Hot Off the Web- October 6, 2014

Contents: Tax smart investing, downsizing to rent? building wealth, reverse mortgages??? ‘advice’ from salesmen or real advisers? universal life insurance- not again? stock/bond portfolio instead of a GIC/CD- must be joking?!? US home price growth slows, Toronto condo prices correlated to stock market? Nortel judge to rule but end may be neither near nor good for pensioners, illiquidity premium is real, global inflation is down, Goldman tapes demonstrate regulatory capture, preventing heirs from battles, psychometrics help with risk tolerance determination? Google in financial services!?! he hopes to die at 75?


Personal Finance and Investments

In the Globe and Mail’s “Tax smart investing, Part 2: Control the type of income you earn” Tim Cestnick refers to his four pillars of tax-smart investing introduced in Part 1 of his tax smart investing series. These are to control the: (1) timing of income, (2) type of income, (3) location of income, and (4) offsets to income. This week’s article focuses on the 2nd of these, the type of income and introduces a number of factors to consider, including: your marginal tax rate, managing OAS clawbacks (and watch out here where capital gains/losses fit into this calculation), selling shares before ex-dividend date if you prefer capital gains.

The Financial Post has a couple of articles on the subject of retiree downsizing by Ted Rechtshaffen: “The newly rich: How your world changes when downsizing creates a windfall” in which he explores the implications seniors locking in the gains in their houses and downsizing to smaller house or a condo by buying or even renting one, and “Why older seniors should rent instead of buy” in which he makes a persuasive financial/practical (locking in current high prices, transaction costs of selling and buying, possible future need to move for health reasons, built-in protections for renters, renting from professional property managers) argument for renting rather than buying for older seniors (e.g. 76 year old couple) if you can get over the “point of pride…I am a home owner, not a renter”. He argues that ‘There is no clear right or wrong answer on the buy versus rent discussion, but for those with greater uncertainty over the next five to 10 years, you may want to consider renting for financial reasons as well as greater overall flexibility.” (Difficult to argue with Rechtshaffen on downsizing to rent, except if suddenly inflation takes off after the Fed’s orgy of QE, ultra-low interest rates and money printing; then suddenly real assets may become desirable for other reasons.)

In the NYT’s “Love them or loathe them, reverse mortgages have a place” Ron Lieber re-examines reverse mortgages: how they are pushed on TV by ‘celebrities’, unethical sales practices (take reverse mortgage and invest in some scam or leave wife of the deed). Still, he argues that there is a place for reverse mortgages: first and foremost because retirees have not saved enough and they have few choices given the need; also some of the most grievous practices have been curtailed and level of defaults have been reduced by legal and regulatory changes. Of course many people have a large proportion of their total assets buried in the house, and with the increasing time people spend in retirement, it often becomes unavoidable to tap into the home equity. Lieber quotes a respected advisor who endorsed the use of reverse mortgages (in a special case) as a form of (standby) insurance in case their portfolio had a massive loss that would otherwise necessitate the sale of assets at distressed prices; access to a ready source of a home equity line of credit which of course should be repaid as soon as markets recovered. Here is another perspective in Bloomberg’s “Why financial advisers still hate reverse mortgages” in which Bev Steverman opines that “A reverse mortgage is a little like a car airbag. It’s nice to know it’s there. But if it ever has to be used, the driver’s already in trouble.” In one example he shows how “Too often, reverse mortgages put people in irreversible situations… with much of her home equity tapped by a reverse mortgage, selling the home will no longer get her the cash needed to move to a smaller place or an assisted-living home.” (Yes, reverse mortgages might have value in some cases, but I would explore other options before resorting to them. For example see the downsizing to rent articles above.)

In the WSJ’s “The simple secret to building wealth” Jonathan Clements explains why “saving steadily is far more important than high earnings or investment wizardry”. The typical wealthy clients (and readers) he encountered “didn’t seem that way (i.e. wealthy)… They’re the couple who live in a modest home and take pride in driving their car until the odometer breaks. By clamping down on living costs, they can save great gobs of money, and that’s easily the biggest contributor to their financial success.”

