Contents: Early retirement-not so fast, structured notes-beware, target-date funds too risky for young??? Moody’s warns on Canada’s house prices, snowbirds: rent or buy? Canadians being hyped to buy FL real estate, only spending rule paper for retirement, retirement savings: adequate or not? working longer risky plan for inadequate saving-29% couldn’t for medical reasons, pension fund solvency ratios hit again, some active managers may outperform but you can’t pick them a priori, silver demographics driven economic opportunities, cost of advice and its impact, Kivenko: financial advice does bring benefits to the economy but most of it accrues to financial industry and advisers, valuations and asset allocation, stocks: how low will they go? positioning for market turbulence, Vanguard seminar on “active in passive”.

Personal Finance and Investments

In the WSJ’s “The real math on retiring early” William Bernstein discusses the two major problems with retiring at age 50: (1) you’ll have a long retirement given that life expectancy at 50 is 82 and 86 for males and females respectively (and half live longer by definition); furthermore with life expectancy growing a couple of years each decade “with a little luck, at least one of each of today’s couples should make it to the century mark”, (2)”expected portfolio returns ain’t what they used to be”, a 60% stock and 40% bond portfolio returned real 5.6% between 1926-2013 allowing you to spend that whereas current expectations might be for a 2% (if you disagree, you can put in your own number for real return of such a portfolio) real return on such a portfolio leading to a safe 2% real spending assuming no “bad return years early in retirement”, no investment fees and expectation of ability to manage your own portfolio now and late in life (given the risk of dementia).

Jason Zweig in the WSJ’s “Structured notes: The risks of insuring against risks” warns about structured notes which are predictably trotted out by brokers and financial advisors each time market turbulence rears its ugly head.” Structured notes follow fear and volatility the way mushrooms sprout after a rain… But whether you should buy them depends on the exact terms of each note—and on whether you can trust your adviser when he says he understands them.” Some of the questions to ask include: what’s the objective? Can it be achieved cheaper? What’s the maximum you can lose? When will income be received and how will it be taxed? (Structured notes and alternatives: if you don’t understand them then don’t even think of buying them, and of course if you understand them you’re probably less likely to do so.)

In WSJ’s “Target funds are too risky for youngest workers: Arnott”  Karen Damato discusses the risks that comes with target-date funds. While the risk associated with them has been covered extensively especially at the point when one transitions into retirement. However this article argues their inappropriateness even for very young workers (who would typically be allocated to stock near the 80-100% level) due to the risk that the might lose their jobs and would have to cash out their retirement savings?!? (Is rule 1 in investing not “put aside sufficient accessible/emergency funds to cover 4-12 months of expenses when young and perhaps 2-5 years in retirement”??? So what is the problem here?)

Real Estate

In the Globe and Mail’s “Moody’s warns on housing, debt, but Canada retains top rating” David Parkinson reports that Moody’s has reaffirmed Canada AAA rating…BUT “it warned, the housing market and consumer debt could threaten these healthy conditions…(and) this combination presents a potential risk to the banks and to the federal government directly”. “The report said Canada’s housing market “appears to be particularly inflated, especially in the largest metropolitan areas… leading us to conclude that Canada’s real estate market continues to pose downside risks to our [economic] growth forecast.””

In the Financial Post’s “The new question for Canadian Snowbirds heading south: To buy or rent?” Garry Marr presents anecdotal evidence that snowbirds are having trouble finding rental property due to the competition for rentals from those who have lost the homes following the market crash and increasing rental prices in general and seasonal rental prices in particular. An example presented shows a couple deciding to purchase a $550,000 property (presumably for cash) “We put the capital into it but the bills are about the same to maintain this place.” They argue that this makes economic sense (you can be the judge) instead of the renting for $5,500-$6,500/mo for 3-months, and they’ll have the flexibility to stay longer.  He quotes RealtyTrack that nationally in the US it is cheaper to buy than to rent based on “monthly mortgage payment for a median priced home versus the average monthly fair market rent for a three-bedroom home…including insurance and taxes when calculating costs for homeowners…. In the 128 counties in the three U.S. sunshine states (FL, AZ, CA), it was cheaper in 107 to buy than rent.” Currently Florida prices are about 30% higher than the bottom but still 30% below 2006 peak. (I have no information on the ease/difficulty of finding appropriate short-term/seasonal rental property; though you would think that most people have lost their homes did so over 2-3 years ago, and that should not be a significant contributor to increased rental demand at this point.) Unfortunately no data was provided as to which counties are more expensive to rent in Florida (especially for snowbirds).  Still, the fact that: maintenance costs are not included, that property taxes for snowbirds in Florida can be 2-10x higher than for Florida residents, would make you wonder about the applicability of those broad statistics. Buying a seasonal property in Florida is not an economic decision; affordability aside it is a lifestyle/psychological decision.) By the way the hype-to-buy Florida real estate is on, especially to Canadians; see the Palm Beach Post’s “This country’s citizens are told to keep buying homes in Florida” (As usual, for Florida-based real estate industry inspired articles fail to mention the discriminatory property tax  treatment of Canadian owners in Florida.).

