Lesson Learned in 2008

2008 has been an incredible year for a number of reasons. The main lesson learned during this year has been the importance of financial stewardship. Stewardship of whatever resources that we have been blessed with.

What does stewardship mean? This year when things became rather uncertain in a very quick period, people who were leveraged with significant debt became stressed. Here are some examples of financial stewardship.

1. Spending less than your income on a monthly basis.
2. Only having debt on an asset like a home not on a car. Understanding an asset is something that grows in value.
3. Not having a loan on a liability. Something that shrinks in value is really a liability. If you pay interest on a loan for something that is shrinking in value it is throwing good money after bad.
4. Paying off the credit card balance every month.
5. Living on 80%.
6. Tithing 10%.
7. Saving 10% for the future.
8. Having an emergency fund, cash equal 3 months income.

Have a Merry Christmas!!!

A Stock Valuation Model

Different valuation models exist for a stock. One model is the Constant Growth Dividend Discount Model. This model works for a stock that is constantly growing its dividend. Not sure this applies to very many stocks. Here is the model and let's see what we can learn.

Valuation = Dividend Payout/(Risk Adjusted Interest Rate - Dividend Growth Rate)

We can make the model more applicable for most stocks by substituting Earnings for Dividend Payout and Earnings for Dividend.

What can we learn from this model?

• Valuations increase as the numerator, top, of the equation increases.
• Valuations increase as the denominator, bottom, of the equation decreases. The key is the difference in values between the interest rate and the growth rate.

How do valuations increase?

• As earnings grow because it decreases the denominator at a given interest rate.
• As the interest rate decreases because it decreases the denominator at a given earnings growth rate.

How do valuations decrease?

• As earnings decline because it increases the denominator at a given interest rate.
• As interest rates increase because it increases the denominator at a given earnings growth rate.

Let's look at the stock market at a peak. Typically, the Fed has raised interest rates to slow the economy. As the economy slows the growth rate declines. The higher interest rate and lower growth rate mean that the stock valuation declines perhaps at a rapid rate.

Let's look at the stock market at a peak. Typically, the Fed has reduced interest rates to grow the economy. As the economy grows the growth rate increases. The lower interest rate and higher growth rate mean that the stock valuation grows perhaps at a rapid rate.

Right now the interest rate is very low, below normal, and the growth rate is negative. Valuations change when the growth rate stabilizes and even grows. A math exercise: If the interest rate is 1% and the growth rate is -4% the denominator is 5%. If the growth rate goes to 0% and the interest rate is a value of 1% this means that valuation would 5 times higher.

The bottom line is at a market top or bottom, stock valuations can drop or raise at a faster rate than normal. This means that when the stock market recovers, which it will do eventually, valuations will increase at a rate much faster than normal.

US Stock Market and Inverted Yield Curve

A previous blog stated that an inverted bond yield curve was a good indicator of a recession and when it occurs it means that it is time to switch from stocks to bonds. The below article from Wikipedia explains it.

Inverted Yield Curve

An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a predictor of economic recession.
Partial inversion occurs when only some of the short-term Treasuries (five or 10 years) have higher yields than the 30-year Treasuries do. An inverted yield curve is sometimes referred to as a "negative yield curve".

Historically, inversions of the yield curve have preceded many of the U.S. recessions. Due to this historical correlation, the yield curve is often seen as an accurate forecast of the turning points of the business cycle. A recent example is when the U.S. Treasury yield curve inverted in 2000 just before the U.S. equity markets collapsed. An inverse yield curve predicts lower interest rates in the future as longer-term bonds are being demanded, sending the yields down.
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To explain further, normally a longer maturity bond has a higher rate due to inflation and to compensate for risk in holding it for a longer period. When the curve changes shape from normal to inverted this is a very bad sign for the stock market and it is time to move to bonds.

2000 US Stock Market Crash

The previous blog showed that for the most recent stock market crash the Fed funds rate was a good indicator. Let's look at the previous crash in 2000. The below table has the date the Fed took action and the resulting rate.

Date/ Fed Funds Rate
February 2, 2000 / 5.75
March 21, 2000 / 6.00
May 16, 2000 / 6.50
January 3, 2001 / 6.00
January 31, 2001 / 5.50
March 20, 2001 / 5.00
April 18, 2001 / 4.50
May 15, 2001 / 4.00
June 27, 2001 / 3.75
August 21, 2001 / 3.50
September 17, 2001 / 3.00
October 2, 2001 / 2.50
November 6, 2001 / 2.00
December 11, 2001 / 1.75
November 6, 2002 / 1.25
June 25, 2003 / 1.00

Note the rate was well above the 3% target rate and the change on May 2000 as an indicator. Also it took 3 years to get to the lowest rate of 1.00% about 3 times longer than the current crisis which indicates that this crisis is unprecedented in speed.

US Stock Market & Fed Funds Rate

The previous blog stated that the Fed funds rate was a good indicator for the US stock market. The below table shows the date that Fed changed the rate and the new rate. Note that the rate was well above the 3% target.

If you remember that the stock market reached a high on October 10, 2007. If money had been moved from stocks to bonds the stock market crash would have been avoided.

Date / Fed Funds Rate

September 18, 2007 / 4.75%
October 31, 2007 / 4.50%
December 11, 2007 / 4.25%
January 22, 2008 / 3.50%
January 30, 2008 / 3.00%
March 18, 2008 / 2.25%
April 30, 2008 / 2.00%
October 8, 2008 / 1.50%

Bottom Line: The stock market and Fed funds rate do not move perfectly together. Acting on the change of the Fed funds rate is very important as it is a very powerful signal.

US Stock Market & Fed Funds Rate

The Federal Reserve controls an interest rate called the Fed Funds Rate. What does it mean for the US Stock Market when the rate goes up or down?

An objective of the Fed is to control the growth rate of the economy, aka the rate of inflation. Typically this inflation rate is about 3% per year. Having inflation significantly above or below this rate is bad for the long term health of the economy. Deflation, something that we are seeing now, is viewed as especially bad for the US stock market.

When the Fed increases this rate it means that economy is growing faster than the 3% target. Conversely, when the Fed decreases this rate it means that the economy is not growing as fast as the 3% target.

The US stock market grows as the economy grows. A direct link exists between the performance of the economy and the stock market. From a macroeconomic perspective, a growing economy would result in growth for the publicly traded companies. This means that as the Fed funds rate is increasing the stock market should do well. Conversely, as the Fed funds rate is decreasing the stock market should do poorly.

The Fed funds rate is essentially an indicator of the direction of the stock market. It is important to watch the Fed funds rate, especially when it gets above the target 3% rate.

In 2000 and 2007 when the Fed funds rate were well above 3% the stock market was doing well. When the Fed lowered the rate, indicating a slowdown in the economy, it would have been wise to have moved most of the money from the stock market and put it in bonds. Also, an inverted bond yield curve condition existed in both time periods.

Did I move my money stocks to bonds in 2000 and 2007? No, I did not and it cost me lots of money. Will I make this same mistake again? Never again, I will not make this mistake a 3rd time.

Why didn't I make the move? Partially, it was due to listening to the experts who have jobs to write articles to make money for publications. Partially, it was due to a bad model that I was taught that showed the stock value increase as the interest rates decrease.

The higher the deviation from the Fed funds rate the larger the move with the rate changes. When the Fed begins to raise this rate, which will occur in the future, this is a very positive indicator for the stock market.

The bottom line: Do not listen the experts and watch for changes in the Fed funds rate. As it is going up be heavier in stocks for your long term investments and as it is going down be heavier in bonds for your long term investments.

Stock Market Capitulation

The stock market seems to have periods when it acts somewhat logically and periods when it acts on pure emotion. When logic goes out the window and emotion is the driving force then the market it at a top or at a bottom. When it market reaches the bottom it is called capitulation or the point when investors give into emotion and essentially throw in the towel.

How can you tell when capitulation occurs? Here are 5 signs:

1. Wild swing during the day. The events of October 10th represent this nicely. The Dow opened down big and kept going down which means that people were selling just to get out and in the afternoon a large rally happened where institutional buyers saw it as a golden buying opportunity. A previous blog indicated that this looked like a market bottom and it was time to buy. October 10th gave us the largest 1 day price swing in the history of the Dow. It was massive selling by people who had finally had enough and emotionally had to get out.
2. Another sign is when the common belief is that it is going to keep going down and any sense of reason is discarded. For example, on Monday November 24th, when the Dow was about 8,000 CNBC reported that about 70% of people who responded to a survey question thought that the Dow was headed to 6,000. Now many experts have said that now was a great time to buy. However, the people who are investing based on emotion have an underlying belief that it will keep going down regardless of the number.
3. When you read it in the newspaper that long time investors have quit. For example, the Monday November 24th Wall Street Journal had an article: "Fear and Frustration: Some Investors Quit." The article gave examples of people who had been long time investors in the stock market and finally could not take it anymore and walked away.
4. When bad news occurs and the market keeps going up. The news in the Tuesday November 25th Charlotte Observer was that home sales had fallen more than expected in October. On Monday November 24th it was reported that existing home sales dropped on average 3.1% nationwide during the month of October. In the past, news like this would have send the Dow tumbling down. In spite of this news the Dow rose.
5. When you are tired of hearing about it, can not turn on the news, and physically feel sick to your stomach. This is a good indicator that you are at the point of capitulation and the question is will you capitulate or not.

What does this mean? If you have not already changed your investments to prepare for a recovery in the stock market now would be a good time to do it. A recovery always follows capitulation.

