Years of low rates, financial bubbles and poor saving plans have led to widespread shortfalls in household finances globally. Canadians are poster children for the consequences.
A new Manulife Bank survey finds that three in ten Canadians are so financially confused that they don’t consider their mortgage a debt; two in ten don’t consider car loans a debt either, see: Three in ten Canadians consider themselves debt-free while carrying a mortgage.
Meanwhile, according to an earlier report from Equifax Canada, non-mortgage debt grew more among Canadians aged 65 and older than for any other age group. See Help older clients control debt:
Desire to maintain a pre-retirement lifestyle, longer life expectancies and financial pressure from family members make staying within financial means difficult for some senior clients.
…Some seniors may find that they retired too soon and cannot afford it, says Laurie Campbell, CEO of Credit Canada Debt Solutions Inc., a non-profit organization in Toronto. “Getting back into the workforce is particularly difficult for seniors, so they rely on credit to make ends meet.”
Self-serving advice from the financial sales force makes the erroneous presumption that corporate securities are attractive places to park our savings at every point in every market cycle, regardless of macro forces, valuation levels, risk or return prospects.
As a result, unrealistic return assumptions are plugged into boilerplate financial calculators that underestimate loss and volatility cycles and over-estimate compound returns, while encouraging insufficient savings/contribution levels and too early retirement dates. This is especially true since the current over-valuation cycle in financial assets is the most extreme in modern history. At the same time, we are living much longer than before, see World Economic Forum: “We’ll live to 100–how can we afford it?”
The net effect is that the most assumptions populating financial plans and calculators today are dangerously inaccurate. The drop in ‘safe’ income yields from 5-6% before 2007 to 1- 2% today will not be permanent, but it does dramatically impact planning and must be acknowledged in financial decisions. Where $1 million in savings could safely produce 50K a year of income a decade ago, today it can produce about 20k. In other words, at current yields, we need about 2.5x more savings today to produce the same retirement income as we did 10 years ago.
Many have looked to magnify yields by increasing leverage—borrowing funds to buy assets—and shifting capital into illiquid holdings such as real estate, infrastructure and private equity funds. Margin debt in brokerage accounts—a marker of speculative appetite—has reached an all-time high globally.
Canada’s six biggest pension funds have increased their average leverage (debt) to 24% of assets under management to try and offset the impact of declining pension member contributions and low interest rates on their cash flow and investment returns. But as warned in an October 3rd report by Moody’s Analytics, increased leverage also magnifies volatility and the prospect for capital losses. See Canada’s public pension funds piling on the leverage—and risk, Moody’s warns:
“these strategies leave pension funds [and other holders] more exposed to potential macroeconomic shocks such as a weaker Canadian dollar or drops in equity or credit markets.”
The solution to funding deficits is not so simple as turning up the risk dial and adding ever more opaque and expensive securities. Indeed, since assets are presently so richly valued as to offer the likelihood of negative returns over the next decade, holding more of them is not likely to increase, but rather only decrease capital from here. And yet, nearly all conventional financial plans and advisors (even those who are not salespeople), myopically assume the opposite.
When we consider that the same risk advocates are advising institutions, businesses, pensions and households, (indeed heading central banks and other regulators) it’s no wonder that government and corporate pension plans and households are so behind in their funding/savings targets.
“Much of what passes for orthodoxy in economics and finance proves, on closer examination, to be shaky business.”
–The Misbehavior of Markets (2004) – by Benoit Mandelbrot & Richard L. Hudson.
Individually-tailored, financial planning can be extremely valuable in reaching goals but only where it uses realistic projections, contribution and withdrawal targets, based on the yields and facts at hand, rather than theory and fantasy.
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