Today is a continuation of yesterday’s post on what to do if you buy a home with a problem; a dialogue between myself and my regular columnist, Mom2KG. Today we talk about how real estate lawyers help (or don’t) and how to approach the vendor in solving problems in the house they are selling you.

My comments are in italics and Mom2KG in bold. Enjoy.

TMW: Yesterday we left off at how the real estate agent was helpful because she knew time was of the essence and got on top of the problem quickly. How about the lawyers?

Mom2KG: The lawyers, on the other hand, were a mixed bag at best. We ended up having four different lawyers, plus ourselves. The lawyer we retained to close the purchase does a very narrow type of work. He closes sales all day, and never deals with problem properties. This was way beyond his retainer. As lawyers, we understood his position.

TMW: Moral of the story is the business model of real estate lawyers is quantity, quantity, quantity with prices to match. Most retail real estate lawyers are ill equipped to deal with problem closings or closings which are out of the norm (shared drive-ways, properties with water frontage, very old homes etc). In this case, you need to pay a few extra dollars for a specialized real estate lawyer or you need to get a second opinion. So what did you do?

Mom2KG: We decided we had to retain a lawyer specializing in environmental law. The first guy we found was very good, again holding our hands and giving us options. He had to educate the vendor’s lawyer on their obligations (with us footing the bill on that call) and again made our position clear.

Unfortunately, he had to pass us off to someone else at his firm, and that lawyer was a complete train wreck. He was incapable of assessing risk, and refused to provide any advice on the real estate side of things. For example, he would not discuss anticipatory breach, claiming that was a real estate issue, and he did not do real estate. So, we had to retain a real estate specialist to help us assess the legalities of backing out or staying in the deal. It was really, really trying.

TMW: That sounds horrible. How could that lawyer have handled things differently? Why do you think the lawyers were less helpful than the agent?

Mom2KG: That second environmental lawyer provided almost no value. No context, no “real world” examples of what our real risk was. We got tons of education on the requirements of the environmental legislation, right down to the maximum parts per million of petroleum allowed in soil and water samples. Who cares? I wanted to know what the risks were in buying a property that was probably clean (after the sellers removed the tank and got in an expert to test the soil). But he simply would not help us with that.

That lawyer was clearly concerned with the extent of his own liability. He kept saying “I’m an environmental lawyer. I don’t do real estate.” Or, “I can’t tell you what to do. I can only tell you the law.” To some extent, that’s true, but lawyers are also supposed to be trusted advisors who can help with decision-making. Our agent, on the other hand, was more interested in helping us than in potentially getting sued. She actually endeared herself to us by freely admitting she had “missed” the oil tank when we first looked at the house. The lawyer, on the other hand, was primarily concerned with his own responsibility in the matter and was unwilling to take any risk himself.

TMW: With your lawyer’s hat on, what role did tackling the problem early help in dealing the vendor?

Mom2KG: We knew there was no time to lose when we first found the problem. We know getting environmental reports can take weeks, and we didn’t have that time. We had to give the sellers time to remedy the problem and satisfy us. You can’t wait to present a huge problem until the day of closing. We were also able to educate ourselves on our possibilities and choices. Finally, it meant we were able to send a consistent message for the weeks this took: we wanted the house, but without the tank or environmental damage.

TMW: What steps did you finally take to provide some satisfactory conclusion that you would be buying the house of your dreams?

Mom2KG: We advised the sellers, through their lawyers and agent, what we needed: the tank removed, and proof we could rely on that it was a clean property, free from oil contamination. We managed to get the purchase and sale agreement amended to say the sellers would do that, so we had some contractual strength. Then, we kept a close eye on what was happening. At every step, we consulted with our lawyers to assess how things seemed to be going. We used our second visit to the house to bring in our own environmental consultant to determine the progress. We continued to advise the sellers of what we needed and expected. We also ensured that the report provided by the seller’s consultant was addressed to us, so we could rely on it if ever there was another problem.

TMW:  What would you have done differently?

Mom2KG: I would have asked for an all-party meeting or mediation early on. It was very frustrating communicating through agents and lawyers. We all should have sat down together so we could present the facts, issues and needs with a more human face. We kept wondering if in fact the vendors were getting all the info we were lobbing over, and I don’t think they did. I think an early meeting would have helped thing along immensely. I would have kept it very low-key and agreed to have it as “no prejudice” – not admissible as evidence in court.

