Shop Smart

Wow, it's hard to believe that Thanksgiving is upon us and Christmas is right around the corner! And of course we couldn't enter the holiday season without the buzz about the best deals on Black Friday and Cyber Monday. I have never been brave enough to fight the crowds and just the thought of getting up at the crack of dawn just to wait in line and maybe get the item I am looking for makes me cringe. The good news is for those of you night owls, many stores are opening their doors at midnight on the 25th. Even better news is that even if you don't partake in Black Friday, there will be many other ways to save this season and as a prudent financial planner (and shopper for that matter), I wanted to share some helpful hints on how to save and survive the shopping madness this holiday season.

According to an American Express survey, while more than 2/3 of consumers actually have a budget, 1/2 will stick to it. I cannot express how important a budget is as the first step in holiday shopping. Without a budget, it is so easy to grab a gift here and there and not realize how much it all adds up to. The sooner you start planning your holiday shopping, the more money you can set aside and the more carefully you can select and personalize gifts at the best price. Americans will spend an average of $831 on gifts this season, which is actually $121 more than last year. But while they plan on spending more, they are also savvier than ever and plan on using a range of tactics to stay within budget while not compromising on gift giving potential. So what are these tactics?

First off, I'm going to assume many of you have smart phones. This season, your smart phone can be your best shopping buddy. Take Red Laser for instance. This super handy free App for your iPhone or Android phone can perform wonders. All you have to do is scan a product's barcode (or other type of code on the product) and this App can pull up other retailers of the product and their prices in an instant. This certainly gives customers the advantage and will in turn cause retailers to have more competitive prices. Not to mention it will save us a lot of time knowing we don't have to hop from place to place but rather just glance at our phones to know if there's a better deal somewhere else. While I think the most relevant feature is the price comparison, there are many other cool things that Red Laser can do. It provides product reviews, finds books in libraries and can even check food allergens and nutrition!

Next on the list of savings tactics, and also available on your smart phones, is coupons offered online either on the retailer's website, coupon websites or through social media outlets such as Facebook and Twitter. Many retailers now accept coupons on your phone and don't require printed coupons. Taking it even a step further, some stores (Macy's and JCPenney to name a couple), have signs in the stores with phone-scannable codes that pull up their website and sometimes coupons on your phone's web browser. You'll need one of the scanning Apps such as Red Laser to do this. You can also go to the store's website and sign up online to receive coupons. This certainly means you will be added to their email distribution list, but you can unsubscribe after you have received the coupons you need if you don't want to receive future emails. Some stores offer exclusive deals if you "like" them on Facebook or follow them on Twitter. And while you are on Facebook, feel free to "like" the Alder Financial Group as well! Last but not least, you can always search online for coupons and print them out. It's funny how this has almost become the "old school" way of coupon clipping. Some good sites for finding coupons are RetailMeNot.com, couponcabin.com, and coupons.com, but of course there are many more. I often start by just doing a Google search for the store I'm looking for and see what I find.

And now back to Black Friday. As stressful as it can be, there are certainly deals for which the pain is worth the gain. Experts are saying that this year retailers are less stocked and therefore not as eager to lower prices. With not as much inventory to go around, those willing to stay up late or get up early, depending on the store, and fight the crowds will have first dibs. But online shoppers can also take advantage of Black Friday from the comfort of their couch. Best Buy for example claims it will be offering 95% of its Black Friday ad items online for the same price. I have also seen that many stores are offering free shipping. Amazon.com aims to match prices for products they have in stock. It might not be a good idea to wait around for Cyber Monday if you see a good deal since there will likely be less availability as the weekend progresses. The bottom line is do your homework and find out where and when the items you are looking for will be at the lowest prices. Then you can decide if the price difference is worth the effort.

I hope this article helps give you some ideas on how to give the gifts you want to give and save money. Have a wonderful Thanksgiving and if you decide to venture out on Black Friday, be sure to pack a water bottle, a phone charger and your patience.

