Saturday 19 December 2015

Understanding Investment Risk - Read Howard Marks' post and reread it over and over

Howard Marks of Oaktree Capital has written the best explanation of investing risk I have ever come across in one of his Memos - Risk Revisited Again (the title revealing that he has refined and revised and expanded his exposition over many years and much hard reflection with much hard experience to inform him). The point of view is very practical as opposed to the academic theoretical approach and the writing is very readable for the DIY investor. That means he looks at risk in all its many facets and subtle but important nuances (24 different kinds of risk!), as opposed to the single volatility measure academics and regulators so love.

I sure wish regulators like the CSA and the OSC would come to grips with this stuff instead of lazily opting for the misleadingly simplistic use of price volatility for classifying the riskiness of mutual funds.

Tuesday 8 December 2015

TFSA Contribution Limit Petition

Keep the annual TFSA contribution limit at $10,000 per year. That's the goal of the online petition on the official Parliament of Canada website. The Liberal government has announced the intention to reduce it back to where it was before the previous Conservative government increased the limit earlier this year. There is no good reason to do that. For those in lower income groups the TFSA is a better retirement savings vehicle than the RRSP and the TFSA is a simpler more flexible tax-free savings account in general. I don't see the government proposing to reduce RRSP contribution limits. I encourage readers to sign the petition like I already have done because it's the sensible thing to do to protect the TFSA (as I have previously written in dissecting the type of wrong-headed arguments criticizing the TFSA that misled the Liberals into proposing the contribution cutback).

Friday 14 August 2015

SIPA's Can't-Lose Investment Contest

Unlike so many investment schemes out there in the real world, here's a chance to make real money with no risk of loss. How? - Create a video and enter the contest being sponsored by the Smaill Investor Protection Association. The $3000 first prize is not too shabby! Kudos to SIPA for the initiative as one well produced video that garners scads of hits will be worth a thousand submissions to regulatory bodies or occupy May Street demonstrations.

Sunday 24 May 2015

No Hype, The Straight Goods on Investing Your Money, 3rd edition, by Gail Bebee

Short, simple, straightforward and sensible. That's No Hype in a nutshell. As an entry level book specifically for Canadians, it covers all the key financial products, services, principles and issues. There's not a huge difference with previous edition (see my review of the 2nd edition), the changes have mostly been updates of data and available investments, which is important since Bebee provides a number of useful model portfolios with specific suggested ETF, mutual fund and stock holdings. Updating is a never-ending and always imperfect task since the instant the writing and editing is done, things begin to go out of date and indeed that is already evident in a few minor spots (e.g. Shoppers Drug Mart got bought out and is no longer traded, the website address of the Financial Planners Standards Council is wrong) but the trade-off of greater specificity of the book vs correct vagueness is well worth it.

All in all, still the unique basic go-to book for investing basics in a Canadian context. Still a very high rating of 4.5 out of 5.

It is available for purchase from Bebee's website - http://www.gailbebee.com/

Disclosure: Author Gail Bebee provided me with a free copy for review

Saturday 23 May 2015

CFP Financial Planning Ethics Commitment or Not?

The Financial Planning Standards Council of Canada lays out the expected ethics of the best-known and most-common certification for financial planners in Canada, the Certified Financial Planner (CFP).

The FPSC's Definitions Standards and Competencies pdf lays out a laudable and crystal clear commitment to the public:
"Principle 1: client first A financial planner shall always place the client’s interests first"

But hold on, wait a minute, don't hold them to it, "Each principle of the Code presents the expected behaviours of financial planners. The Code is designed to guide professionals in their practice but does not undertake to define the standards of professional conduct of financial planners for the purposes of civil liability." [red highlight mine] Such prevarication does the supposed profession more harm than good. The only good thing is that the statement is out in the open whereas a lot of the other self-styled financial planners / advisors obfuscate, and try to have the public believe the client's best interest drives the advice but in fact it is not even a hoped-for aim.

Tuesday 19 May 2015

Financial Industry Culture of Illegal and Unethical Behaviour Getting Worse not Better

The Street, The Bull and The Crisis, a new survey of people working in financial services in the USA and the UK tells us the mind-numbing news that instead of getting better following the financial crisis, the attitude that doing illegal or unethical things is the way to success is getting worse. Reading through the stats in the report it is apparent that the bad attitude is endemic, it's the culture of the industry.

