Category: Government

The Fate of Social Security for Younger Workers – And Three Things You Should Do Right Now

We constantly hear people wonder whether Social Security will still be there when they retire.  The question comes not just from people in their 20’s, but also from people in their 40’s and 50’s as they begin to think more about retirement.  It’s a fair question.

Some estimates show that the Social Security Trust Fund will run out of money by 2034.  Medicare is in even worse shape, projected to run out of money by 2029.  That’s not all that far down the road.

So how do we plan for this?

The reality is that Social Security and Medicare benefits have been paid out of the U.S. Treasury’s “general fund” for decades.  The taxes collected for Social Security and Medicare all go into the general fund.  The idea that there is a special, separate fund for those programs is accounting fiction.  What is true is that the taxes collected for Social Security and Medicare are less than the amount being paid out.

What this inevitably means is that at some point the government may be forced to choose between increasing taxes for Social Security and Medicaid, reducing or altering benefits payments, or going broke.

Another question is whether the benefits provided to retirees under these programs will cover the cost living.  Older people spend much more on medical expenses than the young, and medical costs are increasing much faster than the cost of living adjustments in Social Security payments.  If a larger percentage of a retiree’s income from Social Security is spent on medical expenses, they will obviously have to make cuts in other expenses – be they food, clothing, or shelter – negatively impacting the lifestyle they envisioned for retirement.

The wise response to these issues is to save as much of your own money for retirement as possible while you are working.  There is little you can do about Social Security or Medicare benefits – outside of voting or running for public office – but you are in control over the amount you save and how you invest those savings.

As we face an uncertain future, we advocate that you take these three steps:

  1. Increase your savings rate.
  2. Prepare a retirement plan.
  3. Invest your retirement assets wisely.

If you need help with these steps, give us a call.  It’s what we do.

Getting ready to file your taxes? Pay attention!

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As we head into tax season, many of you have received tax reports – commonly referred to as “1099s” – from your investment firm.

The IRS requires that 1099-MISC forms must be mailed by January 31st,  but issuers are not required to file copies of all 1099 Forms with the IRS until the end of February.

We frequently advise our clients to delay filing their taxes until March at the earliest.  That’s because the tax code is so complex that errors are inevitable.  As a result, investors often receive “corrected” 1099 forms after the February deadline has passed.  This may result in a change in the tax owed.  Those who use tax preparers or CPA firms may need to have their tax re-calculated, increasing the cost to the investor.

We note that Morgan Stanley has admitted to providing erroneous information to its clients.

Apparently Morgan Stanley’s reporting system sometimes generated an incorrect cost basis for its clients’ stock or bond positions, which threw off capital gains tax calculations following the sales of the securities, the paper reports. The errors affected a “significant number” of the firm’s 3.5 million wealth management clients for tax years 2011 through 2016, according to the paper. But around 90% of the under- or overpayments were less than $300 while more than half were less than $20, a Morgan Stanley spokesman tells the Journal.

It is always a good idea to check the accuracy of the statements you receive from your custodian.  There may be erroneous or missing information.  In many cases where securities were purchased years ago, the custodian does not have the cost basis of stocks or bonds that were sold.  In those cases the investor is responsible for providing that information.  If you do not provide that information, the IRS may assume that the cost basis is zero and tax you on the full amount of the proceeds of sale.

On a final note, many clients have asked us how long they need to keep records for tax purposes.  The primary IRS statute of limitations was three years. But there are many exceptions that give the IRS six years or longer. Several of those exceptions are more prevalent today, and one of them has gotten bigger.  The three years is doubled to six if you omitted more than 25% of your income. “Omitted” can mean to not report at all, or it can mean that the amount of income was under-reported by 25% or more.

If you have questions about your tax forms, or wonder where you can get assistance to determine the cost basis of securities bought or gifted long ago, give us a call.

Negative Interest Rates – Searching for Meaning

We have mentioned negative interest rates in the past.  Let’s take a look at what it means to you.

Central banks lower interest rates to encourage economic activity.  The theory is that low interest rates allow companies to borrow money at lower costs, encouraging them to expand, invest in and grow their business.  It also encourages consumers to borrow money for things like new homes, cars, furniture and all the other things for which people borrow money.

It’s the reason the Federal Reserve has lowered rates to practically zero and kept them there for years.  It’s also why the Fed has not raised rates; they’re afraid that doing so will reduce the current slow rate of growth even more.

But if low rates are good for the economy, would negative interest rates be even better?  Some governments seem to think so.

