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.

Health Reform Republican Plan

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Republican politicians and conservative talk show hosts have devoted plenty of time slinging arrows at Democratic health insurance reform proposals. Occasionally, I hear a talk show host or a Republican politician on a Sunday morning talk show mention the Republican health care plan but few or no details. Instead they continue to heap scorn on “Obamacare”.

When someone prefers to attack rather than explain their alternative, I get suspicious. Maybe the Republican plan sucks, I thought, and that’s why conservatives don’t offer summaries of the plan. If you, like me, would like to know what the Republican health care plan is, you can check out a Roll Call summary here on the Real Clear Politics website. It has some good features, notably the reduced government “footprint.”

As a small employer with several experiences with state insurance agencies, I am leery of government insurance solutions. In Colorado, Labor Dept employees seem to assume that the employer is at fault or lying, although a spokesman for the Labor Department would probably deny it.

An employee is taken at his or her word and it is up to the employer to prove that the employee is mistaken. Conversations with several other small employers in this state have confirmed this attitude on the part of state agency employees.

While there have been court decisions to clarify “reasonable grounds” or “reasonable suspicion” in criminal cases, there seems to be little precedent to stipulate what “reasonable grounds” are in civil and regulatory matters. If a state auditor feels they have reasonable grounds to believe that an employer is guilty of breaking one of the hundreds of state laws affecting employers, then, unlike criminal cases, the employer must prove their innocence.

I am afraid that this same attitude will prevail when the Federal government injects itself even deeper into health care and insurance in the U.S. Doctors and health care providers will be in the same position as employers, needing to prove their innocence. As patients, we might think that such a presumption of fault on health care providers is a good thing. Such a presumption will only cause more doctors and health care providers to leave the medical field. After all, who needs the aggravation?

Even without health care/insurance reform, there will not be enough doctors and health care providers for the juggernaut of the aging baby boomers. With or without reform, there will be delays in getting medical appointments with primary care physicians and specialists. We need reform and this is the time to do it. I can only hope that our politicans will use some care and sober judgment as they craft a reform bill.

Lower Taxes

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Want lower income taxes and national health insurance? Move to Britain. As this chart shows, income tax and health insurance takes about 30% of a paycheck in Britain. But wait.. Don’t book your flight to Britain yet. There is also a 17.5% VAT tax (Ouch!), a sales tax on many goods and services, but food and children’s clothing is exempt from the tax.

Here in the good ole U.S.A, about 9.9% goes to state and local taxes, as reported by the Tax Foundation. Keep that in mind the next time you read or hear someone say “half of the population pays no tax”. What they mean is that approximately half of the population pays little or no Federal income tax. Social Security and Medicare tax take a 15% bite (as an employer, I can assure you that the employee pays the company half of the Social Security tax in reduced wages). Add in 10% for state and local taxes and a quarter is gone out of every dollar earned, before the Feds take their share. If you are a breathing adult, you’re probably a taxpayer.

A state by state comparison of median income from the Kaiser Family Foundation shows some surprising data. There are a number of other comparisons at this site.

Health Care Debate

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Joseph Ellis, a historian and author, recently wrote an op-ed in the L.A. Times that provides a historical perspective on the debate about the role of government.

Whatever our position on health insurance, let’s keep it to a debate. The last time we had an unresolvable debate about the role of government was in 1861 and we don’t want to do that again.

Thoughts to Ponder

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“You cannot help the poor by destroying the rich.
You cannot strengthen the weak by weakening the strong.
You cannot bring about prosperity by discouraging thrift.
You cannot lift the wage earner up by pulling the wage payer down.
You cannot further the brotherhood of man by inciting class hatred.
You cannot build character and courage by taking away people’s initiative and independence.
You cannot help people permanently by doing for them, what they could and should do for themselves. “

……Abraham Lincoln —

Thanks to Lydia for passing this on to me.

Stock Returns

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Here’s an interesting table summarizing data from the Federal Reserve on comparative returns on stocks, T-bills and Treasury bonds from 1928 to 2008. What if you had put $100 a stock index like the Dow Jones in 1928? What would it be worth today?

What this illustrates is the power of compounding over a number of years. A nice gift from any parent or grandparent to a newborn child might be a small amount put in a stock index fund in trust for that child.

Confrontational Politics

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It’s called confrontational politics – the yelling and shouting heard this month at town hall meetings on health care. The tactics were first devised in the 1960s by the SDS, the Students for a Democratic Society, to protest the war and include intimidation, physical and vocal defiance and provocation. An underlying presumption of these tactics is that the ends justify the means.

In a twist of irony that would spark a wry smile in Rod Serling, the creator of the Twilight Zone, these strategies were later adopted by the College Republicans in the 1980s to thwart liberal causes on college campuses. Jack Abramoff, a leader of the movement, crafted a disciplined organization that promoted intimidation as an effective tool for conservative political causes.

In the 90s, environmental groups amended the strategy to include both violent confrontation and the passive resistance tactics espoused by Ghandi.

In the late nineties and early in this decade, an anti-corporate movement adopted these “in your face” stategies at several economic forums to challenge the fiscal policies of governments.

Common to all these movements is the perception that compromise is a betrayal of one’s principles. Compromise complicates issues for it requires that one party understand, to some degree, the other party’s point of view. Complexity is the enemy of those who prefer simplicity in their lives, beliefs and ideologies.

Debt Mountain

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There has been a big rally in corporate bonds in the past few months. Decreasing fears of defaults has sparked a huge inflow of money into these bonds. The U.S. corporate bond market is large, with $9.8 trillion in outstanding debt – 1.5 times the amount of outstanding Treasuries, or about 70% of the nation’s GDP.

According to Federal Reserve data, the U.S. mortgage market is even bigger – $14.7 trillion at the end of 2008, of which $8.2 trillion is securitized. The three government agencies Fannie Mae, Freddie Mac and Ginnie Mae now back 90% of mortgages.