It's more than a bit worrying that the same type of behaviour that almost brought down the world's financial system is still rife. As authors Ann Tenbrunsel and Jordan Thomas warn, "Allowing the status quo to persist is an open invitation to the next, perhaps more devastating, financial crisis".

I cannot stop the miscreants from destroying the financial system, other than lobbying politicians and regulators to knock heads, but I can try to keep my personal money as far away as possible from such people (defined in the report as those with titles such as "account executives, financial / investment / wealth advisors, financial analysts, investment bankers, branch/operations management, and portfolio managers").by DIY investing in the simplest possible financial products with the least incentive or opportunity for rip-off, like GICs, low-cost passive ETFs, direct investments in selected company stocks or bonds. It's also a reason I like the CPP - the investment arm, the CPPIB, seems to have a governance structure more likely to curb illegal and unethical employees.

Thanks to Ken Kivenko, a member of the Ontario Securities Commission Investor Advisory Panel, for the heads up on this report.


Monday 18 May 2015

Canada Pension Plan vs RRSP - Which is the better investment?

Not that we have any choice, since there is no way to opt out of the Canada Pension Plan, but suppose we could. Would it be better to invest in an RRSP? What kind of return would we need to achieve to beat the CPP?

Assumptions
CPP: A 65 year old receiving maximum CPP of $1065 fully CPI inflation-indexed income per month for life would need to pay in for 39 years $2479.95 per year (in current 2015 dollars) if an employee, or double that ($4959.90) if self-employed and having to pay the employer portion as well. See RetireHappy blogger Jim Yih's explanation of how to get maximum CPP here.

RRSP: The same $2479.95 (or $4959.90) is invested in an RRSP. At age 65, the person buys a $1065 per month lifetime annuity indexed (increased) annually by 2%, which is our best guess future rate of inflation based on the fact that 2% is the target policy rate of the Bank of Canada. Like CPP, the life annuity stops when the recipient, or the spouse as well in joint life annuity, dies. The prices we obtained from Cannex.com were for annuities with no guaranteed payment period. Buying an annuity that pays, either to you or to your estate, for a guaranteed 5, 10, 15, 20 or 25 years, will pay less than one with no guaranteed period. Compare the reductions in payouts for guarantees that rise with age and guarantee period at the Globe and Mail's annuity rate page.

Single vs Married: The required RRSP return answer differs according to whether the investor is single, since the CPP has an automatic provision that a surviving spouse will get at least 60% of the contributor's CPP income level. But if the surviving spouse also contributed, he/she will get only as much of the dead person's 60% as will take him/her to the maximum of $1065. An annuity doesn't work that way. There's no cap and if a person is already receiving an annuity, it is not reduced or capped by a joint life annuity from the dead person. Instead of trying to directly figure out the comparative value of a single vs married person situation, I've just calculated both a single life annuity and a joint life with 60% continuation to the survivor spouse.

Men vs Women: Men and women pay into the CPP at the same contribution rate and get the same monthly income payment too. But women live longer than men so they collect longer on average. Annuities bought with RRSP (or RRIF) funds recognize the differing life expectancies and so women have to pay more than men. This is NOT the case with annuities bought with LIF, LIRA, RPP, LRIF locked-in funds since the feds and most provinces long ago changed the law to mandate unisex pricing - a blend of men and women rates - see TransAmerica's table on page 5 of this pdf. 

The question is what compound return must the RRSP or the locked in RRSPs attain during the 39 years of savings and investment?

Results - The results table below shows the return an investment portfolio would need in order to match the CPP's $1065 monthly income. Note that the table shows real returns since the required contributions are also indexed annually i.e. the maximum annual pensionable earnings figure, against which the 4.95% contribution rate is applied, rises each year by the amount of inflation, so each year the contribution stays the same in constant real dollars.
(click image to enlarge)


Who gets the most out of the CPP i.e. who would have had to get the highest investment return from their own RRSP portfolio to beat CPP?
1) Employees - because they contribute only 4.95% of their salary, while the employer pays the other obligatory 4.95% on their behalf.
2) Married people - since their spouse automatically continues to receive payment of 60% of the deceased's CPP whether the spouse has worked or not; in fact, the CPP deal is most favourable when the spouse has not worked and paid nothing at all into CPP.

A married woman employee investing in a RRSP (who thus faces a more expensive longevity-based price for the annuity) benefits the most of anyone. She would have to beat a 5.16% annual compound return to outpace the CPP.