TMW: Let’s recall lessons learned then if you run into an issue purchasing or selling a home.

1. Know what you want
2. Time is of an essence
3. Be specific as to remedy
4. Don’t assume the other side will do your work for you. Be proactive in the solution.
5. Use your professionals but always refer to #1.

Is that about it?

Mom2KG:  Yes, I think that’s it. You also have to have good communications with your partner, and you have to resist the temptation to lay blame. There a solution does not lie.

TMW:  Wow, you dropped some Yoda-sim on us. Thanks for sharing. It is a great home in a beautiful neighborhood. If you ever build a spare room over the garage, I will gladly play the Arthur Fonzarelli role and move in.

Decide to buy a home. Hire a real estate agent. Look for houses. Look again. Make an offer on a home. Make another offer. Enter into an agreement of purchase and sale…. and, now, there is a problem before closing. What do you do? Can your real estate agent help you? Your real estate lawyer? Fight or flight?

Today’s post is a 2 parter between myself and my regular columnist, Mom2KG. We re-live a real life issues arising from  purchasing real estate with some problems and share lessons learned. As always, in these types of situations, it is important to obtain advice. My comments are in italics. Mom2KG’s in bold. Enjoy.

TMW: Mom2KG, I believe it was a Wednesday morning when I got an email from you indicating that there was a problem with buying your home followed by a bunch of four letter words. What exactly was the problem?

Mom2kG: Yup, and now that the problem has been solved, we continue to tell the story using lots of 4-letter words. It was an extremely stressful situation.

We had agreed with the seller that we could visit the home twice before closing. Typically, this is so you can measure for curtains or think about paint colours, or just gaze lovingly at your new ensuite bathroom. On our first visit, my husband realized there was an oil tank buried in the back yard. This was bad – an untold environmental liability. We had purchased the home with no conditions – so no home inspection – so we had no idea if we could get out of this or what our options were.

TMW:  Just so that the readers don’t think you are not a smart consumer, buying a house without conditions occurs in Toronto quite often, in order to head off bidding wars. So what you did was not out of the ordinary course.

By way of background to the readers, in Ontario, under the environmental legislative regime, oil tanks buried in grounds were required to have been removed. In other words, having a buried oil tank is now illegal in Ontario. At this point, you really have two obvious options: buy or don’t buy. What did you end up doing?

Mom2KG: We ended up buying. As readers may know, we’re both lawyers. So we called some contacts, and if things weren’t already off the rails, this compounded matters. Astoundingly, each lawyer gave us a different answer, ranging from “GET OUT NOW” to a more reasoned approach. It was really scary in the first few days. And confusing. Besides the illegality issues, we didn’t know if the tank had leaked and caused contamination under the house or even offsite.

However, there were very good reasons to pursue a remedy instead of running. First, we wanted the house – it was great. Location was great. Nothing else had come on the market in weeks. We had already sold our own home. As well, we knew, as lawyers, we had to give the sellers a chance to step up. You have to give them a chance to be reasonable. Finally, we had a leg to stand on – the oil tank existed illegally and no court (if it got to that) would force us to accept a property  not complying with law. But court was also the last place we wanted to end up.

TMW: What is important to note in your response is that as badly as you may have wanted out, I am assuming here, the lawyer in you probably said “have to play this out and put ourselves in a position where a reasonable person would say you did everything you could” before you backed out. Process is key. In most cases, you can’t pull the plug without going through the process.

Mom2KG: Yes, that was a major driver in the decision. You can’t just back of a contract and not incur some wrath, which can lead to serious fights and even litigation. We mapped out a lot of “what-ifs” and one was that if we ever got to court, we needed to be able to say we acted reasonably, even if it was the sellers who were ultimately in the wrong by not removing the oil tank years ago and then by not informing us of its existence.

TMW:  There’s a couple of educational items for readers to note. As you imply, that you cannot contract for an illegal act and, even if you breached the contract, you breached it for an illegality, which makes your argument substantively stronger.

But most home purchasers do not buy homes with illegalities in them. In most cases, problem closings come down to less dramatic issues like the purchaser bought without conditions or the conditions are waived and the purchaser gets laid off and cannot obtain a mortgage and closing.

