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.