All posts by Jonathan Chevreau

The Decumulation Dilemma of Defined Contribution pensions

Depositphotos_18757183_xsAh, life was so simple when all we had were Defined Benefit pension plans! I sometimes envy my late father, who only had to invest in GICs (Guaranteed Investment Certificates) to supplement his inflation-indexed Ontario Teachers pension. Just like a salary, that guaranteed pension flowed in like clockwork, including a healthy survivor’s benefit after my father predeceased my mother.

Unfortunately, such pensions do not pass to the next generation and it’s becoming harder to find employers that offer new employees DB plans: even if you’re fortunate enough to be in one, you may be subjected to pressures to switch to a Defined Contribution Plan, putting stock-market risk squarely on the pensioner’s shoulders instead of the employer’s.

Decumulation Issues similar with RRSPs and RRIFs

Since RRSPs behave quite similarly to DC pensions, the issues are almost the same, both on the wealth accumulation side as well as what we call the Decumulation side. (Here at the Hub, we have sections devoted to blogs on either topic).

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John Por, Decumulation Institute

One of the frequent contributors to the Hub’s Decumulation section is John Por, founder of the (you guessed it!) Decumulation Institute. John recently wrote an intriguing article in Benefits Canada about the need to overcome the Behavioural Obstacles inherent in Decumulation Decision Making.

Unlike DB plans, members of DC plans need some employer-supplied education so as to optimize both the wealth accumulation as well as the ultimate decumulation that is the ultimate raison d’être of any pension. Por says an OECD study found most employer communications programs about DC pensions were rather ineffective in improving the behaviour of the plan members when it came to investing decisions. The average score of such programs was only 10 out of a maximum 100.  (a range of 50-60 is considered effective).

Anyone near retirement and without significant income from old-fashioned DB plans well knows the stress of seeing RRSP or RRIF values fluctuate with financial markets. As Por notes, one reason for the disappointing DC scores is this:

Plan members are expected to make complex decisions about an uncertain future … Members are expected to make the same or even more difficult decisions as chief investment officers (CIOs) of large pension funds.

His fifth point is also instructive:

Educators fail to recognize the inherent challenge of overcoming limitations imposed by human nature, such as people’s hard-wired biases and heuristics.

Most DC plans do a good job educating members in the Accumulation years. Por says default options can guide more than 80% of members to a well-diversified efficient portfolio at low costs. But it all breaks down just when the money is needed at retirement:

Unfortunately, much of this support disappears at the decumulation decision— the very point where complexity explodes. Yet 60 cents of every retirement dollar are paid by returns earned after retirement as the direct result of decumulation decisions.

Por delves into behavioural economics, noting that one reason retirees shy away from annuities is that they “discount” the value of the tradeoff involved in converting capital to long-term secure income stream that should last 20 or 30 years.

While Por’s focus is DC plans, remember that the decumulation issues are also quite relevant for those planning for the transition from RRSPs to Registered Retirement Income Funds (RRIFs). But with 9 million Canadians set to retire in the next 15 or 20 years, he’s optimistic that employers and financial institutions will rise to the Decumulation challenge:

Canadian society will produce 1,500 retirees every working day for the next 20 years, and financial institutions have an overriding interest in serving them. As these institutions vie for asset decumulation, competition will result in better financial products and more effective education efforts.

 

WealthBar takes robo-adviser service across the country

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Tea Nicola, Wealthbar (LinkedIn)

Since I expect robo-advisers will make great strides in 2015, it’s perhaps fitting that the first full week of the new year kicked off with an announcement that Vancouver-based WealthBar is rolling out it service across the rest of Canada.

WealthBar, which describes itself as the country’s “only full service online adviser,” issued a press release Monday advising that it has registered with each provincial regulator across Canada. The company uses low-cost ETF portfolios to deliver online personal financial planning.

Human advice alongside the “robo” advisor

And while it does use the inevitable term “robo-adviser” in the release, it hastens to clarify that the service also includes “access to a real live financial adviser for less than half the cost of most mutual funds.” This “personal financial adviser” will answer specific questions about investing and insurance and provide help with financial plans.

“We’d like to help all Canadians understand how to save money effectively and efficiently,” says Tea Nicola, CEO and co-founder of WealthBar (and daughter of well-known Vancouver financial planner John Nicola). “It’s about knowing how and when you will reach your goals as well as getting the right advice to make the best decisions whenever personal circumstances change.”

Ms. Nicola says WealthBar’s financial planning tool is free to use for everyone. Currently, anyone who signs up also gets a free planning session with a human financial advisor. “We understand that human touch is still important for good financial planning so we made the advisor a key part of the WealthBar experience right from the beginning.”