Pensions and Retirement Income

In the WSJ’s “How to make your savings outlive you” Jonathan Clements discusses a draft paper by Siegel and Waring  “The only spending rule article you’ll ever need” which clearly states what clearly needs to be stated, i.e. “don’t expect a fixed income from risky investments”. One could go with an inflation indexed annuity (in the U.S.) or use a ladder of TIPS which allow you to cover a 30 year horizon (or RRBs in Canada if available). But suppose that you want to use a (more risky) portfolio of stocks and bonds then you should forget about setting “settling on a spending rate when you first retire and then sticking with it (in real terms) for the rest of your retirement”. The authors might not be exaggerating/self-promoting when they call it “the only spending rule article you’ll ever need”. Their approach is a dynamic spending rule based on a method they call ARVA- Annually Recalculated Virtual Annuity”. ARVA effectively recalculates each year the annuity/income-stream that you could buy based on current: (1) real risk-free rate, (2) conservative estimate of how long you’ll need the income, and (3) assets available. If you would buy a TIPS rate ladder based indexed annuity on day one the amount that you would be receiving for life is the same purchasing power but you would have locked in the current interest rates for life (without the impact of the ultra-conservative/opaque life expectancies and administrative costs of the insurance company). Alternatively if you used ARVA with a risky portfolio, you effectively would be recalculating simulated annuity each year based on the then current value of the risky portfolio. So you got to be able to live your life with some built-in spending flexibility. The risky portfolio approach might also be combined with a longevity insurance if you’re still concerned about longevity considerations. The article also has a good discussion about the meaning of risk in terms of income rather than asset variability. (It is a really good article; I will try to summaries some highlights of the Siegel and Waring paper with some numbers based on current context real risk-free rates, how years of required income are calculated, how fixed and variable expenses might be used in conjunction with income variability to get a handle on the asset allocation for the risky portfolio.)

In the Globe and Mail’s “Why Canadians need to get more aggressive with their retirement saving” Rob Carrick reports on the importance of retirement savings discussed at a recent conference focusing on how “The adequacy of the nation’s retirement savings matters to everyone.” “Government per capita spending rises as people age, which is worrisome because there will be a growing imbalance between the number of working-age people and seniors. Mr. Dodge’s numbers show this ratio will fall from 4.5 to 1 last year to 2.3 to 1 in the 2050s.” Carrick notes that some of the speakers suggested that there is no retirement savings crisis (probably based on the assumption that retirees will be selling their homes at current prices), but he argues that “However well we’ve been saving for retirement, we need to do better. Give the taxpayers of the future a break.”  As to the possibility of working longer to make up for inadequate savings, in the Globe and Mail’s “Health issues force many into early retirement, new study”  Bertrand Marotte  reports that according to a Sun Life survey “29 per cent of those who retired earlier than planned did so for health or medical reasons”. “Our research shows that Canadians who are not financially prepared to retire typically say they will work longer to compensate, but unfortunately, they may not have that choice…”

In the Financial Post’s “Stock and bond market turmoil raises concerns about pension solvency” Barbara Schecter reports that “Record low bond yields and falling stock markets are putting pension plan sponsors “on course to revisit some of the financial anxiety of the recent past… The recent market upheaval could cause some pension plan sponsors to pause and re-assess their funded status and de-risking strategies”” “ Since the end of September, as the TSX slid 10% from a record high, funded ratios for most plans have fallen “dramatically…” (Not as dramatically as in early 2009 when some plans were down at solvency levels of 75%. The Nortel plan was at 59% and locked in at that level after the bankruptcy when FSCO and/or Morneau-Shepell in the name of de-risking the pension portfolio, locked-in all the market losses by selling all stocks in the portfolio at the market bottom and replaced them with bonds to get an asset-liabilities matched portfolio and prevent further losses; seemed like a good idea at the time.)

Things to Ponder

In the Economist’s “Curiosity killed the copycat” Buttonwood writes that “CAN active managers outperform? Clearly, the answer, on occasion, is yes. But can they be relied upon to do so? That is a much more difficult issue; one study found that backing the worst fund managers of the previous five years was more profitable than backing the best.” After discussing a study on copycat funds he concludes with “If it is difficult for professional fund managers to pick top performers, with all the information at their fingertips and with a big economic incentive to get it right, how much more difficult is it for the retail investor?”