Basics of Investing in Bonds

A balanced retirement portfolio usually contains some exposure to bonds in the form of a bond mutual fund. I found this article on bond mutual funds written by David Pitt, it gives good basic information for consideration.
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The type of bond fund you choose depends in large part on your financial goal. You need to first ask yourself whether you're seeking safety with little growth or more robust growth at higher risk. While they are safer investments, it's a mistake to think that bond funds are entirely without risk. Government bond funds, for example, have performed very well compared to other stocks and bonds this year and are considered relatively safe investments.

A Morningstar analysis shows that year to date, short-term government bond funds have earned an average of 2.6 percent and long-term government bond funds, averaged a 1.9 percent gain. In the same time frame the various categories of domestic stock funds have lost on average between 27 percent and 55 percent year-to-date. What's more, investors who earlier this year moved from equity funds into bond funds -- which have significant holdings in corporate bonds -- were able to stem some of their losses. Short-term bond funds are down 4.1 percent and long-term bond funds are down 11.5 percent so far this year.

So, you need to decide how much risk you're willing to take to determine which type of bond fund you want to choose as part of your portfolio. Fidelity Investments offers tips on how to choose bond funds.

If you're planning on investing for a year or less, a short-term bond fund may give you a better return than a money-market fund but you must be willing to see your investment fluctuate daily with market conditions. If you have more time to invest and a desire to earn more, you may want to look at intermediate- or long-term bond funds. These funds invest more heavily in higher yielding, lower-quality corporate bonds, which are higher risk. All of these choices require you to know your risk level, which may have changed with double-digit losses in your retirement account. If you can't stand losing some of the money you put into your account, many financial advisers would say a money-market fund might be your best option.

If you can tolerate losing some of your initial money and are willing to trade a little risk for higher reward, then an investment grade bond fund might work for you. The key to investing for retirement even now is not to panic and have a plan, said Jack Thurman, president of BKD Wealth Advisors, a Springfield, Mo.-based wealth management company. Unless you're within a few years of retirement, he said you should have one year's worth of expenses in savings outside your retirement account and the rest should be invested to earn as much as possible.

Millions of workers, scared by the falling stock market have taken their money out of stocks and stock mutual funds. TrimTabs Investment Research, which tracks the flow of money in and out of various funds, said through early November stock mutual funds have seen an outflow of $145 billion and international funds have shed $73.5 billion while bond mutual funds have seen an inflow of $83.2 billion over the same period.

Though the talk is of a deep recession, market watchers are increasingly discussing whether now is a good time to buy stocks because prices are so depressed. Of course the potential length of the recession is unclear, but if you're in this age group, you don't want to be on the sidelines with cash when the market surges upward. Once stocks begin to regain their strength, recovery can happen fairly quickly and if you're retirement plan is properly allocated -- many advisers recommend 60 percent in diverse stock funds and 40 percent in bonds -- you should take advantage of the upside. If you're just a few years from retirement you should have a conservative asset allocation. That means heavier investment in bonds and fewer stocks. If possible, resist the temptation to take more money out of the stock market because you'll probably need to take advantage of the market improvements to recover some of your losses.
Keep in mind that bond prices typically react opposite interest rates. When interest rates go up, bond prices likely fall and falling interest rates send bond prices higher. The current environment has also shown that bond issuers can default and fail to make payments.

One of the drawbacks to bond funds is that they may fail to keep up with inflation and therefore are often used in combination with higher yielding funds to offer portfolio balance. Fidelity advisers say it's a good idea to look at the quality of the bonds in the fund, whether they are investment grade or junk status. Those rated below investment grade (S&P rating of BB or lower) could change more suddenly if the credit quality of the issuer changes.
One more thing to look at is the expense ratio.

Morningstar says its more important to look at the cost of a bond fund, because bonds earn less over time than stock funds they're costs are a heavier burden. Morningstar believes very good bond funds are available with expense ratios of 0.75 percent or less.

Modern Portfolio Theory and the Last 13 Months of Investing

I wrote about the Modern Portfolio Theory in a previous blog. The theory can be summarized by a series of risky investments when combined together yield a greater return with a much smaller amount of risk such that you can approach the return of a risk free investment like a short term treasury bond.

Money moves between investment classes such that wealth is re-allocated rather than be destroyed. Money moves between asset classes such as commodities, US stocks, International stocks, long term bonds, short term bonds, etc...

What I learned during the last 13 months from October 2007 - 2008, when the Dow declined by 44%, was that this theory worked well until June 2008. For the first 9 months things acted normally and diversification worked well. From July through October the theory failed miserably.

In hind sight my blind faith in this theory cost me a lot of money. What I failed to realize is that when things go into a panic and fear abounds the only save place to be is in cash or a cash instrument like a money market account.

From July through October virtually all asset classes crashed. Wealth did not transfer it was destroyed in every class. Long term bonds dropped 25%. Short term bonds dropped 10%. All commodities dropped even gold. All stocks indexes around the world dropped.

Diversification works for 95+% of the time. I believe that diversification is the prudent course of action now. For the other % of time when panic hits it is time to put the theory aside and get in a position to buy at the peak of the panic when few others want to buy.

Be fearful when others are greedy and be greedy when others are fearful.

Learning From Past Recessions

Our economy is stated to be in a recession. We will only know this in the future. The question is what can be learned from studying the past recessions? The Dow Jones Industrial Average was studied from 1940 to today.

Three colums are shown below: The time period, number of months from peak to trough, and % decline

Time Period/# of Months/Dow Decline (%)
1948-1949/13 months/16 % decline
1953-1954/9 months/13 % decline
1957-1958/19 months/19 % decline
1960-1961/10 months/17 % decline
1969-1970/18 months/36 % decline
1973-1976/24 months/45 % decline
1978-1980/20 months/16 % decline
1981-1982/17 months/24 % decline
1990-1991/4 months/21 % decline
2000-2001/21 months/30 % decline

The Average values are: 15 months and 26% decline
The Statistical Maximum (95% Confidence): 27 months and 50 % decline

What has happened so far during 2007-2008: Peak to trough has been 13 months and the decline has been 44 %, close to the previous record. The trough occurred on Friday October 10, 2008 at a 44% decline from the previous peak during October 2007. The October 10th trough value has been challenged twice but not broken.

The trough in price was always in the middle of the recession not at the beginning or the end. It appears as if the increase in the stock price predicted the future end of the recession.

We have a decline that is as large as what occurred during the 1973 - 1976 time period in about half the time. In fact it occured in less time than the average. What this suggests is that the magnitude of the decline in stock price was magnified by outside forces not seen before. This new outside force is the creation and proliferation of hedge funds. As hedge funds sold to cover positions the downfall was amplified.

What does this mean:

1. Now is a good time to buy stocks if you have a longer term time horizon.
2. The downturn was magnified by outside forces, such as hedge funds.
3. As hedge funds change into a buy mode the increase should also be faster than normal.
4. A trough in stocks and subsequent rebound predicts the end of a recession.

Bottom Line: Stocks are on sale and now is a good time to buy stocks if you have a longer term time horizon. While it is impossible to predict an absolute bottom, it does not appear likely that the bottom will be much lower than what we have already seen on October 10th.

Investing, Time To Buy Stocks

The recommendation in the last blog was that stocks are on sale now and get ready to buy. After 1 week of investing it looks like now is the time to buy stocks for mone with a time horizon of at least 6 months. Sell money market funds, short term bond funds, CD's, etc... to get money to invest.

The first reason is the Warren Buffet factor who currently has the most influence in the stock market, even more than the Fed Chairman, Treasury Secretary, President, etc... Below is an article that was published yesterday. Enjoy reading it.

Warren Buffett: Buy Stocks! Cash Is Trash! Posted Oct 17, 2008 10:42am EDT by Aaron Task

"I don't like to opine on the stock market, and again I emphasize that I have no idea what the market will do in the short term. Nevertheless, I'll follow the lead of a restaurant that opened in an empty bank building and then advertised: 'Put your mouth where your money was.' Today my money and my mouth both say equities." Or so declared Warren Buffett Friday in an extraordinary op-ed piece in The New York Times. Buffett's call to stocks amid an ongoing financial crisis could help restore investor confidence, a crucial ingredient so far missing from the government's turnaround effort.

Buffett's optimism is based primarily on the following:

"Be fearful when others are greedy, and be greedy when others are fearful. And most certainly, fear is now widespread, gripping even seasoned investors." Cash is trash. "Today people who hold cash equivalents feel comfortable," he writes. "They shouldn't. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value."A few caveats to Buffett's dramatic call:

By his own admission, Buffett is making a long-term call. "I can't predict the short-term movements of the stock market," he writes. "I haven't the faintest idea as to whether stocks will be higher or lower a month -- or a year -- from now. In the short- to intermediate-term, there's still the issue of reviving the banking sector, and key bank CEOs like JPMorgan's Jamie Dimon have expressed little optimism for the Treasury's program of capital injection. Nobody, not even Warren Buffett, is always right.

The second reason is the low interest rate environment. No long term investor will keep money at an interest rate below the inflation rate very long because they will lose money. When some sort of sanity comes back to the stock market this money will move back to the stock market fueling a rally.

Thirdly, sanity is coming back into the financial sector. Banks are starting to lend again as indicated by the over night, Libor rate, that is the lending rate between banks, has come back to a normal level. Also the Fed has added $600 Billion into the banking system and lowered the Fed funds rate. If the reason for the crash was tight credit then as credit loosens and money begins to flow this should have a positive impact on the stock market.

Lastly, the lower cost of gas and oil will stimulate the economy and increase stock prices. Friday's gas futures price for November delivery was $1.66 per gallon and if you add $0.60 per gallon for taxes and delivery it says that gas will continue to come down to below $2.50 per gallon in most parts of the country by Thanksgiving. This is the financial equivalent of having another $700 Billion infusion into the economy.

