Hot Off the Web- January 12, 2015

Contents: Clements: 31- rules to investment, advice: will that be human/robot/hybrid? FINRA sees value in fiduciary standard for brokers? Canada house price bubble: 63% overvalued? UK house prices fixed, Americans’ retirement savings status? required savings rates? US corporate pensions’ funded status drops 9% as mortality data recognized, risk of complexity in finance, age discrimination? Bitcoin: the risk of private money, Swedroe: don’t buy individual stocks, finance reversed drive for equality, deflation a rising market (but not necessarily economic) threat? Oil price collapse changes everything.

Personal Finance and Investments

In the WSJ’s “How to keep your portfolio on track” Jonathan Clements list “31-rules to guide your investments this year”. To whet your appetite the list covers retirement income, buy vs. rent, home remodeling, student loans, life insurance, spending prioritization, return expectations, insurance investment products, active vs. passive investing, tax strategies, and more; a great list of 31. (Clements is always a source personal finance and investment wisdom; these rules were excerpted from his just released  “2015 Money Guide” . I haven’t read it yet but I ordered copies for myself and my adult children. Clements is always well worth reading.)

The WSJ’s “Brains, bots or both? Which financial adviser?”  and the Journal of Financial Planning’s “I, Robo-Adviser? Creating the blended adviser experience” discuss the some of the trade-offs and drivers to human- vs. robo- vs. hybrid advice for advisors and (not DIY-)investors. Both articles suggest that for investors the answer is it depends on one’s needs, the costs, portfolio size, what you are prepared to do yourself vs. delegate, need for customization to special personal situations, whether one is prepared to do own execution, etc. The potential new business models offer benefits for both clients and advisers who are prepared to lead the way; the future will be radically different than where we are coming from and the advice business will undergo a major discontinuity on service offerings, service delivery, cost structures and quality. The FPA article even suggests that with the commoditization of investment management, the “investment manager is dead”; and since that is not what ‘advice’ is about, that not all bad. Financial planning should be the core of advice and in fact much of the services offered can/should be unbundled and charged for separately. The article believes that the future belongs to the hybrid advisors “who embrace and leverage technology to the fullest—so that clients don’t know where the adviser ends and the technology begins—will enjoy the best of both worlds, giving clients better service and driving costs down.”

In InvestmentNews’ “FINRA: Putting clients first would end compliance issues” Mark Schoeff reports that FINRA is arguing that by adopting fiduciary level of cares, brokers can solve most of their regulatory compliance problems. (If this is an official endorsement by FINRA that fiduciary is the right way forward for all those claiming to be advisers/advisors/brokers (capitulation in the face of the inevitable?) then it is good; if this is just a head-fake to slow down SEC from declaring a fiduciary requirement for all brokers and anyone claiming to be providing advice, then it is very problematic and the SEC must redouble its efforts on the fiduciary front. The reality might be that they have figured out that that there is lots of money to be made in a fiduciary model, and that even under the umbrella of fiduciary level of care and using a fee-only model (as the case of lawyers who have figured out how to prosper from a fiduciary model; the advice may be fiduciary but the costs are not, though at least they are explicit.)


Real Estate

In the Financial Post’s “Canadian housing bulls are joining real estate doubters as warnings and oil collapse sink in” Thophilos Argitis reports that according to a Nanos survey of Canadians’ home price expectations, only 31% are predicting higher prices compared 47% last July. “The survey results suggest policy-maker warnings about overvalued home prices are starting to sink in, amplified by plunging prices for crude oil, the nation’s biggest export. The gloom may spell the end of a housing rally that helped pull the world’s 11th largest economy out of a 2009 recession.” (Forecasting is difficult, especially about the future; lower Canadian dollar could actually increase foreign demand and reduce its sensitivity to rising prices. So while the evidence of a housing bubble is may be strengthening, Deutsche Bank report calls it 63% overvalued, the timing of if/when it might deflate remains uncertain.)

