PWLCapital

There are many components to the area of estate planning. The major ones that come to mind include the preparation of your last will and testament and ensuring adequate life insurance is in place to meet your needs. But what about all those other areas:

• An inventory of your assets, liabilities, sources of income, insurance policies, etc. etc.
• End of life directives for your attorney for personal care
• Discussion of your wishes for your funeral with your executors, who are responsible for the arrangements (Prearrangement of your funeral)
• Direction on how family treasures are to be distributed

I was reminded recently of the importance of some of these areas. A long-term client, for whom I handled his tax planning (although not his investments), passed away just before Christmas at the age of 91. He had a very successful business career and was very well-respected in his industry, maintaining contact with many of his co-workers. He and his wife, who predeceased him, had no children, and his surviving brother is in the U.K. A number of years ago, he asked me to be his co-executor, along with his lawyer.

He was very conscientious in documenting how he wanted his estate distributed and what plans were to be implemented – down to where he wants his ashes scattered, and the company to use to clean out his apartment. When news came of his death, our decisions regarding his funeral were easy – one call to the funeral home with which he had contracted and things fell readily into place. We were able to focus our efforts on providing a means for at least 60 of his friends and business colleagues to celebrate his life.

He also kept a list of all of his assets up to date, and we reviewed it each year. This included his bank accounts, insurance policies, investment accounts, etc. Because I have prepared his tax return for the past number of years, I could readily identify what pension plans had to be notified of his death. Names and addresses of his beneficiaries, who are in various locations around the world, were also documented and kept up to date.

The result has been a relatively smooth process to get the ball rolling for the gathering in and distribution of his estate assets, while providing what we hope was a good send off.

We don’t like to think about our death, but it is inevitable. Often we have our wills prepared, review our insurance and think we have completed our estate plan. But what about all those other areas? Have you defined your wishes? Have you discussed them with family members (an often difficult but very important communication)? Have you made any formal pre-arrangements?

When our clients come in for their annual review meeting, this topic will be on the agenda. Is it on yours?  

Last January, I wrote about some of the changes to the CPP and their impact on timing the start of your CPP benefits. So when should I start receiving my CPP benefits?  I recently looked more closely at one of the new provisions – the Post-Retirement Benefit (PRB).  In my January article, here’s what I had to say about this feature:

A new Post-Retirement Benefit is being introduced, starting in 2012. Under current rules, once CPP payments start, they will not change if the pensioner returns to work – new earnings would be exempt from CPP contributions.
Beginning in 2012, those pensioners who are under age 65 and who return to the workforce will be required to contribute to this new benefit, as will their employer. If return to work is between 65 and 70, additional contributions will be voluntary. Other factors:

• Self-employed beneficiaries will pay both employer and employee contributions
• Contributions will entitle the beneficiary only to Post Retirement Benefit payments. No eligibility or increase in other CPP benefits will be created, nor will these contributions be subject to credit splitting or pension sharing.
• Each year of work will provide an additional post-retirement benefit that will begin the following year and will be paid for life.
• The Post Retirement Benefit will be added to an individual’s CPP retirement pension, even if the maximum pension is already being received.

This provision will become another factor to be considered when looking at starting CPP early. If CPP starts at age 60 and the pensioner subsequently returns to work (or continues to work, since no cessation test will apply), it may be preferable to receive an increased pension at 65 than to supplement the reduced pension with the Post-Retirement Benefit.

Service Canada’s website (slides 51 and 52) provides the following example and calculations to demonstrate this benefit.

• Mr. Lee began his CPP at age 60 in 2007.  In 2012, he will have $50,000 of earnings.  (The example is based on an assumed Year’s Maximum Pensionable Earnings of $49,600, which would require maximum employee contributions – at 4.95% - of $2,281.95, or $4,563.90 if self-employed.)
• In 2013, Mr. Lee will be entitled to an additional $28.02 per month of CPP benefits.  Mr. Lee will be 66 on January 1, 2013, so the calculation adjusts for the pension starting after age 65.
• Mr. Lee will be entitled to a further increase in his CPP benefits each year that he continues to work and contribute to CPP, until age 70.

