Sunday, 26 February 2017

Book Review: The Essential Retirement Guide by Frederick Vettese


This book (available here on Amazon) makes a valuable contribution to the individual investor's bookshelf. It has some unique content on some extremely important topics like the frequency of health problems and their potential costs during retirement. It also provides a lot of common sense on the issues of how and how much to save for retirement, including the old bugbear rule of thumb on what percentage of working age income one should aim to replace in retirement.

The "Contrarian Perspective" in the book's subtitle is not explicitly stated but I would presume arises from key points that depart from the mainstream of advice, namely:
  • the 70% income replacement target is far too high for most people, especially the middle income earners who are constantly being hectored to save more to stave off retirement disaster; author Vettese makes a pretty good case too, showing with examples how major portions of pre-retirement expenses usually go away, such as mortgage payments, child raising expenses and retirement saving itself; instead he says, reasonable targets that maintain lifestyle are often closer to 50%; he usefully provides enough detail to allow readers to figure in variations for their own circumstances.
  • retiree spending declines with age, and at an accelerating pace, after age 70 or so, such that maintaining an inflation-adjusted constant real return overdoes the need; furthermore, he cites sources explaining that this decline is due to falling interest and capability to spend; thus, he believes that inflation at the government's 2% target rate is not as serious an issue as commonly stated.
  • buying an annuity, which only a tiny minority of retirees actually do, is a wise move to counter the risk of out-living your money if you do not have a defined benefit pension plan, which fewer and fewer people do.
The above is good stuff that has been said elsewhere, but the best content in this book is a topic of huge worry to retirees that I have never before seen treated in any kind of depth - the material on retirement health patterns and the costs thereof. It's a top of mind topic for all retirees but how significant is it in fact? I have been trying with great difficulty for some time to dig out hard facts about this and I can say that the book is worth buying just for the 40 pages devoted to health. The key health issues are addressed:
  • How long will you live and how much of that will you likely be healthy?
  • What are the most threatening health problems or diseases during retirement and how likely is it you will need to go into Long Term Care (LTC)?
  • What is the cost of LTC and what are the odds for average years in LTC and worst case?
  • Is it worth buying LTC insurance and might you be ineligible anyway? (which I discovered is my situation so I don't even need to fuss about LTC insurance)
Ironically, given the fact that Vettese is an actuary, the weak part of the book is the treatment of investing leading to and during retirement. Probably this is the result of the book's aim to address both Canadian and US audiences. There is mention of, but no in-depth discussion of types of accounts like RRSPs, TFSAs or the appropriate types of investments for each account and how this should change after retirement except the sound, but general, advice to buy annuities. Chapter 17 confusingly misconstrues the 4% withdrawal rule, ignoring the original formulation by William Bengen as a constant real (inflation-adjusted) annual withdrawal based on the portfolio value at retirement. Vettese instead states it as 4% of the remaining annual balance. The effect of Vettese's version of the rule is of course that you will never run out of money. Mathematically, taking any percentage less than 100% out of a portfolio will always leave something though at higher percentages the remainder gets awfully small. Even at lower percentages like 4, 5, 6% you will face quite significant reductions in spending in larger down market years, which goes against the objective to maintain lifestyle spending.

There is also no discussion of the dangers of poor investment returns early in retirement, termed sequence of returns risk. This is a critical risk (see this simplified example of how much sequence of returns can influence outcomes), one that finance professor and pensions expert Moshe Milevsky has found (in his book Are You a Stock or a Bond?) to be more important than inflation or longevity as a threat to successfully living off a portfolio during retirement.

Bottom line: This book is not the complete answer but it is well worth buying. Four out of five stars.

Monday, 16 January 2017

Suitability of Investments: Why it's so complicated but doesn't need to be

There is much on-going controversy in the financial advice industry amongst regulators, so-called and real advisors and their firms and consumer advocates about the current suitability standard for recommending investments versus a possible best interests standard.

