Contents: Assessing financial progress, Vanguard next disrupting business of financial advice, dumb money getting smarter, factoring health and long-term care into financial plans, housing finance reform needed now, Florida home sales/prices slowing, annuity/pension vs. lump sum decision customized to your needs, relaxing pension withdrawal rules, public vs. private sector pensions, battle over Nortel carcass continues: bondholders 100 : pensioners 0 so far, pension funds start to exit hedge funds, is your portfolio ready for frothy markets? indicators for next crash, stock performance and recessions, emerging markets facing headwinds? negative interest rates in Europe, dementia care paradigm shift: focus on patient not the disease.
Personal Finance and Investments
In the WSJ’s “Three Ways to Assess Your Financial Progress “ Jonathan Clements gives readers three measures to check whether they are on track financially to retirement: (1) years of freedom accumulated (defined as (assets including home – liabilities)/annual spending incl. taxes), (2) the old 4% rule (25 times required retirement income net of pensions), and (3) assets net of liabilities as a multiple of current working income with a target in the range of 10-12. Some measures to consider for these: (1) years of freedom can be improved/raised by reducing spending, (2) 25x retirement income (4% rule) at age 65, can be tracked at milestones like 4x/10x/17x by ages 35/45/55, and (3) calculate income replacement rate by applying 4% rule to12x current income and adding expected Social Security, this might result in about 70% replacement.
In the WSJ’s “The rise of ultracheap financial advisers” Jason Zweig writes that just as the death knell of corrosive fees can be heard, once again Vanguard is trying to bring disruptive change to the business of financial advice as it has already done to asset-management fees. Vanguard is the benchmark with average ETF expenses at 0.19%, and investment management plus financial advice for 0.3% per year. The more assets you have at Vanguard the more advice you’ll get, but if advice is insufficient you can still go to a dedicated planner for more complex planning needs.
In Bloomberg’s “The dumb money is getting smarter, every day” Ben Steverman reports that it is getting increasingly more and more difficult to tell “smart money” apart from “dumb money”. “More amateur investors have given up on trying to outsmart the market. And even the most sophisticated investors are rejecting strategies that require Ph.D.-level math and managers with million-dollar salaries.” (Are you still buying high cost actively managed mutual funds? Why???)
In WSJ MarketWatch’s “The retirement problem your financial advisor can’t solve” Elizabeth O’Brien reminds readers to plan for spending spikes during retirement due to health and long-term care needs. Also one needs to factor in the possibility that while one of a couple might need long-term care the other might still be living at home. Also InvestmentNews’ “Advisers help clients brace for health care surprises” Darla Mercado writes that advisers can help clients plan for such surprises with: disability insurance while working, long-term care insurance (or self-insure by saving for this), assess probability of having high health/long-term care costs based on “health risk factors” such as drug spending and lifestyle. For example somebody with “chronic conditions and (who) lives an unhealthy lifestyle” may only need to plan for 2-years in a long-term care facility but for “healthier retirees whose greater risk might be dementia” should plan for 5-years.
In the Financial Times’ “Deeper reform of housing finance is vital for stability” Martin Wolf writes that “housing finance matters” and high income countries have been doing it all wrong. He writes that the impact of housing finance goes far beyond housing because there is a feedback loop with higher prices driving higher lending which in turn further increase house prices, ultimately leading to “asset-price bubbles, huge increases in leverage and unsustainable household spending”. Wolf discusses how the “strong social consensus in favor of owner-occupation” is often used to justify assorted subsidies including “universal failure to tax “imputed rent””. He argues that if the gravy train is to continue and in order to avoid future disasters, reform must include three things: risk must be privatised (instead of socialized as it is in the US), the need to make “macro-prudential” policies work and that we must replace “inflexible debt contracts” with “shared equity contracts”.
In the Sun Sentinel’s ”Broward home prices up 7%; PB County sees 2 percent drop” Paul Owers reports that Broward prices are up 7% YoY but sales were off 7% compared to August last year. In Palm Beach County prices are off 2% YoY (“the first decline in 27 months”) and sales were down 16% compared to last August”.
Pensions and Retirement Income
Earlier this week I posted the 5th and final part in the series Annuity/Pension vs. Lump-sum- Part 5: Putting it all together which pull together the sequence of steps that you can take so you can explore your personal situation for the annuity/pension vs. lump-sum decision. To help you see the big picture, I have taken here another example, in this case an 85 year old single male with a life expectancy (i.e. 50th percentile) of the order of 5 years and a 90th percentile life expectancy of about 11 years, instead of the previously used, 67 year old couple who need to finance a potentially 30 year long retirement. If you read the through the first four parts and the topic is relevant in your circumstances, then you are ready customize the process for your situation. Good luck!
