Contents: Healthcare cost in retirement? TFSA questions, avoiding RRSP ‘tax-trap’, impact of fees trumps asset allocation, getting even hotter: Toronto real estate, derailing drive to U.S. fiduciary standard? Sun Life insures BCE pension plan longevity risk, UK retirees no longer required to annuitize, active mutual fund managers attempt to stem exit of assets with opaque trusts, LTCI still lose-lose proposition?  active vs. index debate, loser’s game: active management, any safe havens left?

Personal Finance and Investments

In the WSJ’s “How to estimate health costs in retirement” Glenn Ruffenach discusses a new report which suggests when planning for retirement, people might find it useful to consider health-care expenses as buckets of ‘recurring’ (more predictable “doctor visits, prescription drug use and dentist services”) and ‘nonrecurring’ (less predictable “overnight hospital stays, overnight nursing home stays, home health care, outpatient surgery”) expenses. To cover the recurring out of pocket expenses to age 90 which are estimated to be $1885 per year, excluding “insurance premiums and over-the-counter medications”, one needs an estimated $41,000 at age 65.  As far as nonrecurring expenses, the average and 90^th percentile nursing home expenses for over 85 year old individuals were $24,185 and $66,600 during a two year period. Also in the two years prior to death about 50% have received in-home care from a medically trained individual. “For individuals age 85-plus, 62.3% had overnight nursing-home stays before death, and 51.6% were living in a nursing home prior to death.” (The article also comes with some opinionated comments which help further sized the recurring costs. The specifics of the article are aimed at U.S. retirees but concepts are equally applicable in Canada.)

In the Globe and Mail’s “Your tough TFSA questions answered” John Heinzl examines some scenarios pertaining to TFSA’s. One of these relates to what is the best investment to hold inside a TFSA. He argues that “While it’s true that dividends and capital gains receive favourable tax treatment in a non-registered account, it’s likely that you will still achieve greater tax savings over the long run by using your TFSA for these securities rather than using it to shelter a low-yielding savings account.”

In the Globe and Mail’s “Don’t fall into the RRSP tax-trap” Simon Avery writes that contrary to the commonly held view that RRSPs are wonderful because you save by deferring taxes on income at high marginal rates during working years, to lower rates after retirement. But the reality is that RRSPs can be “tax traps” for many, and “Most (?) people end up paying higher taxes in retirement than when they were working…” This is primarily due to the combination of minimum withdrawal requirements from RRIFs and the OAS clawback. The recommendation is to start drawing down the RRSP well before the required age 71 by converting some of it to a RRIF. “The goal is to take out just enough to push their income to the top of their tax bracket.” (The theory was that you can put money into RRSP and save 40-45% tax and then take it out in retirement at 25%, but the combination of minimum RRSP/RRIF withdrawal requirement combined with OAS clawback can force those with total income during retirement of over $71,000 (CPP/OAS, pensions, RRIF withdrawals and taxable investment income) into a confiscatory 60% tax rate; clearly not what was expected or advertised when RRSP benefits were pushed. The simplest solution might be to: reduce/eliminate minimum withdrawal requirements, and/or cap marginal tax due at current maximum tax rate. This doesn’t even factor in future changes in tax rates. That is why tax-diversification might also be useful using a combination of: tax-deferred, tax-prepaid and taxable accounts depending on one’s personal circumstances.)

In the Financial Times’ “Fees matter more than asset allocation” John Authers reports that according to new research, while asset allocation is important “the precise asset allocation model you use is less important than keeping control of fees”. This point is demonstrated by showing how various asset allocations considered resulted in “startlingly clustered results by the end of 30 years” as measured by return and maximum draw-down. However the conclusion of the research was that “In the long term, nothing is more important than keeping fees under control.”

