Contents: Turbulence-proofed portfolio, adviser selection, conversion to fee-based account, LTCI and retirement abroad? adviser succession? retiring in 2015? protecting seniors, Canada/U.S. home prices drop -0.3%/-0.1% MoM, Shiller: Canada home prices in bubble territory, a home is not an investment, privatizing mortgage insurance? Nortel’s Canadian pensioners screwed again: U.S. judge awards $1B in post-bankruptcy bond interest, multiemployer pensions can be cut to prevent PBGC bankruptcy, expert decumulation advice required upon retirement, Canadian life insurers hate mandatory Ontario pension plan, active investing a loser’s game but necessary for “price discovery”, bear markets in perspective, who is long-term care insurance for? low-volatility skepticism, passive investing redefined, Canada income splitting is good, retirement’s ‘happiness bonus’.
Personal Finance and Investments
In the WSJ’s “Structure your portfolio for turbulence” Jonathan Clements recommends two investment rules to keep in mind: (1) “never trade on a market forecast” (nobody knows where the market is heading in the near-term at least), and (2) “design your portfolio so that short-term results don’t matter”. Focus on risk which comes in many forms: risk that you’ll panic and sell in a market swoon, risk that a market swoon you have insufficient cash/bonds/CD/GICs to meet short and medium term needs about 5-10 years, and understand how much risk you need to take to meet retirement objectives and consider not exceeding it significantly.
In The WSJ’s “Full disclosure: Is your adviser hiding something?” Jason Zweig suggests some questions to ask a prospective advisor in addition to checking her out on government/regulatory/ data bases: will you prepare an Investment Policy Statement (IPS) and how long does it take to do one (it takes many hours), what changes would you recommend to a 40% total bond market, 40% total stock market and 20% total international stock market portfolio which can attract <0.1% fees/year (any hint of “tactical” or “insurance products” should make you run the opposite way), a fee in excess of 1% for the advisor is too much to pay for advice).
In CanadianFundWatch’s “Investor ALERT Fee- based account conversions” Ken Kivenko warns about being stampeded by your broker from a transaction based to a fee based compensation model. He discusses the pros and cons of each and what are some of the traps to look for. Kivenko’s bottom line is “Costs count. In short, fee-based accounts may not be the best fit for certain clients if annual fees end up costing more than the trading commissions that would have accrued in accounts that show little to no activity… Experienced investors who manage their own portfolios can cut their costs dramatically. A portfolio of index exchange-traded funds (or index mutual funds) should cost no more than (<)0.4 % annually, including commissions to buy and sell.” (Great advice; in fact go back and re-read Zweig’s article above on selecting an adviser and what you should (and should not pay for) when investing.)
In the NYT’s “How retiring abroad could affect your long-term care insurance” Ann Carrns explores the need to consider the validity of any existing long-term care policies for those thinking about retiring abroad. “Policies vary widely from insurer to insurer and from state to state, he says, so consumers should carefully review their policies before deciding to rely on them when relocating abroad.” Some policies may offer no or reduced coverage outside of the U.S.
In the NYT’s “What to do when your financial adviser retires” Paul Sullivan explores approaches to probing your advisor’s readiness to do the right thing for you as he approaches retirement. Is a succession plan in place, do you understand what it is, and whether there are changes in style and/or substance with the proposed new advisor. Does the advisor provide investment only advice or also financial planning. One recommendation is to test the proposed successor advisor with the same due diligence as one would choose a brand new adviser. Given that advisory relationships tend to be long term ones, it is also essential to review whether the client’s advice needs have changed.
In the WSJ’s “Planning to Retire in 2015? Read This” Tom Lauricella’s checklist for those planning to retire in 2015, includes: (1) understand thoroughly your Social Security entitlement and delaying its start may be advantageous to many (same for Canadian CPP/QPP and OAS/GIS), (2) Medicare/Healthcare signup and understand coverage and (3) budgeting or more specifically a detailed understanding of pre- and post- retirement spending needs/wants including a 6-12 month test-period of living on the planned funding allocation, and (4) don’t forget to plan for the non-financial aspects of retirement- most people can’t spend all their time on golf and tennis, many are looking for ways to “stay engaged and have a meaningful life- over 20 or 30 years.
