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Monthly Archives: September 2011


 Discussion paper will summarize the fiduciary duty debate at home and abroad and identify the key issues involved
The Ontario Securities Commission will publish a discussion paper examining whether to impose a fiduciary duty of dealers and advisors later this fall, the regulator said Monday.In a staff notice detailing the work of the OSC’s compliance branch over the past year, the commission indicates that it is “considering whether an explicit legislative fiduciary duty standard should apply to dealers and advisers in Ontario”.The OSC promised earlier this year, in its statement of priorities, that it would study the issue. That pledge came in response to calls from investor advocates, including the Canadian Foundation for Advancement of Investor Rights and the OSC’s Investor Advisory Panel, to look at whether advisors should be required to act in their clients’ best interests (a more stringent standard than the suitability standard that currently applies).

In the branch report, the OSC says that it intends to publish a discussion paper on fiduciary duty in the fall of 2011 “that will summarize the fiduciary duty debate (both domestically and internationally) and identify the key issues involved.”

It notes that it has been monitoring the fiduciary duty debate in Canada and internationally, and recent rule developments in the United States, Australia and the UK related to fiduciary duty.

“Recently, there have been important international developments on the issue of fiduciary duty,” it says, noting that the U.S. Securities and Exchange Commission is expected to introduce rules in 2012 that would create a common statutory fiduciary duty for investment advisors and broker-dealers when they are providing personalized advice to retail clients. In Australia, the government is also expected to introduce legislation in 2012 that will make advisors subject to a fiduciary duty when dealing with retail clients.

James Langton
Investment Executive
September 26, 2011

September 24, 2011


Figuring out your income-replacement rate is no easy task

BOSTON (MarketWatch) — It is the mother of unanswerable questions in the world of retirement planning. How much of your current salary will you need after you retire?

The replacement ratio rule of thumb suggests you might need 75% of your current salary from a variety of sources — be it Social Security, personal assets (a 401(k) and IRA, for instance), earned income (yes, you’ll likely be working in retirement), and the like — to enjoy the same standard of living while in retirement as before.

How to haggle on medical bills

But according to research conducted by Dan Ariely, people need 135% of their final income to live the way they want in retirement. The reason for this astounding difference has to do largely with the way Ariely, a professor of economics and behavioral finance at Duke University, did his research.

Instead of asking people to ballpark how much of their final salary they will need, he asked the following questions: How do you want to live in retirement? Where do you want to live? What activities do you want to engage in? And similar questions geared to assess the quality of life that people expect in retirement.Ariely then took the answers and “itemized them, pricing out their retirement based on the things that people said they’d want to do and have in their retirement.” Using those calculations, he found that people want to retire to a standard of living beyond what they currently enjoy. (Who wouldn’t if money were no object?) Read Ariely’s blog post on the topic here.

Ariely didn’t respond to emailed questions about his blog post. But I am fond of Ariely’s body of work and have quoted him often.

Needless to say, Ariely’s blog has the financial-advice community up in arms. For one, he suggested in his blog that financial advisers are getting paid far too much (1% of assets under management) to help people build a nest egg that’s “60% too low in its estimation.”  

Two, he criticized the use of those ubiquitous risk-tolerance questionnaires that label investors as aggressive, moderate or conservative. His research showed that people cannot accurately describe their attitude toward risk and as a result, questionnaires about risk attitude are essentially useless.

From my perch, however, the questions that Ariely’s research raises have to do with the current salary replacement ratio. How much of your current salary do you really need to replace in retirement? Is the salary replacement ratio a good or bad rule of thumb? If it’s a bad rule of thumb, what’s a better way to determine how much you need in retirement? And, what are the pros and cons of that “better” method?

How much is enough?

Experts say it’s very hard to estimate with any precision how much income you’ll really need in retirement.

“In some ways, life after retirement is relatively inexpensive,” said David Laibson, an economics professor at Harvard University. For one, the expenses associated with working, raising a family and maintaining a home prior to retirement are typically much less after you retire.

“On the other hand, life after retirement is also a time when expenses might be high,” he said. For instance, costs associated with travel, leisure and health care might rise.

