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Social Security Update

August 23rd, 2011

This was a great article on Social Security that appeared on Marketwatch yesterday, I thought you would all enjoy.  As an LDS financial planner, I feel it’s important for my clients to know about changes to Social Security.  It will be a major source of income for many retirees, including LDS families.

As summer reads go, it might not prove to be as interesting as “A Dance with Dragons” or “ESPN: Those Guys Have All the Fun.” But for gurus and nerds (like me), it’s pretty darn close.

 Yes, retirement-focused (some might say retirement-obsessed) folks are spending their summer days and nights, and in some cases their vacations, combing through the just-released 2011 edition of “Fast Facts & Figures About Social Security” in search of whatever insights can be gleaned about the current state of retirement in America, and what, if any, items we can put on our collective to-do list.

And the latest edition, which answers the most frequently asked questions about the programs the Social Security Administration (SSA) administers, doesn’t disappoint. The book, among other things, highlights basic data for the Social Security (retirement, survivors and disability) and Supplemental Security Income (SSI) programs.

Here’s what experts say you should do or consider given the facts and figures in the 2011 version of this “book,” which is published by the SSA.

Read the report, “Fast Facts and Figures About Social Security, 2011.”

Social Security is a major source of income for older Americans

It might not come as a surprise, but the first item of note is this: About one in every five Americans, or nearly 60 million people, receive some type of benefit or assistance from Social Security. And about 80% of those beneficiaries are age 62 or older. And for those beneficiaries, it’s an especially important source of income for older Americans.

Consider: In 2009, Social Security represented 38% of all income going to Americans aged 65 and older. That’s up eight percentage points from the 30% in 1962.

“Workers tend to dismiss Social Security as a major source of their retirement income,” said Andy Landis, author of Social Security: The Inside Story, 2011 Edition and the founder of Thinking Retirement. “The data say not so fast. Social Security represents the largest source of their income. Social Security provides more income than any of the other legs of the retirement stool — more than earnings, savings or pensions. Workers need to wake up to the reality that Social Security is vital for their retirement finances.”

Others, including Jason Fichtner, Ph.D., a senior research fellow at the Mercatus Center at George Mason University, are of the same opinion. He noted that 66% of all beneficiaries now rely on Social Security for 50% or more of their income in retirement, while 35% rely on benefits for 90% or more of their income.

For non-married beneficiaries, which includes widows and widowers, the numbers are even more staggering, Fichtner said. Some 73% rely on benefit payments for 50% or more of their income and 43% rely on Social Security for 90% or more of their income. See the chart on page 7 of Fast Facts & Figures, which shows the percentage of aged units receiving Social Security benefits, by relative importance of benefits to total income relative importance of Social Security benefits. (In addition to that chart, Fichtner said he tends to focuses on three other charts when reading Fast Facts & Figures: Receipt of Income, 1962 and 2009; Shares of Aggregate Income, 1962 and 2009; and Relative Importance of Social Security, 2009.)

Not surprisingly, a spokesperson for AARP, the lobbying group for older Americans and which recently called on Congress to protect Social Security benefits, had these observations about Fast Facts & Figures: “The report shows that Social Security is the single greatest source of aggregate income for retirees, and represents a greater share of aggregate retirement income today than it did in 1962,” said Cristina Martin-Firvida, AARP director of Financial Security and Consumer Affairs.

By contrast, she said the share from earnings in 2009 is about the same as it was in 1962, and the share from asset income is lower (15% in 1962 and 11% in 2009). “Undoubtedly, an unpromising job market, depressed housing values, and an unstable equities market have all made retirement today less financially secure,” said Martin-Firvida. “This data underscores the critical importance of maintaining the earned, guaranteed and inflation-protected benefit that Social Security offers Americans in retirement.”

Earned income is a big source of income too

While Social Security represents a large percentage of total income for older Americans, earned income is an important source of income as well. In fact, at 29%, it represents the second largest source of total income for Americans aged 65 and older in 2009. The odd thing about earned income, however, is that the percent of total income that earnings represented in 2009 is about the same as it was in 1962.

But those numbers don’t tell the whole story. According to Fichtner, the percentage of ‘aged units’ (basically those age 65 or over) that report receiving ‘earnings’ was only 26% in 2009, down from 36% in 1962 — while the percentage of people 65 or over receiving Social Security has rapidly increased to 87% in 2009 from 69% in 1962. “What this tells you is that Social Security benefits are now a universal income source for those Americans age 65 and over,” he said. “And, it’s a very important source of income to keep people out of poverty.”

