Tag Archives: interest rates

The Day After the Debt Deal: Your Retirement Future

  By petillo | August 3, 2011 - 10:37 am | debt, economics, financial planning, personal finance, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025, social security
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Here we are, just a day after witnessing what President Barack Obama called a manufactured crisis. The Debt Ceiling was raised and the months of angst – mostly sensationalized in the media – are over. Now we can sit back and begin worrying about the next phase of rumblings, this time beginning with a new super Congress of 12. Can you say new deadlock?

If you are feeling anything in the aftermath of the past few weeks, it is what folks who study our brains refer to as the uneasy relationship between sensation and perception. It has been described as thus: sensation is raw and immediate while perception is categorical and slow. So let’s cleave the two and look at some of the items on the table in the coming months and how you should feel about them.

Social Security: There is no doubt a feeling among soon-to-be-retirees and those who currently are that the program will be under attack. Just what kind of cuts face this important program, often called the single, most obvious show of how our government feels about the welfare of its people, remains to be seen. The talks about what to do with this combination disability/retirement insurance, designed to keep retirees from being poor and protecting those who are at greatest risk among us, the young and disabled will not be conducted in any real civil way.

One party will dig its heels in while the other tries to explain that cuts to this program will endanger the lives of millions who cannot return to the workforce to make up for the shortfall they might experience. Changing the increases these folks get, referred to as COLA, or cost of living adjustments, is almost a moot point when you consider these increases are tied to the Consumer Price Index. What some members of Congress have suggested is a chained CPI which would draw down the benefits paid over thirty years – we’re living longer they say so 30-years, from 62 to 92 is a plausible possibility, would lower benefits over time by 8% or more. In other words, Congress would like you to die sooner rather than later and will penalize you for it if you don’t.

The younger you are the less sensational and more perception-based your opinion will be. But to those close to or currently collecting benefits, the sensation is undeniably raw and real. Put a little space between eligibility and your perception of the cuts seem only fair. After all, the younger you are, the greater the chances you have bought into the argument that SS won’t be there when you get there. It will. But in the meantime, we don’t need to tear it down based on bad projections.

Medicare: It seems as though, based on the proposals that are floating out there, more specifically the Lieberman-Coburn suggestion that seniors shop for insurance on a public exchange, that this will become a ne-party issue thus stalling the “super” Congress of 12 from reaching anything worth submitting to the full legislature. And if what I understand the bill to be, the savings are mostly no-existent.

According to Reuters: “This will discourage seniors from using outpatient services. That might cut short-term costs, but it will lead to sicker patients – and higher costs – down the road for those who haven’t received proper preventive care and early intervention.”

According to the two senators, something different: “The Lieberman/Coburn proposal will require those 65 and older who are making more than $150,000 annually ($300,000 for couples) to pay the full cost of their Medicare Part B coverage. We believe that in a time of massive federal debt and long term deficit projections, using federal tax dollars to subsidize the health insurance of high income retirees is unwise. Warren Buffett can afford to pay the full cost of his Medicare Part B insurance coverage and thousands of other wealthy seniors can as well. The Lieberman/Coburn proposal will require those well-off seniors in higher income brackets to pay the full $400+ premium for their Medicare Part B coverage.” Keep n mind, Coburn actually voted to repeal the ACA and will probably do so again if this bill gets any legs.”

According to Bloomberg: “And yet for all the collective self-loathing that attended the debt ceiling talks, it’s important to remember that, like just about everything in human behavior, it was still reducible to a game. Looked at through the prism of game theory, it’s hard to see how the outcome could have turned out any other way.”

 

The Debt Ceiling: The Five Things You Should Consider

  By petillo | July 27, 2011 - 10:22 am | 401k, bonds, debt, economics, financial planning, index funds, mortgages, personal finance, Repercussions: A Retirement Review, Retirement Planning Target 2025
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As we make the slow slog towards August 2nd and the expiration of the debt ceiling, there are a few things we should consider in advance of that date and a couple of additional thoughts in the days immediately following. Like most things, the debt ceiling expiration date is mostly arbitrary, much like the turning of a new year or the end of a quarter. In other words, 08.02.11 means little to the average person and in the days following, should not be of much concern. Here’s why.