In these instances, there is a doctrine known as “anticipatory breach.” In plain English, this means a promising party knows that they can’t fulfill their part of the bargain before the time promised and tells the other side before the closing dead/date the bargain is closed.

It may be strange to a non-lawyer that one would tell the other side you are in breach but the reason why you do this is because the other side has a duty to mitigate damages. In the real estate context, this means the vendor has to resell the house. If the house is resold for more than the purchaser bought it for and their other costs are covered (legal fees), the purchaser is basically off the hook for damages. If the house is sold for less than what the purchaser agreed to, the purchaser’s damages is the sum between (purchasers offering price + costs) – (new purchaser price). What the vendor cannot do is nothing and push the entire burden of damages onto the purchaser.

Mom2KG: These are all good points for your readers to know, and we actually discussed playing the anticipatory breach card as a way out of the deal. But, in our situation, there were other pressure points on how it all played out. We certainly tried to figure out who was in the wrong and why, and that included whether either agent had been negligent. As I’ll discuss in more detail later, though, we never played those cards and got what we wanted mostly through negotiation.

TMW: How helpful was the real estate agent in the beginning of this process?

Mom2KG: Our agent alerted the vendor’s agent to the tank. They realized right away, thankfully, that it was their responsibility. They knew they had to take it out for us, and could not hide it from the next potential purchaser if we backed out. (At that point, it’s what’s called a patent defect – an obvious, known problem with the property. When they sold it to us, however, the vendors, we believe, did not know about it, and that’s called a latent defect.).  Our agent was great – she did online research, talked us off the emotional ledge we were on, and made the hard call to the other agent. She knew it was important to communicate that while we really wanted the property, we weren’t taking it without the tank removed and proof of a clean property. I have to say, she leapt into action on our behalf and tried to find solutions.

TMW:  Timing was very important. Your agent got to their agent very quickly, identified the issue specifically rather than a blanket statement like “my client hates the home” and gave the vendor a reasonable amount of time to fix the issue. In other words, you gave a road map to a solution. Too often, real estate problems are ignored or raised at the last minute which allows the other side to raise the argument you were unreasonable or the issue is raised without a proposed solution being given; this comes off very badly as a negotiation tool. All you are saying is “here, do all my work for me” which provokes a really bad reaction. Be reasonable no matter what since you are framing your problem solving exercise in the context of either litigation or a title insurance claim.

to be continued…

If history is any indication, economically disruptive rescission, like the 1991 variety, tend to produce two things in their wake. There is a predictable increase in companies reporting losses or profits based mostly on cost-cutting initially and, correspondingly, companies begin to be creative in their financial reporting to meeting earnings expectations. However, studies continue to show that the best way to mitigate against these dangers is investing in dividend stocks.

First, let’s state the obvious. In order to be a long-term dividend payer, a company has to be able to sustain cash flow necessary to pay dividends quarter over quarter. The implication being that dividend paying stocks do not necessarily have to be profitable all the time but rather they cannot be losing money over the long-term lest they jeopardize the dividend payment and investor confidence.

However, we appear to be investing in a world characterized by increasing loss reporting. A University of Chicago study on the relationship between dividends and earnings found that the fraction of losses reported by non-dividend payers in the U.S. grew from 28% in 1974-1979 to 52% by 2000-2005. Dividend payers followed the same general trend of increasing fraction of losses reported but in a far lower percentage than non-dividend payers with losses compromising of 3.5% of dividend payers in 1974-1979 to 11% in 2000-2005 (but this percentage of losses has been more or less consistent since 1985-1989). In other words, dividend paying stocks are less likely to report losses.

The losses reported by dividend payers also tend to more palatable than from non-dividend paying stocks. The authors found that over half of losses reported by dividend payers were due to one-time items versus approximately 25% of all losses derived from special items by non-dividend payers.  The authors conclude from this finding that losses tend to be better (for lack of a better term) than non-dividend payers since they are not attributed generally to operational inefficiencies.

The issue with this conclusion is that there is nothing barring companies from repeatedly reporting “one time” items quarter after quarter to hide operational inefficiencies. However, the large differentiation between loss reporting between dividend and non-dividend payers does tend to indicate that if this is occurring it is not in sufficient scale.