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For more, see www.wealthbar.com. And for more background on roboadvisers in general enter the term here at the Hub’s search engine on the top right of the main page. (While the release spells it as “roboadvisor” we at the Hub are sticking  with MoneySense’s use of the e in adviser and so robo-adviser).

 

Why you need to share financial responsibilities with your spouse

Wealth PlanningHub Staff

From the American Family Insurance website, this article focuses on the importance of sharing budgeting and financial responsibilities with your spouse. In many relationships, it seems one party usually takes over much of the financial decision making– knowing important contacts, where money is kept and how it is spent etc. This article stresses the importance of making sure BOTH parties are on the same page with the family finances and, just as importantly, the family’s financial goals.

AmFam provides a few important steps to accomplishing this, beginning with talking to each other about things like saving, bills, retirement planning and debts.
Setting short- and long- term financial goals TOGETHER, knowing where to find your safe deposit box and combinations to the home safe, and finally making sure your loved ones know how to contact important financial contacts are the final steps to being on the same page as your spouse.

The article also discusses the importance of protecting your important papers by using preventative measures such as a safe deposit box, a fire-resistant home safe, a home filing system, and your attorney’s office to keep all your various documents safe.

Hub book reviews: Why the West is Losing the New Cold War with Russia

By Jonathan Chevreau

Over the holiday break I’ve been reading about Russia and its president, Vladimir Putin, who came to power at the turn of the millennium.  As one of the three books flagged below points out, Russia is the only power that has the capacity to destroy the United States in a nuclear strike. Those who assumed the west “won” the Cold War when the Soviet Union collapsed in 1991 should keep reading. From Ukraine to the War in Syria and the battles over gas pipelines and the plummeting price of oil, Russia is very much in the news as we enter 2015. It’s a fascinating story in itself but investors will find it of particular relevance.

putinbookThe Man Without a Face

Before his surprise appointment by Boris Yeltsin, little was known about the former KGB (now FSB) operative, which is why Masha Gessen titled her 2012 book about him The Man Without a Face. Subtitled The Unlikely Rise of Vladimir Putin, the gutsy Moscow-based veteran journalist pulls no punches about the true nature of Putin’s Russia.

She traces Putin’s formative years in a chapter entitled “Autobiography of a Thug.”   Continue Reading…

And your first financial act of 2015 will be …

Canadian Tax-Free Savings Account concept word cloud… contributing as much as $5,500 to your TFSA (Tax Free Savings Account) if you’re Canadian.  Launched at this time in 2009 and behaving somewhat like America’s “Roth” IRAs, it’s hard to believe this is already the seventh time you can contribute. By my calculations, that means $36,500 of collective contribution room plus any investment growth. That’s four years at $5,000 and now three years at $5,500: the maximum was boosted by $500 as an inflation adjustment for calendar 2013.

So if you’re one half of a couple, that means $73,000 in joint contribution room, even if you left it in interest-bearing investments paying almost zero. If you’ve been investing mostly in equities (either stocks or equity ETFs), it’s likely your TFSA had reached $40,000 or more by year-end, so it’s quite conceivable that some couples now have close to $100,000 invested in TFSAs between them.

Thursday, Jan. 1 was of course a holiday. While Friday, Jan. 2, 2015 is likely to be a quiet day for most, there’s no reason why you can’t contribute the next $5,500 to your TFSA that day, particularly if you use online banking and/or discount brokerages.

Good place for equity ETFs

What to invest in? In retrospect, those who invested in US investments with unhedged exposure to the US dollar would have done best up till now. Our daughter’s TFSA is more than half invested in US tech stocks and broader ETFs and the exposure to the greenback has boosted her TFSA to several thousand more than our own TFSAs with more exposure to the loonie.

Generally, I think a Couch Potato approach to investing in TFSAs makes the most sense, using broadly based ETFs from firms like Vanguard or iShares. Those closer to retirement may want a healthy exposure to Canadian dividends: foreign dividends will lose a bit of withheld tax in a TFSA and are better held in RRSPs for that reason. But for younger investors it may make sense to hold non-dividend paying US tech stocks in a TFSA for both the extra growth potential and the exposure to a strong US dollar that is showing no signs of weakening.

I still say the TFSA and Roths are the best games in an over-taxed town. While it’s true that many had hoped the 2015 limit would be more than $5,500, remember that unlike RRSPs, you can continue to contribute to TFSAs well past age 70 or 71: in fact, if you live that long you could still be contributing if you’re a hundred or more.

The key is to get the money in there as soon as you can and let it grow. And that means early January each and every year. While I think the benefit is particularly powerful for the young, they should balance the growth potential with debt repayment. There’s not much point in paying close to 20% a year in credit-card interest if you’re only earning 2% interest in a GIC or cash equivalent contained in a TFSA.