“At the moment we don’t know which argument wins the day. Do we need more income in retirement or less? It’s really hard to say,” Laibson said.

Some — including Stephen Utkus, a principal with the Vanguard Center for Retirement Research — say that 75% is as good a number as there is.

A good reference on this, he said, is a series of studies produced by Aon Consulting and Georgia State University, which put the replacement ratio at 81% for those with a final salary of $50,000 and 84% for those with a final salary of $150,000.

“They make the rational point that when you are retired, you aren’t making large 401(k) contributions, aren’t paying payroll taxes … and living expenses are lower,” said Utkus. “Hence 75%, or thereabouts.” Read the 2008 Replacement Ratio study (PDF).

Adjustments are needed

But the oft-quoted 75% replacement ratio — while good — needs to be tweaked based on one’s income, said Peng Chen, CFA charter holder and president of Morningstar’s global investment-management division.

The typical amount of money one needs to maintain the same standard of living in retirement as before is roughly 100% of one’s income after taxes and 401(k) contributions, Chen said.

“This make sense, as that is pretty much how much one is spending today in the U.S.,” Chen said.

But that’s the average. The salary replacement ratio is closer to 100% or even higher for lower income households (as they get subsidies) while the ratio could be 80% (or lower) for higher income households, as wealthier people do not spend all of their income, Chen said, citing government survey data.

Looking for a ballpark estimate? “My personal view is that households should generate enough retirement income to replace about 75% to 100% of their pre-retirement income,” said Laibson. “This estimate is as much art as science.”

A good or bad rule?

Experts say the salary replacement ratio is neither a good nor bad rule of thumb. “It’s a quick way to come up with a ballpark estimate,” Chen said.

Like every rule of thumb, it has pros and cons. On the pro side, it is easy and everyone understands it, he said. On the con side, Chen said, it’s not very accurate, especially at the individual level.

Others agree. “Replacement-rate calculations are overly simplistic and potentially inaccurate because they often are based on methodologies limited to replacement of preretirement cash flow after adjustment for taxes, savings, and age and/or work-related expenses,” wrote Jack VanDerhei, a Temple University professor, fellow at the Employee Benefits Research Institute, and author of a 2006 research report on the subject.

“One of the biggest weaknesses of replacement-rate models is that one or more of the most important retirement risks is ignored: investment risk, longevity risk, and risk of potentially catastrophic health-care costs.” Read VanDerhei’s report, “Measuring Retirement Income Adequacy” (PDF).

Consider, for instance, just the risk of outliving your assets. Saving to replace your salary for life based on life expectancy is very different from saving to replace your salary to age 95. In the living-to-life-expectancy scenario, you might need to accumulate a nest egg of, say, $500,000 while in the living-to-age-95 scenario, you might need a nest egg of three times that or $1.5 million.

135% isn’t the number

While the experts quibble over whether the replacement rate is 75%, 100% or somewhere in between, they generally agree that 135% is not the right number.

“As for Ariely’s survey, one of the principles of behavioral economics is there is a difference between what people say and what they do,” Utkus said. “I don’t buy his study’s conclusions at all. I’d be curious to know: Were all of the people who wanted to retire at 135% of income saving 30% of their income each year…in order to achieve that goal? Probably not. So it’s just a wish list, nothing more.”

Others are of the same mind-set. “One shouldn’t glibly reject Ariely’s 135% number, but there are quite a few reasons to be skeptical of that calculation,” Laibson said.

“When economists do their best to work through these issues, we generally conclude that your annual income in retirement should be a bit lower than your annual income before retirement,” he said. “I use the word ‘should’ in the sense that an optimizing household would save enough during their working life so their income in retirement is a bit lower than their income before retirement.”

Another expert said it’s not reasonable to try to replace 135% of your current salary. One couldn’t cut spending and save enough now to generate that sort of income later, said Wade Pfau, an economics professor at the National Graduate Institute for Policy Studies in Japan.

“There are just too many trade-offs in getting to the point where a 135% replacement rate is feasible,” said Pfau, who wrote a blog and a paper on the subject..