In the Economist’s “The Silver Economy: Healthier and wealthier” Norma Cohen discusses how “By 2050 those aged over 65 will outnumber children under five. The first part of a series on ageing populations looks at how that demographic shift is creating a new and powerful consumer class.” The article is focused on the opportunity that comes with this demographic shift with a Merrill Lynch report “estimates that the over-50s account for almost 60 per cent of total US consumer spending and 50 per cent of that in the UK”. The article is full of very interesting charts on demographics and wealth distribution across the age groups.

In the Financial Post’s “’One of your only sure things’: Why it’s time to look at what you pay your financial advisor” Melissa Leong reviews investment management costs in Canada and what you get for it. Not new, but a reminder that even 1%/year over 30 years really adds up by reducing your accumulated assets by about 25%. (In decumulation, during retirement, it could be even worse.)

By the way you might be interested in reading Ken Kivenko’s “Observations on Conference Board of Canada report ‘Boosting Retirement Readiness and the Economy through financial advice’” in which he critiques the Conference board report’s conclusions that while advisors have not demonstrated that they can add value over passive approach to investing, but advisors “influence client savings behavior, risky asset holdings, and trading activity, which suggests that benefits related to financial planning may account for investors’ willingness to accept high fees on investment advice.” Kivenko argues that while some benefits from financial advisers result to the Canadian economy, but “most of it accrues to the financial services industry and ‘advisors’”. He concludes that “Financial advisors need to recast themselves as providers of advice, period. As long as selling products is bundled with advice, advisors will always be second class citizens, well behind professional engineers, accountants, lawyers…)

In ETF.com’s “Valuations and asset allocation” Larry Swedroe explains the three very important factors “determining your asset allocation: the ability, the willingness and the need to take risk”. “The ability to take risk is determined both by your investment horizon and the stability of your labor capital (and other income sources if in retirement). The willingness to take risk (risk tolerance) is determined by your stomach’s ability to handle the stresses caused by bear markets. And the need to take risk is determined both by your spending requirements (the higher they are, the greater the need) and the expected rate of return on your investment choices (which are determined by market valuations and bond yields).” Though Swedroe does not recommend making valuation based market timing decisions, he indicates that much higher/lower than historical market valuations will more than likely result in much lower/higher than historical returns. But he notes on the subject of the “need to take risk” this must be weighed against reducing “goals or increasing saving levels”, because the higher risk only suggests higher expected (but not guaranteed) return!

In the WSJ’s “How low will stocks go?” Brett Arends discusses stock market downdrafts like the recent correction of about 10% (quite normal), or the less frequent but larger drops as in the DOW dropping 38% between 2000-2002 and 54% 2007-2009. So a drop of the order of 50% should not be a great surprise given that we experienced that twice in the past 15 years alone. Some very pessimistic prognosticators suggested even a 75% worst-case scenario (As a reference, Japan markets dropped about 90% from the 1989 peaks.)

In the NYT’s “Market turbulence serves as reminder to tread lightly” Tara Siegel Bernard explores the same subject in the context of your financial goals and corresponding asset mix and risk tolerance. It is essential to choose an asset mix that you can live with, if markets drop 10% for a correction or 20% a bear market or even more precipitously, without panicking you into selling and locking in the losses. Taking advantage of rebalancing opportunities helps boost returns and maintain risk tolerance at target. Siegel Bernard concludes with “For investors who don’t feel confident enough to sort this out on their own, it is possible to find an unbiased, fee-only financial planner through organizations like the National Association of Personal Financial Advisors, the Garrett Planning Network or XY Planning Network. There is also a growing industry of online investment managers — sometimes called robo-advisers — that will handle the entire task for a relatively modest fee.” (I tend to stress test my asset allocation and corresponding draw typically by examining the consequences of a 50% market drop on my portfolio; if I can’t deal with that, I need to reduce my stock allocation.)

And finally, in ETF.com’s “Malkiel’s 11^th ‘Random Walk’ to mine ETFs” there is a link to a Vanguard webinar entitled “The power of active in passive” which discusses how passive components can be used to build factor  tilted strategies, differences between market and non-market weighted indexes, what the “new better” indexes really mean and how they tend to be skewed toward recent outperformance (not usually sustained after new index is operationalized), how once you factor in weights of factor risks the risk-adjusted performance disappears. (If you are interested in this subject you might wish to consider this one-hour seminar.)