>Who’s Preying on Your Grandparents? – New York Times

>Who’s Preying on Your Grandparents? – New York Times

A great article on the annuity industry and how they are taking advantage of our senior citizens. I have severl clients who have been sold junk products from companies like American Equity Investment by slick salespeople who have no regard for doing what is right. The only interest is in generating a commision.

I don’t believe annuities are all bad, but the vast majority are and you should be very weary before purchasing one. A client of mine was sold the exact same annuity mentioned in this article and is now stuck for 17 years in it – of course I won’t stand for that, I’ll get her out even if it means suing the company.



>United Air Wins Right to Default on Its Employee Pension Plans – New York Times

>United Air Wins Right to Default on Its Employee Pension Plans – New York Times

Are the dominoes beginning to fall on Corporate Defined Benefit Plans? It sure seems that way as United Airlines successfully defaulted on its pension plan in bankruptcy court yesterday. Many of you are probably thinking to yourself “so what, this has no effect on me.” You would be wrong in that thinking. Contrary to what you may have heard the retirees of United will not lose their pension, but many of the retirees will recieve a much lower payout. The reason for this is that pensions in America are backed by a governement entity called the PBGC or Pension Benefit Guaranty Corporation. The PBGC takes over “underfunded” or defaulted pensions and continues to make the payments so that retirees still have an income. So whats the problem?

The PBGC is itself heavily underfunded by over $23 billion dollars and this is before taking into account the fact that pension programs in the US are underfunded by over $450 billion, some of which will filter down to become PBGC funding problems. The PBGC is backed by none other than you, the taxpayer. The PBGC will need a bailout at some point similar to what happen to the Savings and Loans – you, the taxpayer will foot the bill.

On the bright side it is likely that legislation will be passed in order to allow companies to spread out their pension liabilities over more years, which should help corporations keep their pension plans and not simply dump them off on the PBGC. Of course extending liabilities without new strucutural solutions would simply be another piece of bad legislation. In addition, any bailout of the PBGC will not likely affect our budget deficits too much, after all what’s another $50 – 100 billion when you owe as much as we do (do you detect a hit of sarcasm).

The brightest spot however is that we have a strong economy and strong prospects for the future (despite what you hear on television every day). A growing economy leads to a growing stock market which leads to a reduction in underfunded pensions (ironically though it was the growing stock market that led to the underfunded pension problems…..long story, don’t ask).

I am optimistic about the future of the United States economy. I fully expect that we will have bumps along the way, but am confident the bumps are only temporary. Sure, there are a lot of things that could “derail” the economy, high oil prices, high budget deficits, high trade deficits, but the fact of the matter is that there is always something that could “derail” the economy. Take a look at our history and you can find dozens of things that would make you pessismitic about America, but the pessimists are always proven wrong in the long term. Don’t get me wrong we do have strucutural problems that need to be fixed soon – Social Security and Medicare/Medicaid being the most urgent. I don’t care what party you hail from there is no doubt that if we don’t act soon our long term prospects will be much dimmer.

Ironically as the defined benefit pension plans begin to fall in the corporate sector there are signs that they are beginning to fall in the public sector as well. The Governator in California has proposed getting rid of the pension plans and replacing them with 401(k) type plans (called defined contribution plans). The thought being that the risk should be on the employee not on the taxpayer. Of course, the trend toward 401(k)’s in the public sector is not exactly a slam dunk, West Virginia just nixed the 401(k) plan it has had for their teachers since 1991 and are replacing it with…….a defined benefit pension. My personal opinion is that defined benefit pension plans will rule in the public sector for quite awhile, but their time is coming; I give them another ten years before the pensions begin to give way to 401(k) type plans.

On a completely separate note, my vote for American Idol this year Keri Underwood. Yes, she is a beautiful blond, but she has the vocals and I love country music…..

I would love to hear your feedback….

Till next time….



>Start Life In Debt and Why It Makes Sense..SS Part II

>The best thing we can do for our children right now is to put them in debt from the day they are born.