No magic number

There is no single, correct replacement rate, VanDerhei and others said. In fact, there’s really no substitute for doing precisely what Ariely did: crunching the numbers. It’s not quick, but it’s more accurate than any rule of thumb. According to Chen, individuals should look at their own spending habits to decide how much of their salary they’ll need to replace.

This is easier said than done. “Most people do not start to think about how they would live in retirement until they are close” to it, Chen said, “and this type of financial planning has to be done a number of years before that.”

Others criticize the use of salary replacement ratios altogether. “Ariely’s calculation is as bad as what he’s criticizing,” said Larry Kotlikoff, an economics professor at Boston University and president of ESPlanner, a financial-planning software company that uses the economic concept of consumption smoothing in its calculations.

“What people want or need is irrelevant. The only issue of relevance is what they can afford to spend on a sustainable basis. The goal is not a number,” he said. “The goal is a smooth living standard through time. If financial planners haven’t gotten this straight by this point, they should hang it up. They are disserving their clients using a methodology that not a single trained economist would endorse.”

Ariely raised another point in his blog that is at the crux all things money. In essence, he asked: How do we use our money to maximize our current and long-term happiness? And that of course prompts the question: Just how the heck is one supposed to do that?

“This is definitely the crux of the question,” Chen said. “I am not sure anyone knows for sure, just like everything in life. This not only touches on how much you should save for tomorrow or spend for today, but also on how much you should work to generate more income, or relax and enjoy life.”

For his part, Utkus said the key to striking a balance between saving more now to spend more later, and spending more now to spend less later is this: One, “we need some amount to make us feel secure (in other words, happy), and it’s not unreasonable that that is something like a 75% replacement ratio as a starting point.”

Second, we know that many affluent individuals want a more active lifestyle when they first retire. “If they aren’t willing to shift their consumption patterns — from Westin Resorts to the Ramada, from [first class] to flights in economy on Tuesday — then, yes, they’ll need 100% or more,” Utkus said. “But few actually seem to act on this desire by saving the requisite amount.”

Three, at the other extreme, it’s probable that many individuals can be just as happy with less (except for those with low incomes) because they can make choices about living on less.

Said Utkus: “Happiness is broadly tied to intangible elements beyond financial security…such as family and social relationships, purpose of life, spirituality, and so on.”

Robert Powell,
09 23 2011

Robert Powell is editor of Retirement Weekly, published by MarketWatch.
Robert Powell has been a journalist covering personal finance issues for

more than 20 years, writing and editing for publications such as The
Wall Street Journal, the Financial Times, and Mutual Fund Market News.
Not since the Gilded Age plutocracy of a century ago has there been such a near consensus as there is today in North America on the need to raise taxes on the rich.

Warren Buffett was pushing on an open door with his heavily Tweeted recent op-ed in The New York Times Calling for higher taxes on himself and fellow billionaires.

“While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks;’ wrote the controlling shareholder in scores of iconic American firms ranging from Dairy Queen to the Burlington Northern Santa Fe railroad.

“My friends and I have been coddled long enough by a billionaire-friendly Congress;’ wrote Buffett, whose tax rate last year was just 17 per cent, compared with an average of 36 per cent for his colleagues at Berkshire Hathaway Inc.

“It’s time for our government to get serious about shared sacrifice:’

Buffett no doubt braced for a backlash from the affluent And Conrad Black, for one, has fretted that Buffett is exhorting lawmakers into a “tokenistic fiscal persecution of the most affluent” – a demographic to which the disgraced former press baron remains loyal, though his membership has lapsed.

But the real story here is the scarcity of objections to Buffett’s call for a level playing field, in which all income groups are able to participate fully in society.

Business is in such bad odour that realistically the most it carl ask of others today is what used to be called Christian forbearance. Or to agree with Buffett.

U.S. financier Eli Broad says, ”We’ve been coddled long enough and have tax breaks that 99.9 per cent of the public don’t have, and it’s not fair:’

Hedge-fund manager George Soros adds: “The rich are hurting their own long-term interests by their opposition to paying more taxes.”