Not all that big a benefit

While Social Security represents a large percent of income for older Americans, the actual amount of the benefit seems somewhat small, according to Alicia Munnell, the director of the Center for Retirement Research at Boston College. The average Social Security benefit amount for new awards in 2010 was $1,193 per month, or $14,316 per year according to Fast Facts & Figures.

According Janet Barr, the chairperson of the American Academy of Actuaries Social Security Committee, Americans preparing for retirement should take the time to learn how their Social Security benefit could be affected by the decision of when to retire.

By delaying retirement, the Social Security benefit amount goes up due to additional earnings and years of service, Barr said. It also increases because an early retirement reduction is not applied (5% or 6.66% per year before Normal Retirement Age or what some call Full Retirement Age or FRA).

In cases when retirement is delayed beyond the Normal Retirement Age, a delayed retirement credit also increases the benefit amount (8% per year after Normal Retirement Age), she said.

“Waiting a few years to retire could provide a 25% increase in benefit, which would boost a $1,200 per month benefit to $1,500 per month,” said Barr.

No increase in OASI filings

The economy is down and the unemployment rate is still high. But the number of people applying for Social Security is flat, according to Landis’ read of Facts & Figures.

“One thing that surprised me is that the number of OASI (The Old Age Survivors Insurance, meaning retirees and survivors) claims were the same in 2009 and 2010 (4.7 million in both year),” said, Landis. “I would have thought with all the unemployed, more people would be filing for retirement. Not so. The data show that retirement-age workers are hanging onto their jobs rather than retiring and filing for Social Security — perhaps a fair measure of financial readiness for retirement, or lack thereof.”

Disability claims and SSI public assistance claims are up

On the contrary, Landis noted that disability claims are up, as are SSI public assistance claims. And to some, including John Laitner, the director of the University of Michigan Retirement Research Center, that spells trouble.

The Old Age Survivors Insurance (OASI) fund, from which retirement benefits are paid, continues to grow modestly, Laitner said. The OASI fund is expected to grow from $2.4 trillion in 2010 to an estimated $2.5 trillion in 2011. (See page 3 of Facts & Figures.) But the Disability Insurance (DI) trust fund is shrinking, and has reached a very low level. The DI fund is expected to fall from $180 billion in 2010 to an estimated $154 billion in 2011.

What’s more, disability awards have grown faster since 1970 than those for retirees, Laitner said. The annual number of awards to disabled retired workers rose from 1.3 million in 1970 to 2.6 million in 2010, while for disabled workers it increased from 350,000 in 1970 to 1 million in 2010. And if that wasn’t bad enough, the average age of retired beneficiaries has risen slightly since 1960, but the average age of disabled beneficiaries has fallen.

According to Facts & Figures: “The average age of disabled-worker beneficiaries in current-payment status has declined substantially since 1960, when DI benefits first became available to persons younger than age 50. In that year, the average age of a disabled worker was 57.2 years. The rapid drop in average age in the following years reflects a growing number of awards to workers under 50. By 1995, the average age had fallen to a low of 49.8, and by 2010, it had risen to 52.8. By contrast, the average age of retired workers has changed little over time, rising from 72.4 in 1960 to 73.7 in 2010.” (See page 17.)

Said Laitner: “In my opinion, long-run concerns about the financial solvency of both OASI and DI are warranted, but between the two, DI seems to raise the most immediate alarm.”

Elderly households not slipping behind

After correcting for inflation, both married couples and singles in 2009 have roughly double the income of those aged 65 and older in 1962. According to Facts & Figures, the median income of a married couple aged 65 or older was $43,114 in 2010, up 111% from $20,424 in 1962.

By contrast, wage growth has lagged in past decades, said Laitner. According to the Economic Report of the President for 2011, average wage and salary income for 25-65 year old college graduates rose, after correcting for inflation, 60% from about $50,000 in 1963 to about $80,000 in 2009. And that high school graduate wage and salary income showed almost no gain for the same period.

“We all wish that economic growth could be faster,” said Laitner. “Nevertheless, the data offers some reassurance that elderly households are not slipping behind younger households in a difficult period.”

More than a retirement program

Another often overlooked fact about Social Security is that it’s much more than a retirement program, said Munnell. “Some 31% of benefits go to those under 62,” she said.