Who gets the least?
A single self-employed man investing in an RRSP is at the opposite end. He might consider attaining a 1.14% annual return to be quite feasible. It is especially costly to be making the employer contribution as well as his own that makes the huge difference.

CPP offers solid returns for most
Thus, for the majority of working people who are employees, it would be hard to beat a compound real return of 5% or so per year for the whole of an investing lifetime of 39 years.

Compare a hypothetical portfolio using historical data for the 35 years from 1980 to 2014 on the Stingy Investor Asset Mixer tool. A portfolio of 50% each of the broad Canadian bond index (something like iShares' XBB) and the TSX equity Composite index (e.g. iShares' XIC) with all dividends reinvested and the portfolio religiously rebalanced once a year, costing ETF-like management expense ratios, would have produced a real compound return of 5.91%. The comparison doesn't quite match up since of course there were no ETFs back then and mutual fund fees were much higher, reducing investor returns. Second CPP contribution rates were much lower - too low - in the 1980s and 90s. Up to 1986 it was only 1.8%. The current 4.95% rate started only in 2003.

Other factors
Future likely / possible returns - The future probably won't be like the past. Returns are likely to be lower, as we have written about here and here. 4% or less real returns for mixed stock and bond portfolios are the probable ballpark, not close to 6%. The CPP is very competitive.

Investor discipline and effort - Against the zero effort of the CPP, the chances that the investor will carry out the sustained annual rebalancing and reinvestment must be weighed.

Inflation uncertainty - While the 2% indexing of the annuity is a best reasonable guess of future inflation, it does not remove the uncertainty about the actual future rate. Inflation might be lower, in which case the investor benefits from rising real income. Or inflation might be higher and the investor loses. A few years of 3,4,5% inflation, even if temporary, would significantly and permanently erode the value of the annuity. The protection against the possibility of inflation exceeding the currently expected rate is a big plus for the CPP. The question is whether the government would keep its promise to provide full indexing if inflation got really high. The promise is enshrined in law so not that easy to change, and the promise was kept during the high inflation 1970s but ... you never know for sure, things might be different in future.

CPP disability benefits - Paying into CPP qualifies a person for more than retirement benefits. CPP provides substantial payments - a minimum of $453 up to $1212 per month - for those who have contributed but are no longer able to work. 

CPP children's benefit - Children of a CPP contributor can receive money from CPP two ways. 1) Children of someone receiving a disability benefit can also receive a benefit. 2) Children up to 25 can receive a survivor benefit if the CPP contributor dies.

Perhaps we should not be surprised that polls find that Canadians love the CPP and want to expand it, as the Globe and Mail reported recently.

Tuesday 5 May 2015

How safe is an annuity in Canada?

Handing over a large lump sum out of your life savings to an insurance company to buy a lifetime stream of income in an annuity is a sobering step. It is irreversible. A critical question, considering that your retirement can easily last 30 years or more, is whether the insurance company will be able to carry out its promise to pay. How sure can we be of actually getting those payments?

Protection level 1: Assuris - the backstop for failed insurance companies
As the Assuris website explains in more detail, all companies selling annuities in Canada are required to be members of Assuris, which does a very useful thing. It guarantees up to $2000 per month (or equivalent quarterly or annual amounts) in annuity income, or 85% of income, whichever is higher. It is on a per company basis so it is wise to pick different insurance companies for income above $2000 per month. Thankfully, one of the Assuris FAQs advises that if companies subsequently merge the guarantee continues on the previous basis, i.e. independently and not combined.

The ability of Assuris itself to carry out its guarantee is based partly on keeping a $100 million fund. That's not much at first glance considering the amount of outstanding annuity obligations - e.g. even a small player like Equitable Life had $456 million in outstanding annuity contracts in 2013 per its Annual Report. However, the $100 million fund is importantly supplemented by Assuris' power to levy all its insurance company members for any shortfall. Given that a failing insurance company would most probably still have considerable assets to pay a good chunk of its annuity obligations the net shortfall from the fund and the levy would seem fairly limited.

Assuris has been effective so far in its 25 years of existence. The four insurance company insolvencies in that time resulted in no losses to Assuris-covered customers and only miniscule losses to some non-covered customers.