Bottom Line: The business cycle of what happens in an economy is acting normally. What has not been normal has been the credit crisis that crushed stock prices. As the credit crisis ends stock prices should recover with time. The rate of recovery is fueled by lowered interest rates and lower energy cost. This means that stocks are on sale now and with money that is not needed for at least 6 months it is time to shop.

Investing, Time to Get Ready to Buy Stocks

The guidance from the last blog last week was to hold your investment positions for a number of reasons. The guidance now is to get ready to buy stocks and let the market tell you when to buy as stocks are ON SALE NOW.

This past week, we had the worst performance on record even worse than during the depression. Let's recap:

• Virtually all investments crashed: stocks, bonds, and commodites except for gold.
• Stocks dropped the largest point total and percentage amount ever.
• Investors pulled money out of the market and put it into cash in large chunks.
• On Friday, we had a 1000+ point swing and got within about 5% of the low during the last correction.
• On Friday, we had about 10 times the normal volume on the NYSE, 11.5 billion shares.
• As you check any US or international mutual fund it seems that it has lost about half of the value.
• If you want to see what a financial shock looks like as yourself did you really want to look at your account balance or your mutual fund performance???

If we got within 5% of the previous correction this means that we probably know where the bottom will occur, Notice investors bought stocks to achieve a 1,000 point swing. THIS MEANS THAT THE STOCK MARKET IS NOW ON SALE, TIME TO BUY!!!!!

When do you know when it is a bottom? When bad news comes in and the stock market goes up anyway.

When you see this happen you can buy literally any US or international mutual fund as virtually all of them were punished. You want to avoid gold as it will fall and act like the other commodities as the crisis ends. You want to avoid bonds as interest rates will rise and price will fall as the crisis ends.

US Stocks Market Index, Buy Sell or Hold

The highly touted bailout bill passed last week and the stocks reacted by falling. The most recent 3rd quarter was brutal for even the most seasoned investor. During the last year, from October 1, 2007 to October 1, 2008, the US stock indexes are down about 30%. WOW, the average investor lost about 1/3rd of their money during the last year.

The news on TV and in the newspaper is fear and panic. Non-financial experts are talking about how bad things are things can get worse. When these experts talk about how bad things are and a feeling of panic is in the news it typically means that we are about at a market bottom.

At a market peak the news will be how wonderful things are and people will have a normal reaction of buying. At a market bottom the news will be how bad things are and people will have a normal reaction of selling. If the object is to buy low and sell high, then this strategy is exactly wrong.

What is best choice now between buy, sell, or hold US stocks? The answer is hold and if you have some cash that is not needed within the next year do some buying. Do not sell just for the sake of selling. While it impossible to know the absolute bottom, going down much further would be rather unprecedented.

What is the reasoning behind holding:

1. A 30% drop historically represents the low end of the distribution for the US Stock market.
2. The average length of a bear market is about 14 months and we are at 12 months.
3. The current financial data does not support the US Stock market going down further. A warning is that when the market runs on emotion it is very difficult to know the bottom.

It makes sense to sell to obtain a tax break in certain accounts. This is best done by buying a similar asset and holding it for 31 days or more before repurchasing the asset. It may also make sense if you need cash in the near future.

When fear and panic exist keep your wits about you. You want a diversified portfolio of excellent mutual funds that can weather a financial storm.

If you need assistance with building such a portfolio, contact an investment professional.

Importance of Stewardship

The past few weeks has been brutal for an investor. Last Monday's 777 point loss and the tumultous rest of the week was enough to make even the most veteran investor a little nervous.

What these events do show is the importance of applying christian stewardship principles in finances. What is meant by christian stewardship? This means taking the principles in the Bible and applying them to everyday life. If you follow these principles you never need to worry about a credit crisis. Here are 2 of my favorites.

Credit Card: Never have a balance that you carry forward into the next month!!!!! Paying 20% interest is always a bad strategy. If you can not pay it off each month, cut it up. Do not let a credit card company control your actions.

Personal Auto Loan: A depreciating object such as a car is a liability not an asset. The loan balance will be worth more than car which means that if you turn in the car during the loan period you will also be paying to get out of the loan. You pay interest and fees to get the loan and then pay more money to get out of the loan. The better solution is to save for the vehicle to avoid getting a loan and buy a car that is 2 years old or older to avoid the steepest part of the depreciation curve.

If you live with minimal need for credit you will sleep better at night. In the past, I was guilty of these 2 mistakes. A little upfront effort can avoid sleepless nights.

Interest Rates & Gas Prices

The big news today was the government bailing out AIG and the news on the financial sector, aka Wall Street firms.

The most important business news was a $0.11/gallon drop in gas price futures and low interest rates. So in 2 days the price of gas futures has dropped $0.33/gallon, even after Hurricane Ike and the closing of refineries.

Why is this important? It means that the normal business cycle works and both events are very positive for the equity, aka stock, markets in the US and Internationally.

As interest rates drop, fixed income investments such as bonds are less attractive meaning that money will tend to migrate to the equity markets. Lower interest rates are typically positive for the long term prospects of the equity markets. No investor wants to get a return on an investment that is lower than the inflation rate because you automatically lose money.

As gas prices drop, consumers will have more money to spend putting money into the economy. This is positive for equities that correlate with the economy. The effect of lower energy prices will have a much bigger impact on the economy than the recent stimulus checks.

If you listen to the news and the financial information on the financial sector bailout, you just might be scared and tempted to sell all equities and put money into a money market account. This is probably not the best move.

The financial sector is unwinding and getting back to reality. Interest rates and energy prices are getting back to normal. These 3 points are favorable from a long term perspective for the equity market.

Shut off the news and relax.

Lessons from Economic Declines

Barron's had a wonderful article in the September 15, 2008 publication titled "Lessons From Yesterday's Slumps." This article gives data on the effect of 6 investment alternatives during the previous 6 recessions.

The 6 recession dates are: 12/31/69 - 11/30/70, 11/30/73 - 3/31/75, 1/31/80 - 7/31/80, 7/31/81 - 11/30/82, 7/31/90 - 3/31/91, and 3/31/01 - 11/30/01.

The 6 investment alternatives are: commodities, real estate, S&P Total Return, Gold, Long Bond US Treasuries, & Oil. In a recession, the economy slows down and interest rates should decline. Let's look at the return for each investment during each period.

Commodities: - 6.2%, 23.9%, -16%, -9.9%, -10.8%, & -2.9%. Note that in general commodities decline, in 5 of 6 periods, except for the period of stagflation in the mid 70's.

Real Estate: -5.6%, 26.4%, 4.1%, -5.7%, -1.7%, & -1.8%. It is a mixed bag with more negative than positive.

S&P Total Return: -3.5%, -18%, 8.8%, 8%, 6.7%, & 1.3%. It is a mixed bag with more positive than negative.

Gold: 6.8%, 109.9%, 1.4%, 8%, -2.3%, & 3.8%. A mixed bag with generally a small positive result except for the period of stagflation during the mid 70's.

Long Term US Treasuries: 32.8%, -7.6%, 5.3%, 10%, 6.8%, & 1.7%. A mixed bag with more positives than negatives.

Oil: 0%, 95.9%, 11.8%, -6.9%, -4.8%, & 26.2%. A mixed bag with an outlier in the mid 70's.

What does all of this mean? If you hear that a recession is coming none of these 6 individually can guarantee a positive return. Diversify, Diversify, & Diversify

Minor Story (Financials) Major Story (Oil & Gas Price)

The top story in the news was the historic change in the financial sector. What a historic week in the financial sector: Fannie Mae, Freddie Mac, Merrill Lynch, Lehman, and protection for AIG. This is by far the biggest story for Wall Street, not for main street.

Stock prices in the financial sector dropped to reflect underlying value. When a bubble pops it can be very painful for investors who are not diversified. People with a diversified portfolio felt a little pain.

What happened to the financial sector looks a lot like the tech bust earlier in the decade. We will get through this market gyration.

To me the biggest news today was not reported, the price of oil and gas futures. Oil hit $95 per barrel and gas hit $2.55 per gallon. This is incredible given that hurricane Ike hit oil platforms and gas refineries were shutdown. This indicates that oil and gas prices will continue to go down.

Why is this more important? Because this will impact the consumer's pocketbook and improve the economy. The news in the financial sector is due to an event in the past that can not be undone. Lower energy costs helps the economy in the future and will lead to higher stock prices.

Ways to Botch Your Retirement

You want to retire healthy & wealthy. The question is will you be wise or will you botch it.

How do you botch it:

1. Not Having a Plan - Buy, Steal, or Create a Plan
2. Not Saving enough - You need to be putting 10% aside for your futue. Spend 80% of your income, you get 10%, and tithe 10%.
3. Buying into Marketing Campaigns - Spending money on things rather than living within the 80% and saving 10%.
4. Ignore all of your options - Need to pursue all of your options including IRA's, 401(k), etc.
5. Making bad tax choices - Need to understand tax implications of financial transactions
6. Chasing investments - Need to follow Ecclesiastes 11:2 and have a balanced plan that you follow. Chasing last year's winner is like driving a car by looking in the rear view mirror.
7. Having an over aggressive expectation - Do not have a plan where you need to have a 25% annual return, like your neighbor tells you that they got. Use historical averages to come up with a more realistic value.
8. Head in the Sand - Not keeping up with the higher rate of inflation for medical expenses, cost of long term care, and contingencies.

Get a realistic plan. Paying a professional for a plan is by far better than not having a plan or not following a plan.