Here’s the breakdown according to Fast Fact & Figures: There are more than 54 million beneficiaries in current-payment status. And 64% of those beneficiaries were retired workers and 15% were disabled workers. The remaining 21% were survivors or the spouses and children of retired or disabled workers.

Room to raise the maximum annual wage base

Experts often recommend a combination of increasing taxes and lowering benefits as a way to save Social Security from going bankrupt. And one of the ways to increase taxes has to do with maximum annual wage base subject to Social Security tax. For 2011, the wage base subject to Social Security tax is $106,800, which is the same as what it was in 2009 and 2010.

Given his read of Facts & Figures, Landis figures Uncle Sam has some leeway to raise the maximum wage base. “One issue being discussed today is the growing wealth gap between the top quintile and all other quintiles,” said Landis. “The Social Security taxable earnings ceiling — $106,800 this year — sheds some light here: It has not kept pace with higher incomes. Currently about 84% of all earnings are taxable for Social Security, trending steadily downward from 89% in 1990. That leaves some ‘headroom’ to raise the earnings ceiling to capture more earnings, strengthening Social Security’s solvency.”

The payroll tax gift

One other item of note about Fast Facts & Figures is this: The publication reports that the Social Security payroll tax is normally 6.2% for OASI and DI combined. A special provision has lowered this to 4.2% for 2011. Said Munnell: “The employee payroll tax is 2 percentage points lower than employer (for 2011). Does everybody know they’re getting a tax cut?”

In other words, keep on working. “Actuaries and other retirement experts suggest that those close to retirement might want to continue to work in 2011 to take advantage of the lower tax rate,” said Barr. “Their Social Security benefit amount will not be impacted by the lower tax rate since general revenue reimburses Social Security for the lower tax rate.”

Longer life expectancy

Social Security actuarial studies show that Americans are living longer after reaching age 65 than they have in the past. “Because of this, actuaries have said that we need to either save more for retirement or work longer than we have in the past,” said Barr, who also noted that the American Academy of Actuaries often points to the traditional model of a three-legged stool for a secure retirement — Social Security, employer-sponsored plans and personal savings. “All three elements need to work together to support a longer life expectancy,” she said. “Retirees should not rely on only one leg of the stool to support their entire retirement. As you said, this means they may need to consider working longer or saving more.”

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Increasing the Retirement Age

April 13th, 2011

Most governments are already planning on increasing the retirement age.   America is heading for 67, Britain for 68.  It’s a painful truth that many of us will be chained to our desks longer than we ever expected.  With people living longer, and poor investment returns, we may have to put aside the cruise brochures and golf clubs for a few more years.  Many governments are dealing with this problem by announcing  increases in the official retirement age in an attempt to hold down the costs of state pensions.  Unfortunately, even the boldest plans look inadequate.

Since 1971 the life expectancy of the average 65-year-old in the U.S. has improved 4 to 5 years.  By 2050, forecasts suggest, they will add another three years on top of that.  Until now, people have converted all that extra lifetime into leisure time.

Trying, but not hard enough

Living longer and retiring early may not be a problem if there were an increasing supply of workers.  But declining fertility rates imply that by 2050 there will only be 2.6 American workers supporting each pensioner.  There won’t be enough young workers to keep the already troubled system going.  Economic growth is a function of the size of the workforce, the amount of capital employed and the rise in productivity.  If the workforce shrinks, as domography shows it will, all the growth will have to come from capital investment and productivity improvements.  In Japan, where the working population is already getting smaller, economic growth has been miniscule, despite a good productivity record.  To counteract a shrinking workforce, retirement age will need to be raised.

There are some advantages??

Working longer does have three advantages (if you want to look at it that way).  1.  The employee gets more years of wages and can save more money.  2.  The government receives more in taxes and pays out less in benefits.  3.  The economy grows faster as more people work longer.  Yet many people worry that if workers stay longer, there won’t be enough jobs to go around.  Others have concerns that older workers aren’t as productive as younger workers.  But in a knowledge based job, this isn’t as big of an issue.  Older workers have more experience and, by and large, better personal skills.  Even so, pay will need to reflect productivity.  Traditional pay based on job seniority and time on the job will likely need to change.