The distemper of these times, as Peter C. Newman labelled the social upheaval of the 1960s, is popular distrust of most institutions, including politics, organized religion, the medical-industrial complex and the news media.

Business perhaps looms largest in the rogues’ gallery. This isn’t the place to recite its rap sheet Mere mention will do of the job-killing Great Recession triggered by errant tycoonery in global financial centres. Saving the world economy from that explosion of reckless greed has so far cost the U.S. alone about $2 trillion in taxpayer-funded Wall Street bailouts.

Business leaders have to grasp that in recent years free enterprise misconduct has come so fast and ruinous that it’s a blur. Tepco’s inadequately maintained Fukushima nuclear power plant, BP’s Gulf of Mexico oil spill, Massey Energy’s mining tragedy in West Virginia, the fiscal villainy of war profiteers Halliburton and Blackwater – these all now seem preordained.

Business CEOs now pay themselves 325 times the compensation of shop-floor and cubicle workers. That ratio was closer to 25- to-1 in the 1960s. One cannot sustain an argument that business CEOs are now 300 times smarter than they were a half century ago, before they began “offshoring” manufacturing jobs or being stupendously rewarded for incompetence.

When they were shown the door at Citigroup Inc., Merrill Lynch Inc. and Countrywide Financial Inc. in the late 2000s, the malfeasant CEOs of those enterprises left with parting gifts of $147 million, $162 million and $145 million respectively.

The scandal besieged Rupert Murdoch has paid himself $33 million for fiscal 2010, a 47 per cent increase. The “pay for performance” canard espoused by its fattened business beneficiaries is honoured far more in the breach than the observance.

Bruce Bartlett, a veteran of the Reagan and George H.W Bush administrations, has compiled 23 polls on deficit-reduction over the past nine months. He found a consistent 2 – to -l support for tax hikes on the wealthy. He calculates that without George W. Bush’s tax cuts of 2001 and 2003 skewed to the rich, “federal revenue would have been more than $166 billion higher in 2008 alone” – enough to reduce the deficit by about 10 per cent.

The anti-tax brigade casts all tax hikes as ‘Job killers.” That is nonsense. In the era before runaway pay for CEOs and higher top mar¬ginal tax rates in 1980s and 1990s, the US. economy created nearly 40 million net new jobs. The salient backdrop for the current distemper is a 30-year stagnation in middle-class incomes, while prices for fuel, shelter, tuition and even food have been soaring.

The gap between rich and poor has widened markedly in Canada, where the top 1 per cent of income earners accounts for almost 40 per cent of total national income. That same top 1 per cent collected one – third of growth in national income between 1998 and 2007. In the 1950s and 1960s, that figure was a mere 8 per cent.

Depending on which of the conventional measures of poverty one uses, there are between 3.2 million and 4.4 million Canadians living in poverty.

In a Star op-ed last month, Larry Gordon, co-founder of Canadians for Tax Fairness, a group advocating a more progressive tax system, plaintively asked, ”Where’s Canada’s Warren Buffett?”

Best to ask Ed Clark, CEO of Toronto-Dominion Bank. In February of last year Clark told agathering in Florida that he’d canvassed fellow members of the Canadian Council of Chief Executives, and that almost all had said “raise my taxes” as their contribution to erasing the federal deficit caused by the global credit meltdown.

It took the federal Tories’ attack machine just one week to fire off an email to MPs and party supporters accusing Clark of shilling on the Liberals’ behalf for “massive new tax hikes on working- and middle-class Canadians.”

That was a jaw-dropping slander of both Clark and the Liberals. But it shut up Clark, whose highly regulated firm can’t afford to be on the wrong side of the federal government of the day.

The Conference Board usefully calls for a discussion on the efficacy of the 189 tax loopholes in current legislation, and the attractive alternative of a higher basic exemption. The Canadian Centre for Policy Alternatives would add an examination of the deleterious effects of El and welfare programs grown miserly in the past decade, and the impact on income inequality caused by tax policy changes favouring the aftluent.

We can have that discussion peaceably in school aud.itoriums across the country. Or we can have it in the streets. But there will be a reckoning, because the status quo is untenable.

David Olive
Toronto Star
09 10 2011