Hub Blogs

Hub Blogs contains fresh contributions written by Financial Independence Hub staff or contributors that have not appeared elsewhere first, or have been modified or customized for the Hub by the original blogger. In contrast, Top Blogs shows links to the best external financial blogs around the world.

Retirement, Meet Target Date Funds: The opportunities, and how they work

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By Brian See, Evermore

Special to the Financial Independence Hub

Target date funds are a fantastic investment tool, particularly for Canadians who are saving for retirement. Despite their benefits, though, they have not been made widely available to the masses yet.

If we look at our U.S. neighbor, target date funds are already taking off. In fact, target date funds hit a record US$3.27 trillion in assets in 2021, up from $52 billion in 2020. The market value speaks for itself: target date funds are here to stay, and they’re growing in popularity.

When it comes to retirement, there are many Canadians who don’t save long-term because it seems out of reach. In fact, about 1 in 3 Canadians have never saved a dime for retirement even though the majority of Canadians have expressed concern about not having enough money in retirement. To boot, record-high inflation is leading Canadians to fear a retirement crisis, and 72% of Canadians believe saving for retirement is ‘prohibitively expensive.’

We have seen target date funds play out well in the U.S. If Canada is able to further adopt this form of investing to the market, we can close this retirement investing accessibility gap.

In order to understand the opportunities that target date funds provide for investing for retirement, it’s important to break down how they work.

How Target Date Funds work

At their core, target date funds are a one-stop-shop for long-term saving and investing. Target date funds use a systematic or rules-based asset allocation where the mix of stocks and bonds changes over time as you approach the target date. The funds are a mix of stocks and bonds that increase and decrease their risk levels according to the person’s age. This “glide path” model increases risk as you’re younger, and decreases risk as you get closer to retirement because, simply put, you’ll need that money to draw upon in retirement! Target date funds are also easy to choose. You simply pick the year you want to retire and select the target date fund with that year.

Of course, with any investment strategy, there are risks. The inherent risk here is that you are investing in the market. Stocks and bonds go up and down: they ebb and flow but in the long term, markets have increased in value. A key feature of target date funds is that they are diversified across asset classes, geographies and sectors, and that diversification helps whether there is a downturn in the market or not. Target date funds weather the storm. Continue Reading…

Defined Benefit pensions lagged in third quarter but continue to withstand volatile markets and historic inflation: Mercer

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Unlike the first half of 2022, the financial position of most defined benefit (DB) pension plans “decreased slightly” in the third quarter, as they were buffeted by inflation and volatile stock markets. Investment returns were mostly negative in the quarter, and yields on long-term bonds were lower at the end of the quarter than they were at the beginning, according to The Mercer Pension Health Pulse (MPHP), released on Monday.

The MPHP tracks the median solvency ratio of the DB pension plans in Mercer’s pension database, which decreased from 109% as at June 30, 2022, to 108% as at September 30, 2022.

Of the plans in Mercer’s pension database, at the end of Q3:

  • 72% of plans were estimated to be in a surplus position on a solvency basis,(vs. 73% at the end of Q2)
  • 17% of plans were estimated to have solvency ratios between 90% and 100%,(vs. 16% at the end of Q2)
  • 5% have solvency ratios between 80% and 90% (unchanged from Q2), and
  • 6% have solvency ratios less than 80%. (also unchanged from Q2).

In a press release, the Calgary-based Principal and leader of Mercer’s Wealth business, Ben Ukonga,  said that “In spite of the significant market volatility, the financial health of most DB plans would have experienced only a slight decline in the third quarter of 2022. As for what can be expected for the remainder of the year, plan sponsors should continue to expect significant volatility.”

Mercer says experts “urge caution and encourage plan sponsors to be prepared for anything, with more volatility on the horizon. Markets will most likely remain volatile in the short to medium term due to numerous risks such as the continued war in Ukraine, the upcoming US midterm elections, the potential confrontation between the US and China over the status of Taiwan, risks of a global energy supply shortfall, and of course, the ongoing inflationary environment.”