Know Before You Owe: The Student Loan Crisis

By Lori Eason, CFP(R)

Last week, President Obama announced some changes to the government's plan to help ease the burden of student loan debt. This comes after the student debt level has reached $1 trillion, surpassing the amount of credit card debt in the United States. Student loan debt has also been a recurring theme brought up by many Occupy Wall Street protestors. Unfortunately college tuition and fees are rising at an alarming rate making it difficult for many parents and/or students to afford a college education, but is this proposal the relief students are looking for? While I could write a whole article on increasing college costs or my thoughts on this whole Occupy Wall Street movement, I'd like to focus on what changes the government is proposing and how they will help or hurt students.

To give a little background, I am very familiar with the burden of student loans. I fortunately only have a small amount of student loans because I received the Hope Scholarship which covered my entire tuition, my parents helped with my other expenses and I worked during the summers to save up for the school year. My husband, on the other hand, accumulated a large amount of student debt by going to pharmacy school. By marrying him, I get to join in on the fun of making payments on a student loan that feels like a second mortgage. Thankfully, he chose a field in which he knew he'd be able to pay back his debt. We are hoping to have it all paid off in 3 years.

So now on to the relief proposed. Last year President Obama presented and Congress approved the "Pay As You Earn" proposal which will allow students to cap their student loan payments at 10% of their discretionary income and this debt will be forgiven after 20 years of payments. This was actually a revision to the Income-Based Repayment IBR) plan signed in September 2007 by President George W. Bush. The previous version allowed students to cap their federal student loan payments at 15% of their discretionary income and forgave the debt after 25 years. The new, more lenient requirements were originally set to go into effect in 2014. Obama announced last week that they will go into effect in 2012 instead.

While this new proposal has certainly gained a lot of hype, the truth is it will only financially benefit a small handful of students and it will actually cause the majority of students who take advantage of it to pay more interest when all is said and done. Here's the scoop. To be eligible for the Income Based Repayment (IBR) plan, a former student's monthly payment based on a 10 year payment plan must be higher than 10% of his or her adjusted gross income. Because the IBR payment is a percentage of income, as the debtor's income increases, so will the payments required. If the debtor marries, the spouse's income will also be included in determining whether or not eligibility requirements are met. If the income reaches a level at which 10% is higher than the 10 year payment plan amount, a partial financial hardship no longer exists. At this point, any unpaid interest that has accumulated would be capitalized (added to principal) and the debtor will now be capped at the 10 year payment plan's monthly amount. In addition, if there was any additional capitalized interest owed, that would be paid after the original amount was paid off in 10 years. In many cases, if a student has a hard time finding a job, the amount of interest paid if any might not cover the interest outstanding which results in negative amortization and the loan balance growing.

So who stands to benefit from this proposal? The only group I can see financially benefiting would be those students who have an extremely high debt to income ratio over a long period of time. If the debtor's income remained fairly low for 20 years and he or she had a high loan balance, it is plausible that there would be a substantial amount of principal and accrued interest that would be forgiven. I think it's safe to say that college was clearly not the right path for an individual who can't find a decent paying job in 10 or 20 years.

I would certainly expect that the majority of college graduates, though they may have a hard time finding a well-paying job immediately, would eventually get to a level of income that would force them into the 10 year payment plan. This would most likely mean that they would pay off their student loans well before the 20 year point at which loan forgiveness occurs. That being said, in this job environment, I do believe there are students who would benefit in the short term from a cash flow standpoint. For those graduates who can't find a job or who are underemployed and unable to pay the standard payment, this could give them a break and allow them to get their feet on the ground. But keep in mind, if they don't meet the minimum interest payment, their outstanding loan balance will grow from the accumulation of unpaid interest during this time and when they do find an appropriate job, they will owe more.

I'd now like to switch gears to another fairly recent proposal that I am a fan of. Last year the Consumer Financial Protection Bureau was created and they have since introduced a "Know Before You Owe" campaign for student loans to help students make educated decisions when it comes to paying for college. I can honestly say that as a 17 year old kid, I had no idea what I was signing when I filled out my FASFA application so I am in favor of new steps to help students understand what they are getting into. Currently, schools send students a letter before each school year that details the financial aid they can use. The "Know Before You Owe" initiative proposes a "thought starter" form that colleges can use to present financial aid information to prospective students and their families. This new "thought starter" would not only show the total cost of attendance and the financial aid available to you, but it would also show how much the student would owe in student loans upon graduation and his or her estimated monthly payment. This would help give students a perspective on the impact of taking out student loans. It would also show the student's college cost compared to the national average of other categories of schools and the US student loan default, graduation, and retention rates.