Pension problems

In the private sector, the pension problem is being dealt with.  Rarely are new employees ever offered a pension anymore.  But in the public sector, pensions are still a common benefit for most.  The deficits in our public pension system here in America amount to $3 trillion.  Legal and constitutional constraints prevent the government from changing what has already been promised.  But as this problem worsens, politicians are going to have to do something to change laws and constitutions.

I would welcome your comments on possible solutions to this increasing the retirement age issue.

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Why Do I Need A Will, Living Will and POA?

May 21st, 2010

You may have asked yourself the question, “Why do I need a will?”   If so, you’re not alone.  According to a Harris Interactive survey done in 2007, about 55% of all adult Americans do not have a will.  This article will discuss a few of the most basic estate planning documents that everyone should have. 

Will

A will is probably the most important document that you’ll ever sign.  Among other things, it determines who gets your possessions when you die, things like your cars, house and personal property.  If you don’t have one, the probate court will decide who gets your things, and also who will take care of your children.  There may be someone in your family who you would prefer to take care of your children, and there may be someone else who you really DON’T want to have your kids.  These are decisions not to be left to a judge.  A will does NOT determine who gets your IRA’s, annuities, or life insurance death benefits.  Those types of accounts have beneficiaries named on them, and are NOT directed by a will.  In fact, you need to make sure your beneficiary designations are correct.  Even if your will is more current than your beneficiary designations, the beneficiaries named on IRAs and life insurance is who will get that money.

Living Will

A living will is a document in which you state your wishes regarding medical treatment, especially treatment that sustains or prolongs life by extraordinary means (life support).  This document is used when the signer becomes mentally incompetent or unable to communicate (such as a coma).  If you don’t have this document, the doctors are going to keep you alive as long as possible.  It will then turn into a court battle if your family feels that it is better to take you off of life support.  If you are married, your spouse may feel differently than your parents do about it, so then you have a family feud/court battle going (remember the Terri Shaivo case?).  Having this document written up in advance will save everyone a lot of guessing and heartache.

Power of Attorney (POA)

This is a document that is also very important to have.  It gives someone else permission to make financial and legal transactions in your behalf.  So obviously, your POA needs to be someone that you trust very much.  It can either be a Durable POA, which means that person can sign things for you at any time, or a Springing POA, which means that it only comes into effect if you become incapacitated.

These are a few of the most important legal documents that are important for everyone to have.  For these simple documents you can use a website like www.legalzoom.com or even an off-the-shelf software like Quicken Willmaker Plus 2010  for under $50.  However you get them done, the most important thing is just GETTING THEM DONE!

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Investing Is Like Losing Weight

May 19th, 2010

Losing weight is pretty simple, right?  Eat less and move more, and you’ll lose weight.  So if losing weight is so easy, then why are so many of struggling to lose our extra pounds? 

In a similar way, investing in the stock market is pretty simple too.  Buy stocks or stock funds and hold onto them for 20 years.  History has shown that if you just do that, you’ll make money and be successful.  Well if its that easy, then why do so many people end up with investment returns far below the overall market?

Maybe the answer to both questions is about the same.  The answer is, “It’s not as easy as it sounds.” 

When it comes to weight loss, there are a lot of road blocks that make it hard to be successful.  Just to name a few:  chocolate, oreos, ice cream, enormous serving sizes at most restaurants, and a busy schedule that makes it hard to find time to exercise.

When it comes to investing, there are just as many road blocks that keep most people from staying ahead of the market.  Here are a few of the main things that stand in investors way:

1.  Emotions.  Emotions are one of the main drivers of stock market prices.  But your emotions can also be one of your biggest road blocks.  The specific emotions I’m talking about are fear and greed.  When the market is up 70% like it’s been in the last year, people’s greed leads them to buying more and more, even at sky high prices.  This additional buying can push the market higher for a time, but eventually the steam runs out and it goes back down.  Then when the market it way down and people are losing money, their fear kicks in and tells them to sell before they lose it all.  All the selling pushes prices down further and faster until the selling runs out of steam, and then it heads back up again.  I can’t tell you how many people have said to me, “When I buy something it goes down, and when I sell something, it goes up.”  If this seems to happen to you a lot, then your emotions may be getting the best of your investments.

