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.