Protection level 2: OSFI Regulation - a strict culture of caution
The second reason that annuity holders can find considerable comfort is the strict regulatory regime for insurance companies in Canada, as carried out by the federal government's Office of the Superintendent of Financial Institutions. There are requirements for companies to maintain high levels of capital to withstand financial shocks. All the major insurance companies exceed the OSFI recommended level by a large degree, let alone the legal minimum. A recent International Monetary Fund Review of the effect of the harmful low interest rate environment on Canadian insurance companies notes that the regulatory regime in Canada has forced the companies to make required adjustments. Various standards are being revised to improve safety. In the IMF's words "The regulatory regime has served Canada well in the adjustment to a low rate environment". Any future rise in interest rates will benefit companies.

It is reassuring to remember that though insurance companies suffered in and after the 2008 financial crisis, they weathered the storm. One failed but the Assuris guarantee worked. The current solidity of the Canadian insurers is reflected in their high credit ratings shown in this February 2015 compilation of the annuity issuers by McGill University. Some, like Canada Life with AA ratings, are higher rated than a weaker province like New Brunswick with only A(high) from DBRS. A culture of caution in Canada, that seems to be continuing, reassures for the future.

Protection level 3: Politics, a possible potent wildcard
"Too big to fail" and "too many voters" adds another dimension, possibly the most powerful of all, to the likelihood that annuity holders will not be left high and dry by insurance company failure. It is hard to imagine that, in the face of a single company failure that Assuris could not cope with, which would entail one of the huge companies such as Manulife or Sun Life, the federal government would not step in to bail out the millions of life insurance holders. Systemic risk domino effects on other companies and on banks might force the issue.

All in all, it seems that the safety of annuities in Canada is pretty darn good. There's no certainty that things cannot or will not change (is there ever?) but the situation looks very solid at the moment. It's one worry I will not have about my annuity purchase.

Thursday 16 April 2015

How much does the average Canadian financial advisor earn? You will be shocked....

2014 was an outstanding year for Canadian financial advisors according to PriceMetrix. It could be termed the year of the Yacht (making reference to the classic takedown of Wall Street Where are the Customers' Yachts? by Fred Schwed) for advisors. That's not just figuratively true, it is literally true. Anyone who makes $655,000 in a year is into yacht territory. Yes, that's right, the PriceMetrix press release crows about that being the average advisor income, not the top 1% or 10%, the average!

Advisors are doing well indeed - their 13% rise in revenue over the previous year contrasts with only an 11% increase in average client assets under their management, all this while advisors have been reducing the number of clients each deals with, i.e. the advisors have been firing clients, and it doesn't take a rocket scientist to know it is the clients with low assets who provide less revenue bang for each advisor time buck.

There is an increasing shift to fee-based revenue (which probably means a separate charge for assets under management but might include trailing commissions on mutual funds), as opposed to transaction revenue (one-time commission). It's hard to tell exactly what types of charges are being described - see Preet Banerjee's more detailed run-through of various terminology for various charges on MoneySense - but the end result is clear, clients of advisors got dinged for more per dollar of invested assets in 2014.

Another interesting figure in the PriceMetrix report is that each advisor served 150 clients on average. In a typical year of 236 on-the-job days (251 working days minus 15 for holidays on the yacht), that gives each client 1.6 days of advisor time per year, discounting anything else the advisor does in his/her business. No wonder $20,000 client accounts don't pay and advisors want to get rid of such clients (1% of $20k provides only $200 and 150 of such clients is $30,000 of annual revenue).

Finally, perhaps robo-advisors really are the way of the future. The report says advisors and their clients are getting older. Advisors are making no efforts to attract younger clients, who may not be interested anyway since they can get all of what typically passes for financial advice (10 simple questions and your portfolio is determined) plus automatic rebalancing for a lower cost (using lower MER ETFs plus lower robo charges on assets) from the robos.

Thursday 2 April 2015

BMO InvestorLine allows swaps between like accounts

Recently I've been liberating cash in preparation for buying an annuity. To my relief and delight BMO InvestorLine allowed me to swap cash in my LIRA for bonds in my RRIF, saving me the considerable embedded commission (around 1% from what I have observed from bid-ask spreads) cost of selling the bonds in the RRIF.

It's good to know that at least one broker has not thrown out the baby with the bathwater by banning any and all swaps after the Canada Revenue Agency clamped down on abusive gaming of the system to boost tax-protected balances. Swaps between accounts with like tax properties are still perfectly legal (per this post at TaxInterpretations.com) but some brokers seem to have simply stopped doing any and all swaps (e.g. the discussion following this post at Canadian Capitalist and this other CC post). Swaps between registered retirement accounts like RRSPs, LIFs, LIRAs, RIFs, or TFSA to TFSA are ok but not between TFSA and RRSP (or other retirement) or with taxable accounts.