Borrowing: We have been in one of the most favorable borrowing environments since records began being kept. If you qualify for a loan, be it a home mortgage or other big ticket purchase, the date will not change your ability to borrow. It may cost you more but prudent borrowers should have already considered this eventuality prior to beginning their purchase. Interest rates may and probably should go up if an agreement isn’t reached. The phrase “lock-it-in” will be considered sage advice as it should be. On the flip side, there is little likelihood the seller of whatever big ticket item you are purchasing may just offer additional financial incentives to offset any increased borrowing cost.

Selling: An increase in interest rates would not benefit those who believe their homes are worth a certain amount. It would stymy the housing market, slow the sale of automobiles and create a situation that most retailers have been dealing with already: more saving than spending. While less spending will not get the economy moving and certainly won’t create more jobs, despite the argument in Congress that less spending has the opposite effect. We’ll just be stuck in neutral for longer than we had hoped. But not as long as many suggest we will.

Markets, Bonds: If you are a conservative investor with money in bonds, you are much smarter than the media gives you credit. Savvy bond investors ladder their holdings for just such an event and will probably fair well. Yes, the foreign investor might become a little more cautious and the next Treasury auction will be weaker than most hope it will be. But over the long-term, the real reason folks hold bonds, the effect will be offset as time moves on. Yet, if you are in bond mutual funds, you should have little to worry about as long as your holdings aren’t too much of your portfolio. If you’re older, cash might be a better place in the interim.

Markets, Stocks: More than one person has suggested getting into much safer investments before the 08.02.11 deadline. Cash is okay but if history tells us anything, this might be amongst the worst long-term decisions you could make. Most companies could borrow if they needed to no matter what happens. But why bother. Most of the corporate debt has been refinanced to historically low levels. And most companies in the S&P 500, an index of the largest companies in the country, are flush with cash reserves. That has been the most worrisome part of the recovery: businesses could have hired, they could have afforded to hire but they didn’t. Selling stocks even if they dip somewhat should provide an opportunity to buy shares that are worth more for less. If you are buying steadily, this should prove an advantage for those with time.

You: Turn off the television or change the channel. None of what you are hearing, none of the talking heads everyone is trotting out means anything. The politicians involved in the debate are saying little or nothing and in many respects, act like this is the first time such an event has ever happened. Personally, the President should simply invoke his right in the 14th amendment and raise it without Congress. Yes, it will cause an uproar and yes, it would be the right thing to do. But creating tension among the American people is not a solution to solving some of the nation’s biggest concerns.

In the three years since the Great Recession began, you should have put all of your plan in place: reduced your personal debt, created a modicum of savings and in the process, increased your contributions to your retirement plans. If you haven’t, this will probably send the message again that your wealth is not what Washington thinks it is. You should be much more pliable and hopefully, just a tad smarter – or jaded.

Mutual Funds, Bonds, Interest Rates and Bubbles

  By petillo | January 29, 2011 - 8:29 am | 401k, bonds, debt, financial planning, mortgages, Mutual Fund Investing, Profitable Investments, Repercussions: A Retirement Review, Retirement Planning Target 2025
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Almost every investor in the country owns a bond. This ownership might be via bond mutual funds, investments in individual bonds be it corporate, government or municipal, or through the widely used target date funds. Each is prone to its own troubles.

Bond mutual funds, even though they are managed by expert managers, may be so burdened by the underlying investments as to hide or mask the trouble that may be brewing in this market.

Individual bonds are influenced by the health of a company, the ability of the government to retain its high credit rating or in the case of the municipality, pay off the debt it is owed to those who invested.

Target date funds, the darling of the auto-enrolled 401(k) participant may contain the most trouble in part because you don’t have a good bead on what is owned and in many cases, in what proportion.

There are some essential elements of a bond that many simply do not grasp to its fullest. Not the least of which is the effect that interest rates have on these investments. In short, bonds are loans and the way these borrowers pay you back is with the agreed upon interest. Many bond issuers simply refinance those bonds to pay that interest. But what if the interest rate isn’t favorable to such financial restructuring?