The flip side of the analysis is the author’s also found that dividend paying stocks have greater “earnings persistence” than non dividend earnings; the implication being that a dividend paying company showing a profit one quarter are more likely to show profits subsequently.  Yet, caution should be exercised for companies who rely on share buybacks. Their earnings persistence tends to be less than its counterparts who rely on steady dividend payments and are more likely to report losses (although still in fewer instances than non-dividend paying firms).

The study is interesting but should be read with two caveats. The sample size (1974-2006 studying NYSE, AMEX and NASDAQ) is relatively small and it excludes utilities and financial firms (which, given both are traditionally dividend payers, may distort the data somewhat).

If you are interested in finding the best dividend stocks, I would reiterate what other bloggers have written. The most reliable dividend data is found in the company’s financials themselves and understand what makes a good dividend stock. Start there and move outwards towards an industry comparison. While the study is interesting, please remember that Enron also paid dividends so don’t judge a book purely by its dividend paying cover.

Conventional wisdom is that business booms for litigation lawyers during down times. As the money and cash flow dries up, it is harder for people to buy their way out of disputes and, ergo, cue the lawsuits. If most of us are lucky, we will never be subject to a lawsuit. But, as consumers, the cost of businesses defending or settling lawsuits hits us in direct and indirect ways.

LawPro provides errors and omission insurance coverage for over 20,000 lawyers and title insurance for purchasers of real estate. It was recently announced that LawPro is increasing its 2010 insurance premiums by 20% to slightly under $3,000 per annum.  The primary reason for the insurance premium increase is that claims against lawyers have risen from a typical range of $55-$60 million annually to an estimated $88 million in 2009. There has been a particularly large jump in real estate claims (65% increase in the last 5 years).

No one sheds tears over lawyers but how does this affect you?

Directly, increased insurance claims against real estate lawyers have resulted in an increase in the real estate levy from $50 to $65 per transaction. This levy is paid by anyone buying or selling real estate in Ontario. In other words, the cost of a real estate transaction just went up.

Indirectly, businesses do pass costs down to their clients and customers. Assuming that other industries are suffering from similar issues related to increased litigation, whether through increased insurance costs or increased cost of sales, one would assume that at least a portion of this cost will end up on the consumers’ bill.

Money Energy has commented recently that consumers are feeling inflationary pressures in some goods. While it would be extremely difficult to pinpoint how much the costs of litigation increases consumer costs, it may be a contributing factor going forward.

Imagine you invested in a mutual fund several years ago. You received dividends and, on sale, capital gains. Not soon after the sale of your units, the mutual fund is put into receivership or goes bankrupt. A few months after that, you receive a letter from the receiver or trustee asking for your profits back to help compensate the existing investors.

Hardly seems fair doesn’t it?

Yet, this is what is happening in the aftermath of the Madoff ponzi scheme being exposed.

The Securities Investor Protection Corp (SIPC) is a not for profit corporation which protects investors if broker-dealers fails. It has jurisdiction of the Madoff matters. Under Securities Investor Protection Corp. v. Bernard L. Madoff Investment Securities LLC, 08-01789, U.S. Bankruptcy Court, Southern District of New York (Manhattan), the liquidator appointed by SIPC has begun clawback lawsuits against investors who made a profit from “investing” with Madoff.

Yesterday, it was revealed the owners of the New York Mets baseball club made a profit through the scheme and speculation is that SIPC will also initiate a suit against the owners (whatever the profits, it sure didn’t buy defense or pitching this season).

A clawback suit is analogous to fraudulent conveyance in which individuals are paid out of order to defeat certain classes of creditors (think of  a parent who sells their house to their adult child for $1 to avoid a tax judgement). If proven liable, the typical remedy is to rollback the transaction or, in this case, the return of profits.

The particular issue in the Madoff case is that the liquidator can reach back 6 years and the clawback suits have been initiated against insiders who allegedly knew it was a fraud and cashed out (the intention of these kinds of laws and, if proven true, a just decision), persons who allege they knew nothing about the fraud and where fortunate in their timing (giving rise to some type of  good faith dealing defense) and charities (who have a moral defense at the very least). As I understand it, no allegations have been proven.

The liquidator is in a very tough position. If he does not initate clawback suits, he will expose himself to charges that he did not carry out his fiduciary duties. By initiating suit, he’s now subject to charges he’s being overly broad in the application of the law and costing innocent people time and lawyer’s fees to defend themselves. Of course, he’s been sued too.