In the same way that I believe owning a home is not a birth given right, neither is a college education. Students need to have access to affordable student loans, but they also need to learn responsibility and understand that this money must be paid back with interest. There are apparently people out there that think a college education should be free. When professors start lining up to work for free, maybe that will be an option. Many people who did not graduate from college have gone on to become very successful in their careers (Steve Jobs, Bill Gates, Henry Ford, etc.). I don't think that college is for everyone and a lot of thought needs to be put into what career to choose and how much is a reasonable amount to spend on a particular degree. This would mean researching job prospects and salaries of the field a student is interested in pursuing before deciding to take on student debt.

To conclude, I do believe there is room for improvement when it comes to educating students on loans and the student loan industry itself. How ironic is it that at 18 years old with no credit history you can't get a credit card, but yet you can borrow as much as your parents paid for their house? With this new "Pay as You Earn Proposal," the devil is in the details and these details are not easy to find or understand. I fear that some students might incorrectly assume that college loans just go away in 20 years and that they may be motivated to borrow more than what is necessary. This can be a very costly mistake even though students think it is an easy decision since after all, they are investing in their future. Keep in mind that student loans are not even dischargeable in normal bankruptcy proceedings, so students need to be very cautious when deciding how much is too much.

The 411 on 401k Fees

With traditional pensions practically a thing of the past in the private industry, 401k plans have become the most common tax-deferred way to save and I would guess that many of you currently have a 401k. I'd also be willing to bet that some of you have 401ks at old employers. Because people are often unsure of what to do with these savings, we are frequently asked if it is a good idea to leave a 401k account with a previous employer. Our answer is always the same; No.

A 401k is a great savings vehicle while you are employed, especially if your employer matches even some of your contributions. Even without a match, saving into a 401k has substantial tax benefits since you are allowed to contribute up to $16,500 pre-tax ($22,000 if you are over 50). But 401ks are not perfect. They have several disadvantages, two of which are fairly significant: higher fees and limited investment choices. When you change jobs, an IRA becomes a much better alternative.

401k fees have received a lot of scrutiny over the years due to lack of transparency. Since 2007, the U.S. Department of Labor has been putting together a set of regulations that require 401k plan sponsors to better disclose information regarding the plan. A big part of this disclosure involves the plan fees and expenses. Up until now, it has been almost impossible for participants to understand how much they have been paying to participate in their 401k plans. These new rules are meant to improve the quality of 401k plans and make them more consistent from one employer to another. Unfortunately, they don't apply to 403b and 457 plans even though they suffer from the same shortcomings. These regulations were supposed to take effect this July, but have been pushed back to April 1st, 2012, mostly due to service providers arguing that it is too much work to make the changes. This is all but certain the final deadline.

Interestingly, this lack of transparency has meant that not only have many 401k participants not been aware of all the fees associated with their plan, but in some cases, the employer has not been aware either. This makes it difficult for the employer to select the best plan for its employees. Once the new regulations are in place, there will be a lot more disclosure from the plan sponsor to the employer and from the employer to the participant. Those employers who have been lax on choosing the best plan for their participants will now be forced to be more prudent in their selection since employees will be able to see every fee they are charged. Plan providers who have been overcharging for their services will be exposed and either pushed out by competition or forced to clean up their act. We view these new regulations as a much needed change in the 401k industry.

401k service providers have long gotten away with bundling fees which makes it difficult to identify how expensive a 401k plan is and what exactly the fees are paying for. The two most common categories of 401k plan fees are plan administration fees and investment fees. Administrative fees include fees associated with recordkeeping, accounting and legal fees involved with the day to day operations of the plan. In some plans, the administrative expenses are covered by investment fees and deducted from investment returns. Otherwise these expenses are either paid by the employer or charged directly against plan assets. Large employers often pick up the tab on expenses, but many smaller employers can't afford to do that. Another type of fee that participants may encounter is individual service fees, but these are pretty uncommon and are associated with optional features such as plan loans.

