Archive for September, 2008

One senior’s perspective on navigating this stock market

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This is a contribution from Bud Hebeler who runs Analyzenow.com

To our children and grand children:

 

These can be good financial times, not bad times!

 

The stock market is falling.  It may be bad for many retirees and those that will lose their jobs as brokers or from bankruptcies but not for many people—IF

 

·         their investments have been widely diversified, and

·         they have set a tolerance band for reallocating their investments.

 

Over my almost fifty years of investing, I have seen markets drop many times.  In my first fifteen years I learned the lessons the hard way—by losing money.  I followed the market.  When it got high, I bought.  When it fell precipitously, I sold.  Ugggh!  I was supposed to do just the opposite.

 

Eventually, I found a way to do better.  I set upper and lower limits to the amount of stock (including stock funds) that I would hold at various ages.  The formula was simple:  I would not let the stock as a percent of my holdings get below 100 minus my age.  That was the bottom side.  Then I set a limit for the top side, namely, 110 minus my age.  So, at age 40 (about when I first started this) my stock allocations were between 60% and 70% of my investments.

 

After a while I added real estate investments to my portfolio.  I count the equity (price less debt) as a “stock” because, after all, stock is equity as well.  I did not count the equity in my home as an investment because I reasoned that I would always need a home.  Besides, my home was quite modest.

 

Now, at 75, my equity limits are much lower:  between 25% and 35% of my investments using the very same formula.  The remainder of my holdings are in bonds and money markets.  Using these limits over all of these years has given me a portfolio return that is higher than if I had steadfastly held to an equity limit of 105 minus my age.  That’s because I bought stock when prices were low and sold them when prices were high.  I described the performance differences in my book, “Getting Started in a Financially Secure Retirement.”

 

Not long ago I was on a radio talk show in New England.  I talked about my allocation limits.  The talk show host said I was old fashioned and dismissed my conservatism.  He felt, as do many, that even retirees should have much larger stock allocations.  I thought to myself, “He’ll learn!”

 

I can’t see the future any better than anyone else, so my conservative bent could be wrong.  I base my stance now on something very simple indeed.  That’s the deplorable decline in savings rates over the past 20 years and the almost inevitable changes in demographics.  These embody the effects of overdone consumerism, excessive debt and the forthcoming reduction in the ratio of workers to those who will be retired or trying to retire.

 

In “Getting Started in a Financially Secure Retirement” I show that it will be impossible for the average person to save enough over the next 20 years to be comparable to what the 9% historical savings rate yielded.  We would have to equal the kind of savings we had in World War II when virtually everything was rationed, there was nothing on the store shelves to buy, everyone worked, and buying savings bonds was the politically correct thing to do.

 

My simple analysis of necessary savings rates does not count the great reduction in the percentage of workers who will get pensions over the past 20 years.  The only major segment of our society where the pension benefits are increasing is the government sector which not only is increasing as a percent of our labor force but also has cost-of-living-adjusted (COLA) pensions that are backed by a sovereign power with the ability to tax.

 

On the demographics side, the ratio of workers to those over 65 will go from 3 now to 2 in the next few decades.  Again, the effects are very simple to visualize.  That part of our taxes (the largest part) used to support the elderly will have to increase 50% for working folks.  That by itself will be debilitating for the economy unless government benefits are trimmed with a meat ax.

 

On the debt side, by the end of this year every man, woman and child will have a federal debt obligation of over $180,000.  This includes only the national debt, Social Security and Medicare.  It does not include mortgage and personal debts nor state debts and unfunded obligations.  A family of four could easily have an equivalent debt approaching $1 million including mortgage and personal debt obligations.  At an average interest rate of 5%, that would be equivalent to an annual cost of $50,000, just to pay the interest without retiring any of the debt.  The median family now earns about $70,000.  That leaves about $20,000 for living expenses, state taxes and retirement savings.

 

Of course that assumes that income and taxes are evenly distributed.  Since 40% of workers pay no income taxes at all, the burden will be 67% more on those who do pay income tax.

 

So, what do I think will happen?  I believe that not only will income taxes go way up, so will every other form of taxes go up including ones that haven’t yet been invented.  As has already happened in several places in Europe, the government will also have to reduce benefits.

 

Further adding to the problem will be increased inflation.  That’s because I believe that the demands for higher wages will increase as will the price for goods both because of higher industrial taxes and higher labor rates.  Productivity growth will slow because of increased demand for U.S. labor content.  Finally, the feds will silently applaud inflation growth because it will, as always, reduce the apparent size of the national debt relative to GDP.

 

So why then wouldn’t I advocate holding any stock if the economic future is so bleak?  The reason is that stock represents owning something tangible that will increase eventually with inflation.  The same is true of investment real estate.  If you have been following my past recommendations, you might be buying stock now, not selling it.

 

Do I think that things can get worse?  Absolutely.  That’s why I do things incrementally.  When in doubt I go half way.  That gives me an opportunity to talk about the part that did well and ignore the part that didn’t.  After all, isn’t that way the finance industry promotes its performance achievements?  (Smile!).