Some have questioned if ponzi scheme victims should be compensated for their losses. If you believe they should, should it come from  the unknowing “winners”  (those in on it and cashed out should return money if proven to be so)? You could construct a university level ethics course on the Madoff moral quagmire as it pertains to compensating its victims.

All I know is that some lawyer is going to retire on this matter alone.

Anyone care to share any thoughts about this?

It has been trendy lately to pile on the financial advisor or financial planner. The typical complaints are that financial advisors actually lower returns, increase risk exposure, turnover stock/mutual fund/ETF portfolios unnecessarily and charge fees disproportional to their value. Stories have been written about suing financial advisors and, in a grossly unfair generalization, financial advisors have been lumped in with the Bernie Madoff’s of the world.

The question turns, therefore, what would investor returns be like without financial advisors? In other words, what if we all became DIY investors?

Sweden is mostly known for its knock-off designer furniture and talented hockey players but it has implemented the closest real life experiment of a life without advisors. The results may show that, in some cases, blaming the advisor is nothing more than shifting responsibility for failing to control our worse excesses.

The Sweden Pension System

Sweden’s social security is a mixture of pension benefits, income support and individual and self-directed investment accounts. The latter is funded by a 2.5% payroll tax collected annually and deposited into the contributor’s account based on the previous year’s income. The accounts launched in 2000.

Each contributor is given a booklet complied by the government outlining what funds can be purchased and a contributor can pick up to 5 funds. There are now over 700 choices to pick from. The information package divides the funds by category, risk factor, 5 year returns, management fees and total assets under management.

If a contributor does not pick a fund (a reasonable conclusion with over 700 choices), the default fund, the Premiesparfonden (the “Default Fund”), is chosen for them. The Default Fund is restricted from advertising and, until recently, once you make an active choice, you cannot opt back into the Default Fund.

As I understand it (not being Swedish or being able to read Swedish), the funds may advertise, other than the Default Fund, but the individual investment accounts are self-managed without financial advisors.

While contributors have no restrictions in asking their financial advisors for advice, this is the closest system I have found which replicates an investing world without financial advisors since managing individual investment accounts are carried out without intermediaries (other than the government who administers the program).

How does the typical Swedish DIY Investor do?

Between 2000 and 2007, a contributor who was not in the Default Fund was more likely to:

1. Have greater risk exposure than the Default Fund with a mean equities exposure of 96.2% vs. 82% in the Default Fund;
2. Be highly concentrated in their equity exposure with 48.2% mean exposure to the Swedish public markets (a country of approximately 9.2 million people) vs. 17% in the Default Fund;
3. Ignore passive investing with only 4.1% of its portfolio in index products vs. 60% of the Default Fund;
4. Purchase higher fee products with a mean fee of 0.77% vs. 0.17% of the Default Fund (a fee that would make most North Americans happy);
5. Chase returns since the most actively picked fund when the investment account launched in 2000 was the high-tech Roburs Aktiefond Contura which returned over 500% in the previous 5 years but lost 32% in 2001; and
6. Experience worse returns than the Default Fund with a mean return of 5.1% vs. 21.5% of the Default Fund.

The only sin missing from a contributor’s investing decision is account activity. A 2005 Brookings Institute study found that only 6% of contributors made a single fund switch in 2004 and only 600 of 5.3 million account holders switching more than 20 funds that year.

(Assuming low investor portfolio activity in 2004 is the rule rather than the exception, excess trading may not be as large a culprit of poor investor return as some studies indicate. It could be we invest like we date in high school; we chase the attention seekers and heart breakers rather than the steady and dependable.)

What is more galling for investors who picked funds is that the Default Fund continues to be a superior choice to most of the other 700 funds. The Default Fund outperformed the average of all other funds 23.2% vs. 22.3% for the first 9 months of 2009 (although it did poorly compared to the average return of other funds in 2008). The Default Fund has done so well that on September 30, 2009, the Swedish government changed its rules to allow contributors to actively pick the fund rather than only investing in the fund if no choice is made.

As a side note, if you had a build a perfect fund: low fee, indexed, proper asset allocation, a small allocation in alternate investments, you may end up with the Default Fund (see this recent paper on more information on how this fund outperforms its peers).