Negative interest rates in Japan mean that if you buy a Japanese government bond due in 10 years you will lose 0.275% per year.  If you buy a 10 year German government bond today  your interest rate is negative 0.16%.   Why would you lend your money to someone if they guaranteed you that you would get less than the full amount back?  Good question.  Perhaps the answer is that you have little choice or are even more afraid of the alternative.

Per the Wall Street Journal:

There is now $13 trillion of global negative-yielding debt, according to Bank of America Merrill Lynch. That compares with $11 trillion before the
Brexit vote, and barely none with a negative yield in mid-2014.
In Switzerland, government bonds through the longest maturity, a bond due in nearly half a century, are now yielding below zero. Nearly 80% of Japanese and German government bonds have negative yields, according to Citigroup.

This leaves investors are searching the world for securities that have a positive yield.  That includes stocks that pay dividends and bonds like U.S. Treasuries that still have a positive yield: currently 1.4% for ten years.  However, the search for yield also leads investors to more risky investments like emerging market debt and junk bonds.  The effect is that all of these alternatives are being bid up in price, which has the effect of reducing their yield.

The yield on Lithuania’s 10-year government debt has more than halved this year to around 0.5%, according to Tradeweb. The yield on Taiwan’s 10-year bonds has fallen to about 0.7% from about 1% this year, according to Thomson Reuters.
Elsewhere in the developed world, New Zealand’s 10-year-bond yields have fallen to about 2.3% from 3.6% as investors cast their nets across the globe.
Rashique Rahman, head of emerging markets at Invesco, said his firm has been getting consistent inflows from institutional clients in Western Europe and Asia interested in buying investment-grade emerging-market debt to “mimic the yield they used to get” from their home markets.
Clients don’t care if it is Mexico or Poland or South Korea, he said, “they just want a higher yield.” ….
Ricky Liu, a high-yield-bond portfolio manager at HSBC Global Asset Management, said his firm has clients from Asia who are willing for the first time to invest in portfolios that include the highest-rated junk bonds.

How and where this will end is anybody’s guess.  In our view, negative interest rates are an indication that central bankers are wandering into uncharted territory.  We’re not convinced that they really know how things will turn out.  We remain cautiously optimistic about the U.S. economy and are staying the course, but we are not chasing yield.

A Client Asks: What’s the Benefit of Inflation?

One of our retired clients sent us the following question recently:

“I can’t understand the FED condoning and promoting any inflation rate. To me inflation means that the value of money is simply depreciating at the inflation rate. Further, any investment paying less than the inflation rate is losing money. A quick review of CD rates and government bonds show it is a rare one that even approaches the promoted 2.25% rate. It seems to me to be a de-facto admission of wanting to screw conservative investors and forcing them into riskier investments… Where is there any benefit to the financial well-being of the ordinary citizens?”

I suspect that there are a lot of people who feel the same way. It’s a good question. Who wants ever rising prices?

Here’s how I addressed his question:

Let me answer your inflation question first. My personal opinion is that 0% inflation is ideal, and I suspect that you agree. However, lots of people see “modest” rates of inflation (say 2%) as healthy because it indicates a growing economy. Here’s a quote from an article you may want to read:

Rising prices reflect a growing economy. Prices typically rise for one of two reasons: either there’s a sudden shortage of supply, or demand goes up. Supply shocks—like a disruption in the flow of oil from Libya—are usually bad news, because prices rise with no corresponding increase in economic activity. That’s like a tax that takes money out of people’s pockets without providing any benefit in return. But when prices rise because demand increases, that means consumers are spending more money, economic activity is picking up, and hiring is likely to increase.

A case can be made that in a dynamic economy you can never get perfect stability (e.g. perfectly stable prices), so it’s better for there to be more demand than supply – driving prices up – rather than less demand than supply – causing prices to fall (deflation). Of course we have to realize that “prices” here includes the price of labor as well as goods and services. That’s why people can command raises in a growing economy – because employers have to bid up for a limited supply of labor. On the other hand, wages grow stagnant or even decline when there are more workers available than jobs available.

But for retirees on a fixed income, inflation is mostly a negative. Your pension is fixed. Social Security is indexed for inflation, but those “official” inflation numbers don’t take food and fuel costs into consideration, and those tend to go up faster than the “official” rate. The stock market also benefits from modest inflation.

Which gets us to the Federal Reserve, which has kept interest rates near zero for quite a while. It’s doing this to encourage business borrowing, which in turn is supposed to lead to economic expansion.  However, the actual effect has been muted because other government policies have been detrimental to private enterprise. In effect you have seen the results of two government policies in conflict. It’s really a testimony to the resilience of private industry that the economy is doing as well as it is.