Social Security Strategy - 2 Income Couples

The last blog presented the best strategy to maximize Social Security benefits for a couple where 1 spouse was the primary earner. This blog presents the strategy to maximize Social Security benefits for a couple where both people work.

In this situation, both people have Social Security benefits based upon their individual earning record. Making the assumption that both people are roughly the same age, the question who should collect benefits first?

The answer is the one with the lower amount of benefits. The reason is based upon the total benefits received for the couple during the life span of both people.

1. The individual with the larger amount of benefits will continue to grow at a faster rate if she/he continues to work.
2. If the person with the higher benefits dies first, the widow's benefit amount will increase to the rate of the deceased.
3. If the person with the lower benefits dies first, the widow's benefit amount remains the same.

By having the person with the highest benefit work longer it gives the couple a higher amount of benefit while living and can give the widow a higher benefit in the future.

Each situation can be unique so it would be advisable to sit down with a professional and run the numbers to determine the best strategy based upon a number of factors.

Social Security Strategy - Couple with a Primary Earner

Congratulations you and your spouse are getting ready to start receiving Social Security benefits. The question is what is the best approach to optimize the benefit.

Let me illustrate with my personal situation. My wife sacrificed her career to raise children so her Social Security benefit will most likely be based upon half of my benefit. When I die she will receive more money, my benefit instead of 1/2 of my benefit.

A strategy to get the maximum amount of money is for me to file and suspend Social Security benefits then continue to work. My wife will then collect her portion bringing in more money into the family. I continue to work which increases the amount that I will receive in the future. This is possible because of the Senior Citizens' Freedom to Work Act of 2000.

Why does this make sense?

1. My wife starts collecting benefits to bring in more money.
2. As my benefit increases, my wife's benefit also increases while I am working.
3. The total amount of money received each month is higher when I retire.
4. After I die she will receive a higher monthly payment.

The catch is that I need to keep working until age 70 to get the most money. I better work at something that I love to do. It is lucky that I have been blessed and I am doing what I love to do.

Social Security Strategy - Payback Method

This Social Security Strategy involves paying back benefits to get a higher future monthly benefit. This strategy is not widely publicized and can make sense in specific cases.

Here is how it works. You have been collecting Social Security benefits for years and have reached age 70 in a situation where you have a large nest egg and desire more cash per month. Also the age of the spouse is importand and it may make sense if a spouse is considerably younger than you that has benefits calculated upon your contributions.

Scenario:

You retired at age 62 with a benefit check of $1,200/month. The amount would have been $1,600/month if you had retired at age 66. At age 70 the amount would have been $2,100/month.

At age 70 you decide that you want the higher monthly benefit and file Form 521. You can get it by paying back all of your benefit checks, about $115,000. Once all of the paperwork is done in a few months you can then get the increased monthly payment.

When does this strategy make sense:

1. You are going to live at least to age 85.
2. Your spouse's benefit is based upon your contributions and is much younger. In this case the spouse gets your benefit for the remainder of his/her life and lives a long life span.

In most cases this strategy does not make sense since nobody knows how long they will live. If you have this much money invested you likely will make more money by keeping it invested and drawing from the investment rather than giving it back to the government.

You owe it to yourself to consider this option in your retirement planning. Have a professional walk you through the scenarios to determine if this strategy works for you.

Newspaper Announcement

The business was announced in the Business Section of the Sunday, August 24, 2008 Hickory Daily Record Newspaper. Here is the announcement.

Investment advisory firm new to area

Hickory
Christian Stewardship Retirement, LLC, a North Carolina registered investment advisory company has begun operations here.
The company provides investment advisory and personal finance services including retirement planning for individuals and small business.
Larry Bleich, owner, is a registered investment advisor and a member of the International Association of Registered Financial Consultants. Pat Bleich is the office manager. Pastor James D. Ritch of Lenoir represents the company in the Lenoir area.
The company can be reached at (828)-896-5037.
ON THE WEB:
www.rareinvest.blogspot.com

Near Term Direction Commodity Prices

Last week commodity prices fell. Oil futures reached a 3 month low. Gasoline future went below $3/gallon. Gold sold for less than $800/ounce. In fact, almost all commodities are trending lower.

The question is for the near term, such as through the next few months, what is the direction of these prices. Three choices exist: higher, lower, or the same.

My belief is lower because of:

1. Increasing value of dollar which will make reduce import costs. The dollar is increasing because other global economies are slowing.
2. The growth in the countries trading in the euro went negative in the last quarter which means that these economies contracted slightly.
3. The Chinese government is slowing the economy.
4. The Chinese currency, Yuan RMB, has been steadily declining which makes Chinese made products more expensive.
5. Oil goes down because of: lower demand as economies slow, lower demand as US consumers reduce demand, and the actual cost to produce a barrel of oil has been reported to be about $50/barrel. Seeing oil below $100 seems very reachable.
6. Reducing oil cost has a synergistic effect on other commodity cost.

If money is leaving currency trading, where will it go? Time will tell us the answer. The nice thing is that the current inflation rate reported in July will be reducing as commodity price retreat.

Personally, I will be happier when gas goes back below $3/gallon. Won't that be a nice Christmas gift.

Balanced Mutual Funds

Investors have many options when it comes to investing in mutual funds to build a portfolio and can choose from a seemingly almost infinite number of funds. Once an investor determines their investment risk level, typically a model portfolio of securities are recommended including stocks, bonds, real estate, cash, etc. Typically, the model gives a percentage of each category.

With this knowledge an investor has 2 options:

1. Invest in a mutual fund that has this same blend of securities that meets this risk level.
2. Invest in a series of mutual funds and having at least one mutual fund in each category.

The advantage of a single mutual fund is that diversification can be achieved for a relatively small amount of money, such as $2,500. The disadvantage of this approach is you are at the mercy of the performance of the mutual fund manager at selecting the portfolio. If the fund manager selects poorly you have a poor result.

The advantage of a series of mutual funds is that you can select mutual funds for each category and greatly improve diversification. The outcome is no longer up to the performance of a single mutual fund manager. Diversification exists with having multiple fund managers.

Which option is best? If the amount to be invested is less than $5,000 a single mutual fund probably makes the most sense. If the amount is above $10,000 having multiple mutual funds probably makes the most sense.

Keys to selecting multiple mutual funds include:

• Understanding the securities in each fund
• Interactions with the other funds
• Having highly rated mutual funds

Bottom Line: Having diversification is good for an investor and a balanced mutual fund has its place. Better options probably exist when a larger sum of money is available.

Retirement Investing Lessons

The Monday August 4, 2008 Wall Street Journal had an article on the importance of proper investing for retirement. The title of the article was “When 401(k) Investing Goes Bad.” This article talks about West Virginia school employees who 17 years ago shifted from a pension plan with a defined benefit to a 401(k) defined contribution plan.

A defined benefit plan has the employer contributing and having a professional managing the money for retirement with the employer at risk to meet the retirement need. A defined contribution plan typically has the employer matching contributions of the employee and the employee assumes the risk to meet retirement needs.

This is a story that applies to many people. The article states that only 21% of full-time employees have a defined benefit pension plan in 2007 down from 54% in 2004. In 2007, 54 of the largest 100 US employers offered a defined benefit plan down from 58 in 2006.

For the people in the article, things have not gone well for all of the members. One person called it horrible. Most of the members felt poorly informed and they invested too conservatively. Many got guidance from people they knew and trusted who represented a life insurance company over lunch and during school hours. Those giving guidance were just representatives selling a financial product acting in an investment advisory role rather than being a Registered Investment Advisor.

The guidance given was to purchase a fixed rate annuity because it was safe. What happened over time was these annuities could not grow as fast if the money had been diversified and professionally managed in a defined benefit plan. The end result is people not having enough to retire in a manner that they desire or deserve.

The average 401(k) balance for people 60 & above in this group was $34,420. Not enough to replace the benefit from a defined benefit plan.

A couple of other issues are mentioned in the article. Some members did not contribute as much to the plan as would have occurred with the defined benefit plan. Some members took money from their 401(k) plan reducing their retirement account.

As employers move away from defined benefit plans and shift to defined contribution plans the employees have a greater amount of risk. This means people need to understand how much to invest and how to invest to meet a future need. In short they need professional guidance and a retirement plan.

Most investment professionals will choose a defined contribution plan over a defined benefit plan if investing with a long term time horizon because they should get a higher return. However, if a person does not know investing and the ramifications of certain actions, a defined contribution plan can lead to a very low amount of retirement savings.

Bottom Line: If you are in a 401(k) plan and do not feel comfortable about investing, get professional guidance and develop a retirement plan.

Beware of Hedge Funds

The Monday August 4, 2008 Wall Street Journal had an article on the performance of hedge funds. The title of the article was “Hedge-Fund Sluggers Strike Out.” Hedge funds are leveraged funds that tend to lack the diversification represented in Ecclesiastes 11:2.

A Hedge fund typically uses leverage, such as options, where a relatively small amount of money can control a lot more of a security. A person who can predict the future correctly can make a lot of money. Unfortunately, I do not know of anyone who can predict the future with 100% accuracy.

What this means is that when things are going up they go up faster than the rest of the market. Conversely, when things are going down they go down faster than the rest of the market. This is illustrated by the Boyer Allen Pacific fund that is down 28% for the year while it was up 52% during 2007.

At first glance it appears that this fund is up 24%, 52% - 28%. However, this is not true and can be illustrated by starting with $1.00. If it goes up 52% then the value is $1.52. When $1.52 goes down 28% the end value is $1.52 times 0.72 = $1.08. This fund is up 8%. Everyone is happy with a 52% return. Few people are happy with a 28% drop. At a 34% drop this fund will be even.

