Hot Off the Web- November 10, 2014

Contents: Decumulation-ARVA is progress, robo-advice and financial insanity, rental car insurance, conflict disclosure won’t cut it, financial abuse of older Americans, Bank of Canada warns on government’s housing exposure, more Americans rent rather than buy, South Florida house sales 60% cash, US retirement savings bleak, pension buyback? indexing upends risk-return relationship? Risk mistakes of planners, dementia risks for: clients and advisors, ‘alternatives’ not an asset class, Gross: deflation possible, Great Recession: fault-fix-prevention? “Winning the loser’s game” videos.

Personal Finance and Investments

In case you missed it, earlier this week I posted a review of a significant article “The only spending rule article you’ll ever need” by Waring and Siegel- A review   the authors propose a dynamic spending rule based on ARVA or “Annually Recalculated Virtual Annuity”. ARVA effectively recalculates each year the income that you would get if you could buy a fairly priced level payment fixed term real annuity based on current: (1) real risk-free rates, (2) a conservative estimate of how long you’ll need the income, and (3) the available assets. With a risky portfolio and ARVA, you effectively would be recalculating virtual annuity each year based on the then current value of your risky portfolio. So you got to be able to live your life with some built-in spending flexibility. The article also has a good discussion about the meaning of risk in terms of income rather than asset variability. I have added a spreadsheet illustrating the maximum (%) withdrawal rates for a given real risk-free rate as a function of age based on the proposed approach; the spreadsheet also includes a way to address maximum portfolio risk (stock allocation) consideration by factoring in fixed and discretionary expenses, and your “worst case” stock market drop assumptions. (I am impressed with their proposal and the “The only spending rule article…” may not be an overstatement at least now.)

In’s “Robo-advisor rally in ETFs has a big problem” Dave Nadig writes that while arrival of robo-advisers is wonderful as it will help solve some of what he calls “investor insanity”, but he worries that investors “…won’t remember to adjust their position as they get closer to retirement. They won’t realize the implications of an early withdrawal. They won’t understand that investing in the stock market while you’ve got credit-card debt piling up is a dumb idea. Worse still, they won’t think they need a financial advisor, because it’s all being taken care of by computers.”

In the Globe and Mail’s “Do you need to buy rental car insurance?” Neil Vorano discusses this important question, as well as some of the unsavoury practices of some car rental companies: “National Car Rental, Alamo Rent A Car and Enterprise Rent-A-Car (all owned by the same company) will charge a rental fee for a damaged car for every day it’s in a repair shop”. The article recommends that you check before you travel with your credit card company (and or your own car insurance company) to make sure that you are covered at all, or for the specific country you are traveling to or specific type of car that you are renting, and whether the coverage extends to both collision and liability. (So there you have it; the answer is that there is no simple or universal answer. And by the way don’t be surprised if the car rental company didn’t give you a flawless car to start with and won’t fix any additional damage that may have occurred during your rental. They may not make much money on renting cars, but they make it up on scratches. )

In’s ‘CRM2 could cause irrational client behaviour” Dean DiSpalatro reports that the bar is set too high on the expectation that greater disclosure requirements of potential conflicts of interests (e.g. fees) will decrease the information gap between advisor and client, but experiments show that “On the one hand, when they hear about conflicts, they lose faith in their advisors; on the other, they feel more pressure to comply“. Sunita Sah’s experiments showed that “About half the time, clients followed biased, poor advice when conflicts weren’t disclosed; but they followed that same advice 81% of the time when the conflict was disclosed.”(Interesting, and perhaps shocking results on human behaviour, but surely it was always at least naive but more likely disingenuous to argue that if we have proper disclosure of conflict of interest then we don’t need fiduciary level of care.) You might also find of interest the (US) CFP Board’s “Senior Financial Exploitation Study” which concludes that “older Americans (62 years of age and older) are indeed subject to unfair, deceptive or abusive financial practices and the problem is pervasive . (Thanks to Ken Kivenko for recommending)

Real Estate

In the Globe and Mail’s “Canadian government overexposed to housing market, Bank of Canada of Canada warns” Michael Babad reports that a new Bank of Canada study warns that “The Canadian government is now too “exposed” to the country’s hot housing market, warns a top central bank official who’s calling for more private-sector involvement…. the system is sound, as long as there’s no “severe” shock that would drive up unemployment… more work is needed to determine the appropriate adjustments in the pricing of, and quantitative restrictions on, mortgage insurance and securitization to create the right incentives…”. The article also notes that house “sales in the Toronto area climbed 7.7 per cent in October from a year earlier, to 8,552, while the average price surged 8.9 per cent to $587,505, according to the Toronto Real Estate Board…” Vancouver also continued to move along nicely. (No bubble here?!?)