The effect on conservative investors (the ones who prefer CDs or government bonds to stocks) has been negative. It’s absolutely true that after inflation and taxes the saver is losing purchasing power in today’s low interest rate environment. The FED is not doing this to intentionally hurt conservative investors, but that’s been part of the collateral damage. The artificially low rates will not last forever and the Fed has indicated they want to raise rates. They key question is when, and by how much?

Government shuts down: No sign of economic problems

The news has been co-opted by the partial government shut down with its attendant predictions of economic catastrophe if the government doesn’t re-open all its branches in a few hours.  Meanwhile in Realville, First Trust notes:

we’ve still seen the two ISM indices (on manufacturing and services), auto sales, chain-store sales, and two weeks of unemployment claims.  None of these reports suggests the economy has broken out either to the upside  or the downside from the pattern of Plow Horse growth of the past few years.  While real GDP itself probably slowed in Q3 to around 1.5{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} growth, the economy as a whole looks to be expanding at roughly a 2{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} annual rate over a two or three quarter average.
The bottom line on  the economy right now is that there is no sign the partial shutdown, or anything else for that matter, has knocked it off the same course it’s been on for the past few years.  Hopefully, when the government finally opens back up, it’ll do so with a better set of polices, which would help the plow horse pick up his pace.

It’s a different view than we get on the 24/7 cable shows, but it helps to look at reality when those around you are losing their heads.

How Does a Government Shutdown Affect Investments?

The stock markets do not like uncertainty and a government impasse leading to a partial shutdown leads to uncertainty.  People begin asking questions like: How long will it last?  Who will be affected?  What are the long-term consequences?  The day before the shutdown that began October 1, the Dow Jones Industrial Average fell by 129 points.  Traders said that the markets had been anticipating the political gridlock, which had contributed to the Dow’s recent slide.  The day the government actually shut down, the same index rose 63 points because positive economic news impressed investors more than the shutdown.

Despite the size of government and the number of people they employ, the economy as a whole has a much greater effect on the markets than a shutdown.

During a shutdown, money still flows into the Treasury Department via things like tax receipts and it still flows out via things like Social Security and interest payments on Treasury Bills.  The military, weather service, food inspections, border control, air traffic, prisons and even the U.S. Postal Service (“Neither snow, nor rain, nor sleet, nor hail, nor government shutdown shall keep the postmen from their appointed rounds”), they all keep operating.  And as long as the Treasury Department still has flexibility, it still pays the debt as it comes due without missing a beat.  The interest on the debt runs about $220 billion while tax revenues exceed $2.5 trillion, so there really is not a chance that the U.S. government will actually default.

The government purposely tries to make a shutdown much more painful than it really has to be by, for example, closing the National Mall, the World War II Memorial and other open air monuments and attractions in Washington, D.C., in an effort to get the public to put pressure on Congress to reach a settlement.

But if you need a passport or want to get into a national park (via a park entrance, anyway), you are out of luck.  Non-essential federal workers get furloughed and non-essential services stop.

You’ll surely hear certain analysts, pundits and politicians saying a shutdown will hurt the economy, but if history is any guide that is hard to prove.  Recently, The Washington Post listed every shutdown – there were 17 of them from 1976 to 1996, spanning a total of 110 days – and of those 110 days only 6 were during a recession.  That’s very few considering that the U.S. was in a recession about 14{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} of the time during those twenty years.

The last, and longest, shutdown doesn’t appear to have hurt the economy either.  That was mid-December 1995 until early January 1996, a three-week shutdown under President Clinton.  The year before the shutdown, real GDP grew 2.3{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  In the fourth quarter of 1995 it grew at an annual rate of 2.9{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93} and then during the first quarter of 1996 it grew at an annual rate of 2.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}.  This was despite the shutdown and the East Coast Blizzard in January 1996, which was then followed by large floods.

Remember the dreaded sequester?  It was forecast to be an economic and political disaster.  Today few people actually remember it because most never felt it.  Paradoxically, the real result of sequesters and shutdowns may be the realization by the public that the government is spending and wasting too much, and that political wrangling by the two parties in charge does not help the economy and may actually hurt it.  In the late 1990s, that reaction slowed government spending relative to GDP dramatically and the U.S. eventually moved into a surplus.

In other words, if you look back at history and didn’t know beforehand when the government was in a shutdown, you would be hard pressed to ever figure it out.  Keep this in mind as politicians, journalists and pundits work overtime in the coming days trying to scare investors and the public with the ramifications of keeping the government shut.  In more ways than one, it may be a good thing.

Government shuts down, markets rise.