Friday 27 March 2015

Book Review: Never Smile at a Crocodile by Paul DioGuardi

This book (available here on Amazon) of several dozen two to four page mini-stories, is a disparate random collection with many messages:

  • cautionary tale about the single-minded unforgiving nature of the CRA bureaucracy and the dangers of disobeying tax laws, deliberately or accidentally (as he says, there is "no compassion in a crocodile brain")
  • cautionary tale about citizens who don't pay the taxes they should, some of them due to reasons we can be sympathetic to, and others who are just plain cheats - he has met all types
  • how the insider game works in politics and business deals where who you know makes a big difference
  • self-promotion and self-congratulation of the tax services of the author
  • memories of personal holiday and work adventures, (I'd guess all of which were arranged to legitimately be tax-deductible as business expense though he never utters a word about his own tax affairs)
  • how sometimes innocent people get caught up in the CRA idiotically and harshly using its power
  • how sometimes very guilty people get away with lots of cheating by hiring a good lawyer

There's no specific tax advice, just the general message to pay your taxes on time .. because the crocodile is lying in wait.


It's quick reading, always light and chatty, flows easily, not technical even when discussing specific (all of them non-viable) tax avoidance schemes. One could imagine all these stories being told over a drink in a bar, the reminiscences and tales of an old raconteur, most of it true but some of it probably embellished. Good entertainment value, a few good laughs along the way. 

[There is even a defense in the book of his law firm's current on-going dispute with the Law Society of Upper Canada, reported in the Toronto Star in 2014, about how to hold client retainer money. He makes a pretty good case. He describes himself a number of times in the book as a fighter, not easily deterred. It certainly seems to be so, as he has announced his candidacy for the Law Society Bench in order to shake it up. If the CRA is a crocodile, DioGuardi might be a leopard, which this site says occasionally eats crocodiles. I don't know if he looks soft and fluffy but he certainly seems to have claws.]

Monday 16 March 2015

Investment Advice Trust Index - A Simplistic but Simple Retail Investor Guide

Whose advice can you trust? It's complex and confusing but you cannot wash your hands of getting an idea of whom to trust because a mistake can be extremely costly, as in having your retirement savings wiped out.

There are titles galore in the financial and investment industry that we individual investors must deal with. Some titles mean something, others are just fluff to impress us.

The key idea is that only a few select people we might deal with are obliged to act first and foremost in our best interest, what is called behaving according to fiduciary duty. Most are held to a much lower standard, such as suitability, for instance in the Mutual Fund Dealers Association Member Regulation Notice on Suitability. That allows the industry professionals to behave with great latitude and often in their own best interest, mostly as salespeople, as long as their "advice" is not outright fraudulent or misleading.

Two documents from official regulatory sources provide a means to narrow things down to a list that has substance:

1) Canadian Securities Administrators Understanding Registration, a one-page list of all the types of people and firms that can sell or offer advice on securities (mutual funds, ETFs, stocks, bonds). Acknowledgement to the Small Investor Protection Association, where I found this link.

2) Canadian Securities Administrators Consultation Paper 33-403, The Standard of Conduct for Advisers and Dealers: Exploring the Appropriateness of Introducing a Statutory Best Interest Duty when Advice is Provided to Retail Clients, a 37-page legalistic, technical document (why is it that such important consumer information is only to be found buried in such a user-unfriendly place?). Page 9 of the pdf contains the following chart; most of the entries in the fiduciary duty columns have a No, few a Yes and several It Depends.


What is your firm's and your personal registration category? This is the first question to ask. Check the registration here. If the answer is "not registered", run for the hills!

Only three categories of individuals matter.

Ninety percent of people who call themselves financial advisor, investment advisor, financial planner, wealth advisor or some variation of such are Dealing Representatives, which as we see from the charts, are actually salespeople selling mutual funds. Caveat emptor! Assume they will not necessarily provide recommendations or plans that are best for you (except in Quebec where they are obliged by law to always act in a client's best interest). 

Advising Representatives and Associate Advising Representatives almost all work for Investment Dealers or Portfolio Managers. If they have explicit authorization to buy and sell in your account i.e. a Discretionary account, they have a clear responsibility to act in your best interest (the Yes entries in the second table). Of course, that does not negate human nature and some bad apples might still do lots of trades to generate extra commission income for themselves.