About two years ago I came up with a method for saving social security & medicare long term; actually abolishing both while still providing economic security and providing for a higher standard of living than current retirees have. I mentioned the idea to a few people, my wife included and they thought it was a great idea. The problem though was that the idea was too great, not to mention extremely costly in the short term. I shrugged the idea off as yet another great idea that would never be implemented by government.

Two years later and the nation is starting to focus again on the problems of social security and a lot of proposals are being floated around Washington. One of the proposals caught my attention because it sounded very similar to my own.

Paul O’Neil, the former Treasury Secretary for President Bush (and former CEO of Alcoa) was being interviewed by a newscaster and low and behold, Mr. O’Neil was talking about a plan very similar to what I had come up with a few years back. A story by the Washington Bureau captured the genesis of his idea:

“To move away from Social Security’s chronic funding problems, O’Neill suggests that the government put $2,000 in a special investment account for every newborn American. The government would invest $2,000 more each year until the child reaches 18.
The money would be invested in a conservative index of stocks and bonds and couldn’t be touched until retirement. The investment would grow at a compounded rate, meaning that as the value of assets in the account grows, profit would be reinvested so the account would grow even more. Without adding a single cent beyond compounding after the child turns 18, he or she would retire at age 65 with $1,013,326 in the account, O’Neill reckons.

“If you do the arithmetic, the $1 million would provide an annuity of $82,000 a year for 20 years,” O’Neill said in an interview.”

My idea was slightly different. I would have the government loan each child born a much higher amount, giving them a lump-sum instead of payments for 18 years. This gives the money more time to compound and grow. The stock market tends to go up more than it goes down, thus a lump-sum of a similar amount, say $36,000 would grow to about $5,000,000 by the time the child retired at 65.

This would provide an inflation adjusted income of about $31,000 in today’s dollars, with the ability to leave money to heirs. The other thing that is different about my plan is that the government is not “giving” the child anything except a government subsidized loan. The child would be required to pay it back once they begin working. Instead of paying into social security, which would amount to 12.4% of their potential income, they would be paying off the loan instead. Even a person at minimum wage could end up paying off the loan during their life very easily and not pay nearly the rate of 12.4%, plus they would have the benefit of an account with a huge growing balance. Imagine having the opportunity to retire with more money than you made during your working years. This plan would benefit low-income workers without subjecting them to welfare.

Are there some flaws with my plan? Sure. It would require a ton of borrowing, the details would be a little more complex, and we would need to figure out a way to take care of the disabled, widowed, and survivors. But these are problems that would be easily overcome. The best thing we can do for our children right now is to put them in debt from the day they are born. The public in America has a love affair with debt, as does the federal government, isn’t it about time that we started using debt in a much more powerful way? Of course an idea like this would never work on capitol hill; it’s too good of an idea and the government usually rejects those. I applaud Paul O’Neil and his idea and hope the congress will see that meaningful reform in the long term will lessen welfare, increase economic security, and grow the economy while empowering people.

Until Next Time……



>The Rise of Interest Rates

>For nearly two years I have predicted interest rates will rise. Of course I was not alone in my prediction, pretty much everybody thought the same. We were all wrong for nearly two years, which just goes to prove you can be right about something, just not right about when it will happen. For example, I could predict that American will have another terrorist attack, but if I can’t tell you when, am I really making a prediction?

Short term interest rates have actually been rising for the past year, at the end of March last year the 90 day treasury bill was yielding .96%, which meant money market accounts were yielding about half that, some of them yielding nothing. However, as of yesterday the 90 day treasury bill was yielding 2.70% and you can get a money market account paying 3.25% at www.emigrant-direct.com. In other words, short term rates have nearly tripled in the last year. This marks one of the fastest rises of short term interest rates in history.