2.  Conflicts of Interest.  Many of you have heard me talk about this before, but I feel that it’s a big enough road block that I’m going to keep talking about it, sorry. :)  Investors out there are getting a lot of advice from commission driven brokers and insurance sales people.  Most people want to believe that others are honest and will in turn trust the advice they are given, especially when it’s coming from “an expert”.  But what they don’t realize is that “expert” may have a sales manager looking over his or her shoulder making sure that he or she is meeting the company’s sales goals.  Often, the pressure to sell, and the commissions that are paid, are too much for an advisor to resist when it comes to giving advice.  What ends up happening is the client gets “sold” something that is in the best interest of the broker/advisor, and not in the best interest of the client.  For this reason, it’s EXTREMELY important that as an investor, you ask for full disclosure of potential conflicts of interest your advisor may have.  Is he getting a commission from the sale?  Is there an incentive trip involved with the sale of this product?  Is he or she required to meet certain sales goals each quarter or year?  I’m not saying these things are bad.  I’m just saying that if you are aware that there are possible conflicts of interest, you will be more inclined to do some more homework or ask for a second opinion before you make a decision.

People can lose weight, and they do.  Studies have shown that people are more successful at losing weight when a close friend, family member or coach is helping to remove the obstacles in your way.  People can also be successful investors in the stock market.  Having a trusted advisor who can help you control your emotions, and who has your best interest in mind will help eliminate the road blocks that stop you from achieving your goals.

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Should I Hire A Money Manager?

April 23rd, 2010

Many people wonder if it would be worth it to hire a professional money manager.  Managing your own money isn’t exactly rocket science, but there are many pitfalls that can get you into trouble.  Working with a professional can help you avoid many of these dangers.  Here’s a couple of the big ones, and then a short test that everyone should take:

Emotional Investing

Investing according to your gut is one of the most dangerous things you can do.  When the market it way up and you see double or triple digit returns, your gut tells you to buy.  When the market is tanking into the abyss and you’re losing lots of money, your guts tells you to sell.  So if you follow your gut, you’re buying HIGH and selling LOW!  I can’t tell you how many hundreds of people have told me they do just that!  A money manager can take some of the emotions out of the process, or talk you away from the ledge, and hopefully avoid this common trap.

Chasing Returns

This is really related to emotional investing, but it happens more often.  You look at your holdings and the Morningstar reports on the funds you own.  You see that you have some dogs (1, 2, or 3-star funds), and you decide it would be better to buy some 5-star funds.  So you sell your dogs and buy some hot funds that have been way up in the last year.  Seems like the right thing to do, right?  Wrong.  What you’re really doing here is once again, selling LOW and buying HIGH.  You’re selling something that has underperformed the market, and buying something that is already way up and has been outperforming the market.  Things go in cylces.  A money manager can help you construct an all-weather portfolio.

The Test

I call this the money management T-I-R-E-D test, to help you decide if you’re tired of managing your own money.

T – Time.  Do you have the time it takes to properly manage your money?  Doing investment research, evaluating your holdings, calculating rebalancing changes, making the changes, keeping up with tax law changes, updating beneficiaries and account information, reviewing your insurance holdings…it all takes a lot of time, and time is money.

I – Inclination.  Do you really enjoy managing your investments?  Most people would rather eat shards of broken glass than read a mutual fund prospectus.  You really can’t blame them, they are written by attorneys.  But even if you do enjoy researching and reading about investment products, trends and strategies, is it really what you want to do with your free time?  Or would you rather be playing golf, working in the garden, watching your kid play a sport, or spending time with the grandkids?  No matter what it is, if you don’t like doing it, you probably won’t do it.  And your investments are something you really should not ignore.

R – Research.  Do you feel that you have access to the kinds of research that you need to manage your money most effectively?  Reports from Morningstar, Lipper, Standard & Poors can be costly and not easy to come by.  Professional money managers also have access get on conference calls with best mutual fund managers and ask them questions about thier funds.  Having all the right information can make a world of difference.

E – Expertise.  Do you have enough expertise in the investment world to effectively manage your money?  Everyone has an area of expertise, and it makes sense to leverage your own, and others areas of expertise.  You wouldn’t hire a plumber to fix your car.  Nor would you pay your dentist to put a pool in your backyard.  A good professional money manager will easily pay for himself with the money he can save you in taxes, fees, penalties, not to mention the extra returns he can put in your portfolio.

D – Discipline.  Do you have the discipline it takes to strategically manage your own money and stick to a plan?  This one relates in part to the emotional investing discussed earlier.  It’s easy to stick to a plan when the market it up.  But when things are crazy, having a level-headed money manager to stand by you and help you makes all the difference.  To become financially independant, it takes time  and the dedication to follow a disciplined strategy.  Having someone to keep you accountable and make sure you stick to your plan can really help.