Continued short- and medium- term volatility

Markets will most likely continue to remain volatile in the short to medium term due to numerous global risks, including the war in Ukraine (and the Russian Government’s actions in response to Ukraine’s recent successes on the battlefront, such as the recent annexation of parts of Ukraine in violation of International Law, and the geo-political fallouts from these actions). Mercer is also cautious about the upcoming US mid-term elections, the increasing political gridlock and polarization in the US, and the potential for a confrontation between the US and China over the status of Taiwan. The recent volatility in the UK currency and bond markets and the risk of contagion to other markets.

Mercer also sees risks from a global energy supply shortfall, and the effect such a shortfall would have on the global economy: “… plan sponsors should pay attention to the risks associated with energy insecurity in Europe – such as the risk of the Russian Government using Russian gas supplies against Europe in retaliation to sanctions on Russia, and the effects on European economies if their energy supplies are curtailed.”

Inflation at levels not seen in 30 years

With inflation running at levels not seen in over 30 years, central banks globally are “on an aggressive monetary tightening mission in order to get inflation under control. Will they succeed without triggering a hard-landing global recession? Will higher interest rates make governments, corporations and households unable to meet the interest payments on debts they accumulated during the very long period of low interest rates? This could lead to an increase in bankruptcies and crowding out spending and investments, further exacerbating the risks of a hard landing global recession.”

As workers see a decline in the purchasing power of their wages, there will be increased pressures on employers for higher wages, Mercer says. “Sponsors of indexed DB plans will see increases in the cost of these arrangements, and sponsors of non-indexed DB plans may face pressure from their pensioner groups to provide ad hoc cost of living adjustments. Coupled with labour shortages, some employers may have no choice but to increase their labour costs. And companies that are unable to pass these increased costs to their customers will face profit margin pressures and reduced profitability, hurting their future economic outlook.”

Covid still poses macro risk

The global health landscape also poses a macro risk, Mercer says. “As the western hemisphere is entering the winter months, will a new vaccine-resistant strain of the COVID-19 virus appear? And how will governments and citizens deal with such a resurgence? Will the Chinese government continue with its zero-COVID policy? And how much of a negative impact will this policy, along with what some would call draconian lock down measures, have on the Chinese economy? And how deep will the negative knock-on effects be on China’s trading partners?” Continue Reading…

Nasdaq 100: Exposure to the Modern Economy

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Image via Pixels/Anna Nekrashevich

By Sa’ad Rana, Senior Associate – ETF Online Distribution, BMO ETFs 

(Sponsor Content)

Indexed investing, when done properly can be an efficient and low-cost way of gaining exposure to various markets. Investment vehicles such as exchange-traded funds (ETFs), make it possible for individuals to invest in these indexes, i.e., the Nasdaq-100 index.

Nasdaq-100 & Exposures

Launched in 1985, the Nasdaq-100 is one of the world’s most well-known large-cap growth indexes. The companies in the Nasdaq-100 include over 100 of the largest domestic and international non-financial companies listed on the Nasdaq Stock Market based on market capitalization. It is mainly comprised of technology, consumer, and health companies – with a slight exposure to industrials and telecom.

When looking at what is powering economic growth in the 21st century, we look to those new economy sectors that are highly digital. These are disproportionately tech or consumer companies like Amazon, Microsoft, and Google. This index gives you exposure to the biggest Nasdaq-listed names, along with others that follow closely behind these leaders in technology.

Nasdaq-100 vs S&P 500 Volatility & Performance

When looking at volatility, one may think of the Nasdaq as being a more growth-oriented index, and if looking at returns alone, these have certainly shown to be significant over the years. Investors may assume that the indexes’ higher performance leads to higher volatility compared to other leading indexes. However, if we take a look at the chart below, which is more of a longer-term picture, you are getting a pretty significant consistent volatility range. Of course, if you look at this year in comparison inflation has been at the forefront of headlines, growth-oriented companies have been taking a harder hit than more cash-up-front companies: you see more volatility in the Nasdaq this year vs the S&P 500.