 

Caution:  I can’t see the future any better than anyone else.  But I can testify that (1) if you don’t save anything, you won’t have any savings, (2) that regular savings grow faster because of reverse-dollar-cost-averaging, (3) that diversifying investments helps savings growth over the long-term, and (4) that allocation control really pays.

Solving the nation’s debt problem with I.O.U.S.A.

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 This is a contribution from Bud Hebeler who runs Analyzenow.com


Last night  I went to the movie I.O.U.S.A. followed by live commentary from Warren Buffett, Pete Peterson, Dave Walker (headed GAO and was Controller General), William Novell from AARP, William Niskanen from the CATO Institute and an Economist whose name I can’t remember.  You’ll have to pardon the errors in this because I was taking notes in the dark and found later that it’s almost impossible to read them.

 

The commentary that followed was handled by Becky Quick from CNBC’s Squawk Box show who fielded questions from the audience.  The movie was loosely based on the book, Empire of Debt, and was actually exciting—quite a surprise for a financial show.  It even got our local movie audience clapping and laughing.  The show was financed by the Peterson Foundation and starts out with a lot of material from the Concord Coalition.  It was non partisan.

 

The more I think about the conclusions of the experts (Buffett, Walker, Peterson, et.al.) at the conclusion of the movie I.O.U.S.A., the more I wonder about their almost universal opinion that the main solution would be to increase the federal tax rates and moderate Social Security and Medicare payments to solve the $53 trillion government obligation problem.  Nowhere did they mention the other main debt problems:  personal debts, business and financial firm’s loans, State obligations including unfunded public employee pensions, and the sorry state of our transportation infrastructure.  These have to be satisfied as well.  As bad as the national condition was portrayed, our share of the total obligations was far understated.

 

One position that was mentioned was a mandatory savings program although the small percent cited would do little to solve our huge savings problem.  After all, Social Security costs us 6.2% plus another 6.2% from our employer—and that isn’t enough to keep the program solvent.  Further, as I have cited in Getting Started in a Financially Secure Retirement, the savings rate (not including Social Security) has to be well over 20% for the next two decades just to make up for the lack of savings in the past two decades of consumerism.

 

There are those that would only tax the rich, but as much as I dislike the extreme over-compensation of the top executives in major companies, those people eventually have to spend their money, and in so doing enrich the rest of us.  They and their children may live what we consider (or wish we could achieve) obscenely ostentatious lives, but their incomes (less taxes) eventually come into the economy.

 

On the other hand, government spending and wealth redistribution do little to increase productivity.  In fact all of the paperwork, additional government employees, even more private sector employees to respond to government regulations, and the imposition on our personal time all hurt productivity.  That’s not to say that some innovation doesn’t come from government sponsored research in medicine, military and space activities, but there is lots more that comes from the private sector where competition and necessity are the stimulus for invention.  This is well illustrated by the modern examples of nations that have converted from pure welfare states.  Russia and China now have booming economies by comparison with their past under totally controlled economies.

 

Higher taxes and increased savings have to reduce economic activity.  Some other alternative solutions are particularly unappealing:  Government bankruptcy, revolution, and hyperinflation.  Bankruptcy destroys much of the world’s economy with it.  Revolution ends the way of life we and few others know.  Hyperinflation puts those on fixed incomes into poverty.  Yet, in my view, a little of each of these horrible extremes is the medicine that might be necessary to at least end up in some reasonable equilibrium.

 

How about some real government changes to same money?  The Congress should start by setting the example and cutting its overgrown and bloated staffs by 50%.  Then it should act to change all federal pensions, including their own, to fixed pensions like all of those in the private sector.  (Only one in five private sector employment earns a pension, and they don’t have cost-of-living-adjusted pensions like federal and most state pensions.)  Stand up to your unions.  Let them strike.  That would reduce cash outflows too.  Then deny state largess from the federal coffers unless the states do likewise.  Don’t stop there.  Demand IRS 1040 simplification so that the IRS can cut its work force in half and we don’t have to use accountants and computer programs to do our taxes.  Simultaneously, get Medicare to do the same thing so that both government employees and the private medical facilities can cut their own staffs with less paper to handle.  Then sell off the excess office buildings.  Give up your perks.  These are the kind of things we have to do in the private sector in order for a business to survive.  You’ve got to save a country—that’s even more important!

 

This is not “change” as envisioned by current political parties.  Current political “change” is aimed at things that increase government spending and control.  In my view, change should be moderately more inflation than now considered acceptable, reduced bailouts of industry and financial firms, meat-ax reductions in government personnel, and much increased foresightedness in Congress and personal financial planning –together with some tax increases and entitlement reductions.  We all have to consider much longer horizons than hours or days in financial markets or a few years as in elected office terms.   We even have to think in terms longer than decades as we did in our Boeing planning.  We have to think in terms of generations and life-expectancies, just as in the insurance business.