If you answered NO to any of these questions, then it would be good idea for you to find a money manager whom you could work well with.  The annual fee that you would pay them to help you with this most important task will be well worth it.  I have found in my 15+ years of doing personal financial planning, that I can usually increase a clients returns by at least 2-3% even after my fee comes out.  But the best part for the client is that they no longer have to worry about it at all.

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Special-Needs Financial Planning

April 6th, 2010

Personal financial planning for families with special-needs members is becoming more and more crucial.  According to the 2000 U.S. census, one in five people in this country ages 5 to 64 have some type of disability.  The number of people with disabilities is growing.  No one knows if this is due to more accurate diagnosis, or something in the environment, or both.  For example, autism, once considered rare, now is diagnosed in one out of 125 births – and one out of 70 boys!  People with disabilities are living longer and more productive lives, which means they need more long-term care.

Challenges

Many parents of disabled children are not sure of the best way to plan for their family’s needs.  Two of the biggest challenges these family’s face is first, how much money will be needed to care for their child; and second, who will take care of the child when the parents are gone.  Family members often feel that the best thing they can do is to open an account in the disabled childs name and put as much in it as possible.  While it is wise to save as much as you can for this person, having it in their name can cause problems when you later try to apply for Social Security, Medicaid, and all kinds of other social programs that are available to them.

Most people with disabilities cannot get their own health insurance.  If they are able to buy it, it’s very expensive and will come with pre-existing conditions exclusions.  The maximum coverage amounts are also often too low.  Because of this, many of these people end up having to apply for Medicaid.  With Medicaid they lose the ability to see any provider that they want to, and they often can’t go to the specialists that they really need to see.

Solutions

If you have a special-needs family member, the first thing you should do is to sit down with a financial advisor who is familiar with this type of planning.  This type of personal financial planning involves a mix of social work, life coaching, and finances.  It will also involve working with a special-needs attorney to draft the proper documents that will protect your loved one and your resources.  A good attorney like this will be able to give a lot of direction on things you can do to protect your family.

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The Perfect Storm – Part 3

September 30th, 2009

south-pacific-tsunamiWe saw today the effects that a tsunami in the south pacific can have on a civilization, which can be devastating.  My heart goes out to these people and I pray that the people affected will be ok.  I know that there are many LDS families in Samoa.  My great, great grandfather joined the church while living in Samoa many years ago.

Much like this tsunami has had a crushing and devestating impact on people’s lives in Samoa, the financial tsunami now known as the great recession is currently upon us all.   The factors that caused this recession were like the earthquake that caused the tsunami.  Once the earthquake happens, that wave is coming at you no matter what.  And there is nothing anyone can do to stop it.

This is the last of a 3-part series in discussing the factors that have contributed to this great recession we are in.  You can view Part 2 Here. and you can view Part 1 Here. 

When doing personal financial planning with an LDS financial advisor, you have to take steps to prepare yourself for these types of economic situations.  They kinds of things are sure to happen again in the future, and you can start preparing yourself now for it.  I would welcome any comments you may have about this topic.

Today I will discuss the last 3 factors that I feel have contributed to this current recession, which are:  Credit default swaps, unemployment, and the stock market.

Credit Default Swaps

This is something that most of you had probably never heard prior to this mess.  In my 15 years of personal financial planning, I had never heard of them until a few years ago.  A credit default swap is similar to an insurance policy that is supposed to protect the buyer from losing money.  A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if a credit instrument (typically a swap or loan) goes into swap (fails to pay). Less commonly, the credit event that triggers the payoff can be a company undergoing restructuring, bankruptcy, or even just having its credit rating downgraded.

There are some differences between a CDS and real insurance though.  With insurance, the buyer of the policy typically has some insurable interest such as owning the debt that he is insuring.  With a CDS, the buyer doesn’t even have to own the security.  Sellers of CDS’s do not need to be regulated entities, and do not have to keep reserves to pay off buyers.  However, major CDS sellers are subject to bank capital requirements.

One of the largest sellers of CDS’s was AIG, and they were selling a lot of them that were designed to insure against losses in mortgage securities.  When the mortgages started to blow up, everyone was coming to AIG to get paid, and they couldn’t pay them.  They didn’t have enough money to pay everyone they had sold them to.  You all know how the government stepped in to bail them out and cover their losses with tax payer dollars.