In the Globe and Mail’s “New pension rules allow retirees to withdraw directly from plans” Janet McFarland reports that “The federal government has introduced new regulations that would permit retirees to remove varying amounts of money each year from their defined contribution (DC not DB) pension plans, meaning they can take more cash than is currently allowed as they reach later years of retirement.” These new rules, which apply to federally regulated pension plans (banking, telecom and transportation) add a new 3rd option to the existing choices of buying an annuity with fixed annual benefits or a LIF which limits withdrawals within age dependent caps and floors intended to insure that government gets tax income even if you wouldn’t need to draw from assets but also limits withdrawals to insure that you don’t run out of money before about age 90-95. The new option apparently will still have caps in early years but allow much higher withdrawals after age 80. This is presumably intended to help people who have high medical expenses. (Some might suggest that this is just tinkering. The changes really required is to relax both floor and ceiling limits for both federally and provincially regulated plans. Even more importantly what is really needed is to allow the purchase of longevity insurance inside a LIF/RRIF/DC-plan, as was recently done in the U.S. for 401(k)s). By the way, BenefitCanada’s “Nova Scotia amends Pension Benefits Regulations” reports that “The Government of Nova Scotia has amended pension regulations to allow greater flexibility for people to withdraw from locked-in pensions when facing financial hardship.” Financial hardship definition includes reduced income, high medical expenses, mortgage foreclosure and imminent rental eviction.
In MoneySense.ca’s “The truth about public sector pensions” Jonathan Chevreau discusses the pension envy resulting from the large and expanding gap between public and private pensions. The security and size of public sector pension plans are unmatched by what is achievable by RRSP savings given the cost and the inherent savings caps specified in RRSPs. Chevreau notes that “one sure route to financial independence is to land yourself a government job right after college, make sure you’re in the DB plan if it’s offered and hang in for 30 or 35 years.” (May not work for everyone J)
The Nortel bankruptcy trial moves along this past week with focus on who owns the intellectual property sold for $7B as discussed in “Nortel judges query patent licences in $7 Billion fight” and “Nortel bankruptcy trial closing arguments begin” with “A key question for the courts to decide is: which of the Nortel companies owned the patents and IP.” The Canadian creditors argue (correctly) that the Canadian parent owned all intellectual property and only licensed it other subsidiaries, whereas US bondholders argue that the US subsidiary is entitled to the patent sale proceeds. (A few weeks ago the bondholders wanted their claim jacked up by a billion or so dollars claiming entitlement to interest on bonds since bankruptcy, this week they also want unfair share ownership of assets in the lock-box.) “A spokesman for the Canadian Nortel employees and pensioners says its members could get just 11 per cent of their benefits under the U.S. approach to dividing the patent money, compared with about 60 per cent under the Canadian approach and, even more, about 70 per cent, under a third approach proposed by the U.K. creditors.” The U.S. bondholders want ownership to be determined according to proportion of Nortel’s sales in the US rather than legal ownerships according to “Nortel was a multinational firm, not Canadian, U.S. unit argues”. Whereas “Nortel’s Canadian workers face meager payout under bondholder deal” reports that Canadian pensioners’ representative argued that “Canadian parent company has become “the dumping ground” for claims from creditors worldwide, yet is being told by other claimants that it doesn’t have the right to proceeds from the sale of Nortel’s assets because they belonged to individual subsidiaries.”
Things to Ponder
In the Financial Times’ “Investors lose that lovin’ feeling for hedge funds” David Oakley re-tells the old joke about the definition of a hedge fund as being a “A fee structure in search of a client to rip off…” in an article discussing Calpers’ exit from hedge funds. The reality of recent poor performance and high/complex fee structure and the lack of predictable/sustained performance are no doubt testing the patience of many institutional investors; Oakley writes that “pension funds are starting to take the old financial joke seriously”. (And by the way when retail investors hear ‘alternatives’, they should do the same.)
In the NYT’s “Parents, the Children Will Be Fine. Spend Their Inheritance Now” Ron Libber writes that the “vast majority of retirees with children cling to an intention to leave something behind, even though many of those offspring have no expectation of receiving an inheritance”. He argues that there is neither the need to do that nor the expectation on the part of beneficiaries. Libber asks “how can we middle-aged kids convince our parents that they are officially off the hook?” So he suggests the following letter to parents: “Mom and Dad: I expect nothing from you going forward except love, conversation, holiday meals and grandchild babysitting. Spend your money on your health and comfort and making the kinds of memories with close friends and family members that will last even as other, older ones fade. Leave a bit aside for me or for charity if it truly makes you happy, requires no sacrifice or makes sense for tax reasons. But otherwise, spend what you have and have faith that the education and life skills you already gave me are more than enough. I don’t want an inheritance, nor do I expect one.” He concludes with “If any fellow adult children agree, go tell your parents the same thing this weekend.”