In the Globe and Mail’s “Why is selling products intertwined with giving financial advice?” Rob Carrick (asks this good question embedded in the title, while he) discusses a new financial industry sponsored report “showing that if more people used advisers, we could solve two challenges posed by our aging population. One is that people aren’t saving enough for retirement, and the other is that economic growth could slow down with people aging and leaving the work force.” He correctly notes that, what the report does not, but the industry needs to address is that “the title “adviser” is just a word, not a profession backed by universal standards of training, transparency, ethics and regulatory oversight with clout. Pretty much anyone can call himself an adviser… (a term he calls one) which must surely rank as one of the vaguest terms in the financial realm.” He notes the lack of differentiation between true “advisers” and salespeople, and the need for real advisers to deliver a fiduciary level of care. On the same topic, InvestmentNews’ “An ‘adviser’ in name only” suggests that “calling a broker an adviser is dangerous, and it’s time to embrace the black-and-white distinction”. The article was triggered by the “recent termination of a team of top (Merrill Lynch) advisers because of allegations they had recommended that clients invest outside the firm… If recommending that clients buy off a platform is in their best interest, but doing so is forbidden, an adviser in this situation cannot possibly act in a fiduciary capacity. The question of whether all advisers should be held to a fiduciary standard becomes meaningless. They can’t when the broker-dealer’s interests bump up against the client’s.”

In the WSJ’s “Scrutiny of stock-linked insurance policies grows” Leslie Scism reports that just as sales are growing, New York State regulators and insurance industry leaders are increasing scrutiny (and criticism) of “indexed universal life insurance, (which) offers both a traditional death benefit and the potential for gains in a tax-deferred savings component, depending on the performance of a stock-market benchmark. Insurers cap the annual interest in exchange for protection against losses if the market drops”. The concerns are that “some insurance companies may be giving buyers overly optimistic projections of potential gains.” The article mentions other issues with universal insurance, such as: rapid growth of expenses as the insured ages, promises that future policy costs will be covered by accumulated interest often go unfulfilled and additional payments are required to keep policy in force especially given that many companies exclude dividend from the stock returns; and of course those really needing life insurance are usually better off with term insurance.

And in the bizarre (and don’t you believe it) category, is the Globe and mail’s “How about a GIC alternative that returns almost 8%?” where Gordon Pape flogs stock/bond portfolio as a GIC replacement. (The article seems to have overlooked what GICs are for in a portfolio. What is being proposed may or may not be considered conservative (as a portfolio), but certainly could not replace a GIC in my portfolio.)


Real Estate

The just released July 2014 S&P/Case-Shiller Home Price Indices “show a significant slowdown in price increases”, with 10/20-City composites increasing 0.6% in July compared to 1.0% in June, and 6.7% over the previous 12 months. “As of July 2014, average home prices across the United States are back to their autumn 2004 levels. Measured from their June/July 2006 peaks, the peak-to-current decline for both Composites is approximately 16-17%. The recovery from the March 2012 lows is 28.6% and 29.3% for the 10-City and 20-City Composites.” Miami and Tampa are up 0.8% and 0.6% for July and up 11.0% and 7.2% for the previous 12 months, respectively. According to the Sun-Sentinel’s “Home price index up 11 percent in South Florida” “The metro area of Palm Beach, Broward and Miami-Dade counties saw an 11 percent increase from a year earlier…” (And, as a result of the higher market prices, Florida non-homesteaded snowbirds should be receiving their new property tax assessment imminently and should not be surprised when they see 7-10% increases over the previous year…I always said that I was very happy with the property crash in Florida, at least it closed some of the unfair/discriminatory property tax gap between homesteaders and non-homesteaders. It doesn’t look like politicians are going to try to fix this inequity in the foreseeable future.)

In the Globe and Mail’s “What the TSX could tell us about Toronto condo sales” Tara Perkins reports that according to Urbanation economists “Over the past five years in particular, new condo sales have shown a strengthening, albeit still moderate, correlation to stock market values with a one quarter lag…” This may “suggest that condo buyers use financial gains to invest in condos, or buy units because they feel wealthier thanks to their rising financial portfolio…” (Interesting observation, although correlation does not necessarily imply causation. Does this mean that Canadian condo prices will be falling next quarter, given recent market performance???)