So, does it make sense to continue to contribute between 65 and 70? To get a general idea, I ran an annuity quote using Manulife’s software.  The minimum income number on their quote system is $100 and it would cost $20,801.75 to purchase a life annuity, for a 66 year old male, which would pay $100 per month for the rest of his life, increasing at 1.5% annually (CPP is indexed to inflation, so a 1.5% increase was included in the annuity quote to simulate inflation).  Bear in mind that one of the factors in an annuity is the interest rate that is used in the calculations.  The quote was prepared on November 25, 2011, so is based on rates in effect then.  Given that quote, if we take 28% (since Mr. Lee’s benefit is about $28 per month and the quote was for $100 per month), it would cost $5,825.  Compare this to the total premiums paid for the CPP benefit of $4,563.90 and the CPP benefit may not be such a bad deal after all.

This material is meant to provide some guidance.  As with so many things, these are general comments and may not apply in all cases.  Everyone is unique and decisions must be made with their personal circumstances in mind. 

I was reminded today how difficult it can be for some people to move from worker to retiree, while others make the transition easily. There are those who devoted their careers to their employer(s) and who found it difficult to separate their corporate self from their personal self. So when the time came for retirement, they had difficulty.

Take the mid-70 year old, whose career has spanned over 50 years and who still works full-time and volunteers in industry-related activities. There are essentially three buckets that take up his time – his job and two volunteer positions. He thrives on discussion of what’s happening in his field and relies on his contacts to remain current. But he’s starting to feel that it’s time for change. When we talked about giving up one of the time buckets there seemed to be a reason why each carries unfinished business to be seen through to the end. As our discussion continued, I asked what a day would look like if some of the current activities were not part of the picture. There was real concern over how the hours would be filled – not really interested in playing a lot of golf, doesn’t play bridge, isn’t handy around the house, likes to travel, but you can only do so much. The things that he sees his peers doing are not for him. And you can only walk the dog (if the recently departed dog is replaced) so many times in a day. I mentioned other volunteer activities that can be meaningful, including delivering Meals on Wheels, visiting shut-ins, or driving seniors to appointments. Shortly after our meeting, I received an email that he has resigned from one of the three “buckets”. One step at a time.

In another situation, I was worried that early retirement at 60 by a client who had served in senior executive positions with a multi-national corporation would not know how to spend her time. She lived and breathed for her work. Was I wrong on this one! Now in her fourth year of retirement, she is doing those things she never had time for - exploring Toronto’s diverse neighbourhoods, subscribing to theatre and music productions and volunteering within the arts community. In between, she travels extensively, taking time in each place to learn about and absorb the culture. 

But there is one common thread in these two cases. Both hated the thought of using their savings. It was as if their lifestyle had to suffer at the end of the paycheque. No matter how many projections we ran showing that these clients are financially independent, they didn’t see it. Both felt they would need to sell their homes to reduce their costs. So what to do? Well, in the case of the 60 year old, we have taken steps to replace the salary with a monthly income stream made up of some annuities (yes, annuities do have their place) and some withdrawals from other investments. (We invest on a total return basis, so don’t think in terms of withdrawing only investment income.) The case of the mid-70 year old is still in process, but strategies are taking shape to supplement defined benefit pension income. 

All of which goes to show us that no matter what the numbers say, human behaviour is a stronger driving force in the profession of financial planning. Being able to recognize the stumbling blocks and suggest strategies to overcome them is a key part of our role.
 

Why wouldn’t I hold dividend-paying stocks – they pay me while I wait for the market recovery. There is certainly a strong behavioural bias here, but the academic studies and math don’t support this premise.

Dividends are only part of the story when it comes to stock performance. The other is the potential for increase in value. Total return is key.

