How to tell if you will be fine financially in retirement

Never mind all those complicated calculators, spreadsheets, assumptions about stock returns, interest rates, asset allocation models, taxes, risk tolerance questionnaires, longevity assumptions etc etc. Nope, all you have to do is to be able to answer these three questions correctly and you will do fine in retirement!

1) If the chance of getting a disease is 10 percent, how many people out of 1,000 would be expected to get the disease?
2) If 5 people all have the winning number in the lottery and the prize is 2 million dollars, how much will each of them get?
3) Let’s say you have 200 dollars in a savings account. The account earns 10 percent interest per year. How much would you have in the account at the end of two years?

Who says so? Professor Olivia S. Mitchell of the Wharton School at the University of Pennsylvania, in Implications of the Financial Crisis for Long Run Retirement Security. According to the paper "... these three financial literacy questions turn out to be incredibly good predictors of whether middle-aged people plan for retirement, save for retirement, and do well at retirement".

Those who can, do, and those who can't, don't.

Capital Cost Allowance in need of reform says CGA

A camel is a horse created by a committee goes the old saying ... or is it the other way round? It doesn't matter because the point still applies. Something that started out in 1949 being a nice simple method for the income tax system to take account of and treat capital depreciation fairly has transmogrified into a complicated mess doing things it wasn't designed or suited to do.

It's not dumb ole me saying this, it's the Certified General Accountants of Canada, which has just released a study that describes the problems - Is the Capital Cost Allowance System in Canada Unnecessarily Complex?. 

Among the particular issues:

• proliferation in the number of classes from 12 originally to 56 in 2012
• more complex and confusing wording for the classes
• changing rates from year to year for the same thing e.g computers (I've encountered this myself trying to do my taxes in claiming computer equipment and it is frustrating and time consuming to figure out.)
• special classes that misuse the CCA system to achieve industrial policy or economic incentives for certain industries

The end result, according to the CGA press release quoting Rock Lefebvre, FCGA and vice president of Research & Standards at CGA-Canada: “... it has added increased complexity to the tax system and the many changes introduced weakened the system’s equity and neutrality.” 

Good on the CGA for raising the issue. It's a little bit altruistic considering that the more complicated the tax system is, the more we have to pay accountants who know all the infuriating gotchas.

Let's hope that the federal government folks in Ottawa are listening and that if they act they do not give rise to a new saying going something like "a naked mole rat is an improved rat created by a government reform". See photos of the naked mole rat here.

WaterFurnace Renewable (TSX:WFI) 2012 Results Show Disappointing Weakness

In mid-March, WaterFurnace published its 2013 Annual Report along with the Annual Information Form and the Information Circular. The results were disappointing for investors, though we should not have been too surprised, as the last quarter exhibited a continuation of significantly slowing sales (down 13% for the total of 2012) and earnings (down 27%) that had been evident through earlier quarters.

Among the not so impressive details:

• Inventory rose 15% and the finished goods portion was up 29%
• Operating expenditures as a percent of sales rose from 18% to 20%
• Employee compensation was up 4% (i.e. more than inflation) and executive compensation rose 49%, or 60% if director compensation, which stayed constant, is excluded; much of the exec comp came from shares issued, which diluted earnings per share a full penny; what in heaven's name justifies that sort of increase?
• Warranty claims expense had a big jump up due in part to rising claim rates, not just additional units under warranty, which makes me wonder if management is building a warranty cookie jar in this non-cash item so that later the claim can be reversed with wonderful instantaneous effect on earnings.

A few positive notes:

• the joint venture in China seems to have got underway quickly and successfully, being relatively close to breakeven despite a bunch of one-time startup costs
• the Hyper subsidiary acquired a few years ago, contributed more to the bottom line, though it's still not large
• Cost control on the manufacturing side partly offset the Opex rise

On the conference call, CEO Huntington and CFO Andriano were predictably optimistic. However past calls have conveyed the same "the light is just beginning to dawn and we are now facing an upward trend" message without coming to pass as we know.

Should we believe this optimism? A supposed key driver of sales in the USA doesn't seem to be working as the WFI managers think and say:

• Housing starts - this is said to be the key for residential sales which have dropped steadily. How does falling sales jive with this YCharts graph which shows US housing starts going up slowly for the past two years.

Instead I believe it's that low natural gas prices have kicked the bottom out of the economic argument for installing a ground source heat pump system as opposed to one based on natural gas. There are a few brief comments here and there in the documents and the call about natural gas competition. Interestingly and perhaps tellingly, the AIF does not include natural gas a risk factor. Does management of the Board not believe or want to admit it? In the call, Huntington predicts natural gas prices will go up as everyone adopts it and says they have already started to firm up. Huh? Doesn't look much like it in this chart from the US Energy Administration Administration.

WFI was not alone in its 2012 difficulties as competitor LSB Industries' climate control division suffered lower sales and income, though not as much.

Bottom line: Unless the joint venture in China pays off big time and quickly, we investors (yes, I still own the stock) need to be prepared for falling sales and earnings, or stagnation at best, and probably a dividend cut from the $0.96 per share to something like $0.60. In 2012, the dividend per share was 17% more than earnings.

On that basis,
- Middle estimate: with no future growth at all and a cut in dividend to $0.60, the stock is worth around its current $16 market price.
- Low estimate: If earnings fall 5% a year on average for 5 years, WFI is only worth about $13.50.  
High-estimate: With no growth for ten years, then 3% per year growth after that for ten years, WFI's value is $20.70 or so. (figures calculated using the discount model in this downloadable spreadsheet from McGraw Hill Investments book that I used in my original post on WFI in September 2010)

Which is more likely? Maybe the China venture will offset the US sales decline. Don't really know. Maybe I need to face sober reality, but like the alcoholic who keeps saying just one more drink, I'm still hangin' in.