So let’s talk interest rates for a moment and some of the assumed beliefs you may have.

The trickle up effect

We often put a good deal of the emphasis on the Federal Reserve bank and their presumed control over all interest rates. They lend to the largest banks in what is called an overnight rate. Banks increase that rate to consumers at each level of lending, the last rung being the consumer loan for a mortgage or a personal loan.

Those rates are determined by demand, the market forces at play and in many instances, inflation and/or governmental budgetary needs (deficits). The Fed looks at money supply, the other half of the demand equation and depending on how much is circulating – too much and the interest rates remain low, too little and they increase. Sometimes.

Sometimes fear increases those rates as well. Growth forecasts and a strengthening economy normally lead to more demand for capital which leads to higher interest rates. Add to that the increasing possibility that inflation will rise as well. gives everyone who borrows the jitters. They know, should these things happen, the Fed will raise interest rates in the name of stabilizing the economy.

The emerging market conundrum

The world is global – while an oxymoron as a stand alone phrase, it represents a growth not previously seen in the decades prior to this one. Emerging economies are building at a pace that is much faster than anyone anticipated. Much of this growth is coming from China but there are numerous other economies doing the same thing on a slightly smaller scale.

The flip side of that growth is investment and investment needs money and countries, faced with growing populations who no longer worry about saving, instead shifting to spending, force borrowing. This will increase interest rates – probably sooner than we expect. many of us have experienced low interest rates for so long, we consider it to be the norm.

Consumers: should you save or should you spend?

The most common answer is to spend. Popular economic theory is that if consumers fail to spend, the economy will languish. This is actually not the whole truth. If interest rates are low, it would pay for infrastructure improvements much more cheaply than otherwise – and these improvements are necessary if corporations expect to become more efficient in their production of goods and services.

The bottom line, a healthy savings rate actually adds to the improvements that need to be made. It doesn’t suggest that folks won’t spend. But it does prompt companies – at least in theory to do a better job enticing you to do so.

Is mortgage deductibility important?

Possibly but the impact is lower and more specific than many suggest. Lower interest rates on home loans entice borrowers to buy more house than they need, refinance to increase their debt and those actions pour more money into the economy. Yet at the same time, estimates of lost revenue to the federal government have been estimated to be as high as $104 billion a year.

Raise those interest rates

No doubt, we expect interest rates to remain low. But they should be inching up. According to Richard Dobbs, director in McKinsey’s Seoul office and a director of the McKinsey Global Institute (MGI) and Susan Lund is director of research at MGI, higher interest rates would “also limit financial bubbles, restraining speculative and heavily leveraged investment while encouraging more investment that would actually raise the economy’s potential growth rate, such as expanding the country’s broadband network, developing new green technologies, and rebuilding aging infrastructure.”

The authors of that report also suggest, a rightly so, that “higher rates would also focus executives’ attention on the return that companies earn on their capital, prodding them to make sure they get more bang for each buck. This could boost the nation’s productivity, which is the key to raising standards of living over time.”

Does this point to a bond bubble?

Not necessarily so. What it does however is seduce investors into thinking that all is well and bonds do not come with risks. Gus Sauter, chief investment officer of The Vanguard Group, the largest U.S. bond mutual fund manager with $413.6 billion of fixed income assets as of Dec. 31 wrote that he is “increasingly worried that people aren’t aware of the risks in the bond market. The problem is that when you’re at historically low rates, as we are now … yields aren’t likely to go significantly lower, and at some point when the economy does strengthen, they’re likely to push higher.”

This does suggest that bond investors are overbought, denying the risks involved and ignoring the potential, even probable readjustment in this corner of the market. Will it burst as a bubble might? Not likely but the slow hiss will take the least experienced investors by surprise and it may be too late by the time it happens for them to do much of anything.

With one exception, possibly two. Increase your equity exposure is one. The other, buy short maturities. This last one might make it difficult for individual bond holders to ladder their portfolios. But at least you won’t be stuck with bonds that are worth less in an inflationary period.