Consider what a dividend is – the company has made a profit and the board of directors decides to distribute its profits to the shareholders. Instead of paying a dividend, the Board could decide to keep the cash in reserve, reinvest it in the company through research and development or new fixed assets, pay down debt or buy back some stock. All of which should increase the value of the shares – thus returning profits to the shareowners in the form of capital gains. Paying a dividend is not the only option and may not be the right thing for management to do for the health of the company.

Now consider the math – if a company, whose stock is trading at $50, declares a $1 dividend, the value of the stock should decline by $1 since payment of the dividend will reduce the cash reserves of the company. If the dividend is not declared, the stock value would not change based on this criteria.

Over the years, the percentage of publicly listed companies paying cash dividends in the US has reduced from 66% in 1978 to only 20% in 1999¹. And those 20% likely represent 70% of the total market value. So if you focus only on dividend paying companies, you also focus on large companies. 

Something to bear in mind - there are a number of well-known companies which do not pay dividends – Google, Amazon, Apple and Berkshire Hathaway, to name a few. 

Similarly, if dividend-paying companies are perceived as being “safer”, why should they have a higher expected return? If the risk is perceived to be low, the return should also be expected to be relatively low. Risk and return are related.

Academic research supports the concept of value companies outperforming growth companies, over time, and smaller companies outperforming larger companies, over time  – recognition of the higher risks involved with small and value holdings.  

All of which draws me to the conclusion that PWL’s approach to portfolio construction, which includes exposure to various asset classes based on an allocation designed for our client, makes sense.

¹Fama, Eugene F., and Kenneth R. French. 2001. Disappearing dividends:  Changing firm characteristics or lower propensity to pay?  Journal of Financial Economics 60:3-43.

As I reviewed semi-annual performance reports for clients, I found myself thinking about this question. Our reports tell our clients the return on their portfolio for the year to date, the past three and five years. These are absolute returns, after all costs, which can be used to relate to individual needs and risks. If your financial plan shows a return of say 5% is required each year and your return is more, then things are looking positive, and a cushion is being built. If the return is less, then some changes may be required – save more, spend less, work longer.

Of course, we know that it is impossible to generate a consistent annual return when investing in a diversified portfolio containing a number of asset classes.  When the markets declined in 2008, we recalculated our long term projections for clients, using the lower asset values, to determine what actions may be required. We have since compared actual to projected results at the end of each year, thus keeping the planning current and meaningful.

Absolute return should be the most relevant to a retail investor. However, our world is full of news and talk of relative returns. How did my portfolio perform compared to my neighbour’s? How did that fund manager perform relative to all funds in the class? How did that pension fund perform?

In order to look at relative returns, a “benchmark” must be established. And here is the first step in the imperfect world of relative returns. Many benchmarks can be supported as valid. For example, comparing the performance of a Canadian equity fund to the S&P/TSX Canadian Composite index is a commonly used benchmark. Or comparing to the peer group – i.e. all Canadian equity funds – is another. But there are many factors and strategies that can be built into the Canadian equity component of a portfolio (or any asset class, for that matter) – holdings in small companies versus large, value versus growth, concentration on a certain sector, to name a few. Should each of these be built into a benchmark?

Index suppliers such as Standard & Poor’s, Dow Jones, Russell, MSCI, FTSE, DEX and others build and maintain indices based on many criteria, often including the strategies referred to above. But if the “value added” benefit of a particular approach or manager relates to the use of a particular strategy (or dare I say stock picking ability!) should that be reflected in the benchmark? Or should the comparison be made to the broad market?

Similarly, should a benchmark be a weighted average of the components that are targeted to be in a portfolio – i.e. 40% fixed income, 20% Canadian Equity, 20% US Equity and 20% International equity – even if the manager chooses not to be in US equity for some period of time?

And don’t forget that it’s impossible to replicate an index without incurring costs. So those benchmarks come without any costs, making it difficult to compare “apples to apples”.

Performance reports from PWL report absolute returns for clients. (Securities administrators are contemplating making this a requirement for all securities and mutual fund dealers.) When we meet to review your portfolio and the performance report, we also review benchmark returns which compare your return to the broad market indices of each component of your portfolio.