Both the Nasdaq-100 and the S&P 500 have had very similar volatility over last 15+ years

Index returns do not reflect transactions costs or the deduction of other fees and expenses and it is not possible to invest directly in an Index. Past performance is not indicative of future results.

The big story for everyone is the performance of the Nasdaq-100 vs. the S&P 500. The long-term performance of the Nasdaq-100 shows an upward trend. If we look at post-2008, generally monetary policy had been very supportive of market growth, and companies had been able to invest in research, helping them grow over time. You see this reflected in the Nasdaq-100, where thanks to the underlying companies in this index, there is outperformance. The chart below showcases this quite well. It tells us that the Nasdaq-100 is a valuable holding in a portfolio based on performance.

Index returns do not reflect transactions costs or the deduction of other fees and expenses and it is not possible to invest directly in an Index. Past performance is not indicative of future results.

Market Considerations: Performance vs Interest Rates

The chart below shows what happened the last time rates went up by a similar amount. You can see a gradual stairway up from almost 0% to about 2.5%. You can see the dip in the NDX price (grey line), which looks like a blip, almost not noticeable (but it was 23%). This isn’t very far from the drawdown this year to date. Albeit the Fed is raising rates much faster.

Based on experience, the Fed may keep rates high until inflation gets under control into that sort of two to three per cent range. The question for investors is, what happens to stocks if rates get to 3%, 4% or maybe 5% and perhaps stay at that level for a few years? This is where it is imperative to look at the amount of debt these companies have on their balance sheet, how much the interest costs will go up and what their earnings power looks like. Will they be able to remain competitive with the price of everything rising? Will consumers continue to pay for these products vs. downsizing or even substituting for cheaper alternatives? Continue Reading…

MoneySense Retired Money feature on Canada’s new “Tontine” Retirement solutions

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My latest MoneySense Retired Money column looks at the revolutionary “Tontine” type Retire Solution announced by Guardian Capital and finance professor Moshe Milevsky earlier this month. My initial take was here on the Hub and the more in-depth MoneySense feature story can be viewed by clicking on this highlighted headline: Tontines in Canada — Moving from Theory to Practice as a solution to our Retirement Crisis.

We’ve illustrated this blog with financial projections of one of the three new Guardian Capital Retirement solutions developed in partnership with Milevsky. Some of the ideas were adapted from Milevsky’s latest book: How to Build a Modern Tontine. The theory behind this book is a driving force for Guardian Capital’s efforts to commercize these concepts and put them in the hands of retirees and would-be retirees worried about outliving their money. Nobel Laureate Economist William Sharpe has described this as “the nastiest, hardest problem in finance.”

Milvesky’s book is certainly aimed at industry practitioners and sophisticated financial advisors and investors, and contains a lot of mathematics that may beyond the reach of average investors or retirees. So rather than attempt to review it, we’ll move on to the efforts to bring these ideas to the market. What Milevsky calls “tontine thinking” is belatedly showing up in the marketplace in Canada, starting last year with Purpose Investments’ and now with three different solutions from Guardian Capital. Hub readers also can read an excerpt of the book which ran earlier Wednesday: Longevity Insurance vs Credits — a Primer.

All this has been a long time coming. MoneySense readers may recall two of my Retired Money columns about Milevsky and the future of tontines published in 2015: Part one is here and part two here. Also see my 2018 column that explains tontines in detail: Why Ottawa needs to push for tontine-like annuities.

Last June (2021), Purpose got the tontine ball rolling in Canada with its Purpose Longevity Fund. Here’s my MoneySense take on that one: Is the Longevity Pension Fund a cure for Retirement Income Worries? 

As the MoneySense feature explains, Milevsky is Guardian Capital’s Chief Retirement Architect. It sums up the original 2021 launch of Purpose Longevity Fund, and how it compares to Guardian’s three solutions.

Think of Purpose’s product as a lower-case tontine, and Guardian Capital’s as a Tontine with a capital T.