In the NYT’s “More Americans are preferring the lease to the mortgage” Floyd Morris  reports that home ownership rate fell to 64.3%, the lowest since 1994 and well below the69.4% level in 2004. The article notes that it is not just that homes are perceived to be expensive and mortgages are difficult to get, but people are also worried that if they lose their jobs they can’t move to where jobs may be available. Single family housing starts are still about 60% below their 2004 level but multifamily housing starts are back now at 2004 levels and the latter now represent about 35% of total housing starts compared to 17% in 2006.

In Sun Sentinel’s “Cash sales dominate South Florida housing market” Paul Owers reports that “Roughly six of 10 Palm Beach County buyers paid cash in the third quarter, down slightly from a year ago but still well above the national average of 33.9 percent…” This phenomenon extends to much of South Florida metro market. “Fort Myers, Sarasota, Tampa-St. Petersburg and Melbourne ranked right behind South Florida in percentage of cash sales among metro areas nationwide. Florida led all states at 53.5 percent… But the abundance of cash sales is shutting out first-time buyers and young families, the foundation of a healthy housing market.” (Doesn’t sound like a healthy market…welcome to Florida.)


Pensions and Retirement Income

In the Financial Times’ “The numbers are grim for US pension savers” Tom Stable reports that while the start of DB to DC shift occurred decades ago its impact is only emerging now. The bottom three income quartiles of 50 to 64 year olds had an average of about $28,000 in retirement savings; and in the 1st, 2nd, 3rd and 4th income quartiles in that age group 77%, 66%, 41% and 22% respectively, had zero retirement savings.  The article also notes that an EBRI study indicated that “43 per cent of workers aged 55 and older reporting they had saved less than $25,000”. Furthermore about one quarter of retirement account holders surveyed have taken loans or made early withdrawals from their accounts. Much of the pension related discussion has been around how to fix underfunded DB plans, but “Policy makers have done little to avert what could be an epidemic of senior citizens hovering near or below the poverty line” given the state of affairs of DC savings. (Certainly not a pretty picture, though I am not sure how these statistics count people with multiple DC plans or factor in those who may also have some DB plans and assets in non-retirement accounts?)

In the Globe and Mail’s “Should I opt for a pension buyback offer?” Nancy Woods considers whether a 67 year old member of Canada’s federal superannuation plan (the gold standard of all pension plans- fully indexed and guaranteed by the AAA rated government of Canada) should exercise an option to buy for $57,000 an extra $5,052/year pension. She point to an 11 year break-even for the purchase or it would take 16 years exhaust a portfolio which earned 5% per year. So questions like: Will you live to 83 (individual health situation)? Can you earn 5%/year? Can you manage your own investments? Tax considerations? Estate considerations (do you want/need to leave an estate and what are pension spousal benefits)? Do you have need to control/access assets? Woods wisely recommends the individual choose what is best for them but get a professional financial plan as well. (And might be worthwhile to perhaps to consider some of  Annuity/Pension vs. Lump-Sum- Part 2: Drivers to and away from annuitization considerations, but the decision may not be that difficult for somebody who is in good health and has no intention/desire to leave an estate, needs that extra income to meet basic/fixed expenses and doesn’t have a large portfolio to fall back on should the market drop significantly, is somewhat risk averse and not a self-directed investor. In similar circumstances, many might find it difficult to resist this (likely) inflation indexed pension increment guaranteed by the federal government which could not be purchased from any other source in Canada for any price; and if it was available it might cost 50-100% more than indicated by the offer in this article. Of course the opposite conclusion might still be reached by somebody who has six months to live and wants to use the $57,000 to take a tour around the world.)

Things to Ponder

In the Financial Times’ “Risk-return relationship has been upended” John Authers discusses whether and how the increasing use of indexing as an investment approach and as a benchmark has been responsible in recent decades for an inversion of the “cornerstone of market theory” which states that “higher risk investments, in the long run, deliver better returns”. Data covering the period from 1970 to2011 indicates that US stocks in the highest volatility quartile have underperformed (at 7.2% return) compared to the lowest volatility quartile stocks (at 10.6%), suggesting “deeply distorted markets, with capital badly misallocated”. For global equities the effect is even more pronounced at 10.1% for lowest vs. 4.1% for highest volatility quartile equities since 1983. The problem for non indexing managers whose performance is measured relative to indexes is that “underweight positions in stocks with large weights in the index and volatile prices” result in doubling of the mismatch compared to the index “if a stock doubles in price and investor is half weight…but if the manager is double weighted and price halves, the mismatch halves also”. No wonder more and more active managers have felt compelled to be closet indexer. If lower risk investments have higher returns then as the article notes we have” deeply distorted markets, with capital badly misallocated “, which is ultimately bad for society. (Interesting article, but I am not sure about causality. It would be interesting to test the extent to which the Fed’s ultra low interest rate (as far back as the 2000 tech stock crash)  policy induced dividend stock stampede could be at least a partial explanation for the higher returns observed for lower volatility stocks?  If yes, then if/when interest rates normalize the effect would disappear? Need to think more about this subject.)