Long term interest rates on the other hand stayed pretty much the same throughout the year. The ten-year for a short period jumped up to the 4.80% range, but then quickly fell back down to the 4% level and didn’t budge…….that is until February. Since February the ten-year treasury has risen to 4.63% (as of 3/22/05), not a huge rise, but one worth noting as it will add nearly 3/4 pt to a mortgage loan.

The real question is whether or not the trend will continue. It appears that if Greenspan has his way it will. What most people don’t know is that Greenspan mostly has control over short term rates, long term rates are determined more by the market than what Greenspan wants. Thus there is the possibility that short term rates could continue to rise, while long term rates stay in the mid 4 – 5% range. This would actually hold the best of both worlds scenarios, good returns on short term bonds, and good rates on mortgages. My first mortgage was 7.75% and I thought I was getting an incredible deal, of course my loan was only $163,000. If rates rise I think new home buyers will still be able to squeeze into a home, but they will start having a harder and harder time.

What does this mean for your portfolio? Well, your bonds and bond funds will take short term hits to their principal, but will start earning higher interest rates as interest and maturing bonds are reinvested into new bonds paying higher rates – in the long run rising rates are good for bonds and bond funds especially (despite what most illiterate financial advisors will tell you).

There it is, my treatise on interest rates for the end of the 1st quarter, nothing fancy, but things are starting to look up……rates that is!

Till next time,



>Does Diversification Always Work? Why Most People Would Have Fired Me……

>I build diversified portfolio’s for my clients. This means that I have my clients buy all sorts of different types of investments. A typical portfolio will have large stocks, small stocks, value stocks, growth stocks, & international stocks along with bonds. Diversification is the bedrock of investing and serves to give you a similar (hopefully better) return than the market with less fluctuation. But does it always work?

No. Diversification doesn’t always work. There will be time periods, sometimes long time periods where the benefits of diversification do not seem readily apparent. Between 1995 and 1999 a diversified portfolio drastically underperformed the market. The market, as represented by the Russell 3000 returned an annualized 26.95% between 1995 – 1999, an incredible run. A well diversified portfolio that held international stocks returned about 16% annually, a great return, but over 10% less than the overall market. How enthused with a diversified portfolio would you have been after five years of drastic underperformance? Had you invested $100,000 on January 1, 1995 you would have had nearly $330,000 if you bought the market, but only about $212,000 with a diversified portfolio – a difference of over $100,000 – would you have been happy with this differential? It is entirely likely that you would have already fired me and moved on to an advisor who was willing to put you in what was hot at the time, large cap growth stocks. Let’s consider what happened over the next five years.

Between 2000 and 2004 the market as represented by the Russell 3000 returned a negative 1.17% (that is -1.17%) annualized. A diversified portfolio during the same five year stretch annualized a 10.41% return, an outperformance of about 11%. People who invested $100,000 in a diversified portfolio on January 1, 2000 and held till the end of 2004 would have ended up with about $164,000 vs $94,000 with the market strategy. At the end of this five year period a diversified portfolio strategy would have look ingenius.

For the entire ten year stretch the market returned an annualized 12%, with a diversified portfolio a little over 13%. The diversified portfolio had a higher return, but more importantly a more consistent return. The diversified portfolio had only one down year versus three for the market. The market based portfolio fluctuated nearly 30% more than the diversified portfolio. The diversified portfolio had less fluctuation and a higher, more consistent return. In hindsight it is easy to see which would have been better, but while you are in the moment people tend to make decisions based on emotion.

What will the next five years bring us? I wish I knew, unfortunately I haven’t located the crystal ball that will tell me. What I do know is that a diversified portfolio should provide much more consistent returns with less fluctuation than the overall market, and with a higher return to boot. We may be in for a time period where the market outperforms diversified portfolios, I urge you to not follow the crowd and do what is easy. Stick with a diversified portfolio and in the long run you will be the real winner. I can’t promise we will beat the market in the short term, but in the long term I believe that a well diversified strategy combined with low costs will give you the best chance of success.

Until next time….



An Independent Fiduciary

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