Unemployment

This is always a part of a recession, as businesses struggle and close up shop, people lose jobs.  As they lose jobs, they have less money to spend.  Since most of our economy stands on the back of consumer spending, more businesses start to struggle.  Then more businesses start to make cutbacks, and more jobs are lost.  It’s a downward spiral that won’t stop until things finally hit bottom and equalize.  In August 2009, the unemployment rate rose to 9.7% with 14.9 million people being unemployed.  Since this recession started in December 2007, the number of people who are unemployed has risen by 7.4 million and the unemployment rate has risen 4.8%.  So this is obviously affecting a lot of people, and you can see why there is so much less money being spent by consumers.

Stock Market

Some people may think that the stock market crashing causes recessions to start, and that recoveries make them end.  While there is definitely a correlation to the performance of the stock market and the economic cycles, the market doesn’t really cause recessions to start or end.  I would say that instead, the stock market is a good indicator of where we are at in an economic boom or recession.  There is certainly a relationship between the two.  The stock market peaked in November 2007.  When markets near high points, you might be surprised to know that those are the times that more people are adding new money into the market.  Stock mutual fund in-flows usually peak at about the same time that the market is peaking.  And when the market bottoms out, that’s when most people are taking money out of the market.  That’s just the time that you should be putting money back in.  But psycologically, it’s very difficult for someone to sell their stocks when they’re hitting highs, or buy them when they’re hitting lows.

This peaking out of the stock market in late 2007 was just another sign that a big correction was coming.  And there was nothing that anyone could do to stop it.

People ask me all the time, “Mark, why is it that when I buy something it goes down, and when I sell it, it goes back up?”  It’s really very strange how this happens to almost all individual investors.  This is one major benefit to hiring a professional money manager to help you manage your investments.  That person can take a lot of the emotion out of the investment process which helps them to do the opposite of what your gut tells you to do.  As the market hits highs, your advisor can take profits and rebalance your portfolio to protect money that you have made.  Then, when the stocks decrease in value, he or she can add more money to them at the the time when you should be buying more.

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Posted in Economy, Financial Planning, Recession, Retirement Planning

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Consumers Lack Personal Financial Planning, Survey Says

September 25th, 2009

personal-financial-planningPlanning for retirement remains a top concern for many Americans, but that hasn’t resulted in a greater reliance on financial planners.

This year’s National Consumer Survey on Personal Finance by the CFP Board of Standards suggests the nation’s advisors have a big void to fill when it comes to the way the public is preparing for retirement.

The survey of 1,742 consumers found that 51% of respondents listed building a retirement fund as one of their most important financial concerns. Forty percent cited managing retirement income.

Yet 64% of respondents said they did not have a financial plan, and only 17% said they have a financial plan that they update regularly.

“These results tell us that Americans of every type of background and income level think carefully about their assets and how to improve their financial state,” said Eleanor Blayney, consumer advocate for the CFP Board. “We also see that many lack an understanding that everyone can benefit from having a financial plan, regardless of one’s wealth or social status.”

Among the reasons cited for not having a financial plan were the expense of hiring an advisor, the feeling by some that their financial situation wasn’t complicated enough to merit professional involvement and confusion over the qualifications of financial intermediaries. Forty percent said they were not aware of any credentials for financial professionals.

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The Perfect Storm – Part 1

September 24th, 2009

perfect-stormMany families have been asking their LDS financial advisor what factors contributed to the great recession that we are currently experiencing.  This is a very good question because there are a lot of contributing factors, many of which have been brewing for years.  This three part series will discuss the major factors.

Globalization

The North America Free Trade Agreement (NAFTA) went into effect on Jan 1, 1994.  This was an agreement between the United States, Canada & Mexico that was meant to open up trade between these countries.  The idea of this globalization was that if we bought products from Mexico we would raise their standard of living, and eventually they would all start buying more products from us.  While this agreement did increase trade between the countries, the long term effects have been somewhat damaging to us.  Currently we buy as a country about $1 Trillion in goods per year from other countries, and we sell about $200 Billion of our good to them.  That’s a trade deficit of about $800 Billion per year.  Why is this?  Because we don’t really have anything to sell to them.  Everything is now made in other countries like Mexico, China & India where labor costs are so much cheaper.  Why would they buy things from us when they already have it, and they make it, and it’s cheap.  This has made our country very dependent on other producing countries for goods that we need.  It has also weakened us financially.