A growing number of articles are warning about frothy markets, how to identify them and what to do about them. In the Globe and Mail’s Four questions you need to answer about your current asset mix Tom Bradley, while admitting that he doesn’t know “where we are in the market cycle”, suggests four questions for a reality check relative to 2010, 2011 and 2012: Is your portfolio equity content higher now? Are your “stable investments” riskier today? Is your equity allocation appropriate given that you are 5-years older, Are you less concerned about negative returns? A yes answer to most of these suggest that your risk is much higher (By the way, systematic/regular rebalancing to your target asset allocation compatible with your risk tolerance would have gone a long way to reduce your “yes” answers.)
Another warning in the Financial Times’ “The glaringly obvious guide to the next crash” where James Mackintosh enumerates the various signals flashing red warning signs (leveraged loans to private equity, low yielding junk bonds, boom in IPOs, the buy-back and take-over boom, etc) but he also notes that “The warnings are clear, but history teaches that markets can ignore sell signals for years. Only with hindsight can we know for sure.”
But then Larry Swedrow in ETF.com’s “Stock performance in a recession” notes that “during the 12 recessions since 1945… the average total return to the S&P 500 Index was a positive 3.9 percent. This, however, was below the 4.9 percent average total return to one-month Treasury bills.” But he concludes with “The important takeaway is that the track record of economists’ ability to forecast recessions is poor, and there hasn’t been much—if any—advantage from timing the market, even if you happened to know exactly when a recession would begin and end. As a result, trying to time the market based on forecasts of recession doesn’t seem to be a prudent strategy.”
Emerging markets have been retreating the last couple weeks due to fears of the impact of the Fed’s QE tapering and possibly even starting to raise interest rates. In the Financial Times’ “Emerging markets brace for a bumpy ride” Gillian Tett discusses the damage inflicted on emerging markets in 2008 due to losses they had to absorb when investors rushed from their currencies into the USD, perceived as safe haven. There is concern that investors reaching for yield in emerging markets will try to rapidly exit when USD bond returns start rising. Tett refers to the “data fog” surrounding issuance of emerging market bonds and the highly concentrated asset management industry and its tendency to herd-like behaviour, all adding up to higher risk. John Auther’s Financial Times article “Funds and ETFs magnify EM volatility” fuels emerging market fears further when he discusses how the growing number of emerging market funds and ETFs, and investors’ tendency to herd-like behaviour could have significant negative effect on prices of EM securities. His suggested solutions include: active managers to really be active, and ETFs that “do not track mainstream indices”.
In the Financial Times’ “Europe shows negative interest rates not absurd- and might work” Ralph Atkins writes that while “”negative interest rates” might appear nonsensical” they may be the answer to the threat of eurozone deflation, and Ireland, Germany, Belgium and Switzerland are now experimenting with this. The objective might be to encourage people to spend fast since “holding money erodes its nominal value”. Some might decide to just put the money under their proverbial mattresses or into safes. The author notes that “markets have not yet priced in full deflation or the “Japanification” of the eurozone”. (Could it happen in Europe? Then US/Canada? If yes, then today’s puny rates may not look so puny in retrospect.) Sure enough the WSJ article entitled “Treasury-Bill yield tips into negative territory” indicates that US T-bills “maturing on October 2 trade at -0.01%” due to a scramble for scarce short-term assets to park short-term assets.
In a three minute video by Morningstar’s Ben Johnson entitled “Kicking ‘smart beta’ to the curb” he calls it a marketing slogan initiated by product manufacturers, noting that not all so called” smart beta is smart, and even the smart ones only outperform in some markets. Cheap, multi-factor strategies will always be better than active management.
And finally, CARPs “Let’s Talk: Canadian dementia care is need of a paradigm overhaul” argues that a paradigm shift in dementia care is needed “…to change how we think of cognitive impairment – it is more than a disease – it is a social issue and how we treat sufferers says as much about us as it does about them. We need to focus on the person and not the disease. There is more to patient-centered care than empty rhetoric. In fact, the whole concept of person-centered care is essential to the provision of excellent dementia care. Each one of us should ask ourselves: how would we want to be treated and most importantly – how would we want our mother to be treated if she suffered from dementia?”