The "It Depends" situations are very problematic for the individual investor. You have a Non-Discretionary account and still have final say on buying and selling. But you may be reliant on the advice given, which may mean you can or cannot count on that advice being in your best interest, depending on how the five determining factors (vulnerability, trust, reliance, discretion, professional rules or codes of conduct) cited in the CSA consultation paper pan out. In the case of dispute, usually when it's too late and and bad things have happened to the investor, the only way to find out for sure is to go to court at great cost of money, time and effort. The ambiguity, which usually works to the benefit of exploitative abusive firms and investment professionals, is a big reason for the long-standing but so far unsuccessful push to have a much broader best interest fiduciary standard imposed on the investment management and advice industry. Therefore, as a pre-cautionary rule of thumb, assume the "It Depends" will not necessarily provide recommendations or plans that are best for you.

For all my dislike of the provincially-partitioned investment regulation in this country, I wish the other provinces and the CSA would do what Quebec has done and clear up the ambiguity by statutory imposition of the best interest fiduciary standard.

A source of much un-necessary confusion is the proliferation of so-called financial certifications and designations, some much flimsier than others. Even for the more substantial ones amongst those listed here on the IIROC site, there is a wide range of best-interest related clauses in the codes of ethics or conduct. Trolling through any one of them to know the exact legal ramifications of each code is time-consuming and of uncertain value. Therefore, ignore designations and stick to the above basic approach.

That says who you should be able to trust, legally speaking. But even then, there are a few bad apples, so it is of course necessary to keep a watchful eye and be aware of a gut instinct that says something may be wrong.

As for me, I know where I stand. The Discount brokerage entries show a clear No in both columns. I know I'm on my own. If I mess up my investments, it's all my fault.

Saturday 14 March 2015

More reasons to buy an annuity

Last post, I came to the conclusion that buying an annuity makes sense given a couple of guiding principles and the contrasting alignment of annuities vs my present stock/bond portfolio against key retirement risks and desired features.

That's not quite the whole thinking, however. Some additional motivations are driving me towards annuities.

Not burdening my children or the state - I want make sure I have enough income throughout my life not to oblige my children to pay for my upkeep. Call me old-fashioned but I also don't want to count on the government to bail me out at age 85 either.

Wish and project as we might with the best financial planning, monte carlo software and projections based on historical data, there's always a residual chance that an invested stock/bond portfolio subject to withdrawals might run out except at ridiculously low withdrawal rates or impossibly long planning horizons. But the slower and safer I withdraw, the more chance the money is never withdrawn, so I don't get to enjoy a lot of it. Which complements my next motivation ...

The inheritance I leave will be what's left over, not any specific planned amounts - I (and my wife) have already given the kids a good legacy by supportive parenting and a solid education that seems so far to be enabling them to make their own way.

Tax increase risk diversification - Governments can get into financial trouble and may look to the "wealthy" to impose extra taxes, spurred on by social activist thinking such as at the Broadbent Institute. Turning assets into an income stream today reduces the risk of future rising taxation on either accounts (like TFSAs, which are viewed in some politically-correct quarters as accounts benefiting the rich despite the opposite reality) or dividends and capital gains.

Living a longer and happier life - It is well-known by insurance companies that people who buy annuities live longer than the average population. Now, it is comforting to me to think that because I am intending to buy annuities, I will live longer. But it may not just be accidental, that people who are in good health figure the odds are good. It may be causal i.e. buy an annuity and it will make you live longer! Moshe Milevsky's superb summary of annuities for the CFA Institute quotes the research on page 108: "... he found that veteran pensions reduced mortality for both acute and nonacute causes of death ... [and then Milevsky quotes Jane Austen to put it in plain talk] ... All of these findings echo the famous Jane Austen quote from Sense and Sensibility (published in 1811):If you observe, people always live forever when there is an annuity to be paid them.
It's called buying peace of mind. Bill Gates or Warren Buffett don't get disturbed when markets go down because they have far more than they could ever need. But for those of us who have managed a relatively volatile stock-bond portfolio for twenty years and who cannot sustain a prolonged period of poor returns, we can relate to the findings Milevsky quotes.

Wednesday 11 March 2015

My Retirement - Should I buy an Annuity?