Real Estate

Toronto real estate continues to fire on all cylinders! The Globe and Mail’s “Average cost of detached Toronto home tops $1-million” reports that the average price of a detached home in Toronto was up 9% to over $1-million in February. Sales of all types of homes were up 11.3% while average prices rose 7.8% to just under $600K. Inventory was down 8.7%   The Globe’s Tamsin McMahon also reported in “Toronto condo market booming again” that “After years of slow growth, Toronto’s condo market has come roaring back to life. Builders were putting the finishing touches on nearly 10,400 new condo units in January, eight times more than the monthly average over the past decade.” This might worry many, but Marcus Gee in the Globe’s “Toronto’s housing prices boom is a sign that the city is thriving” assures us that instead of fretting about speculation we should rejoice because it is a sign that “people want to live in the city”. (What more can one say than…amazing! The Bank of Canada’s lowering of interest rates likely added some fuel to the fire. We’ll watch and learn from the outcome.)

Retirement Income and Pensions

Call me naive, but it is a sad day for Americans when the ‘fiduciary’ discussion is not just politicized but also inexorably driven by vested interests; perhaps the ‘congressional capture’ in play is the parallel of ‘regulatory capture’ by the financial industry. Even a large number of Democrats don’t support ‘best interest standards’. The requirement for someone calling themselves an ‘adviser’ and then refusing to play by ‘client’s best interest standard’ is not about politics, it is about morality and doing the right thing and delivering some level of protection to the average human being attempting to save for retirement. But in InvestmentNews’  “Republican introduces bill to halt Obama’s fiduciary push” Mark Schoeff Jr.  demonstrates that only politics and vested interest are driving the outcome.

In the Globe and Mail’s “Sun Life to take on $5-billion BCE pension risk” Jacqueline Nelson reports that Sun Life has assumed the longevity risk associated with the $5-billion BCE pension plan for  a monthly premium; also “Sun Life will take over making the required pension payments to existing pensioners, and will continue to do so during their lifetimes…(but) The deal doesn’t take the responsibility for the pension plan out of BCE’s hands.” (The available information is very sketchy, but from the sound of it, Sun Life is not assuming any market or inflation risk but is using its substantial life insurance portfolio as a way to hedge the longevity risk of pension plans and collects a premium over the next few decades while doing so.  This is magic for Sun Life’s bottom line as the worst outcome is that losses resulting from longevity increases substantially beyond what is built into the premiums would be offset by gains on life insurance portfolio resulting from longevity improvement for policy holders; in the meantime premiums are rolling in and flow straight to the bottom line.)

In the Economist’s “Into the unknown” Buttonwood discusses that starting next month UK retirees will no longer have to take a mandatory annuity upon retirement. But, even though the government will be providing a website with available options as well as human guidance accompanying it, no retiree knows the answer to the three key questions: “How long will they live? What will be the impact of inflation? What will be the returns from “risky” assets such as equities or property?” Retirees want “three things from retirement: income that grows with inflation, security of income till death and protection from stock market fluctuations. They can get that with an inflation-linked annuity. They don’t, of course, because hedging against inflation, longevity and investment risk is expensive; the starting income is low.” (Retirees will need personalized professional advice to make the decision, but there are no guarantees. Time will tell how well this will work out, but for many/most the elimination of mandatory annuitization will likely lead to improved outcomes.)

In Reuters’s “U.S. mutual funds cut expenses by shifting billions into trust” Tim McLaughlin reports that actively managed funds are trying to lower fees by using Collective Investment Funds (CITs) structures to lower cost of their mutual funds and stem the outflow of assets into lower cost passive investment vehicles, in retirement accounts they manage for retirement plan sponsors. “CITs are more opaque to the outside world because reporting requirements are not as stringent…” according to Morningstar. CITs instead of being regulated by the SEC come under state regulatory supervision which will vary from state to state. (Many plan sponsors have recently come under attack for not acting in the best interest of their employees, at least in part due to the opacity of the fees/costs associated with the funds offered. Not sure how less disclosure will help overcome the opacity of retirement plans. If lower costs are desired, as they should, a shift to passive might make more sense.)