What are we to make of all of this?

Other than decreased trading in an account, the Swedish experience shows that DIY investors suffer from the same behavioral tendencies as generally attributed to poor financial advisors. Sweden has literary and education rates which are comparable to North America’s. Thus, one cannot assume differing education levels could produce different results if the investment accounts were applied in North America. In fact, studies show the more educated a Swedish contributors, the more likely they actively picked funds rather than being given the Default Fund.

Could it be that as DIY investors we would do no better than having a financial advisor and our finger-pointing distracts us from the larger issue: we, as a society, are not financial literate or savvy and we have collectively found an easy scapegoat?

This is not to suggest that we need all need a financial advisor. Enough studies show that, despite the title, financial advisors tend to be pretty mediocre portfolio managers. However, as other non-advisors have suggested, to boil down the value of a financial advisor purely to a ROI number misses the fact that value is given in many different manners by a good financial advisor.

Does there need to be an overhaul of the financial advisor and financial planner industry? Certainly. The system is broken in many different respects and the stakeholders in the system are all equally at fault.

But, if the Swedish example is applicable to North America (and Bush proposed individual investment accounts as part of his failed social security reforms), it is unreasonable to assume a poor investment advisor is the ONLY reason stopping anyone from superior investment returns. Blaming a financial advisor may make one feel better but the Swedish example shows it may not necessarily produce any different results.

Instead, I likely sit with the majority of other financial bloggers in believing financial self-education and improvement should be a corner-stone of any personal financial strategy. To the extent an advisor or planner can add value to this exercise, then retain accordingly. Best of luck. Thanks for your indulgence in a long post.

Ted Williams, arguably the greatest left-handed hitter in baseball, died in 2002 with 3 adult children. In the immediate aftermath of his death, rather than celebrate a full life as a hall of fame baseball player and war veteran, his children squabbled over what to do with his body. Ted’s will stated he wanted to be buried but two of his kids had his remains frozen instead based on Ted’s hand-written instructions on a napkin. A legal fight ensued among the children over whether these instructions were real or not  with the two kids eventually winning (I am, sadly, not making this up).

Most of us would never engage in such a high-profile and costly legal fight over the burial of a loved one but what does the law say about this topic?

First, here is some practicality about the matter. Wills are often read weeks after the funeral. Therefore, the possibility exists that your family may have had you cremated rather than the New Orleans style funeral you wanted. Given the timing issue, some lawyers suggest not even putting burial instructions in your will.

Instead, the practical step would be to set out in writing (preferably not on a napkin and witnessed by an adult with no vested interest in your estate) the manner in which you wished your body to be disposed of. In some jurisdictions, in the absence of any instructions, the spouse then the children (assuming they are not minors) then the parents of the deceased can decide. Please consult a lawyer if you live in one of these jurisdictions.

However, there is a catch. There is long standing common law that the executor/estate trustee may over-ride both the deceased and its next of kin’s wishes for burial instructions. Given one of the executor’s largest responsibilities is to settle the estate financially,  the executor may ignore burial instructions if the carrying out of such instructions would place an undue financial burden on the estate (just so you know, estates can declare bankruptcy if the deceased passes away with debts greater than assets on a liquidated basis).

For example, a deceased with young minor children and a modest sized estate passes away in Maine and wishes to be cremated and his ashes scattered off the coast of Hawaii having being born there. The cost of this type of funeral arrangement can be quite substantial and the executor may have to make the decision that it is better to leave more for the minor children rather than draining the estate’s assets to carry out the deceased’s wishes.

In light of the foregoing, the practical step, if funeral arrangements are very important to all concerned, is to set aside money or pre-pay for the arrangement. For example, if an elderly person has been moved to a long-term care facility far from where their beloved and late spouse is buried, financial arrangements should be made now so that they lay together at death. While a morbid topic to discuss, it is better to plan now from both an emotional and financial perspective.

Congrats to David for winning the draw for the book The Secret Language of Money. David has received an email informing him that he was the winner. Thanks for participating and I hope to have at least one more draw this year.