Should I or should I not buy an annuity? (An annuity is financial product in which an insurance company, in exchange for a lump sum today, pays the investor a pre-determined cash amount for life.)

Why am I even considering this step?
First, I'm in my early 60s and no longer earning appreciable employment income. Yup, I'm retired and I would rather not un-retire if I can avoid it.

Second, I'm getting CPP but OAS is a few years off. I do not have any defined benefit pension so my investments in various registered plans, a TFSA and a non-registered account are the only possible sources of living expenses for the rest of my life, though at some point I am likely to receive a lump sum inheritance. Probably I am fairly typical of a growing number of Canadians, for whom the comfort of DB pensions providing assured lifetime income is no longer a possibility.

Third, I aim to follow a couple of simple financial management principles that make intuitive sense:
  • Guiding principle #1 - Match spending liabilities with income assets.
To the extent possible I want my various spending needs for food, housing, recreation, health to align with income sources in terms of timing, amounts, regularity and certainty aka riskiness. Grocery money, electricity and property taxes are essentials and must be matched by equally reliable income. On the other hand, I can put off or reduce travel.

This means matching the characteristics of income-producing assets with retirement financial risks and desired benefits, many of which are unique or especially important to the withdrawal phase of investing and to later life. The following chart summarizes the nature of the two main categories of financial products - i) stock & bond portfolios in the various types of investment accounts like RRSPs, RRIFs, LIFs, LIRAs, LRIFs and Defined Contribution pension savings plans and ii) annuities, CPP & OAS and Defined Benefit pensions.
(click on image to enlarge)


The striking feature of the chart is how well the two categories complement each other. Neither ticks a Yes in every box but where one category falls short with a No, the other in almost every case has a Yes. The two exceptions are inflation protection and tax minimization, where each category can only offer partial protection.

The obvious conclusion is that every retiree needs to have some of both types of products, except perhaps for those lucky or wise few whose 70% of final salary fully CPI-indexed DB pensions are more than adequate and who are net savers in retirement.

  • Guiding principle #2 - Take only as much risk as necessary.
Given that my objective is to maintain the lifestyle I have been happy with through the pre-retirement part of my life, if I can see that risk-free income sources will suffice to fund that lifestyle, why should I take any more risk?

Since my present CPP and even including my eventual OAS fall far short of my essential needs, the above considerations naturally lead me to plan for an annuity.

The next steps, for future posts to explore, is to decide:
  • how much to annuitize
  • when - now or later, when I'm 65, 70 or later, or whether to buy today a deferred annuity that only starts paying (how many?) years hence
  • which bells and whistles to buy, like guaranteed minimum payout periods, annual payout increases, death benefits
  • whether to use money from a registered account, which offers a higher payout, or a non-reg / TFSA account, where a prescribed annuity offers a tax advantage

Tuesday 3 March 2015

Size doesn't matter (in investing)

Small-cap stocks no better than large caps - It is a waste of time to add a separate small-cap ETF or "tilt" to a portfolio since the extra return from small cap stocks can no longer be observed in the USA where it was first named, nor in any other market around the world, as Vitali Kalesnik and Noah Beck write in Busting the Myth about Size.

Worth a tilt - The tried- and still-true sources of equity premiums are market (the basic one that we get when we buy a total market ETF), value, momentum and low volatility, which Jason Hsu and Vitali Kalesnik conclude in Finding Smart Beta in the Factor Zoo. One interesting note they make is that while value and low volatility are amenable to low cost, transparent, rules-based, low turnover investing (such as in ETFs), capturing the momentum factor is best done through active alpha managers.

Avoiding back-tested data mining - There is also a sensible-looking list of criteria for deciding whether some return-enhancing rule discovered in past data is actually an equity premium source / risk factor or just a data mining artifact that will almost surely not work in future:
"
1.    The factor was discovered many decades ago; it has survived numerous database revisions as well as extensive out-of-sample data.
2.    The factor has been vetted, replicated, and debated in top academic journals over decades.
3.    The factor works in non-U.S. countries and regions.
4.    The factor premium does not change materially due to minor variations in the factor definition/construction.
5.    The factor has a credible reason to offer a persistent premium
a.    It is related to a macro risk exposure, or
b.    It is related to a deep-rooted behavioral bias that is present in a meaningful fraction of investors, or
c.    It is related to an institutional feature that cannot be easily changed.
6.     The factor exceeds a more stringent t-stat threshold of 3.5 (preferably 4.0) instead of 2.0 to adjust for data-snooping and other biases evidenced by the recent explosion in factor proliferation."