Things to Ponder

In Bloomberg’s “Miscalculated risk: The old-age bill that’s crushing Genworth” Zachary Tracer reports that long-term care insurance provider Genworth is having financial challenges associated with the LTCI policies. “Long-term care policies written in past decades have turned into a black hole for the insurance industry. Executives misjudged everything from how much elder care would cost to how long people would live. Result: these policies are costing insurers billions.”Insurers had to contend with: “the rising price of elder care”, “interest rates have plunged to record-low levels”, “demographics: America is greying”. And of course the price of new policies have been increasing; but even worse, existing policy premiums have doubled in many cases. Furthermore, the article notes that many insurance companies are dropping out of the LTCI market and fewer people are buying LTCI product, just as it appears that the need is growing. (I can’t tell if this article is intended to create fear and drive people to buy LTC insurance, or just trying to justify the outrageous premium increases on existing policies to regulators and policyholders? Most of the policies come with stringent requirements to start receiving benefits, and they typically have caps on annual benefits and often on lifetime benefits. Again, the real question is whether LTC, which the industry indicates to be needed by 50% of the population, is a risk appropriate for mitigation by insurance; after all insurance is for low probability high financial impact events, and 50% is not what one might call low probability. Is LTCI a lose-lose proposition?)

The WSJ’s “Is there a case for actively managed funds?” presents two perspectives on active vs.  index funds. In one corner Zhang argues that “when a market is inefficient, active funds can pay off”. So active management may have benefits “in illiquid and data-inefficient markets, where mispricing of securities is frequent and the rewards more substantial”, such as small caps, microcaps, bond market and developing markets. In the other corner is Solin who calls active management a “shell game”. “Don’t invest in actively managed funds. The better approach is purchasing a globally diversified portfolio of low-management-fee index funds, passively managed funds or exchange-traded funds that track broad market indexes….Identifying any outperforming actively managed fund prospectively is exceedingly difficult. About 50% of actively managed funds disappear over a 10-year period. Only about two of 10 funds will survive and beat their risk-adjusted index. And when taking taxes into account, the risk-adjusted odds of an active portfolio beating a comparable passive one are nearly zero.”

In ETF.com’s “Avoid the loser’s game” Larry Swedroe answers the question whether active value managers outperform passive value managers by pointing to passively(?) managed DFA  value funds which are consistently top quartile performers in the Morningstar 15 year value fund rating. (A related topic, which I need to read up on, is the subject of DFA funds which are only sold through DFA selected advisers., and the meaning of them being passive (versus just another index which happens to be tilted to factors such as value and small cap and how their performance is compared on a risk adjusted basis and other related questions…but that’s for another day.

 And finally, in the Financial Times’ “Who is fooling whom in haven asset hunt” John Plender discusses the shortage of really safe assets given the global savings glut in search for a safe haven. Safe assets are typically “the bonds of governments that have their own currency and central bank “ and as a result of the creation of the Euro much of the source of such bonds has disappeared. The supply demand imbalance continues to aggravate with introduction of bond buying QE in Europe and the requirement that financial institution buy domestic government debt. The need for pension plans with aging members to match pension liabilities further aggravates the demand for the safe bonds. People and institutions are clamoring for safe assets even at negative-interest rates. “And as in all overheated markets, there will be those who are buying expensively on the assumption they will be able to pass the parcel to a greater fool. “ Also in the Financial Times, Chris Newlands’s  “Gross criticises race to keep interest rates low” argues that that there is an “undeclared currency war” and a “race to interest rate bottom ” may exacerbate rather than stimulate low growth rates by “raising savings and deferring consumption”. Mark Mobius is also quoted that the low interest rates are “are now a disadvantage to regular bank deposit savers and pensioners”; and things can get worse if/when the easing will result in “high inflation and asset bubbles”. By the way, the WSJ’s “Treasurys offer bonus”  reports that 10-year U.S. Treasurys yield 2.11% compared to the corresponding German bond at 0.338%, which is the highest yield premium in 14 years. (QE, competitive devaluation, interest rates driven to zero…one would sure hope that Central Bankers are working on the timing and mechanisms by which the world will be allowed to return to normalcy without making the cure worst the disease.)