There are three main issues:
1) suitability definitions (e.g. IIROC Rules or Ontario Securities Commission requirements) for investment industry salespeople are meant to stop abusive practices. Most often this involves putting clients into highly risky, high cost securities. This issue accounts for 99% of the whole suitability vs best interests debate.
2) suitability for someone like me, a reasonably informed self-directed investor (who thereby has no ethical conflicts), equates to the best interest standard. The only thing that's suitable for me is what's best for me. ... But it still leaves a very wide possible variation of investments. I could probably ask three highly experienced, completely ethical true financial advisers to tell me what investments to make and I could probably get three very different answers. This reality shows up in the definitions - beyond the words about Know Your Client and Know Your Product, the regulatory definition of suitability is still either circular where the word suitable itself is repeated, or it says something vague like "must apply sound professional judgement". That's because there is no single correct best answer even when you take into account risk tolerance and risk capacity, short and long term objectives, complete financial circumstances, including taxes and so on. The world, and life, is too uncertain to be sure you have what will turn out to be the best answer. I can say that things get even more complicated in retirement when additional factors become as or more important than the investment portfolio, such as future inflation, unknown longevity, other products like annuities, unknown health, mental decline, account choice for holdings and withdrawals (TFSA, RRSP, RLIF, regular), CPP and OAS changes by the government. If you don't believe me, peruse the writings of Wade Pfau whose research seems not to (yet?) have uncovered, after probing many suggested approaches, a right answer on how to organize the investment side alone. For example, see this discussion of three ways to incorporate bonds in a retirement portfolio about which he notes "Scholars and practitioners have numerous disagreements about the best way to incorporate bonds into a real-world retirement income plan."
3) suitability can and should also apply at the portfolio level, not just individual securities, funds or ETFs. Asset allocation is a powerful risk mitigation tool that works at the portfolio level. Thus, robo services that propose and actually implement collections of ETFs with rebalancing rules should not have to apply a suitability judgment against individual ETFs - a more volatile emerging markets ETF as a minor portfolio component with USA equity and a bond fund can reduce overall volatility and that would make it ok even for a conservative investor. On its own, it would probably not be ok however.

When all is said and done, I believe, for example, that a low fee balanced equity - fixed income fund (such as Larry Macdonald's One Minute Portfolio or our similar Reluctant Investor's Lifelong Portfolio) is suitable for everyone and anyone, of whatever age or financial circumstances. Why? simply because it is not unsuitable. The anti-definition is best >> What is suitable? = Anything that is clearly not unsuitable. 

Eliminating the Unsuitable by avoiding dangers
In practical terms, a default automatic suitability pass could consist of individual securities, mutual funds, ETFs or portfolios with all of:
  • no leverage 
  • no use of derivatives
  • low fees, for example under 0.75% MER
  • diversification, such as individual mutual funds or ETFs with holdings of 50 or more individual securities
  • avoid over-concentration by holding less than 10% of total portfolio value in individual securities, which also must be listed in the TSX Composite index, or S&P 500
  • fixed income (individual) with ratings of investment grade or funds with no less than 70% investment grade holdings
  • portfolios (such as robo advisors provide) of equity combined with fixed income where each of the two is limited to 30% to 70% of the total value
  • minimum liquidity characteristics, an exact number for which I cannot suggest but would be based on trading volumes in a public market
It's quite possible that other securities could pass the suitability test - indeed one of my favourite and highly suitable funds is BMO's Low Volatility Canadian Equity ETF with only 46 holdings. Such alternatives would need to have more justification as to why they are suitable e.g. low volatility is very beneficial for a retired investor to reduce sequence of returns risk (a large market drop early in retirement combined with portfolio withdrawal causing an irretrievable reduction in the portfolio) while retaining the equity exposure.
Such a restrictive approach to suitability as the above makes investing simpler and allows the focus to shift to the other elements of financial management for individuals, which is where it should be.

Wednesday, 26 October 2016

Work for your passion or for money?

Recommended reading: "Don't do what you love for a career - do what makes you money" by Catherine Baab-Muguira.

It's a timely rebuttal to the rose-coloured glasses view that you should follow your passion and only work at something that you love. Baab-Muguira is right with respect to 99% of the population. No job is perfect and no job is without considerable hassles. Very often one discovers that the "passion" fades. Circumstances can and do change. Let's face it, humans are built to be adaptable. Almost all of us are not so gifted at anything that our legacy to the world and our happiness is uniquely tied to one job, occupation or career.

My wife is a perfect example of what can happen when you start a job for money. While in secondary school she wanted to study languages and possibly be a translator. The family situation did not permit this and she was obliged to go into something practical, which would help support the family (this being the bygone era when kids were expected to contribute financially as soon as they could work). That undesired, unsought occupation was teaching. Guess what, by determination and hard work (e.g. taking extra courses necessary for advancement while having two children) she got really good at her job. So much so that she rose to become principal of a primary school. She also learned to love the job. So much so that she worked on for a year and half beyond the age at which she could retire with full pension. And the languages since she retired? Nope, she has not gone and done it. She's more interested in our grand-children.