Pensions and Retirement Income

In the Financial Post’s “The fate of once-mighty Nortel’s last billions lies in the hands of two men” Hasselback and Tedesco report that U.S. Judge Gross and Canadian Judge Newbould have “separately retired to write opinion on which creditors can recover how much of Nortel’s remaining ($7.3) billions…”. There is no question that the complexity of this multinational bankruptcy case is probably one of the greatest in the history of insolvency. The judges noted that “while they might discuss some matters behind closed doors, each is obliged to draft his own decision that will follow the laws of their respective countries”. Of course they must also consider that their decisions might be appealed in their respective countries. The bondholders (who bought these bonds often at 10% of their face value) want 100% face value plus interest up to today (and this is at junk bond rates over five years past bankruptcy date), while everyone else seems to be suggesting a pro-rata distribution. Justice Newbould called writing his opinion a “daunting task” while judge Gross noted that when his wife told him “you are almost finished” he replied “No, it’s just beginning’’. (It may be daunting to judges but it is discouraging/demoralizing to pensioners who already took a 40% or so haircut. I have suggested many times before, if you are a Canadian pensioner, you should keep your expectations for recovery very low (American and UK pensioners already were made more or less whole due to pension insurance schemes in those countries.) Whatever the two Judges will rule according to the laws in their respective jurisdictions, the assets available for distribution (after the lawyers and other professionals get their pound of flesh which is already likely in the $1.5B area) have ended up in a JP Morgan lockbox in the U.S. (Why was that???) Furthermore, the U.S. Judge was not present (for the first time in the proceedings over the past 5+ years) when the Canadian Judge announced his decision on the treatment of bond interest (essentially that bondholders are not entitled to interest post bankruptcy protection date, and perhaps suggesting disagreement with the Canadian judge’s ruling). Now is your chance to place your bets on who will receive an unfair proportion of the remaining Nortel carcass, after the lawyers/professionals are finished feasting on it: Will Canadian pensioners be screwed one more time?)

BenefitCanada’s “Canadian pension plan solvency declines” reports that “Lower long-term interest rates drove down the solvency of Canadian DB plans from July to September. It was the first decline in two years.” The solvency ratio declined by 4.9% to 91.1%. Further downward pressure (to 86.9% if applied to this quarter’s result) will occur next year when the Canadian Institute of Actuaries’ new mortality tables take effect reflecting longer lifespan is scheduled to be introduced.


Things to Ponder

In the Financial Times’ “There is a history lesson to be learnt from Yale endowment” John Plender discusses that as the Yale endowment has demonstrated there is such a thing as liquidity premium, and (some of) those who can tolerate the illiquidity might be able to benefit from it. The article opines that investors tend to overpay for liquidity and “inefficiencies in illiquid markets offer a treasure trove for astute (long term) investors”. Also for a “genuinely long term fund a strong equity orientation need not be damaging except in the very short term”. Still, investing in illiquid assets resulted in superior outcome (both assets and annual contributions to university operations) for Yale. Plender also makes a point to distinguish between endowments (with flexibility in annual payouts) and pension plans where “liabilities are fixed in a way that university spending plans are not”.

In the WSJ’s “Global inflation eased again in August” Paul Hannon reports that “the annual rate of inflation in its (OECD’s) 34 members fell to 1.8% in August from 1.9% in July, the second straight month of decline. Among the Group of 20 leading developed and developing economies it fell to 2.7% from 2.8%. The G-20 accounts for 90% of global economic activity.”

In Bloomberg’s “The secret Goldman Sachs tapes” Michael Lewis  writes that given the complexity of the financial system and the revolving door between regulator and the financial industry, “Wall Street’s regulators are people who are paid by Wall Street to accept Wall Street’s explanations of itself, and who have little ability to defend themselves from those explanations.” Lewis calls the financial regulatory system dysfunctional with few among the public paying any attention to its proceedings. But Lewis thinks this will now change with the airing of the radio program “This American Life” a jaw-dropping story about Wall Street regulation, and the public will have no trouble at all understanding it…(based on) 46 hours of tape recordings, made secretly by a Federal Reserve employee, of conversations within the Fed, and between the Fed and Goldman Sachs. The Ray Rice video for the financial sector has arrived.” (Very interesting reading; it is not news but confirmation of the worse suspicions about so called “regulatory capture” by the financial industry, whereby over time the regulated industry ends up controlling the regulators/politicians who are supposed to regulate in the public interest. Some call this outright corruption while others explain it in terms of lack of knowledge/competence on part of the regulator.)