Martin Wolf in the Financial Times calls it “Britain’s self-perpetuating property market” reports that UK new housing constructed in 2012/13 was 136K units compared to 378K in 1969/70 and it was not due to lower demand. “Collapsing supply and soaring prices: nothing could better indicate severe constraints on supply.” This is not due to physically limited supply of land, but artificially created man-made constraints by vested interests. “…this is a corrupt arrangement whose result is to benefit the haves at the expense of have-nots.” (How much of this is a factor in Canada’s housing bubble?)

Retirement Income and Pensions

Brian Stoffel in FoxBusiness’ “The average American has this much saved in a 401(k)- How do you compare?” tables some interesting data on 401(k) trends based on a recent Vanguard report. The article notes that mean 401(k) balances were up 80% (good) to $101,650 (bad), and those who maintained their accounts since 2008 and continued to contribute had seen average balances increase by 182% by 2013. What’s disconcerting though is that while mean is at about $100K the median 401(k) is only $31K. For more granularity and meaning the article includes average balance by age, average balance by income   but the it also warns that you should not think you are doing so well just because you might exceed these medians or even averages (… for at least a couple of reasons: (1) people have multiple accounts reflecting the fact that they have worked in a number of different places and (2) if your current income puts you at 80th  or 90th  percentile  (i.e. say 3x times) of the average or median American family income than your savings should be at least proportionately higher than that. But the most difficult test based on the: 4% rule of thumb, equivalent to 25x your actual annual expected spending (grossed up for taxes) is the amount (in inflation adjusted terms) that you need at start of retirement to achieve/maintain spending for 30 years or so. Actually, to be safe one might even need more since expected returns are lower than historically, longevity is increasing and half the people live longer than median and some a lot longer. So using round numbers, if your spending need is $100k/ year in retirement and your tax rate is 20%, you annual required income would be $125K/year. Suppose that other family income (e.g. social security or pension) brings in $35K/yr, then you still need $90K/year, which using the 4%/25x rule of thumb suggest about $2.25M inflation adjusted assets at age65. And of course, there are only very few things that you can control (and return is not one of them): savings, spending, investment costs and asset allocation. (Thanks to MB for recommending article.)

In another related article Darla Mercado in InvestmentNews’ “Retirement readiness: 15% salary deferrals are the new 10% for 401(k)s” discusses the “how much to save for retirement?” question. Specifically that the 3% of salary default level for 401(k) contributions even with the “auto-escalation” feature and employer matching contribution up to some level, is not even close to 15% recommended by Wada Pfau for a 35 year old hoping to retire at 65. “If you’re 40 years from retirement, 8% to 10% [contributions] is fine, but if you’re already 45, 50 years old and you haven’t saved much, 15% isn’t going to get you a very good lifestyle at retirement.” In one of my early blog posts around  2007 timeframe (as you’ll no notice from the assumptions) I used an EBRI calculator in this Planning post to generate a table of savings rates vs. age and annual salary increases; this suggests for a planned retirement at age 65, the required savings rate of 11% at age 25 with 1% annual salary increases and 14% at age 25 with 2% annual salary increases; then a further 1% increase in savings rate is required for each year delay to start saving beyond age 25. One ends up with fairly significant savings rate requirements.

In Pensions&Investments’ “Corporate pension funding plummets in 2014 on mortality tables, falling rates”  Meaghan Kilroy  reports that according to Towers Watson “Falling interest rates and improved mortality assumptions nearly “wiped out” 2013’s gains, bringing the funded status closer to 2012 levels, when it was 77%…The funded status of the largest corporate pension plans fell nine percentage points in 2014, down to 80% from 89% in 2013”. (While interest rate changes might be unpredictable, the mortality data shouldn’t have been a surprise. This is more of a “when it is recognized” vs. “when it is known” event, and mortality data should be adjusted annually based on the best available information at the time, so that corporate pension sponsors are not ‘surprised’ by sudden increases in life expectancy and corresponding drops in funded status. You might call this a government endorsed scam.)


