Month: September 2009

Public Option

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Some people in this country have expressed concern that a “public option” in health care would drive out private insurance companies. The warning is repeated over and over again as though this prediction were fact. We have a history of a public option competing with private insurance companies – Workmen’s Compensation Insurance. Has it driven private companies out of the market? No.

In an 8/16/09 San Diego Union Tribune article, Dean Calbreath relates the early history of Workmen’s Comp insurance and the criticism that Pres. Woodrow Wilson endured from conservatives for initiating a public medical plan for workers. Dean recounts the century long struggle between private insurance companies and the California State Fund in this insurance market. The result? Private insurance companies in California dominate the Workmen’s Comp insurance market. Yet there are those clamoring that such a thing is impossible.

Were we to have a public option in health care insurance, a plan covering basic insurance needs, we might expect that private insurance companies would design insurance plans that filled the gaps left by such a public plan. Just as workmen’s comp insurers did in California, health insurance providers will offer competitive pricing to larger companies and command the majority of the market. Like the workmen’s comp example, the public health insurance option will appeal to small businesses and those individuals who have difficulty getting affordable insurance.

Had they been born a hundred years ago, those arguing against a public option today probably would have argued against Workmen’s Comp then. This debate is less about public insurance options and more about the role of government, a long and fierce argument that began before the founding of this country and continues to this day.

A hundred years ago, Andrew Carnegie was criticized by conservatives for his support for the use of public taxes for libraries. Public libraries did sometimes swallow up the collections of social libraries that charged a subscription fee to members. However, libraries whetted a desire for books, and private booksellers fluorished in larger cities to meet the demand for popular newly published books, a need that libraries were not designed to satisfy.

In smaller towns like Kankakee, Illinois, citizen-initiated drives for a public library were met with resounding support from their neighbors; private donations of books and land helped launch the library in 1896. Does President Obama hope that this kind of community spirit is still smoldering in the hearts of Americans?

How can any company possibly compete with a public entity as large as the Post Office? UPS, FedEx and other private mail and package delivery companies have met the challenges of this competition and fluorished. The once stodgy Post Office, in turn, has offered new services and products to compete with these private companies.

In the 1850s, conservatives protested loudly at the use of public dollars to fund free education for children. Has public education led to the demise of private schools? No.

The competition between a public option and private companies in insurance, libraries, mail delivery and education have promoted a vigorous environment which offers better choices to the public. To those who predict that a public option will kill the private insurance market, history replies, “You’re wrong.”

Consumer Debt

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Each quarter, the Federal Reserve calculates the average percentage of debt payments to income for households in the U.S. In 1980, credit card and automobile lease payments were about 11% of disposable, or after tax, income. By 1998, they had climbed to 12%. In 2006, that percentage broke 14%. During 2008, the American consumer has been whittling down that percentage to about 13.5% of disposable income.

Every 3 years, the Fed conducts a detailed survey of consumer finances. In its most recent released 2007 Survey of Consumer Finances, the Fed found that 2/3 of families had applied for credit in the past five years. 30% of those had been either turned down or been approved for less credit than they applied for (pg 45). 73% of families had credit cards but only 60% of those with credit cards had balances due, a healthy sign that families were paying off their credit card balances each month (pg 46). However, those holding credit card balances saw a 25% increase in their balance to about $3000. The median interest rate on a bank type credit card was 12.3% (pg 47).

Einstein said that compound interest was the most powerful force in the universe. When we owe debt, that power of compound interest is working for the other guy, the company we owe the money to. That 12% in interest we pay to a credit card company is in after tax dollars, meaning that it is more like 15% – 20%, depending on the tax bracket we are in. Translating that into hours, it means that we may work 1/2 day to a day each week just to pay the interest on the debt. We become someone else’s work slave.

Asset Allocation

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A portfolio analysis adds up your investments in various categories to determine your asset allocation, a measure of the anticipated risks and returns of a portfolio.

The historical returns of stocks are higher but so are the risks. Bonds have less risk and less return. More importantly, there is a historical inverse correlation between stocks and bonds so that bond prices usually rise when stock prices fall and vice versa.

These historical trends were broken during the past year as almost all asset classes fell. Since March 2009, both bond and stock prices have risen dramatically. The recent crash and credit crisis has made people more cautious and we can expect that money will continue to flood into the perceived safety of bonds. How long can both stocks and bonds rise? When will the inverse relationship reassert itself? Which is the more powerful emotion? Will fear continue to drive money into bonds or will greed goad investors into the more risky stock market?

Asset allocation can dampen the emotional driving forces behind your investment decisions.

In an October 1999 WSJ article, Jonathan Clements examined the finer points of asset allocation with some investment professors. Most people calculate their asset mix by adding up the value of their stocks, bonds and cash. An old maxim is that the percentage of bonds and cash in your portfolio should approximate your age. The truest maxim may be “Go with your gut.” If you can’t sleep at night worrying about your investment portfolio, then it’s time to ease up on the risk in your investments.

So what about your house? House prices historically rise 3 – 4% per year, a return that approximates the return on a bond. When calculating your asset mix, should you include the equity of your house in with the total of your bond investments? A real estate professor that Clements interviewed maintains that a house is not a conservative investment. Historical data shows that, over a period of three years, housing prices have sometime fallen 40%. Remember, this article was written in 1999. How many people heeded that advice and treated the equity in their house as though it were more like an investment in a stock fund?

An investments professor interviewed by Clements “suggests treating your mortgage as a negative position in bonds”, subtracting the amount of the mortgage from the total bonds in your portfolio.

The point of analyzing a portfolio is to assess the risks that your investments are exposed to and that you personally are comfortable with. In this past year, too many older Americans found out that they were exposed to a lot more risk that they thought.

Heirs Looking At You

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In a (undeterminate date) 2005 WSJ article, Jonathan Clements shares some retirement advice from a Pittsburgh accountant and estate-planning lawyer, James Lange, author of “Retire Secure” and a web site devoted to IRAs and other retirement strategies. “Spend your after-tax dollars first, and then your IRA dollars and then your Roth dollars.”

Children inheriting a regular or Roth IRA have to start taking minimum withdrawals based on their life expectancy. For a regular IRA, they will owe tax on the amount of the withdrawal. Withdrawals from a Roth IRA are income tax free.

Most people will not leave estates large enough to trigger an estate tax (in 2009 the threshold is $3.5M).

Many employer sponsored 401K accounts require beneficiaries other than a spouse to cash out the account. In this case, it may be wiser to convert the 401K to an IRA.