In WSJ’s “When heirs collide” Liz Moyer reports that family fights over inheritances often destroy family relationships and in fact “it isn’t uncommon for people to spend more money on legal fees battling siblings or other family members than they stand to inherit”. The battles are not just over money, and fair doesn’t necessarily mean equal; getting family input while one is still alive can also give you an opportunity to explain “lopsided inheritances”. The article also notes some maneuvers to minimize strife among heirs (e.g. have heirs “take turns at choosing what they want while you are still alive”) and choosing an unbiased and possibly an uninterested (not an estate beneficiary) referee in charge of resolving conflicts.

In the WSJ’s  “The challenge of gauging Risk Tolerance” Daisy Maxey discusses the challenges faced by advisors in determining clients’ risk tolerance and consequences of getting it wrong. A company which sells a “psychometric” assessment of an individual’s risk-tolerance” to advisors is FinaMetrica; its founder argues that “Getting risk right is one of the most critical parts of the adviser-client relationship, if not the most critical… The thing that sours most relationships is–usually in a bear market–a client discovers that he was taking more risk than he was comfortable with, and he didn’t understand the risk he was taking.” And of course, risk tolerance would likely be changing with time so it is important to review it especially as circumstances (not just age) change. The Financial Times’ “Can you resist instant gratification?” also discusses psychometric testing in context of risk-tolerance and overconfidence (as well as the marshmallow test in the context of deferred gratification) to insure that the “good wealth manager should try to get people as close as possible to the right financial solution in a way they’re comfortable with.” (Clearly there is a growing trend and need for better ways to determine risk tolerance of investors; and it is good to hear that work is going on to improve understanding. Of course we will only know after the next crash, whether the new approaches were useful.)

In’s “Open letter to Google’s Larry page on ETFs” Dave Nadig discusses the rumours about Google’s potential entry into the financial industry and provides some interesting unsolicited advice on the subject of: fiduciary duty, doing good (investor education, focusing on long term), buy instead of build (at least the corporate shell) and being a little humble. The entry of a non-traditional player like Google would no doubt “mean the opportunity for new ideas, new avenues and new ways to make investor outcomes even better”.

And finally, you might be interested in a provocative but thought provoking article in the Atlantic, entitled “Why I hope to die at 75” where the 57 year old Ezekiel Emanuel (Director of the Clinical Bioethics Department at the U.S. National Institutes of Health and head of the Department of Medical Ethics & Health Policy at the University of Pennsylvania) explains why he hopes to die at 75 (or rather why he expected no heroic efforts which might extend his life beyond 75). This will no doubt seem bizarre to readers who are a lot closer to or even well passed 75 than Emanuel, but it is a thoughtful article, whether you agree or not, in an age when the discourse is increasingly focused on euthanasia and physician assisted suicide. His discussion includes some expert views such as “over the past 50 years, health care hasn’t slowed the aging process so much as it has slowed the dying process”; and Emanuel adds that “American immortals may live longer than their parents, but they are likely to be more incapacitated. Does that sound very desirable? Not to me.” He also discusses the age-creativity relationship, our shrinking expectations as we age, the impact of hanging around too long on our family, and the importance of mentorship as a societal role for individuals as they age. He does admit (near the end of the article) that 75 was somewhat arbitrarily chosen, but then he shifts to a discussion of his planned changed approach to health care once he reaches this (or some other TBD age) milestone. “I won’t actively end my life. But I won’t try to prolong it, either.” He concludes with his own “do-not-resuscitate order and a complete advance directive indicating no ventilators, dialysis, surgery, antibiotics, or any other medication—nothing except palliative care even if I am conscious but not mentally competent—have been written and recorded. In short, no life-sustaining interventions. I will die when whatever comes first takes me.” He realistically does not (and should not) expect a rush by society to endorse his views, and he indicates that he “does retain the right to change his mind”!  (Still worth a read to at least force one to reflect upon the heroic efforts often undertaken by families/doctors to preserve the ‘life’ of a patient even when the patient might not even aware of it.)


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