By far the largest component of 401k fees is investment fees. Investment management fees are generally stated as a percentage of the amount invested in each particular fund. There may also be sales charges associated with the buying and selling of shares. Some mutual funds have sales charges known as front-end or back-end load charges which are assessed either up front when you invest in a fund or when you sell the shares. One type of mutual fund fee expected to receive serious scrutiny is 12b-1 fees. These are ongoing fees paid out of fund assets to cover commissions to brokers.

Every 401k plan is different and so are the types and amounts of fees. While as an employee you don't have direct control over which plan your employer chooses, come April you will at least have a much clearer picture of what expenses you are paying. Armed with knowledge, employees who think they are paying an unreasonable amount in fees will be able to approach their employers and ask for some lower cost alternatives. Hopefully employers will use this as an opportunity to make sure that the plan they have in place is in the best interest of the employees. I don't think they want to get caught fielding complaints from unsatisfied employees.

While these new regulations are sure to improve 401k plans, an IRA held at a brokerage firm is still a superior long term alternative. Once you have left an employer, you are eligible to roll over your 401k into an IRA without incurring any taxes. If you have changed jobs over your career multiple times, you can roll all of these 401ks into a single IRA consolidating your assets and making them easier to keep up with. But perhaps most importantly, your investment choices are infinitely greater with an IRA than the handful you have to choose from in a 401k plan.

In conclusion, I want to reiterate the point that 401k plans are a great savings vehicle for employees. But there is definitely room for improvement and I am glad the Department of Labor's regulations are finally being put into place. Transparency is extremely important when it comes to the cost of services, especially with one's retirement on the line.

More Triple Digit Days

By: Charles Webb

We've been busy in the Alder Financial pressroom this summer. Again, we're seeing more extreme volatility in the markets and once again, it's all about Europe. We've written over the past couple of months that we felt the stock market was going to be largely driven by news coming out of the Euro Zone. That's exactly what we're seeing today.

Today's selloff came after U.S. federal bank regulators expressed concerns that Europe's debt crisis could spill over to the U.S. banking system. Some of Europe's biggest banks have major operations in the U.S. and rely heavily on borrowed funds to finance those operations. The worry is that the Euro Zone debt crisis could eventually hinder the ability of European banks to fund loans and meet other financial obligations here in the U.S.

U.S. regulators are seeking to avoid a repeat of the 2008 financial crisis, when the global financial system began to seize up, and are turning up the pressure on these banks to transform their U.S. operations into self-financed businesses. This would better insulate them from liquidity events in their home countries. The most immediate concern is how these banks are going to refinance their maturing debt in the coming years. While these banks are adequately funded now, one lesson from our own banking crisis a few years ago is how quickly those resources can disappear.

In addition to the banking news, the market is reacting to more weak economic data released this morning. This data shows a continuing deterioration in manufacturing and home sales as well as higher inflation. The uptick in inflation was largely driven by higher gas and food prices.

The worry is that we're headed into another recession next quarter. GDP has recently slowed considerably and is barely in positive territory. This is where the events in Europe become so important. Most of the economic recovery so far has come from rising exports, thanks largely to the weak dollar. Much of those exports have gone to Europe. Should Europe suffer a major setback, the chances are pretty good that we'll see what little growth we have here disappear.

The decline in stock prices are now reflecting another recession. If we're able to avert this, the recent selloff represents a buying opportunity. Otherwise the summer's selloff is justified. Our opinion is that another recession is technically likely but would be short and far less severe than the last one. We've positioned our client portfolios as defensively as we can without making a huge bet in one direction or another.

With cash yielding nothing and the Fed announcing it will remain that way for the next year and a half, we believe bonds are the only place to hide. This is why we continue to be overweighed in that asset class and focused on current income. We're still positioned to wait this out.

Our forecast for this year has been subdued by recent events but remains positive. Our belief is that the headline risk coming out of Europe will begin to subside by the end of September. We're hopeful that stocks will get a bounce off these levels and finish the year modestly in the black. Add this to the cash income, and we'd wrap up the year with a respectable total return.

Another Week, Another Crisis

By Charles Webb

Standard & Poor's was kind enough to send us home over the weekend with a credit downgrade of U.S. long-term debt. This would have been unimaginable only a couple of years ago, but here we are. Now we're faced with the first day of trading in what many think of as a new financial world, a world in which U.S. debt backed by the U.S. dollar is no longer the unquestioned safe haven in troubled times.

