Juggling Dynamite

In the late 1990s, thousands of Canadian teachers were offered early retirement packages that included the option to take a lump-sum withdrawal and forfeit their vested right to a defined pension for life.

My mom was a teacher and she–and others–approached me to review the options. Cash-out values of several hundred thousand sound huge to people who had been making fairly modest salaries all of their lives, but it was very obvious that the capitalized value of the indexed pension (with a survivor benefit option) was much greater than the commuted lump sum being offered.  I advised all of them that it was in their best interest to stay in the plan and collect the guaranteed income.

In 2007, I heard from police officers who were offered similar cash out options from their defined pension plans. In every case that I reviewed, I advised the person to stay in the plan.

Unfortunately, most others met with financial salespeople who counselled the retiring members to cash out and buy stocks and stock mutual funds (that generated fees for the ‘advisers’) and set up unsustainable withdrawal plans to fund their retirement.

As stock markets tanked in the bear markets that followed, those who bought the sales pitch lost heavily and were left cannibalizing what capital they had left to try and pay their bills.  Most suffered permanent capital losses; many had to return to work.

Two of the police officers who took my advice in 2007 and stayed in their pension plan, told me later that they were the only ones in their precinct who had not cashed out and lost heavily in the 2008 collapse. It makes me ill to think about that.  In reality though, bad outcomes are typical when lump sums meet with owner ignorance and investment sales reps.  The latest cycle is producing a fresh crop of victims all over the world.

Case in point:  the British Financial Conduct Authority sent letters to 7,700 former and current steelworkers this month, warning that those who have transferred out of the British Steel Pension Scheme since 2017 may have received unsuitable advice.  Though lawsuits may follow, losses have already hit and pennies on the dollar are typically recouped.  See Thousands of UK steelworkers told to seek possible pension compensation:

Although the FCA advises that most people are better off keeping a “defined benefit” pension rather than transferring the pot to a riskier pension arrangement, the BSPS members opted to transfer out of their scheme on the advice of authorised financial advisers. The average value of the transfers was £400,000.

…In its letter, the FCA said a review of a sample of files found only a fifth of the transfer advice provided to BSPS members “appeared to be suitable” for the client. It advised: “we encourage you to act; if you do nothing, you may end up with less money during your retirement than you should have done.”

…The action comes nearly three years after The Pensions Regulator allowed the giant BSPS to be spun off from Tata Steel, its struggling sponsoring employer. As part of the restructuring, 42,000 members of BSPS were given three months to decide whether to stay in the scheme, or take a lump sum and transfer their benefits to a riskier defined contribution plan.

…In 2017, a parliamentary select committee said the steelworkers had been “woefully” under-supported in making “complex” decisions about what to do with their pension. The work and pensions committee said many who transferred their pensions had been preyed upon by “unscrupulous” advisers and were “shamelessly bamboozled” into placing their cash in unsuitable, high-risk funds with punitive exit fees.”

Allowing non-fiduciary, self-interested salespeople and firms to counsel the masses on financial matters has an enormous social cost.  Unfortunately, actions taken are typically reactionary, after the damage has been done, and it is too late to recover.

“Having the Flu and Coronavirus together in the same patient is going to be a recipe for disaster,” says Jennifer Rohn, principal research fellow at University College London, as she discusses the efficacy of a Covid-19 vaccine, and the spread of the coronavirus. Here is a direct video link.

Billionaire investor and GMO co-founder Jeremy Grantham is growing more and more sure that the U.S. stock market’s rebound amid the coronavirus pandemic is a bubble that will end up hurting many people.

“My confidence is rising quite rapidly that this is the fourth ‘Real McCoy’ bubble of my investment career…“We’ve now reached a level where you buy bankrupt companies and issue stock in bankrupt companies” Grantham told CNBC’s Wilfred Frost.  Here is a direct video link.

A note on Grantham’s comments about emerging market securities and how they offer better value than “ludicrously” priced US corporate securities today.  While this is true overall, the problem is that equity correlations are highly coupled globally in terms of trend and money flow.  When US stocks rise and sell off so do corporate bonds and other global equity markets all at once (note price action year to date as one vivid example).

In this environment, stocks and corporate debt are all jelly beans that are indiscriminately bought and sold in forced liquidation all at once.  Thus, when jelly beans start falling it does not matter much whether one is holding purple or red,  they all fall together and there is little capital protection in equity diversification.

This is why Grantham adds that if one must own equities today they are best to hold zero in the US and if they own some in emerging markets they must be able to “throw the key away for a few years”.   In other words, only where the buyer can ride through large drops and not need nor want to use the money or withdraw income for several years, is an allocation to ex-North American equities today a reasonable bet.

Just a tiny fraction of potential investors have enough time, resources and income from other sources that they are comfortable in the ‘it doesn’t matter if asset prices crash and take years to recover’ category.