Asset allocation is the strategy of distributing one’s investments across different investment classes. The underlying theory being that, since different assets may not be correlated, a proper asset allocation provides diversification and manages risk. For most retail investors, proper asset allocation is necessary since we neither have the time nor expertise to invest substantially in one investment class. The general rule of thumb is 120- investor age should be your asset allocation in equities (i.e. a 40 year old should have a portfolio containing 80% equities) which replaces the more conservative 100-age rule (the one I follow).

The enemy of asset allocation is inertia. Since assets gain or lose value of time, an investor needs to reallocate their portfolio periodically (annually is typically recommend). Without such periodic reallocation, an investor’s portfolio tends to drift outside their ideal asset allocation to, more often than not, an overweight in equities (since equities have greater returns than fixed income over time). Many investors woke up circa October 2008 to find that they were much more exposed to the equities market then they thought having not rebalanced in the previous years.

But does overwhelming product choice also upset proper asset allocation?

A 2007 study on retirement savings behavior, which also partially formed the research for the book Nudge: Improving Decisions About Health, Wealth and Happiness (an excellent read), found that choice and branding confusion affects investor asset allocation in different manners.

Using the investment patterns of 170 retirement savings plans as a sample size, the authors found the following:

1. The greater the percentage of equity mutual funds offered to employees as part of the fund selection process, the greater a portfolio was invested into equities.  For example, a retirement plan that offered its members a selection of funds of which only 37% of all options were equity funds resulted in the employees having a mean asset allocation of 48% equities; a similar plan with equity funds consisting of 81% of the options increased mean asset allocation to 64% equities.
2. Paradoxically, the greater number of mutual funds an investor picks, the more likely an investor reduces exposure in equity funds towards money market and bond funds. However, the allocation towards money market and bond funds is relatively small (3.28%). The authors’ explanation is when the number of fund choices no longer are within 1-4, the investor can no longer allocate among asset classes using some set percentage (25%, 25%, 50%) and adopts more creative asset allocation strategies.  One assumes the investor mitigates quantity risk by drifting towards safer assets.
3. Branding confusion for balance mutual funds tends to result in high equity weightings. The authors’ findings supported a Vanguard study that even if an issuer creates a balanced mutual fund, consisting of a mixture of bonds and stocks, investors tend to also pair this investment with equity mutual funds, pushing their equity allocation up. For example, investors who invested in a conservative “lifestyle” fund paired this investment with much more aggressive offerings, resulting in a 77% equity weighting. If, in fact, these investors wanted less exposure to equities, they ended up self-defeating this purpose in their other mutual fund selections.

The implications of this study are manifold:

1. We are strongly influenced by product; perhaps much greater than strategy. Since the study shows  a correlation between the number of equity funds offered to the equity weightings, it follows that the average investor makes decisions based on product selection rather than assessing whether the products actually fit into an over-arching strategy. Product seems to be leading strategy and not the other way around.
2. The greater the choice, the greater the chance of improper asset allocation. Rob Carrick recently wrote that an investor should only buy 3 exchange traded funds. It is prudent advice since the more product we have in our portfolio, the more likely we are not following our strategy properly. Adhere to the KISS principle.
3. Don’t buy by name. Actually research what each product contains. As I commented last week, if an investor bought a dividend ETF along with a broad based equity ETF, the investor has created overlap and may not be any further ahead. Don’t buy by brand. Research how the product fits into your strategy.

Although the research piece dealt with mutual funds, the same analysis should be applied to ETFs. What I hear and read is that many investors are replicating the same mistakes they made as mutual fund investors: chasing returns, buying multiple niche ETFs, creating over-lap in their ETF portfolio, pursuing higher MER ETFS and being interested in what one does not understand (leveraged ETFs). Making a mistake once is a learning experience. Making the same mistake twice is sheer folly.

The effective unemployment rate (those out of work and those who have stopped looking for work) is, in some regions, in double digits. No doubt, some of this unemployment is due to businesses being petitioned or assigned into bankruptcy or receivership (typically, a receiver is a person placed in custodianship of a business to, often, liquidate the assets under either court order or by a lender under the powers granted in a lending agreement).

If you are in this situation or your company may soon be facing the prospect of bankruptcy or receivership, do you have any rights?

Under the Canadian Wage Earners Protection Program, any employee who is NOT: (i) director or officer; (ii) in a managerial position; (iii) have a controlling interest in the business; or (iv) did not have an arm’s length relationship with the foregoing, can be eligible to receive payments for unpaid wages. However,  employment must be terminated due to bankruptcy or receivership of the employer.