The market does not like uncertainty and as the House and Senate ping-ponged bills at each other yesterday, the markets sold off.  But as the reality hit that there was not going to be a last-minute compromise and the sun rose in the East, people realized that a government shut-down in a free-market economy is not a financial Armageddon.   So at the opening bell, the US stock market rose, as did many markets around the globe.

From the Wall Street Journal:

Stocks rose, shrugging off the first U.S. government shutdown in 17 years, helped by a strong reading on manufacturing activity.
The Dow Jones Industrial Average advanced 63 points, or 0.4{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 15191 in recent trading. The S&P 500 tacked on 11 points, or 0.6{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 1692, and the Nasdaq Composite Index rose 29 points, or 0.4{030251e622a83165372097b752b1e1477acc3e16319689a4bdeb1497eb0fac93}, to 3800.
Global stocks showed resilience after lawmakers failed to reach agreement to keep the government fully funded to start the new fiscal year as Senate Democrats and House Republicans remained at loggerheads over government spending and the launch of the Affordable Care Act.
Traders said that the markets had been anticipating the political gridlock, which has contributed to the Dow falling seven over the past eight sessions, including Monday’s 129-point slide.
“Most people are pretty sure that this is going to be a short-lived event,” said Ian Winer, director of equity trading at Wedbush Securities. “Even though there were big moves leading up to this, most people are positioned for a near-term shutdown, and it looks like the selling has let up. There’s not a lot of new buying, but guys have sold what they wanted to sell.”

There is an old Wall Street adage: “Buy on the rumor, sell on the news.”  That simply means that an event that is widely anticipated is probably priced into the market by the time it actually comes to pass.  That seems to be what happened in case of this much-anticipated shut-down which, it seems, was actually wanted by both sides.

Stop worrying about the Federal Reserve

There are lots of people fixated on trying to figure out what the federal reserve is going to do with interest rates and when they are going to do it.  If you are a retail investor, you are not going to beat the professionals in that game, so stop trying.  Instead, let the pros handle it and relax by looking at the view from 30,000 feet.  Here’s what the bond experts at Oppenheimer are telling us in a messge titled Why Fed Watching Is Likely a Waste of Your Time

What to Remember for the Long Haul

For long-term investors, I believe there are essentially five important points to keep in mind.

1) Overall global economic growth is slow but most likely the worst is over. While there may be hiccups every so often, it is unlikely that we will revisit the financial abyss in the near-to-medium term.

2) Real interest rates are quite low. Over any reasonable investment horizon, they are going to go up. That is true irrespective of what the U.S. economy looks like this quarter or who the next Fed chair is.

3) Because interest rates are so low now, the likelihood that returns from any part of the bond market will get you to a comfortable retirement based on their real returns is virtually zero. You most likely have to have a significant portion of savings in assets that provide better real returns, albeit with greater risk.

4) That said, you can’t just put all your money in stocks. There will be future periods of equity underperformance. In order to make sure you don’t panic and go all cash at the worst point in the cycle, have some part of savings devoted to bond or bond-like instruments now. Even if they aren’t generating a lot of income, those investments may provide protection during equity downturns, which is as important.

5) Income, not price appreciation, is typically going to be a significant part of overall returns. Therefore, wherever you can, and whatever risks you are comfortable with, seek out income-generating investment options. As always, past performance does not guarantee future results.

Good advice.

Federal reserve surprise

The highly regarded Art Cashin commented on the announcement coming from the Federal Reserve that it would not begin “tapering” its bond buying this month.

The financial media has joined the trading community in speculating about possible damage to the Fed’s “credibility” from its no taper decision.  The question is based on the process.  In late spring, Mr. Bernanke floated the idea of gradually reducing the Fed’s QE purchases and, ultimately, ending the program – possibly as early as the middle of 2014.  In the following weeks and months, various FOMC members (voting and non-voting) opined on the matter.  The collective impression was that tapering would begin by yearend (and before Mr. Bernanke’s term ends in January).  The media odds-makers generally moved toward September as the likely start. Instead, the FOMC opted to stand pat in September.  Shocked markets around the world reacted violently.   If the Fed was moving toward a delay of tapering, why was there no intervening “guidance”?  Traders now speculate that the FOMC may have made up its mind at the meeting itself.  If so, was there some last minute economic data or development that moved the FOMC away from a decision that was broadly expected by markets around the globe (as demonstrated by the sharp and sudden reactions that followed)?   That could make the Minutes of the meeting very enlightening – unless they are heavily laundered.  We await with great anticipation.

And here’s a brain teaser:
An ancient Roman Puzzle – “Start with five hundred, end with five hundred just five in the middle will be.  Between them shall be a first of numbers and of letters to give ye the name of a great king.”  Who is it?

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