This year some hedge funds have reportedly gone bankrupt and some hedge fund managers have been arrested. Since nobody knows the future investing in hedge funds more closely resembles a form of gambling rather than a form of investing.

The lessons learned from this article are:

• Understand what you are investing in.
• Do not chase phenomenal returns made by a fund in one year because it may very well be followed by a phenomenal correction after you purchase it. Remember the story of the tortoise and the hare.
• Buying of a hedge fund is to be avoided by the average investor who can not afford to take this much risk

Barron's Financial Statistics

The August 4, 2008 edition of Barron's had useful financial statistics. We hear some statistics and their interpretation in the news but what are the rest of the numbers and what do they mean.

2nd Quarter GDP = 1.9%, 1st Quarter GDP = 0.9%: What does this mean? We are not in a recession

June rate of inflation = 5% annualized: What does this mean? We are not in a recession

Index of Coincident and Leading Indicators = Flat during the 2nd Quarter: What does this mean: We are not in a recession.

What are going up: Business Sales, Consumer Spending, Durable Goods, Factory Shipments, Non-Durable Good, Public Spending, Non-Residential Spending, & Exports to name some. These are all good things.

What are going down: Imports, Petroleum Capacity (Not producing at as high a rate to keep prices up), Auto Sales (In the news), & Residential spending (In the news).

What does this mean? Besides the news on auto sales and residential spending things are better than what most people would think. Do not focus on the news and recession fears and keep investing.

Retirement Savings Statistics

Retirement savings statistics are published on a regular basis in newspapers and magazines. Recently, some statistics were published on the front page of the Business section in the August 2, 2008 Charlotte Observer. The paper reported on a study done by Ernst & Young LLP done for the Americans for Secure Retirement.

• Nearly 3 out of 4 middle income households in the Carolinas that plan to retire in the next 7 years will outlive their retirement savings.
• 3 out of 5 new middle class retirees would run out of savings and have to reduce their standard of living by nearly 25%.
• Those planning to retire in the next decade would need to reduce their standard of living by more than 1/3rd.

Retirees will run out of savings because of fluctuating investment returns and longer lives.

My guess is that these statistics also hold for the rest of the country, not just for the Carolinas.This should be a wake-up call that all of us need to have a financial plan for retirement. The future is never predictable and we need to be prepared.

Frequent Social Security Questions

Answers to Social Security related questions can be found at www.socialsecurity.gov. Here are the most frequently asked questions that I have been asked recently.

Do I have to pay income tax on my Social Security benefits?

You will have to pay federal taxes on your benefits if you file a federal tax return as an "individual" and your total income is more than $25,000. If you file a joint return, you will have to pay taxes if you and your spouse have a total income that is more than $32,000.

How much will a widow or widower receive?

The amount you will get is a percentage of the deceased's basic Social Security benefit. The percentage depends on your age and the type of benefit you are eligible for. A widow or widower, full retirement age or older, will receive 100 percent of the deceased's basic Social Security benefit.
A widow or widower can receive full benefits at age 65 or older (if born before January 2, 1940) or reduced benefits as early as age 60. The age for receiving full benefits is increasing for widows and widowers born after 1939 until it reaches age 67 for people born in 1962 and later.

How are my retirement benefits calculated?

Social Security benefits are based on earnings averaged over most of a worker's lifetime. Your actual earnings are first adjusted or "indexed" to account for changes in average wages since the year the earnings were received. Then we calculate your average monthly indexed earnings during the 35 years in which you earned the most. We apply a formula to these earnings and arrive at your basic benefit, or "primary insurance amount" (PIA). This is the amount you would receive at your full retirement age, for most people, age 65. However, beginning with people born in 1938 or later, that age will gradually increase until it reaches 67 for people born after 1959.

I have worked as a stay at home parent and part time while my spouse has worked full time. What will my benefits be?

You can be entitled to as much as one-half of your spouse's benefit amount when you reach full retirement age. If you want to get Social Security retirement benefits before you reach full retirement age, the amount of your benefit is reduced permanently. The amount of reduction depends on when you will reach full retirement age.

Credit Card Offers for College Students

The topic of the previous blog was credit cards for undergraduate college students. My daughter who enters college this fall got 3 credit card offers: BB&T, Discover, and Capital One. From the offers it is apparent that she is considered a high financial risk by all 3 issuers, which is probably justified given her current level of income.

All 3 offers offer no annual fee and lots of other benefits.

Discover stated "Don't delay - start building your credit history today." Captital One stated "Keep in mind, we may increase your APR if you pay us late twice within 12 months."

These offers in the order of BB&T, Discover, & Capital One are presented below:

Annual Percentage Rate (APR) : It is a variable rate at the prime rate + ___% with a current rate of 17.9%, 16.99%, 19.8%.
Cash Advance APR: 24.15%, 23.99% with a default rate of 30.99%, 22.9% with a default rate of 24.9%.
Transaction fee for cash advance: 3% ($5 minimum), 3% ($5 minimum), 3% ($10 minimum).

Assuming a $500 credit limit here are the rest of the fees:

Late payment fee: $35, $39, $39
Over the credit limit fee: $35 and no overlimit paid, $39, $29.

For illustration sake lets use $35 for both the late payment fee and the over the credit limit fee.

Let's assume my daughter buys $350 worth of books and school supplies in a single transaction, probably a low amount. The first thing that happens is this amount is authorized and reserved by the issuer. Later the account is settled. The process of reserving and settling this account will essentially double book this account for a period and the credit card account will show a balance of $700.

For this $350 transaction and $35 fee will be assessed for the month. If the credit card is paid late another $35 fee is assessed. This single transaction can have $70 worth of fees. This is 20% of the transaction amount for a month and if this annualized by multiplying by 12 it becomes 240%. The account balance has now grown to $420+.

The largest potential problem with a credit card is with the fees, 240% annualized, not the APR of about 20%.

Just say NO to credit card offers for undergraduate college students.

Credit Cards and College Students

My daughter just graduated from high school and is preparing for college this fall where she will be a full time undergraduate student. Many are in this same situation.

The question we looked at was should she have a credit card? Here is the research we found in Volume 6 of the Journal of Personal Finance:

1. In 2003, credit cards are used by about 1/3rd of Americans age 18 and 19.
2. In 2004, one credit card is held by at least 70% of college students.
3. In 2001, 47% of undergraduate had 4 credit cards or more.
4. In 2001, 21% had balances between $3,0000 - $7,000.

I am sure these numbers have grown with time. Consequences for undergraduate students with credit card debt:

• Students feel forced to put jobs ahead of school to keep up with payments (notice not being able to pay off each month and having to make payments).
• Students who had an academic hearing often mentioned working multiple jobs to pay on debts as reasons for poor academic performance. The end result for some is dropping out of school, delaying graduate school, etc.
• This can lead to a poor credit rating and put the student in a more difficult financial position. The key justification given by a credit card issuer is "it is important for the student to establish a credit rating." Having a good credit rating is never stated.
• Having a poor credit rating leads to difficulty in obtaining future loans.

The bottom line is a credit card should be used by college student who has shown financial discipline. If financial discipline does not exist delay getting a credit card and use a debit card. A debit card is a good tool to teach financial discipline without having long term financial consequences.

My daughter went to a bank, with a branch in the town she is attending college, to open an account. The bank had a program for students that included a saving accounnt, checking account, debit card, and a credit card. She is now fully equipped to spend money.

What is she doing with this new found financial freedom? She is going to keep the debit card and cancel the credit card. The strategy is to use the debit card through undergraduate school and start using a credit card after graduation.

The next blog will show the 3 credit card offers and pitfalls of using any of these cards.

Estate Tax Charitable Deduction

This is the final blog in the series on reducing gift and estate taxes. If your estate is larger than the estate tax exemption limit another good strategy is to give a portion to your favorite charity.

Beside doing something good for others you also do something good for you. The strategy is to do a split interest transfer where both the charity and you benefit.

Seven requirements must be met for a gift to be tax deductible:

1. Contribution must be made to a qualified charity
2. Property must be the subject of the gift
3. Contribution must be in excess of any value received in return by the donor
4. Must be paid within the tax year
5. The value, if over $5,000, must be attained through a qualified appraisal. An appraisal is not required for publicly held securities.
6. Contribution effective at death is deductible and transfer must be made by the decedent.
7. A split interest must be in the form of a trust.

This split interest trust comes in 2 forms. The first form is the Charitable Remainder Trust where you derive an annual benefit and the charity gets what is left. Secondly, is the Charitiable Lead Trust where the charity derives an annual benefit and your beneficiary get what is left.

A Charitable Remainder Trust is an irrevocable trust designed to provide a fixed amount annually to a non-charitable beneficiary, usually you the donor, with the remainder left to the charity. The annual amount must be somewhere between 5 % & 50% of the initial fair market value. Future additions to the trust are not allowed.

This works really well when a person has assets and needs more money to live. Instead of selling the asset and paying capital gains tax reducing your income, you donate the asset, increase your income through a tax deduction and you get paid an annual income. You can do something good for a charity, get an income tax deduction, have more money to live each year, and you do not have the hassle associated with disposing of the asset. A good deal for you and the charity.

A Charitable Lead Trust is an irrevocable trust design to do just the reverse. You transfer an asset's income interest for a period of time, get a tax deduction, and retain ownership of the asset. This works well for a person who has sufficient income and wants to reduce the value of the estate.