In Morningstar Canada’s “Protecting seniors: Part 3” Michael Ryval writes that “Arming oneself against scams, inappropriate recommendations and other misconduct is at the core of financial literacy.” Here are some of the items on the list of tips for seniors and their children: (1) “be skeptical, very skeptical” (…if it sounds too good to be true…), (2) never enter into an investment originating from a cold call” (…duh…), (3) “be wary of sales pressure’, (4) check advisor registration and designation, (5) understand your risk tolerance (and your overall current portfolio risk and the impact of the proposed portfolio addition), (6) make sure that you and your advisor understand your “investment and lifestyle objectives”.
The November 2014 Canadian Teranet-National Bank National Composite House Price Index shows the first MoM fall in the index in a year with a drop of -0.3% from October. Of the 11 metropolitan areas surveyed 8 were down, 2 were flat and only Edmonton was up (+1.1%). Vancouver was flat, Toronto was down -0.3%, Montreal -1.0%, Ottawa -0.6% and Calgary -0.2%. On a YoY basis Calgary was up +9.2%, Toronto +7.3%, Vancouver +5.9%, Montreal +0.6%, while Ottawa was off -0.2%.
The just released October 2014 “S&P Case-Shiller National Home Price Index” shows the 20—City composite increase continues to decelerate and was up YoY by 4.5% compared to 4.8% in September. Highest YoY increases were recorded in Miami at +9.5% and San Francisco at +9.1% while New York was up only +2% and Chicago +1.9% over the past 12 months. On a MoM basis Miami was up +0.4%, Tampa +0.8%, while New York was off -0.5%. As to the pace of home sales, in the NYT’s “Housing Market’s Foundations Crack” John Carney reports that “The U.S. housing market has gone wobbly. Sales of new homes in November were down 1.6% from a year ago, according to Commerce Department data last week. Existing-home sales for that month were down 6.1%.”
In the Globe and Mail’s “Why the predictor of the U.S. collapse hates Canada’s housing market” Brian Milner reports that Robert Shiller “regards housing as a lousy investment, particularly in Canada”. He notes that U.S. data going back to 1890 indicates a real 33 bp return on housing which makes sense considering that “Usually the overwhelming value is in the house, the structure rather than the land,” he said. “And the structure is constantly deteriorating, subject to weathering. It also has style changes that come and go with fashions. There are all kinds of problems that are associated with housing that make it not a congenial investment.” He thinks of house investment much the same as “putting a lot of money into a car”. The Canadian household vulnerability is particularly high should interest rates rise given high debt levels, and the Bank of Canada figures that house prices are 10-30% overvalued. He argues that a clue that a housing bubble is in trouble is “how the question is being framed in the media. Based on the U.S. experience, “There was a turning point at the peak of the market. You can see it in popular culture. It had gone so far that people started to make jokes about it [the bubble].” And the WSJ’s “Australia, Canada House Prices Beat U.S., U.K.” a DBRS study indicates that “House prices in Australia and Canada have outperformed those in the U.S. and U.K. over the last 10 years…The study compared house prices in 50 cities in the U.K., U.S., Canada and Australia…Canada and Australia held the top 12 spots in the 50-city list…Housing markets in all four countries face potential corrections if interest rates rise.” Another anecdotal data point is mentioned in Rob Carrick’s Globe and Mail article “Why Canada’s cult of home ownership is in trouble” where he refers to a McMaster professor who asked his urban housing class to assess their plans to rent or buy and “last year, in a class of 29 students, a clear majority said they would buy…this year only 5 of 23 said they’d buy”.
In the WSJ’s “Don’t Buy a Home as an Investment” Jonathan Clements tackles the house as an investment question and writes that “home prices have climbed just 3.7% a year over the past 30 years, not much above the 2.8% inflation rate. To make matters worse, this figure doesn’t reflect the hefty costs of buying, owning and selling a home…The big gain from owning a home is getting to live there. Think about how much you’d collect if you rented out your home. You might pull in an annual sum equal to 6% or 7% of your home’s value—far more than you’re likely to make each year from price appreciation.”
