many believe could lead to price bubbles and illiquidity in market sell-offs”
In the Financial Times’ “Yield chasers cross the beta desert at their peril” John Plender writes that “In a market where asset prices are comprehensively rigged by central bankers, rational investment becomes impossible…the search for yield is simply a euphemism for buying a higher income while ignoring higher risk”.
In InvestmentNews’ “Vanguard urges caution on liquid alts” Trevor Hunnicutt reports that Vanguard, which has so far mostly avoided alternatives warns that “neither investors nor manufacturers know enough about the value those (alt) strategies will have over long run. Their performance, so far, hasn’t “been living up to their billing”. On the same subject in the Financial Times’ “The Rubik cube of liquid alternatives” Tom Stabile writes that money is pouring into liquid alts which are nothing more than “a mysterious blend of liquid and illiquid assets, sometimes with other ingredients such as leverage and derivatives…cloaked in the familiar” mantle of mutual funds! One manager calls liquid alts a repackaging of “investments meant for the long term into a mass-market vehicle that trades practically in real time” with much of the investment allocated to “assets that are highly correlated to the public markets”. Regulators are also starting to look more deeply into these funds.
In Bloomberg’s “Financial strategies for new single majority” Ben Steverman reports that “For the first time, a majority of U.S. adults are single. In 1976, the earliest comparable statistic available, 37 percent of adults were single…The single life has its perks, but can also be more expensive and harder to plan for.” Steverman discusses some financial threats to single living, such as: requirement to start saving earlier because those marrying later will make saving more difficult due to overlapping expenses, long-term care planning, and divorcing women wanting the family home which is more of a “burden than a benefit” and end-of-life plans (power of attorney, healthcare proxies, etc)
And finally, in the NYT’s “Increasingly, Retirees Dump Their Possessions and Hit the Road” David Wallis discusses a growing trend among retirees “who have downsized to the extreme, choosing a life of travel over a life of tending to possessions” and becoming what they call “senior gypsies” or “international nomads”. The same issue also has a couple of related articles, Ron Lieber’s “For some, ‘tis a gift to be simple” in which he discusses new research showing that “If you can cover basic expenses, pursuing inexpensive, everyday things (e.g. a library card) that bring comfort and satisfaction can lead to happiness equal to jetting about on international trips in your 70s and 80s.”, and Claire Milners “Is owning overrated? The rental economy rises” in which she explores how “…the rental economy is part of a growing, post-recession movement to value experiences over possessions. Anticipating a new belonging can bring more happiness than actually owning it…”