So what does all of this actually mean? Well, we've written fairly extensively over the past few months on the subject of sovereign debt and the dollar and have touched on the subject of a possible downgrade. Now that it's here, it's a good time to put all of the pieces together.

The first thing that is important to acknowledge is that a downgrade on sovereign debt is very different than a downgrade on corporate debt. A downgrade in the corporate world is serious stuff. It directly affects the rate a company will pay when it borrows money, either from a bank lender or from the bond market when it issues debt. Nations, on the other hand, issue their debt via an auction process and the interest rate paid on those bonds is strictly based on the bids received. Thus, their cost of borrowing is a function of the demand for their bonds. That demand is only marginally (at best) influenced by a credit rating agency. For a major economic power like the U.S., the rating is meaningless. What we have there is a moral defeat and not a financial one.

I think it's best to frame this discussion more as a political failure than a financial one. No one, including S&P, thinks that the U.S. will default on its debt. The only risk that holders of U.S. treasuries face is what I earlier described as a soft default. That is to say that higher interest rates and a weaker dollar will hurt current bond holders by devaluing the purchasing power of their future interest income. This is no small thing to foreign investors that hold trillions of dollars in treasuries. There has been a real concern in recent years about holding U.S. dollar denominated assets when the Fed has been pursuing a weak dollar monetary policy while also running massive fiscal deficits. The irony surrounding S&P's downgrade is that there is absolutely nothing in their announcement that hasn't been widely understood for at least two years. That's why I call this a moral defeat or simply the cherry on top of a pile of bad news.

The Financial Fallout

Wall Street often thinks of macro trading strategies as risk-on or risk-off. Risk-on usually means buying stocks- i.e. going long risky assets. Risk-off is the opposite and usually leads to a flight to the safest asset - i.e. U.S. treasuries. What does a risk-off trade look like now? Well, it turns out that it looks like it always has. Treasuries are rallying driving rates down. Not exactly what the textbooks teach. This is why we don't think this downgrade will actually lead to higher consumer rates or hurt the economy long-term. The economic damage will result for the same reason as the downgrade and not from the downgrade. Obviously, this is too much debt and the prospect is for even higher debt levels in the future.

Once again, we are benefiting from the focus on Europe. Due to their own debt chaos, the U.S. treasury market remains the only game in town. There certainly are other nations in better fiscal shape, but those markets simply aren't deep enough to accommodate the required liquidity. Quite simply the world doesn't have anywhere else to park $10 trillion.

Short-term we expect to see a lot of volatility. That is to be expected as market participants digest this news. We still view this as headline risk and are far more concerned with the fundamental underpinning of the economy. The only way this downgrade could affect things long-term is if it leads to higher rates. We just don't see that happening.

Make no mistake, stock prices over the last few weeks, today and in the coming weeks have and will be driven by fears of slowing GDP that could lead to another recession. Market sentiment is pretty low right now. This downgrade is only exacerbating that feeling. As we've seen in the past, attitudes can turn quickly.

Don't be surprised to hear of other downgrades over the week. Because the federal government backstops a lot of other debt issuers, this downgrade is going to trickle through. We're already seeing rating changes on Fannie Mae and Freddy Mac, as well as several other agency debt issues. Once again, I don't expect this to have much of an impact. In fact, spreads on many of these bonds, including treasuries, have widened over the past couple of months. This implies that the market has been pricing in this rating change for weeks.

The Political Fallout - warning: if you're politically sensitive stop reading here. This is about to get very opinionated.

As I stated earlier, this event is primarily a political failure. Standard & Poor's really didn't downgrade our debt as much as they downgraded our fiscal policies. This is the result of an abject failure of leadership in this country. The federal government has run deficits for decades. Not surprising as that's what governments do left unchecked. Only from time to time has Congress been serious about addressing our country's debt and spending level. Even then, they usually just gave it lip service. The last time any real effort was made was during the Clinton presidency when the Republicans took control of the House and Senate.

Over the ensuing years of Republican control, the party in charge became drunk with power (because this is what politicians do) and went on a spending binge. Government spending exploded with all of the fresh tech-bubble tax revenue in the late 90's. We then had to suffer through the Bush presidency that never saw a spending bill worth vetoing. Add a couple of wars and we were off to the races. From there we then went to a Democratically controlled Congress and Senate led by a very activist arm of the party. Two years later president Obama was elected.

