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is a never-ending and always imperfect task since the instant the writing and editing is done, things begin to go out of date and indeed that is already evident in a few minor spots (e.g. Shoppers Drug Mart got bought out and is no longer traded, the website address of the Financial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 -

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?

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 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.

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