TurboTax Giveaway Winners!

The random draw for the TurboTax web version has been done and the two winners are:

• Erick
• SWT

Would these lucky winners please contact me by the email link in the right hand column of this blog page so that I can send you the access code. Congratulations!

TurboTax for Canadians Giveaway

The April 30th deadline for filing a tax return for 2012 is fast approaching and to help procrastinating readers take that final step of actually filling in the numbers we are offering a giveaway.

Thanks to Intuit, makers of TurboTax, I am giving away two codes for the online web version of their personal tax preparation software for Canadians. That's a value of $17.99. With the online version of TurboTax you can use the Canada Revenue Agency's NETFILE online tax submission service instead of mailing paper forms. It's quick and convenient.

Here are the details of the giveaway:

• To enter submit a comment on this post below - use a unique name (Anonymous won't suffice!) so I can distinguish people
• One entry per person please
• Entries close Friday, April 12th midnight EST
• I'll do a random draw of two (2) names from amongst the entries after the deadline
• Winners will be announced on the blog and asked to contact me via email with their own email address so I can reply with the code to enter in the TurboTax software (your email will not be used for any other purpose than to contact you as a winner)

Best of luck everyone!

New US Equity Low Volatility ETF from BMO

This past week BMO announced the startup of a bunch of new ETFs. The one that intrigues me the most is the BMO Low Volatility US Equity ETF (Symbol: ZLU). It is described as being constructed with the same method as the BMO Low Volatility Canadian Equity ETF (ZLB) that uses beta (stock price movement relative to the market average) to pick stocks that are less volatile i.e. low beta stocks.

As I blogged about just recently, passive rules-based alternative selection & weighting schemes (so-called smart beta) are coming to be accepted as being superior to traditional market-cap passive indices as an investment strategy. ZLU fills a gap in the smart beta space for US equities for an ETF using beta instead of simple price volatility e.g. funds like SPLV. Russell had some low beta US equity ETFs on the market for a while but closed them down due to lack of uptake. A mix of funds with different non-market cap weighting schemes in a portfolio is the way to go (e.g. this relatively simple smart beta portfolio), so ZLU is a useful additional component.

It is interesting to see how different market conditions in Canada vs the US are affecting low beta/volatility funds in comparison to the market-cap benchmarks. US equities have been on a tear recently as we read about all-time market highs. High beta ETFs like SPHB have been outstripping the market in the short term, such as the past 6 months, but low volatility funds like SPLV are handily ahead of both SPHB and SPY over a year or longer. The reason - SPLV doesn't spurt ahead in big leaps but its dips are much less pronounced. see the Yahoo Finance chart below. Slow and steady wins the race, huh?

Though BMO's Canadian equity low beta fund ZLB has been growing slowly since its launch in October 2011, I would have thought those return-chasing investors would have leaped on board this performance vs its market cap rival XIU.

Another interesting feature of ZLU, traded in Canadian dollars despite holdings of US traded and US-dollar denominated equities, is that it also comes in a US-dollar version traded in USD on the TSX under symbol ZLU.U. Given that ZLU and ZLU.U are in effect the same fund, just with two different prices, one in CAD the other in USD, it might even be possible to do low cost currency exchange using Norbert's Gambit as described on Financial Webring, which is often done with DLR and DLR.U.

NB I have voted with my money some time ago and own a fair chunk of ZLB and no XIU.

Budget Shoots Down Tax Advantaged Swap and Forward-based ETFs

Expect to see a few ETFs disappearing in the next few years. The federal budget delivered yesterday by Minister Flaherty announced that the clever conversion of interest into capital gains (or temporarily, return of capital) through the use of forward contracts or swaps would soon become invalid. The Investment Executive article on the proposed measure makes it clear existing funds that have to renew at some point get caught as well. If I am not mistaken, that would cover pretty well all such funds as the prospectuses I have read include a fund termination date, which would require renewal / extension at that time.

Some of the funds whose days would appear to be numbered:

• all of the former Claymore, now iShares, Advantaged ETFs that Canadian Couch Potato listed and described here.
• various Horizons ETFs like the Horizons S&P/TSX 60™ Index ETF ( symbol: HXT), which I will need to remove as the Canadian equity component from my cap-weight portfolio contest at the bottom of this page, and the Horizons S&P 500® Index (C$ Hedged) ETF (HXS)

Of course, it's a loss for investors when tax benefits are pulled away. On the other hand, with all the moving parts to figure out in such ETFs, which does not necessarily result in a better choice for the investor, as I discovered in this post on HowToInvestOnline comparing one of the iShares Advantaged ETFs to a plain old GIC, maybe it's not such a big loss after all. Chasing investments merely for tax reasons is generally a bad idea.

...  addendum
Horizons has put out a press release saying its fund HXT will NOT be affected by the tax change. The press release does not mention HXS but it works the same way as HXT as a total return swap. The budget document itself on page 353 of the pdf refers to transactions that change ordinary income into capital gains which HXT as an equity fund does not primarily do, so maybe HXT and HXS will escape. We'll have to keep monitoring to see exactly how this pans out.
... addendum 2
BlackRock says in a press release that the rule change will affect several of its funds - CAB, CVD, CHB, CHB.U, CYH, CBR, CMF and CMF.A