An example of how this works is a person donates $10,000,000 worth of securities that likely will appreciate with time and the charity gets 8% ($80,000) for 24 years. The value of this is calculated to be worth $9,600,000. At the end of the 24 years the trust still has a value of $10,000,000 even after the annual payments. The value of the trust from an estate tax perspective is $400,000, below the exemption limit and free of any estate tax.

This is a relatively complicated topic and professional assistance is required. It is wonderful that both you and your favorite charity can benefit so that your life can continue to have an impact into the future.

Estate Tax Marital Deduction

A major issue for retirees is avoiding paying estate tax especially if the estate tax exemption limit is reduced back to a level of $1,000,000 - $1,500,000. It may be easier than you think to reach a $1,000,000 estate especially for a married couple. Consider the value of your home, personal property, life insurance proceeds when a spouse dies, IRAs, Annuities, 401(k)s, and future inheritance from your parents and other family members.

Once you reach the exemption limit, your estate will pay at least 41% in tax to the government. As the size of the estate grows so does the tax rate and tax burden.

Married couples have an option to reduce the amount of estate tax called the unlimited marital deduction. A spouse can give the entire estate to a spouse without paying estate tax if 3 requirements are met:

1. The property left to the surviving spouse must be included in the gross estate of the first spouse to die.
2. The property must actually pass to the surviving spouse.
3. The property must not constitute a terminable interest when ultimately received by the surviving spouse.

Even with the unlimited marital deduction, paying of estate tax can not be avoided. Once the surviving spouse passes the estate tax is calculated.

To minimize the amount of estate tax liability a dual approach is often used. The estate is divided into 2 parts, an amount of the estate equal to the exemption limit is given to the surviving spouse and the remainder is put into a trust. In this manner, the number of exemptions can be increased from 1 to 2. Saving 45% on $1,000,000 means that $450,000 is given to an entity you choose rather than the government.

Options exist with the design of the trust. This is a complicated topic and getting professional assistance may be extremely beneficial.

An option to reducing estate tax is to take advantage of the charitable deduction. This is the topic for the next blog.

Gift Tax Reduction Strategy

The previous blog showed that once the $1,000,000 gift exemption limit is reached for the giving of gifts a gift tax is imposed. This gift tax rate is at least 41%. For a transfer of wealth to be considered a gift, 4 conditions must be met: 1) a capable donor, 2) a capable donee, 3) delivery and acceptance, and 4) intent to make the gift by the donor. The tax is paid by the donor.

If you have accumulated wealth and do not want to give at least 41% to the government, you need a gift tax reduction strategy. Three other reasons exist to make gifts: 1) the appreciation of the property is transferred to the donee further reducing the tax liability, 2) reduces the donor's gross estate reducing estate tax liability and 3) shifting of income and overall reduction of income tax liability.

The easist strategy is to make gifts below the annual exclusion limit. For 2008, an individual can give up to $12,000 in a year per recipient. For couples, a gift splitting election can be used raising the limit to less than $24,000 in a year per recipient. Gifts are typically given to children and grand children and can be given for as many years as possible. For example if you are married and have a total of 10 children and grand childred about $240,000 can be gifted without impacting the gift exemption limit and reported on IRS Form 709.

An easy way to give a gift to a minor is through a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) account. The donor retains custody of the account and ownership transfers in the future to the minor at the age of majority typically age 18 or 21. You need to gift assets that give off little active or passive income due to the higher tax rate for the minor. Investing in assets that pay little or no dividends reduces the overall tax liability.

Charities are good entities to make gifts especially appreciated assets. I believe in tithing, giving 10%, of you income and this is typically done on a cash or check basis. Another acceptable alternative is the transfer of appreciated assets which transfers the capital gains to a tax exempt entity.

If you have a variety of assets which ones are the best to gift? The best assets to gift include: appreciated property to reduce tax on capital gains, fully depreciated property as the tax reduction has been eliminated, and out of state property to avoid probate. Gifts that are less desirable include: property with a value less than purchase as the individual wants to take the tax loss and property not fully depreciated to further reduce the tax.

Additional gift tax reduction strategies exist including various forms of trusts. This is a relatively complicated topic and it is good to get professional estate planning advice.

Gift and Estate Tax Planning

Congratulations you have been successful and have a large sum of assets. You have now entered the final stage in financial planning known as Estate Planning. It has 2 components, Gift Tax and Estate Tax reduction.

This is a very complicated topic that requires legal guidance. The blog will give an overview to get you on the road. You can avoid paying as much in taxes by taking a few steps.

TAX RATES

The Unified Federal Estate and Gift Tax Rates (1977 - 2009) for Taxable Transfers:

$1,000,000 - $1,250,000 = 41%
$1,250,000 - $1,500,000 = 43%
$1,500,000 - $2,000,000 = 45%

GIFT TAX EXEMPTION LIMIT

The gift tax exemption limit is $1,000,000. An amount less than $1,000,000 is not taxed. Gifts given to a recipient in a year worth less than $12,000 per person or $24,000 per couple are not reported and do not count toward this limit. Amounts above this limit must be reported and counted toward this exemption limit on IRS Form 709.

ESTATE TAX EXEMPTION LIMIT

For 2008, the estate tax exemption limit is $2,000,000. This limit increases to $3,500,000 for 2009. In 2010, the estate tax is repealed.

What happens to the exemption limit in 2011 and beyond? The answer is unknown. My belief is that given the current political environment that it could easily be reduced and could go back to the $1,000,000 level.

If the estate tax is repealed then no planning is required. If the exemption limit is reduced to $1,000,000, in an effort to raise taxes revenue and reduce the national debt, a considerable amount of planning may be requred. My strategy is to plan for the $1,000,000 limit and hope that the tax gets repealed.

Future blogs will discuss gift and estate tax reduction strategies.

Taxes and Social Security Benefits

Do I have to pay income tax on my Social Security benefits?

The answer is no if below a base income amount. Some people who receive Social Security benefits will have to pay taxes on their benefits. Less than one-third of our current beneficiaries pay taxes on their benefits.

You will have to pay federal taxes on your benefits if you file a federal tax return as an "individual" and your total income is more than $25,000. If you file a joint return, you will have to pay taxes if you and your spouse have a total income that is more than $32,000. For more information review IRS Publication Number 915.

Many states and local authorities do not tax Social Security benefits. You should contact your state or local taxing authority for more information

Can I have state or local tax withheld from my Social Security benefit?

No. The Social Security Administration has no authority to withhold state or local taxes from your benefit.

What should you do if you are required to pay tax federal income taxes on some or all of your social security benefits? Be thankful that you make enough money that this is a concern.

Age To Take Social Security Benefits

Starting at Age 62 a person is eligible to take Social Security benefits. You can start receiving these benefits anytime until age 70. The question is when should you take them?

A penalty exists for taking benefits early:

• When collecting Social Security before the normal retirement age the benefit is reduced.
• If benefits are received early, the reduction is 1/180 per month for the duration
• For a person retiring 3 years early this is a 20% reduction, 2 years is a 13% reduction, and 1 year is a 7 % reduction.

A bonus exists for taking benefits later:

• If benefits are received at a later date, the benefit is increased.
• This increase is 1/240th per month for the duration
• For a person retiring 3 years later this is a 15% increase, 2 years is a 10% increase, and 1 year is a 5 % increase.

If you do the math all of the option converge when a person is in their mid 80's. Taking benefits early gives the most money for a person living only up to the mid 80's. Taking benefits later gives the most money for a person living after the mid 80's.

What is the best time to take benefits? The above info suggests that it only depends on how long you are going to live and nobody knows the answer to the question. This is a tough question.

Actually, the best thing to do is to have a retirement plan and consider a number of factors before making this decision. Get guidance from a professional on this issue.

Income Sources & Social Security Benefits

Yesterday's blog showed the impact of income levels on receiving Social Security Benefits starting at age 62. This begs the question of what is and is not considered income. Obviously, wages and tips are considered income. What is excluded from income?

Income items that are not counted as earnings include:

· Payments from tax exempt accounts including: annuities, 401(k), IRA’s, trust funds, and Keogh Plans
· Pension and retirement pay
· Interest, dividends, and capital gains on stocks, bonds, and capital assets

This means that distributions and withdrawals from tax exempt and taxable account will not count toward reducing Social Security benefits. If you have been disciplined in saving for retirement, you have lots of options that does not impact Social Security benefits.

Bottom Line: Another reason to start saving now.

Social Security Earning Limits

Social Security Earning Limits and Losing Benefits

People receiving Social Security benefits can have earning limitations where benefits are taken away. It is important to know these limits and stay below them. The limits for 2007 were:

· Starting at Age 62, income during years prior to retirement = $12,960/year without a penalty. If above this income level a $1 loss of benefit is incurred for every $2 above the limit.
· Income in the months of the year prior to attaining normal retirement age = $34,440 without a penalty. If above this income level a $1 loss of benefit is incurred for every $3 above the limit.
· Income after normal retirement age = No limit on the amount of income.

This limit is increased annually at the rate of inflation. The 2008 limits were increased above the level of 2007. The limit for 2009 will be higher than that for 2008.

What happens to your Social Security Benefit at retirement if you continue to work and receive benefits? No significant impact since you continue to pay FICA and Medicare taxes while you are working.

Bottom Line: If you are at least 62 years of age, working and can receive Social Security benefits, even at a reduced level, you should do it. Contact your local Social Security office for details. What do you do with the extra money? Use it to prepare for retirement and do things like pay off debt or invest for the future.

Biblical Perspective on Paying Yourself First

The last topic in this series on the Bible and financial teaching is the importance of paying yourself first. A verse on this principle is Ecclesiastes 11:6.

"Sow your seed in the morning, and at evening let not your hands be idle, for you do not know which will succeed, whether this or that, or whether both will do equally well."