In a WSJ blog “How to Save Like the Rich and the Upper Middle Class (Hint: It’s Not With Your House)” Josh Zumbrun reports that according to a new research report “for the wealthiest 1% of Americans (with over $7.8M in assets) only about 9% of their total net worth is tied up in their home” compared to the next 19% wealthiest at 28% and the middle 60% at 63%. (This should also be a warning on house prices if/when the middle 60% tries/needs to start living off the home equity. By the way the NYT’s “Selling the Family Home Is Liberating for Many Retirees” discusses the drive to downsizing to a cheaper home and a lower cost area of the country as a means of getting some financial flexibility during retirement.)
The WSJ’s “Life Without Fannie and Freddie” discusses a new report suggesting that transiting Fannie and Freddie mortgage financing functions to the private sector would have “only a modest effect on housing market”. The impact on mortgage rates over a 10 year transition period of gradual withdrawal of government subsidy would start at 20bp and end at 60bp, while house prices might end up about 2.5% lower. Of course this would get the taxpayer off the hook from the risk associated with these “monsters that guarantee mortgage-backed securities and contributed so much to the 2008 credit crisis”. (How about a transitioning of the CMHC mortgage insurance to the private sector?)
Retirement Income and Pensions
And for the final nail in Nortel’s Canadian pensioners’ coffins is in the CBC.com’s “Nortel’s U.S. bondholders in line to get $1B US in interest”, WSJ’s “Nortel U.S. unit wins court approval for bondholder deal” ; in Globe and Mail’s “Nortel’s U.S. bondholders to receive up to $1-billion in interest” where Janet McFarland reports that the U.S. judge Gross has just ruled that bondholders are entitled to $1-billion post-bankruptcy interest…. (Not a surprise, since the U.S. judge Gross has absented himself from the court when the Canadian judge Newbould announced his ruling some three months ago that bondholders are NOT entitled to post bankruptcy interest. Also don’t forget that the proceeds of the bankruptcy asset sales are in a JPMorgan lock-box in the U.S. How pathetic is that…especially since the US and Canadian judges on the case were ‘partners’ on this case for the last 6 years since bankruptcy (and the Canadian judge Morawetz (Newbould predecessor) initiated or endorsed to the best of my recollection every (adverse to pensioners) decision…enough to make you nauseous if you are a Canadian pensioner. The federal and provincial governments have failed to protect the pensioners with necessary regulations and oversight before Nortel’s bankruptcy, and then failed to protect them post- bankruptcy with the necessary changes in bankruptcy legislation. All Canadians will also pay when the poorest of the pensioners and the long-term disabled will end up on welfare. What a disgrace for a civilized country!)
In the WSJ’s “Pension change seen as setting a precedent” John McKinnon reports that U.S. Congress passed legislation which “would allow troubled (multiemployer pension) funds to cut benefits for current retirees in some circumstances. That is an exception to a long-standing federal rule against scaling back private-pension benefits… This change was deemed necessary to prevent the bankruptcy of the multiemployer PBGC pension insurance plan.” While some lawmakers think this is a good thing other “lawmakers maintain that the new legislation could encourage policy makers to consider cutbacks in benefits in a variety of underfunded retirement programs.”
In the Financial Times’ “Complex pension choices require expert advice” Sophia Greene writes that according a Financial Services Inquiry report that (now that annuitization is no longer compulsory in the UK) savers need more support to insure that they not only don’t exhaust their assets during retirement but also don’t live so frugally that it results in a significantly lower standard of living than necessary. The reports recommends that fund trustees should designate a default “comprehensive income product for retirement” (CIPR) but allow retirees to take a lump sum if they so choose.
In Benefit Canada’s “Reflections on decumulation” Greg Hurst discusses how the ”financial services industry does a very poor job when it comes to decumulation” in Canada, using his mother as an example. (A key missing element for Canadian retirees is “longevity insurance” type protection in the form of a deferred income stream starting around age 85. This could be offered either within the framework of the CPP/OAS or the new Ontario pension plan and/or by insurance companies. The U.S. has even introduced such products as an option within 401(k) plans.)
And surprise…surprise the Canadian life insurance companies are finding reasons to object to Ontario’s mandatory pension plan as discusses in the Globe and Mail’s “Insurers object to Ontario government paper on mandatory pension” by Jacqueline Nelson. (The insurance industry has been milking Canadians with high fee products at least the past two decades since the demutualization craze started. They need to get with the program; and a good way to do that is by requiring fiduciary level of care by all those selling retirement savings and decumulation products.)