Retirement is no uninterrupted orgy of selfish passionate pursuits either. The phase of not being able to do whatever the heck you like never arrives, not even in retirement. You can do more of what you want to do and less of what others want you to do with financial independence, but as long as there are other people around, starting with family, and extending to whatever groups you belong to, the mix of good and bad, success and disappointments, is always there to contend with.

Saturday, 21 May 2016

Fraser Institute Trying to Damn the CPP with Faint Praise

The Canada Pension Plan will generate only a 2.1% real rate of return for Canadian workers starting out today, concludes Rates of Return for the Canada Pension Plan (May 2016) by Jason Clemens and Joel Emes of the Fraser Institute. Therefore, we Canadians seem to be invited to further conclude (given the Fraser Institute's past attacks on the idea of expanding the CPP), that's a very poor investment and therefore a good reason for Canadians not to support expansion of the CPP.

Telling half the story truthfully is a sly way to debate an issue. Clemens and Emes appear to have crunched the numbers properly. Here's what they forgot or neglected to say.

2.1% compared to what? - For CPP to be judged as poor, it needs to be compared against a realistic alternative that covers both the savings phase and the retirement phase of life, such as an RRSP and a life annuity. I calculated and posted such a review in 2015 and found that the relative attractiveness of the CPP varied enormously according to whether the person is a man or woman, single or married, and self-employed or an employee. Married women employees benefit most from the CPP, enjoying the equivalent of a prospective lifetime guaranteed real return of 5.1%, while single self-employed men would get only about 1.1% return. The biggest difference arises from the fact that employers pay half the contribution on behalf of employees while self-employed pay the full shot.

Managing investments yourself vs Total auto-pilot of CPP - It's easy to say you can beat 1.1%  or even 2.1% real return investing money in an RRSP yourself without breaking a sweat but consider:
  • Will you with absolute regularity for 39 years without fail save out of your income to accumulate investment funds like the CPP imposes automatically, or will you like most people find a more pressing use for your pay, especially early on in life, and only start to save seriously when the reality of retirement stares you in the face? Starting to invest late means needing to achieve much higher returns since you miss out on the power of long term compounding.
  • Will you then invest wisely, maintaining a sensible strategy of diversified low cost funds, or instead like most individual investors, buy return-sapping high-cost funds that are offered by salespeople disguised as advisors, or chase returns and hot ideas that only occasionally pay off? Will you properly compare the riskiness of your portfolio, probably containing a lot of riskier equities, to the lowest risk triple A guarantee of the Government of Canada? To be comparable risk, you would need to invest in Government of Canada bonds, which currently yield a nominal max of 2% (on long term bonds), or about 0.3% after the latest 1.7% inflation. And how much is your time and effort worth to do all this in comparison the fully automatic zero effort required by you for the CPP?
CPP extras that are difficult to price but very valuable - As my above-linked post mentioned, CPP also has bundled into it disability benefits, survivor children's benefits, survivor spouse benefits, a death benefit.

True inflation protection - Only the CPP offers true inflation protection, i.e. CPI-linked increases. The best fudge available in the annuity market are annuities that ratchet up by a pre-set amount you choose, like 1.0, 1.5 or 2.0%. You have to guess at what future inflation will be. Guess too high and you over-pay un-necessarily, or guess too low and you still lose to inflation. Either way the uncertainty about inflation is not removed and your retirement annuity income does not keep in step with inflation, drifting further and further apart as years roll on and the differences compound.

Hilarious irrelevant comparisons - The Clemens/Emes report also details some laughable calculations about how people who started receiving CPP back in the 60s and 70s have been getting phenomenally high returns, mainly because they did not contribute long but get full benefits. As if that should make present-day contributors jealous and angry to not want to pay any more - i.e. not support an expanded CPP because they would be handing even more money to retired rich so and so's. Well, we should first note that anyone retiring at 65 in 1969 on CPP launch would now be 112. They're all dead. The ranks are pretty thin at the older higher return end. There's only one living 111 year old Canadian and one of 110. Besides, what happened is done, We must look forward. And, individuals can do much worse or better than the average - die soon after after retirement and get a tiny of your money back, live long beyond the average life expectancy and your rate of return rises to very high amounts. If the report authors are inferring inter-generational inequity needs to be fixed, then the payouts to past retirees needs to be reduced. It is not by stopping CPP expansion.