Things to Ponder

In the Financial Times’ “Risks lurk in failure to simplify finance” Satyajit Das opines that “regulators have not solved the problem of complex (financial) products… Low returns and the need for income are driving the dash for trash.” Policy makers have not even attempted simple solutions as they are politically difficult to introduce. “In the next financial crisis, the failure to deal with complex financial instruments will increase risk, exacerbate losses and speed contagion, yet again.”

In Time’s “This is the toughest threat to boomers’ retirement plans” Dan Kadlec discusses the cognitive dissonance that Boomers face when they hear that “Most employers say they support older workers. But boomers don’t see it, and age discrimination cases are on the rise.”

In the Financial Times’ “Security breach halts Bitcoin exchange” Murad Ahmed reports the latest (and last) security system failure driven suspension of operations of Bitstamp, “Europe’s leading Bitcoin exchange” and “world’s third busiest bitcoin exchange”. Bitcoin is a great idea but private money has its problems, in addition to Bitcoin’s current $275 price compared to recent $1,240 peak.

In’s “Legends of indexing: Jeremy Siegel” Heather Bell interviews Jeremy Siegel on the subject of indexing. It’s a short but interesting article. An area of innovation in indexing that he has been a “critic of (is) the way we internationally diversify: We only look at country of origin and measure risk and returns of individual countries. I always thought it was natural to do diversification by industry, instead of by individual countries, but that has not yet caught on.” (No doubt a diversification opportunity; perhaps a mix of industry and geography?)

In’s “Swedroe: Why buy individual stocks” Larry Swedroe explains why “the rational strategy is not to buy individual stocks…Unfortunately, the evidence indicates that the average investor, while nominally risk averse, doesn’t tend to act that way. In fact, individual investors often fail to properly diversify. That is the triumph of hope over wisdom and experience.” Investors are “overconfident in their skills; they overestimate the worth of their information; they confuse the familiar with the safe; they have the illusion of being in control; they don’t understand how many individual stocks are needed to effectively reduce diversifiable risks; and they don’t comprehend the difference between compensated and uncompensated risks (basically that some risks are uncompensated because they are diversifiable).”

In the Financial Times’ “How financiers turned back forces of equality” John Kay argues persuasively that “the growth of the banking sector has helped turn back egalitarian trend”. Developed countries’ top 1% income earners accounted in 1920 for 15-20% of total income; by 1970 this was halved to 7-10%, but the trend reversed to the order of 1920 levels (with country variations). Of the top1% in the US, 33% are corporate executives, 25% are doctors or lawyers, while finance professionals have increased to 14% (from 8%). The principal drivers of inequality were “two interrelated causes: the growth of the finance sector; and the explosion of the remuneration of senior executives”. Kay notes that “Finance employs more people, recruits more able people and pays them a lot more.” (So, finance is parasitic in two ways: it is rent-seeking by its nature despite the fact that it adds very little economic value compared to the income extracted, and drains a disproportionate number of highly capable individuals from the real economy’s productive activities.)

In the Financial Times’ “Deflation is a rising threat for markets” John Plender writes that market pundits missed foreseeing the drop in developed market yields because they are fixated with end of QE in the US rather than paying attention to “adverse demographics” driven “deficient demand, leading to disinflation”. Historically the US, due to its open market policies, has been a “clearinghouse for global supply and demand”; previously the “excess supply being cleared through ever higher US household debt, it is now being cleared through lower prices.” We are living in a world in which “geopolitical risk, competitive devaluations and protectionist pressure could bring a descent into intractable deflation and long-depressed yields in the absence of robust policy”. (Even though it may impact capital market expectations, deflation is not all bad for the economy; see Bloomberg article below.)

And finally, keeping in mind John Kenneth Galbraith’s note that “The only function of economic forecasting is to make astrology look respectable”, in Bloomberg’s very interesting article “How $50 oil changes almost everything” Armsdorf and Kennedy look at the impact of collapsing oil prices on various economies both good and bad (even impact on oil producing Canada’s GDP is slightly positive). “But, net/net, strengthening the U.S., Europe, Japan, China and India, while weakening Russia, Iran, Saudi Arabia and Venezuela, is likely to make the world a safer place in the end.” (I can live with that.)


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