Things to Ponder
In the Financial Times’ “Investment: Loser’s game” John Authers writes that with only about 10% of active managers now beating their benchmark, “sales of actively managed funds have collapsed” due to loss of faith in active management. Even active fund managers who might outperforms for a couple of years there is no persistence of outperformance. Authers notes that active managers are still needed to do “price discovery” because passive investors are price takers and active investors do the work for “setting a sensible price for shares, so that capital will be efficiently allocated to where it can be of most use”. Active managers are looking for ways to earn their fees by: lowering them, eliminating index hugging, and by focusing on bold bets on a small number (<10?) stocks. So active management is not dead but the future will look different than the past. The Economist’s Buttonwood column “Reliably unreliable” also discusses active manager performance, and argues persuasively that even if there is persistence of outperformance in rare cases such managers can only be identifies after the fact.
In ETF.com’s “How to think about bear markets” Larry Swedroe takes a perspective look at bear markets. He reminds readers that bear markets and volatility are inevitable. In fact, they are the true source of the equity risk premium, and why it has historically been so large.” If the three worse bear markets’ losses would have been 25% rather than 50%, the equity risk premium would be lower.” He advises discipline: (1) accepting the inevitability of bear markets and making sure that you don’t “assume more risk than you have the ability, willingness or need to take”, and (2) understanding that “diversification is the only free lunch in investing”. But he reminds readers that low long-term correlation measure is not the same as diversification, especially since “at times of stress correlation of all risky assets tend to rise”. You won’t be protected by diversifying across equity asset classes; high quality bonds (Treasurys) are the only one’s uncorrelated to stocks. He also suggests tilting portfolios toward a higher exposure to small and value stocks relative to the market portfolio.
In WSJ’s “Is long-term care insurance for you?” Anne Tergesen discusses a Georgetown University report which indicates that “about 70% of individuals 65 and older will need some kind of long-term care” but only about “at 19% of men and 31% of women” should purchase long-term care insurance according to a Boston college report. The article discusses situations when one might or might not consider such a purchase. (But if insurance is for low probability high financial impact events, then you might ask why is long-term care a risk worth insuring against?)
In ETF.com ‘s “Skeptical on the low-vol ‘factor’” Larry Swedroe argues that the explanation of low-volatility outperformance, if any, can be explained by value premium and duration premium (stable cash flows). But he asks whether low-volatility strategies may have been overgrazed and whether expected (?) interest rate increases might reduce the duration-risk premium. He concludes that “That low-volatility portfolios in the past have provided market-like returns without any greater volatility is an anomaly that cannot be explained by the efficient markets hypothesis. As is the case with many anomalies, their discovery often leads to their disappearance.”
In ETF.com’s “How to define passive investment” Larry Swedroe suggests a broader definition of ‘passive’ that has two characteristics: (1) transparency (well defined) and (2) systematic implementation (rules implemented in a” systematic and mechanistic manner”. He even argues that low turnover is not a ‘passive’ requirement as in the case of momentum strategies.
In the Financial Post’s “Income splitting is not perfect, but it’s a step in the right direction” Bazel and Mintz write that income splitting deserves support because it is about “horizontal equity, the notion that similar households with similar circumstances should face similar tax burdens”… “if two people or families with similar financial circumstances find themselves in different tax brackets, we fail to achieve vertical equity regardless of the rate structure. In the interest of a more fair and efficient tax system, we should first address the problems with how we define the tax base, to measure income and circumstance properly before determining the distribution of tax burdens. Horizontal equity is a prerequisite to achieving vertical equity.” (I resonate with their arguments. It is completely unfair to have families at any income level, pay different tax rates. That’s called equity. Some families choose to have one spouse stay home to take care of the household in general and children in particular. It is bad enough that the stay at home spouse’s contribution to society is valued a zero and thus is ineligible for CPP contributions/benefits. But in addition to be penalized because the family income is earned by one rather than two souses- it makes no sense at all.)
And finally, in the WSJ’s “Will Retirement Pay You a ‘Happiness Bonus’?” Anne Tergesen reports that a new poll run by Mass Mutual indicates that “Life gets better after retirement—despite the financial and physical challenges associated with that time of life… (and) that positive emotions increase and negative emotions decrease over time among those in or near retirement…and fewer retirees than pre-retirees report feeling negative emotions, including stress, frustration and nervousness.”