In the Journal of Financial Planning’s “Five biggest mistakes planners make helping clients manage risk” Michael Carpenter, addressing advisors, explores “how we can recognize and avoid some of the biggest unrecognized errors made in understanding and managing risk, while improving the quality of our risk communications with clients”. His list includes: “not asking clients what concerns them most”, not having a common and meaningful definition of risk (e.g. perhaps “degree to which an outcome varies from expectations”), “not using a proven method for neutralizing risk”, not understanding characteristics of risk (exposure, likelihood, impact), and risk prioritization and determination of which risks to avoid and accept.

Speaking of risks, here a couple of articles discussing dementia related risks. “Early onset Alzheimer’s: When plans are upended” discusses how otherwise well planned retirement finances of a couple get are turned upside down when the 47 year old husband is diagnosed with early onset Alzheimer’s (not mentioned was existence or lack of disability insurance), LTCI not recommended by advisor because couple was too young, advisors could: ask for family medical history, enable access to help/support).  “Unraveling minds” discusses advisors’ challenges when dealing with elderly clients with cognitive decline: clients/couple accusing each other of mental incompetence, or elderly lady wiring thousands of dollars to get million “won” at phony sweepstakes, or something as simple as client mishandling finances. Advisors are also concerned about the extent of liability in such cases, and some firms have established their “own elder abuse units” as a resource to advisors in the firm. Getting the client to sign a “diminishing capacity letter” giving “permission to notify a trusted family member who could act as a fiduciary in cases where there are questions about a cognitive issue” should it arise, how to detect/prevent elder abuse even if it originates in the family. (Planning ahead for decline in cognitive capability is important for investors with or without advisors.) And a sad story, perhaps a sign of things come, is Bloomberg’s “Dementia crisis roils Japan as 10,000 seniors go missing”.

In the WSJ’s “Are ‘Alternatives’ an asset class? Maybe not” Matthias Rieker explores whether ‘alternatives are a separate asset class and concludes that mostly not as they are just “diversifying an equity or fixed income bucket, not creating a new investment bucket”. However “managed-futures funds, which take long or short positions in futures contracts tied to equities, commodities, interest rates and currencies…(and) collateralized reinsurance contracts, also known as catastrophe bonds” would qualify as they are uncorrelated to stock and bond markets.” (Tread with care, if at all.)

In Bloomberg’s “Gross says deflation a ‘growing possibility’ threatening wealth” Mary Childs quotes Gross as opining: the “growing possibility” of deflation. ““The real economy needs money printing, yes, but money spending more so, and that must come from the fiscal side –-from the dreaded government side –- where deficits are anathema and balanced budgets are increasingly in vogue…Until then, the possibility of deflation is a challenge to wealth creation…”, “Stimulus is “not working like it used to… “wages simply sit there for years on end. One economy (the financial one) thrives while the other economy (the real one) withers.””

In the Economist’s “The guilty men” Buttonwood asks: “Who was to blame for the great financial crisis? How effective was the response of the authorities? And how can we stop it happening again? Those questions are at the heart of a fascinating new book of essays by prominent economists and regulators, well-worth reading by anyone with an interest in such topics, and free to download from the Hoover Institution.” (I haven’t had a chance to read it as yet, but sound very interesting.)

And finally, a video series entitled “How to win the loser’s game, Part 1”, Part 2, Part 3, Part 4, Part 5, Part 6, Part 7, Part 8, Part 9 and  Part 10 each between 5-10 minutes long. “Most of what we see and hear about how to invest comes from either the fund industry or the financial media – both of which have their own agendas. This landmark documentary is an attempt to redress the balance. Nine months in the making, How to Win the Loser’s Game aims to provide ordinary investors with the information they need to achieve their investment goals. It includes contributions from some of the biggest names and brightest minds in the investing world.” (Thanks to Nancy Graham of PWL for recommending.)


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