Low Savings

Currently the United States is the richest country in the world, but we have the lowest personal savings rate in the world.  In China the personal savings rate is 30%, in Japan it’s 16%, and Germany saves about 12%.  Up until 1989 our savings rate was 11%.  Today we are at -1%.  That’s right, people are spending  ALL of their income and then some every year.  Because of inflation, today’s wages are the same as they were 20 years ago.  Yet our standard of living has increased dramatically.  How is that possible?  Today about 90% of couples under the age of 50 have both spouses working.  We’ve also been using home equity, credit cards, and our savings to maintain our standard of living.

It used to be that people set up sinking funds to pay for purchases like new cars, vacations, Christmas, etc.  They would set aside a little money into their separate sinking fund account each month so that when it was time to go on the vacation the money was there.  Today, people just put it on the credit card or get a loan for it, and then make monthly payments on it (with interest).  This lack of savings has made our country very vulnerable to financial crisis.

Cheap Money

The Federal Reserve started making it very easy to borrow money when they reduced interest rates to near zero levels.  This was an effort to “prime the pump” and get money flowing, and it worked.  Banks were able to borrow money from the government at 1% interest rates, and then lend it back out in the form of home mortgages at 5 – 6% rates.  They were making money hand over fist, and Wall Street was getting flooded with mortgages.  So many mortgages in fact, that something had to be done to deal with all of them.

Deregulation

During this same time there was much less reguation going on in the banking industry.  With a lack of regulation, many banks got greedy and started giving loans to people who really shouldn’t have had them.  People got really good at falsifying loan documents in order to get a loan.  This is where the NINJA loans started to run wild.  NINJA stands for No Income, No Job or Assets.  Here’s how they worked.  Lets say a person comes in looking for a loan to buy a house and they have an income of $5,000 per year.  The mortgage officer might have said something like, “Well lets just put an extra zero on the end of that income and make it $50,000, since a zero isn’t worth anything anyway.”  “And you don’t have a job, you just watch TV all day?  Let’s put down that you’re an entertainment executive with Dish Network.” and so forth.  These were the kinds of people who the banks were lending out cheap money to on a daily basis.  Can you see how this was setting us up for the big crash?

Look for “The Perfect Storm – Part 2″ for more on this topic.

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Posted in Credit, Debt Reduction, Economy, Financial Planning, Recession, Retirement Planning

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Don’t be fooled by an imitation!

September 22nd, 2009

Jays_Potato_Chips

My wife and I had been married for a few years when the Lays potato chip company came out with their new “Baked Lays” brand.  I really liked these chips but they were a lot more expensive than regular chips, so we didn’t buy them that often.  One day I was in a discount store similar to Dollar General when I saw great big bags of Baked Lays for only $2 each.  I was excited about my value discovery, grabbed 2 bags and headed to the register.  By the time I got home I had already opened a bag and was enjoying my bargain bag of chips.  They weren’t as good as I had remembered them being, but I didn’t care.  I proudly showed the bags to my wife and was patting myself on the back about finding such a deal when she said, “Uh honey, those aren’t Baked Lays, they’re Baked Jays.”  I looked more closely at the bag and my pride sank.  The logo looked a lot like the Baked Lays logo with similar cursive writing and the same colors, but it was different.  She was right again!  Suddenly I also realized why the chips really weren’t that good, to which my wife also agreed.  I had been duped by a cheap imitation.

Don’t let this happen to you when doing your personal financial planning.  Many people in the financial services industry today want to offer you a cheap imitation for a personal financial plan.  There are so many titles that people use to imply that they are an expert in financial planning that it’s hard for the average person to know who they’re really dealing with.  Many of these people want to offer you a free review or analysis of your portfolio.  While on the outside it may seem like the price is right, this can often be a slick way to try and sell you some products.

Make sure you understand clearly how the person is going to be compensated by your business, and whether or not there are any conflicts of interest involved.  There is nothing wrong with someone earning a commission on a sale, but you want to be sure that they are keeping your best interests first.  One way to ensure that this will happen is to work with a Certified Financial Planner.  These individuals must act as a fiduciary for you, or in other words, place your interests ahead of their own at all times.  They also much disclose any conflicts of interest in the relationship.  Having it all out on the table will help to make sure you don’t end up with a financial bag of “Baked Jays”.

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Posted in Financial Planning, Retirement Planning

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