Assuming one falls within this class, an employee is eligible for unpaid wages (including vacation, severance, disbursements, bonuses and, as decided by a B.C. case, union dues and health care premiums usually paid by the employer) for the six months period preceding the date of the employer’s bankruptcy or receivership if it occurred before July 8, 2008.

The maximum amount an employee can be paid is effectively the greater of $3,164.00 or 4 weeks of the maximum EI earnings (currently $3,254). It is actually a bit more complicated than that but this is the effective maximum rate.

Here is where things get a little more difficult. Suppose the business has little to no assets  and the trustee in bankruptcy or receiver receives little for liquidating the assets of the business to satisfy creditor claims. In this case, is the employee still eligible for the maximum eligible amount?

Much to the dismal of secured creditors, employees have a “super priority” of $2,000 maximum over and above secured creditors, other than registered equipment financiers, and the government. In plain English, IF (see below why this is in capital letters) the assets of the business are not enough to satisfy the creditors, all the employees have to be paid up to $2,000 each before the creditors receive anything (lender side bankruptcy lawyers are up in arms over this). The employees may not be paid their maximum but they could be eligible for up to $2,000 each before the creditors.

This works well in theory but many businesses that go under were basically using government remittances (EI and CPP) to fund the business in its last days. These “source deductions” are held in trust for the government (they were never the business’ monies to begin with) and the trustee or receiver is basically liquidating assets to satisfy the govenment’s priority. Thus, in some cases, this $2,000 super priority may be a hallow victory which looks great on paper but does not match business reality.

The other catch is that trustees and receivers administer the program and have a duty to not only account for any unpaid wages to an employee but to also deduct source deductions if and when the unpaid wages are paid. In other words, trustees and receivers are co-opted tax collectors.

More information on the Wage Earner Protection Program can be found here. Just remember that employment matters falls under provincial jurisdiction except when the business is bankrupt which is when the Federal government asserts jurisdiction. Thus, questions as to employee rights outside of bankruptcy should be directed to the province or to a qualified lawyer.

For American readers, the following is a quick and dirty article on employee rights during bankruptcy in the U.S. (bankruptcy and employment benefits are also a federal matters in the U.S.) and a fact sheet from the U.S. Department of Labor on employee benefits during bankruptcy (especially important for those with 401K).

Best of luck.

Special thanks to my regular columnist, Mom2KG, for research support (the errors are my own).

Numerous studies have found that the number of dividend paying stocks continue to decline. Not surprisingly, this has resulted in an increasing concentration of dividend paying stocks in large cap indexes as medium to small cap indexes tend to have members with characteristics not conducive to paying shareholder dividends: mainly lower profitability and less reliable earnings given relative immaturity in the business cycle.

The implication being that an overlap exists between broad based equity indexes and dividend paying stocks. But, just how large is the overlap?

The U.S. is considered one of the two countries (Japan being the other) where dividend concentration is less pronounced. However, if one purchased the Vanguard Large Cap ETF (VV) and the Vanguard High Dividend Yield ETF (VYM), of the top 50 holdings of each, there are 24 stock in common. This includes a staggering 19 of the top 20 holdings in VYM by weight.

Similarly, if one purchased iShare’s flagship Cdn. Large Cap 60 Index Fund (XIU) and iShare Cdn. Dividend Index Fund (XDV), one would find 15 of the 30 stocks compromising XDV are also found in XIU. This figure has more context if one considers that the overlap constitutes over 60% of XDV by weight.

The result is that one is not diversifying by investing in a large cap ETF and a dividend based ETF. Instead, an investor has merely created a redundancy in their portfolio and failed to mitigate against downside risk.

The issue becomes magnified if that same investor commits mutual fund-itis and begins purchasing niche ETFs which overlap the broader equity based ETFs. The ETF pairings to watch for in particular would be purchasing a broad based equity ETF and then a financial services industry ETF and/or preference share ETFs. Given the latter are typically issued by the same companies that pay dividends, if they can’t make a preference share dividends, which typically ranks in priority to common share dividends, they are not paying any class of shareholders a dividend.

The lesson being, and as a preview to a post next week, choice and selection are often not the best thing for the investor.