Tuesday 3 February 2015

My ETF picking is working better than my stock picking

Michael James' tongue in cheek The Stock Picker's Checklist prompted me to look at one of my accounts at TD where I have bought individual stocks as part of my overall Canadian equity allocation.

On first glance, the screenshot below of my account return against the TSX Composite Index Total Return (which is the appropriate benchmark since the account is entirely Canadian equity holdings and all the stocks, and the holdings of the one ETF, are part of the TSX Composite) makes me look like a rival to Warren Buffett and Charlie Munger.
(click to enlarge)
... but the sudden divergence of the lines around September 2014 made me look a bit closer and the source of the marked difference is the sole ETF in this account, BMO's Low Volatility Canadian Equity fund (TSX: ZLB). ZLB contains much less weight in energy and materials by virtue of its criteria to select low volatility stocks.

The following chart from Yahoo Finance shows ZLB against the TSX Composite and a couple of other ETFs - iShares' XIU, which tracks the TSX 60, and Powershares' PXC, which is a fundamentally-weighted Canadian equity fund. PXC has closely tracked the pattern of the TSX while doing appreciably worse. Meanwhile ZLB works completely differently.
(click to enlarge)





The TD account balance screenshot (edited to remove dollar amounts of my holdings, which unfortunately are nowhere near rivalling those of Buffett and Munger) confirms this. ZLB is about half the holdings and its gain is far ahead of anything else. Its return has dominated the account.
(click to enlarge)






My takeaways:
1) My stock picks so far have been doing about the same - no better but no worse either - than their benchmark. Not much benefit or harm either way.

2) ZLB's low correlation with PXC and the TSX Composite indicates that a portfolio built to include non-cap-weight components (like the Smart Beta described here on my other blog) makes sense. The last three years, market conditions have been such that ZLB is powering ahead. At some point, it will be PXC's turn. All along my portfolio is more stable / less volatile.

Monday 26 January 2015

Short Selling - Superb "how to" from a pro

Worth reading, even if you have no intention of ever trying to be a short seller - Short Selling: Cleaning Up After Elephants by Guy Judkowski on Seeking Alpha. He describes in understandable, brief yet explicit detail how he did it successfully. It made me realize the exacting, relentless, painstaking effort involved.

Friday 23 January 2015

CEO Pay - Benchmark this, corporate Canada

The 2015 version of the Canadian Centre for Policy Alternatives report on CEO pay by Hugh Mackenzie revealed a substantial increase in average pay from the year before. The comparison to the pay of employees and all Canadians, who own shares in all these companies through their pension plans, mutual funds ETFs or directly, is shockingly out of whack. Companies justify this through incredibly complex schemes (got to Sedar.com and download a sample Management Information Circular aka Proxy Circular) that basically use peer comparison to benchmark.

So ... let's benchmark this:
  • BBC reports that in 2014 Apple CEO Tim Cook received total compensation of $9.2 million. Apple is the world's largest company (by far ahead of #2 Exxon), with a market cap of $659.21 billion. His pay was 9.2/659210 = 0.0014% of market cap. Cook is not exactly working for peanuts by CEO standards though. in 2013 he earned $73.9 million US, which is about $81.3 million CAD (mostly from stock options), or 0.0123% of market cap.
  • According to the Mackenzie report, the top CEO earner in Canada, Gerry Schwartz of Onex, took in $87.917 million in 2013. Onex's market cap is $7.67 billion. If we apply the Apple Cook percent as benchmark, Schwartz should have earned roughly 0.0014% x $7670 = $107,000 in 2014. Even at 2013 rates for Cook, Schwartz would deserve only $938,000. We'll be watching with high expectations in early April when Onex's 2015 Proxy Circular is filed with 2014 actuals.
Mackenzie is coming at the issue from from an ideologically leftist viewpoint, so those who merely want to invest profitably may want to read investment author and industry insider James Montier's investor-centered case against CEO pay run amok, which he ascribes to a faulty corporate philosophy of shareholder value maximization. One of his conclusions: "
Shareholder’s Lesson
Firstly, SVM has failed its namesakes: it has not delivered increased returns to shareholders in any meaningful way,
and may actually have led to poorer corporate performance!"

Disclosure: I own zero Onex shares and won't be buying any soon, given the pathetic earnings history of the company. I own Apple shares inside the PRF ETF.

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