The key part of this verse is sow your seed in the morning. If you want a crop you must plant seeds and these seeds have a defined growing season. If you never plant the seeds you never get a crop. Since it takes a fixed amount of time for a seed to grow to a mature plant the earlier you plant the seed the sooner you get to a mature plant.

When you have been given money, invest a portion of it and give it time to grow. The more seeds you plant the bigger the harvest.

Investments take time to grow so start investing now.

Biblical Perspective on Paying Yourself First

The last topic in this series is the Bibli

Biblical Perspective on Diversification

What does the Bible teach on the importance of diversification for your investment portfolio. The best verse on this topic is Ecclesiastes 11:2.

"Give portions to seven, yes to eight, for you do not know what disaster may come upon the land."

This verse states that nobody can not predict the future and can not predict when an investment will run into a problem. Since we do not know the future the best way to keep you portfolio on a more even keel and in the correct direction is to diversify into 7 or 8 investments rather than have a single investment.

In today's terms this has been called Modern Portfolio Theory. Here are some specifics on this theory.

• Harry Markowitz won Nobel Peace Prize in Economics in 1990 for his theory published in 1950.
• Principal of Co-Variance: Risky higher returning investments, each having their own variance, when combined in certain amounts will have an overall lower amount of risk and maintain higher returns.
• Example: Blend of International and US Equities give a better return and lower risk than just US Equities alone.
• Why is this important? Because money moves between stocks and bonds and between different parts of the world.

A Nobel Peace Prize winner has proven that what the Bible documents makes really good sense.

Biblical Perspective of a Long Term Investor

The Bible talks about the long term investor. Proverbs 13:22 states:

"A good man leaves an inheritance to his children's children, but a sinner's wealth is stored up for the righteous."

This means that:

• A solid investment plan will pass the test of time even to the grandchildren.
• A biblical perspective financial steward will prosper while those with the opposite perspective will act in a manner to lose money.
• Who gains the money? The person who has a biblical perspective financial steward.

A great idea for a grandparent who has a grandchild is to start a Uniform Gift to Minors Act, UGMA, account for this child. This act sets up the grandchild for college or a first house or retirement. If you give $5,000 to a grandchild at birth it can grow to a large amount with time.

Example: A UGMA account with $5,000 that doubles every 10 years will double 7 times by retirement.

$5,000 doubles to $10,000

$10,000 doubles to $20,000

$20,000 doubles to $40,000

$40,000 doubles to $80,000

$80,000 doubles to $160,000

$160,000 doubles to $320,000

$320,000 doubles to $640,000

Having money that grows with a long term focus can yield great wealth.

Biblical Perspective of Financial Stewardship

The company name is Christian Stewardship Retirement derived from Bible based financial stewardship. What does the Bible say about Stewardship?

Proverbs 21:5 says "The plans of the diligent lead to profit as surely as haste leads to poverty."

What does this mean: Let's put the word steward for the word diligent and then this reads the plans of a steward lead to profit. A financial steward makes money the right way that leads to profit.

Matthew 25: 14-30 is known as "The Parable of the Talents." In this parable, 3 servants were given money or talents to invest for their master while he was gone.

• 1 servant was given 5 talents and returned 5 more for a total of 10 - a good and faithful servant
• 1 servant was given 2 talents and returned 2 more for a total of 4 - a good and faithful servant
• 1 servant was given 1 talent and hid it and returned the 1 talent - a wicked and lazy servant.
• The servant with 10 talents was given this 1 talent
• "For everyone who has will be given more and he will have an abundance. Whoever does not have, even what he has will be taken from him."

What does this mean: As a person learns stewardship it will lead to abundance. If you never learn stewardship, ultimately it results in a loss in wealth to those who know it.

If you are a good financial steward, Congratulations.

If you are not a good financial steward, you can either hire someone who is and gain from it or lose money. My advice is to hire someone who is and gain from it. It is your call. Send me a comment if you want to gain stewardship.

Potential Retirement Financial Crisis

Monday May 19, 2008 USA Today had a front page article titled "Bill for taxpayers swells by trillions". This article states that US Federal Government deficit is far bigger than government estimate.

The official government accounting method stated that the deficit for 2007 was $162 billion. The government accounting method and does not look at future obligations. When future obligations are considered the number increased to $2,534 billion or $2.534 trillion.

Statistics:

• Long term financial obligations grew by $2.5 trillion last year primarily related to cost of Medicare and Social Security benefits.
• We are on the hook for a total $57.3 trillion in future liabilities.
• This equates to $500,000 per household.
• When the state and local government obligations are included the number increases to $61.7 trillion or $531,472 per household.

What is driving the future obligations? It is higher projected medical cost. For some reason, I am not seeing future medical costs going down or growing at a rate less than inflation. As people continue to live longer medical costs will continue to increase at a steady inflationary pace.

Use this information as a wake-up call that you need to save for retirement. With these future obligations on the horizon you need to prepare for a dramatic reduction in Social Security and Medicare benefits. Reduce your future dependency on Social Security and Medicare benefits by increasing your retirement savings.

Be prepared now for the potential retirement financial crisis.

Generation X Retirement Planning

Tuesday, May 20, 2008 the USA Today had an article "Generation X struggles to build a nest egg". Generation X is defined as a person born from 1968 through 1980 who would currently be 27 to 43 years old. Bryan Short is featured in the article. He is a 30 years old attorney living in the Washington, D.C. area who graduated from Boston College and law school at the College of William and Mary.

You would think that an attorney would be doing well financially and would be able to save for retirement. The article paints a different picture because of the repayment of college and law school debt.

GenXers have a looming retirement problem because of 3 issues: fewer and fewer companies are offering a defined pension, the growth in social security benefits is not keeping up with inflation, and excessive debt preventing saving for retirement. This perfect storm looks like this: companies are no longer giving a guaranteed pension, the government program is losing ground, so they need to start saving for retirement now but are not able to afford it. No guarantees for a retirement and not able to save for retirement. OUCH!!!

The good news is that about 80% of GenXers have access to some kind of retirement saving plan at work. The bad news is that only 60% of GenXers actually contribute to a retirement plan at work. 40% either do not have access to a retirement plan at work or do not contribute to a retirement plan.

This means that 40% are not planning for retirement and will be less prepared, and more dependent on social security benefits. Given the bad news on the future solvency of the social security program this leaves a GenXer in a precarious position.

What should you do if you are a GenXer? Get some professional retirement planning help now.

How Fear Can Lose You Money

I found this article on MSN.com "How Fear Can Make You Lose Millions". It has a paragraph that recorded an October 10, 2002 headline in the USA Today "Where's the bottom? No end in sight...". The article says that it just so happened that this was the most recent bottom in the Dow Jones Industrial Average. In hindsight it was the day to buy instead of a day for fear.

Fear can be a good thing if you are a speculator or have a very short term focus. If you are investing in things like options, futures, or an individual stock.

Fear is not a good thing for a long term investor. The world's greatest investor is Warren Buffet. Does he invest out of fear? I think the answer is no because I have never heard or read where he used this word. Is he selling his investments in a downturn just because it is a downturn? No, he is a long term investor who invests based upon fundamentals.

If you have a portfolio that you are comfortable with and have a long term horizon you should never make investment decisions based upon fear. You hurt your future by becoming emotionally attached and listening to the media.

Emotionally Attached: It is human nature that when an investment is going up that it makes us feel successful because we were smart enough to invest in it. It also makes us feel not so smart when an investment is going down because we were dumb enough to invest in it. Isn't the object to buy low and sell high. When we get emotionally attached we tend to do just the opposite, buy high and sell low.

A natural tendency exists to invest more money in successful things so we tend to buy when something is going up. We want to avoid emotional pain and tend to get rid of it when it is going down.

Media: Why does the media exist? To make money for the media business. When you listen to a radio station, watch a TV channel, or read something in print the company that owns this media ultimately needs your attention because of money.

A media business needs more subscribers or listeners. Normally journalist rather than investment professionals write these articles. To sell more media, articles tend to feed your emotion. So when things are going up the media says that things are great. When things are going down the media says that things are bad.

A new media invention is the appearance of trading as investing. Take the show Fast Money or Cramer on CNBC. What is the purpose of the show? To get you to buy and sell stock. It is important to the brokerage firms that is sponsoring this show that you trade more often because they only make money when you buy or sell. A trading show gives the illusion of having a purpose of making you money fast. The main purpose for the sponsors of the show is for you to give them money fast. It is a seconday benefit if you make money.

In a broker transaction, the broker and the brokerage firm are guaranteed to make money. You are never guaranteed to make money. Keep the money in your pocket rather than giving it away.

Perhaps the phrase a penny saved is a penny earned should be modified to a brokerage fee saved is money in your pocket.

Portfolio Building, Improve Return with Minimal Fees

You want your retirement money to grow as fast as possible. One way to improve the return on your investment is to purchase the best No-Load Mutual Funds and hold them to minimize transaction fees. This is better called Portfolio Building.

Where does this start? It all begins with an understanding of the current financial state and future needs. A financial assessment is needed along with a risk assessment. Then the key is Diversification, Diversification, Diversification of No-Load Mutual Funds.

No-Load: It is really important to purchase a no-load fund if at all possible. Sometimes, when you research mutual funds that invest internationally, the best funds have a load and in this instance it makes sense to buy a loaded fund.

When you pay a load you are really paying the mutual fund to sell it to you and others. Also a loaded fund has higher annual fees called 12b-1 fees used to promote the fund. Yes we pay to see our mutual fund company on TV or in print. Why pay money to a mutual fund so that they can sell and promote it to others?