 

Everyone is going to get hurt, but we all have to understand that a little pain now is a lot better than a lot of pain if we wait longer to take our medicine.  Perhaps the only Congress and Administration people willing to take such long range positions might be those nearing retirement, but certainly not the others and especially their supporting staffs which provide all of the advice and “smarts” on which government officials depend.  These all need their jobs to feed their families, and most are terrified of leaving their jobs to seek private sector employment and much lower benefits than the government provides.  Further, they have demonstrated that they have no interest in solving the additional problems of personal savings to replace debt, business debt, State obligations including public pensions and the sorry state of our transportation infrastructure. 

 

That said, here are my notes from the movie, I.O.U.S.A., and the comments from some of the more powerful people in financial circles and former government executives.  I feel all citizens should hear this message—and consider some of the points I have made above.

 

 

Of course, the movie is mostly about debts this country has incurred to date as well as the history leading up to our current situation.   Before the movie began, they had a digital display showing the current national debt as it was actually changing.  It was increasing by millions as we watched.   The only time this country was out of debt was 1830.   At the time the movie was made the total unfunded obligations of the country were $53 trillion or $175,000 for every man, woman and child in the US.  By 1/1/09, it will be $55 trillion and $184,000 for each person.

 

$10 trillion of this will be the national debt at the end of the year.  44.5% of our debt is owned by foreigners, principally China.  The other time the country reached levels of national debt to GDP like we are now was at the end of WWII, but that debt was owed to ourselves, largely as savings bonds.  Unlike now, the people were willing to make great sacrifices because they had experienced the Great Depression and had come out of the War where most things were rationed.  So much of the debt got paid.

 

One of the few periods in modern times when the government was not outspending its income was in the Clinton administration supported by a Republican Congress.  The movie came down hard on President Bush for not containing spending, especially for approving Medicare drug assistance with Part D.  It showed clips of Secretary O’Neill who was very upset about being fired for his disagreements with President Bush.

 

All commentators agreed that the current problem was largely due to excessive consumption.  Our national savings rate is now -2.9%.  The graphics showed the highest savings, about 23%, occurred during WWII.  Most of the time savings rates in the past have been about 9% to 10% through good times and bad.

 

There was a considerable amount of material on inflation with laudatory comments about Paul Volker raising the interest rate to 20% to combat what had occurred in the Carter years.  There were also clips of Ron Paul railing the government for printing money.

 

Social Security was highlighted in the movie as well as the commentary.  Various solutions were suggested such as raising the full retirement age from 66 to 70 or doubling the Social Security tax on the work force.  After 2017, without action, the Social Security Trust Fund will no longer be able to support cash flows for things other than Social Security as it does now because the trust funds won’t be there.  As most of us already know, the trust fund is a fiction.  It’s full of IOUs from the federal government.  One person said that the trust fund is neither a fund, nor can it be trusted.

 

The movie showed street interviews with ordinary people.  It was shocking how little they knew not just about the country’s financial conditions, but even simple financial terms like deficit.  The movie and all commentators (except Warren Buffett) felt it was grossly unfair to have our children and grandchildren and following generations have to pay for our current excesses.  Buffett felt that the ingenuity of our people would come up with things to solve the problems so that our children would actually have better lives than us.  The movie and commentators showed how poor our schools were compared to all other developed countries.  We are particularly deficient in math and science.  After seeing the movie, I’d add that they are even worse in teaching basic finance and money management.

 

The movie also made some dramatic points about the trade deficit.  It showed a US scrap yard where the manager said the majority of his scrap was being sold to Japan and China who were manufacturing things to be exported back to the US.

 

Foreigners that hold our debt hold it in dollars, so if they sell it to another foreigner, the other foreigner will have the same debt in dollars.  It’s like a tar baby.  The risk is not the foreigners dumping the debt; the risk is the interest rate and being able to get them to take on more of our debt.

 

Walker pointed out that one of the things that made the debt problem so intractable is that 68% of the national budget is on autopilot (e.g., automatically adjusted for inflation) and only 32% is for the things originally intended by our founding fathers to be what the federal government was supposed to do—like defend us.  Also, Congress was supposed to be a part-time job where the congressmen went back home to their regular jobs the rest of the year.  Now, congressmen work to preserve their congressional jobs and have a very short term perspective directed at whatever it takes to get reelected.

 

Most of the commentators agreed that the solution to our problem relies on national leadership—and it just isn’t there.  Politicians are campaigning with programs advocating more government spending, not less.  Medicare is currently the largest single unfunded liability—and it looks like the finance problem not only will not get solved—it will get worse with all of the add-ons.

 

The $53 trillion debt and unfunded liabilities is made up (as I recall the numbers) with $10 trillion national debt, 7 trillion Social Security, $26 trillion Medicare parts A and B, 8 trillion Medicare part D and some miscellaneous items.  I don’t remember how they accounted for the trade deficit, and there was no mention of State debts or industrial debts which must exacerbate the problems.

 

If you get a chance to see a replay, I’d urge you to see it yourself.  It has a very compelling message that should be understood by all citizens including those in high-school.  We need better government leadership and we must greatly increase personal savings.

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