Guardian Capital’s Modern Tontine  

Guardian Capital’s September 7th press release uses the term “Modern Tontine.” There, Guardian Capital Managing Director and Head of Canadian Retail Asset Management Barry Gordon said “With our modern tontine, investors concerned about outliving their nest egg pool their assets and are entitled to their share of the pool as it winds up 20 years from now … Over that 20-year period, we seek to grow the invested capital as much as possible to maximize the longevity payout.”

 Along the way, investors who redeem early or pass away leave a portion of their assets in the pool to the benefit of surviving unitholders, boosting the rate of return. “All surviving unitholders in 20 years will participate in any growth in the tontine’s assets, generated from compound growth and the pooling of survivorship credits. This payout can be used to fund their later years of life as they see fit, and aims to ensure that investors don’t outlive their investment portfolio.” Continue Reading…

Longevity Insurance vs. Credits: A Primer

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This guest blog is excerpted from Moshe Milevsky’s recently published book, How to Build a Modern Tontine

By Prof. Moshe A. Milevsky, Ph.D.

Special to the Financial Independence Hub

I have been asked about the difference between a tontine – be it modern or medieval – and a conventional life annuity, purchased from a regulated life insurance company. Both might appear to perform similar tasks at first glance, but the differences are subtle and important and get to the essence of the distinction between longevity insurance versus longevity (or survivorship) credits.

One aspect of the life annuity story is the financial benefit of risk pooling, and the other is the insurance benefit and comfort from having a guaranteed income that you can’t outlive. Allow me to elaborate with a statement that some readers might find shocking. If you are 75 years old with $100,000 in your RRIF and would like to guarantee a fixed annual income for the rest of your life, there is absolutely no need to purchase a life annuity from an insurance company to achieve that goal. There are other options.

This might sound like something odd for a long-term annuity advocate to say. But the fact is that a non-insurance financial advisor can design a lovely portfolio of zero-coupon strip bonds that will do the job. That collection of bonds will generate $4,000 per year for the rest of your life, even if you reach the grand old age of 115. Ok, financial advisors need to eat too, so they may not do it for $100,000, but I’m sure that a lump sum of $1,000,000 will pique their interest and in exchange you will get $40,000 per year.

Moreover, with these strips, if you don’t make it all the way to the astonishing age of 115, they will continue to send those $4,000 (or $40K) to your spouse, children or favourite charity until the date you would have reached 115, if you had been alive. This collection of strips would be completely liquid, tradeable and fully reversable, although subject to the vagaries of bond market rates. For this I have assumed a conservative, safe and constant 2.5% discount rate across the entire yield curve, which isn’t entirely unreasonable in today’s increasing environment.

Stated technically, the present value of the $4,000 annual payments, for the 40 years between your current age 75 and your maximum age 115, is exactly equal to $100,000 when discounted at 2.5%. Yes, those numbers and ages were deliberately selected so my numerical example rhymes with the infamous 4% rule of retirement planning but has absolutely nothing to do with it.

Now, I’m sure you must now be thinking (or even yelling) “Moshe, but what if you live beyond age 115, eh? You will run out of money!”

Touché. Let’s unpack that common knee-jerk reaction to non-insurance solutions for a moment. To start with, the probability of reaching age 115 is ridiculously and unquantifiably low. If you do happen to be the one in a 100 million (or perhaps billion) that reaches age 115, I suspect you will have other things on your murky mind. Personally and post-covid, there is a very long list of hazards that worries me more than hitting 115.

Nobody really “runs out of money” in this century

Second and more importantly, nobody really “runs out of money” in retirement in the 21st century. That is plain utter fear-mongering nonsense. With CPP, OAS/GIS, the elderly will continue to receive some income for as long as they live even if they have completely emptied every piggy bank on their personal balance sheet. In fact, with tax-based means-testing you might get more benefits if you actually do empty your bank accounts.

Ok, so back to my prior claim and the supporting numbers, if you want a guaranteed (liquid, reversable, bequeathable) income for the rest of your life, you can exchange your $100,000 for a bunch of strip bonds and voila, you have created a sort of pension plan. My point here is that the primary objective isn’t a guaranteed lifetime of income: which anyone can create with a simple discount brokerage account and a DIY instruction manual. Continue Reading…