The Best Funds: Mutual funds are given a grade and I use the Morningstar 5 star rating system. This looks at risk and return from a historical perspective. Another indicator is the size of the mutual fund and being too big or too small can hurt your return. Typically, for mutual funds with the same investment objective, the largest Morningstar 5 star rated mutual funds will not perform as well as medium sized Morningstar 5 star rated mutual funds.

Diversification of Stocks: It is important to have a broad portfolio that includes the best investments around the world. Multiple mutual funds are needed that invest in different sizes of companies and different industries, including commodites. Having mutual funds that invest internationally can improve your return while reducing risk.

Diversification of Bonds: It is important to have bond mutual funds with different time horizons. Short term bonds seldom, if ever, go down and have little exposure to a capital loss as interest rates rise. Long term bonds over a longer holding time will give a better return.

A retired person should have a certain amount of cash in a money market account. The reason is freedom to sell an investment when you want rather than when you have no other alternative.

Diversification of Time: Since it is impossible to know when an investment is at a market top or a market bottom making contributions on a regular basis makes sense. This is also called dollar cost averaging. Disciplined investment with regular contributions helps take some of the volatility.

Happy investing!!!

Suitable Retirement Investments

Congratulations you have started and are contributing to a retirement account. The question is what should be your investments?

From a legal perspective a retirement account can include: Stocks, Bonds, Mutual Funds, Annuities, Limited Partnerships, & U.S. Minted Coins. It can not include: Margin Accounts, Short Sales, Tangibles/Collectibles/Art, Speculative Options Trading, Term Life Insurance, Rare Coins, & Real Estate.

From a tax perspective 2 important points should be remembered:

1. A retirement account grows either tax deferred, such as in a traditional IRA, or tax free, such as in a Roth IRA.
2. Investment losses can not be deducted in a retirement account. A loss can be deducted in a non-retirement account.

Since it grows without a concern on paying taxes it is important invest in taxable investments. A tax free bond, such as a municipal bond, would not be appropriate. The focus has to be on growing as fast as possible.

Since investment losses are not deductible in a retirement account, you need to be concerned about the amount of risk. A higher risk investment, such as an individual stock, would be more appropriate in a non-retirement account as you can deduct any potential loss. A mutual fund of stocks would be more appropriate in a retirement account. Even though it is possible for a mutual fund to go down an individual stock can go down even further due to a lack of diversification.

Would I invest in bonds or a bond mutual fund within a retirement account? Only when the timeframe is less than 8 years and investor preference. Personally, I doubt if I will ever own a bond or a bond fund because of my personal preference.

Happy Investing!!!

Retirement Mistakes to Avoid

In the current state of stock market volatility it is very easy to lose focus and discipline. Keep your perspective and avoid investing by emotion. This blog talks about common investment mistakes that can have a significant impact on creating wealth for retirement.

Mistake Number 1: Cutting back on contributions. Let me give you a personal example. I owned Avaya and it tumbled along with every other stock in the telecom crash. As it was going down, I stopped buying it in my Employee Stock Purchase Plan and I did not get the company funded 15% discount. The stock went down to about $2/share and initially I was glad that I had avoided the pain. As you may remember in 2007 all Avaya shareholders got about 8 times this amount. Every share that I would have purchased at $2/share and I could have bought quite a few increased by a factor of 8 in less than 8 years. In hindsight, this was a very dumb move on my part.

Mistake Number 2: Changing investment strategy in mid stream, aka Market Timing. This has to do with switching away from equities with long term growth into something safer in a downturn. The problem with this is that nobody makes an announcement that says this is the bottom now change back. By the time you realize that a stock market is now going up you have to switch everything back. Typically, this move costs you 2 ways, lost money from a slow growing investment as well as the transaction costs.

Mistake Number 3: Using retirement money as a bank. Since I have a farm background, let me illustrate this with a field of corn. Imagine you plant an acre of corn and you can get 100 bushel of corn from this acre. Now as the corn stalks are starting to grow, rip them all out and replant the field. You have lost both time and money because now you have the cost to replant (penalty for early withdrawal) and lost time because it takes a full season for the corn to grow (delay retirement date). Once you plant your corn, let it grow.

Mistake Number 4: Cashing out a retirement plan at a job change or transfer. Just like above, why do you want to rip out your corn stalks before harvest? If you find yourself in a financial situation with a job loss, Do Not Sell Everything and Go Into Cash. Get professional help as alternatives exist.

Mistake Number 5: Avoiding professional help. Being penny wise and pound foolish can be very bad. A $10,000 investment invested for 30 years at an average 5% return grows to about $40,000 while at an average 10% return grows to about $160,000. This was calculated using the rule of 72. I assure you that I will not come anywhere close to charging $120,000 in fees.

Learn and profit from my mistakes.

Index of Leading Economic Indicators

The last blog covered the current status of the United States Business Cycle based upon the most recent Gross Domestic Product, GDP, report. In the news, we hear doom and gloom and the discussion of the r word, recession. Based upon the GDP report, our economy is still expanding and not in a recession.

Previous blogs looked at three categories of economic indicators: leading, coincident and lagging indicators. Each category contain a grouping of individual indicators. These individual indicators within a category rarely if ever all are going in the same direction, up or down. Some very smart people figured out that you could give each individual indicator within a category a weight and a score. Once the score was tallied it could be called an index.

The end result is today we have an index of leading economic indicators, index of coincident indicators, and index of lagging indicators. Smart people figure this out every month and report it on a monthly basis.

What is the value of a monthly index of leading economic indicators? To Warren Buffet, it means very little as he stated during his annual meeting last weekend. Warren has a very long term view that goes beyond the timeframe of a single business cycle. To me, it gives me a sense of direction. It would mean a great deal if I was investing in options, which I do not.

It feels like things were better the middle of last year. Then things got worse last year until early this year, Not it feels like things are getting better again. This is what the stock market told me. The GDP numbers do not indicate this as the number has always been positive. Something else must be a better indicator than GDP.

If you look at the index of leading economic indicators, from September 2007 through March 2008, we see where the economy went down and in March is now positive once again. This makes me feel good about the direction of our economy and the US stock markets.

If you could choose between watching news reports or the index of leading economic indicators for investment advice which one is best? The answer is the index of leading economic indicators.

Current Status Business Cycle

Yesterday, April 30th, GDP was reported to have increased by 0.6% for the 1st Quarter of 2008. This period is from January - March 2008. I saw President Bush on TV giving a speech talking about how the economy had slowed and did not mention anything about a recession. I did not see any of the Democratic Party candidates talk about this economic data.

When GDP is negative for 6 months it indicates that our economy is in a recession. If the Quarterly GDP had been negative, the Democratic Party candidates would have been much more vocal. The data means that our economy is not in recession.

An excellent websites on economic data is www.bea.gov. This the website for the U.S. Department of Commerce, Bureau of Economic Analysis. GDP is reported 2 ways, in current dollars and inflation adjusted dollars. The below table shows Current GDP, in both current dollars, and Real GDP based upon 2000 dollars. Real GDP based on 2000 dollars is less than current dollars due to inflation.

Quarter/ Current GDP/ Real GDP (2000 Dollars)
2007Q1/ $13,551.9 Billion/ $11,412.6 Billion
2007Q2/ $13,768.8 Billion/ $11,520.1 Billion
2007Q3/ $13,970.5 Billion/ $11,658.9 Billion
2007Q4/ $14,074.2 Billion/ $11,675.7 Billion
2008Q1/ $14,185.2 Billion/ $11,693.1 Billion

This data shows that in current dollars GDP increased by $101 Billion or about 0.8%. Real GDP, taking out the impact of inflation, GDP increased only $17.4 Billion or about 0.1%. For the last 4 Quarters, GDP has increased in each Quarter with the last 2 Quarters having less growth.

Where are we in the Business Cycle? We are still in an expansion. We are not yet at the peak. We are not in a contraction. Does the news reports indicate that we are still in an expansion stage of the business cycle? No, it sounds like we are in a recession. Leading economic indicators suggest that we are not headed for a recession.

Bottom Line: If you invest by the news reports instead of real economic data, you will make very poor choices. Keep the faith in your investments.

Business Cycle Lagging Indicators

The previous blog gave information on the coincident indicators for a business cycle. This blog gives the lagging indicators or the indicators that will change in the future after a change in the Gross Domestic Product, GDP.

These lagging economic indicators include:

• Average Duration of Unemployment
• Labor Costs
• Corporate Profits or Earnings
• Consumer Debt Levels
• Commercial & Industrial Loans
• Business Loans

As GDP increases, Unemployment goes down (more people working), labor costs go up (more people working), earnings go up (higher revenue), debt levels go down (more money available)and the amount of loans should go down (less loans are required).If GDP decreases these indicators should act in a reverse fashion. As you watch the performance of these indicators, do not believe that they predict future performance of GDP.

While this is good economic data, using it as an investor is like driving a car while looking in the rear view mirror. I follow the 4 leading economic indicators more closely for making investment decisions rather than any lagging indicator. Do not confuse a lagging indicator with a leading indicator.

Note that corporate earnings are a lagging indicator instead of a leading indicator. This the one indicator that gives investors the most problem. Why? A good earnings report leads people to believe that good things are going to happen in the future so that an increase in earnings will increase stock price because we have a Price to Earnings number for a stock.

The key learning point is to pay much more attention to future revenue & earnings rather than earnings for a previous quarter. This is why a stock has a great earning report for a quarter and the stock goes down because of a comment about future revenue or profits.

The next blog will review the GDP for the 1st Quarter 2008 and see what it tells us about our current business cycle.