Most proposals for CPP expansion are that higher benefits come only when they have been earned through higher contributions. That would be fair. You get back for what you put in and you are not paying extra for someone else already a recipient to receive more.

When the full context is given and the whole story told, the CPP sure looks a lot more reasonable than a single low return number seems to imply.

Saturday, 30 April 2016

Canadian Securities Administrators Ignore Rule #1 about Rules

What's rule #1? A rule is not a rule unless it's enforced. Any two year old knows that if the parents say to do or not do something, unless there is a sanction that is actually applied, you can behave as you want. And that's what kids do. The rule doesn't actually exist in any practical sense.

The CSA is exactly in that situation as the "parent", supposedly regulating financial firms and their employees dealing with the public, getting them to behave honestly and responsibly towards the public. The Small Investor Protection Association recently released a shocking and dispiriting report Unpaid Fines: a National Disgrace, which details the almost non-existent collection of fines imposed on financial miscreants in recent years. As the report says, this abysmal performance undermines the whole system of regulation. Investors will lose confidence. The financial industry will not feel deterred against misdeeds.

Such utter neglect of the CSA's mandate is especially annoying in the light of its recent excellent proposal to institute a best interest standard (as opposed to the weak suitability standard now in force) for financial advice on the investment industry. That proposal, even if implemented, won't have much real beneficial effect unless enforcement takes place. It's high time for the CSA to start doing its job properly. Just ask any parent.

Thursday, 7 April 2016

Visitors to Canada Beware - You might need a "not-a-visa" eTA

Formerly, Brits, like my wife, travelling to Canada for a visit needed only their passport and no visa. That has changed, as from March 15, 2016 (with an interim grace period till the fall of this year) she and other foreign nationals, except US citizens, will need an Electronic Travel Authorization to enter Canada by air. The eTA is not formally a visa but it sure feels like one to my wife, since after the grace period, without it you don't get to board the plane.

Some key things facts I discovered digging through the website and phoning a Canadian consulate:
  • you can apply in advance, even before you make a booking or plan a trip
  • the eTA is good for five years, but ...
  • if you need to renew your passport before then, you need to buy ($7 now) a new eTA because the eTA is linked to your passport number
  • the eTA is stored in the Canadian government's vast databases so that you do not need any piece of paper to prove you bought one (of course, it's gonna be your problem if you say you bought one and may even have the printout but for some reason the database says no, you don't)
  • it supposedly takes "minutes" to apply online and receive an email confirmation i.e. make sure you know where your airport internet access is or your phone has access just in case
Welcome to the new world of travel to Canada!

Saturday, 26 March 2016

Yikes! Federal Budget Revives Support for Toxic Labour-Sponsored Funds

It was a shock to see the recent Canadian Federal Budget measure to restore the 15% tax credit to encourage retail investors to buy into a proven loser investment vehicle, Labour-Sponsored Venture Capital Corporation funds. I, like almost every other investor in these toxic funds, lost a lot of money in their first incarnation during the tech boom years. The pleasure of a one-time tax credit is sooner or later replaced by the grinding regret of declining asset value and often extreme difficulty in redeeming the investment to limit losses.

I said it four years ago when I slammed labour unions in Labour-Sponsored Rip-off for aiding and abetting such LSVCCs, and I'll say it again: stay away, don't consider for a second investing your money in them.

Look at the track record of one such surviving company, Covington, whose latest annual report tells a sorry numbers tale:
(click on image to enlarge)
Note how the benchmark average, the Retail Venture Capital Index that measures all Ontario-based LSVCCs, has a negative compound 10-year return (which understates the poor performance since it no doubt excludes all the worst loser funds that have disappeared along the way).

Even people in the investment industry mince no words about LSVCCs, viz the Investment Executive article linked-to at the top, where Ian Russell, president and CEO of the Investment Industry Association of Canada is quoted: "All our research shows these funds are ineffective in raising capital for successful small businesses, so that's a disappointment," Russell says. "The labour-sponsored venture capital funds were a disaster in the past." They did no good for investors or small business. What is the government thinking, anyhow?

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