Federal spending has expanded exponentially to the point that we now borrow 40 cents of every dollar. This trend has been particularly egregious over the last three years - all in the name of stimulus. So let's take a moment to talk about stimulus spending and how it's supposed to work. I'll try to do this without getting lost in the weeds of economic theory.

By nature, government fancies itself as the solver of problems (real or imaginary). As such, Keynesian economic theory has always been very popular in governments around the world. Keynesian economics is a school of macroeconomic thought based on the ideas of 20th-century English economist John Maynard Keynes. Keynesian economics argues that private sector decisions sometimes lead to inefficient macroeconomic outcomes and, therefore, advocates active policy responses by the public sector, including monetary policy actions by the central bank and fiscal policy actions by the government to stabilize the business cycle. One might call a recession an inefficiency. Keynesian economic theories were first presented in The General Theory of Employment, Interest and Money, published in 1936.

Part of this theory incorporates the concept of the multiplier effect. This theory believes that, for a number of reasons, for every dollar of government spending you will get a larger number back in GDP. The president's first set of economic advisors seemed to think that we would see a 1.5 multiplier. This means that for every dollar they spent, the economy would see a $1.50 increase in GDP (I'm not sure where this brain trust came up with that figure but it seems to be the same place they got unemployment not exceeding 8%). From here the Stimulus Bill was born and all other policy responses were based. In all fairness, stimulus spending was Bush's first response too, although nowhere near in size.

What we have seen in the past two and a half years has been a giant experiment in Keynesian economics and the results are not looking promising at all. This experiment has come at a great cost to our public debt and, in my opinion, not shown much in the way of working. Not only have we had trillions of dollars thrown at the economy, but we've also vastly increased baseline expenses in perpetuity. This is at the heart of the S&P downgrade and the pushback from the public at large.

One thing that I find very disheartening is the response from the White House. Instead of honestly critiquing their results, the reaction is to blame others and want to double-down on this experiment. To be sure, all the president's men came out in full attack mode this past weekend blaming all of this on S&P's analysis. Absurd. Is there anything that S&P said on Friday that everyone else doesn't already know? S&P essentially declared that on present trend the U.S. debt burden is unsustainable, and that the American political system seems unable to reverse that trend. This is not news.

So after trillions spent on "investments" like cash for clunkers, cash for caulkers, cash for first time home buyers, making work pay, cash for green energy, cash for high speed rail, etc., we now have the latest grand idea - an infrastructure bank. This is simply code speak for more stimulus spending. It's a "bank" funded with - can you guess? More debt to invest in our infrastructure. Sounds very shovel ready in my opinion.

To me it sounds like these people are so very in over their heads and out of ideas. I've never been a big believer in the multiplier effect. I think instead all it does is postpone the inevitable. All of these programs have done nothing but drag out this recession/recovery. A great example was the housing price bust. Untold amounts of money were paid to folks to buy homes sitting on the market and thus create demand. It worked. That is until the program ended and then prices fell yet again. Interestingly, they fell by about what the credit was. So instead, the housing price decline lasted a couple more years with prices ending up at basically the same place. In the meantime, our kids have just paid the down payment on a stranger's home.

The bottom line is that the spending must stop and their other favorite solution, raising taxes, would be counterproductive. It's unclear to me how you fix a spending problem by throwing more money at. That's a bit like solving alcoholism with another drink.

This leads me to another complaint. The blame game isn't going to help matters. I'm perplexed to see time and time again the president go on national TV demagoging entire industries and large segments of our population. One of the other themes seen this weekend was that the downgrade was the fault of the Tea Party movement. I fail to see how a movement that arose out of the desire to curtail spending is in anyway responsible for the situation we find ourselves in today. Of course, what the administration is really saying is that those members of Congress aligned with the Tea Party objected to a balanced approach - i.e. raising taxes. Once again, this problem didn't spring up because of any tax shortfall thus the solution won't be found there. At best, higher taxes would only slow (and not by much) the decline in our fiscal situation. There just aren't enough corporate jets in this world or hedge fund managers to make a difference.

S&P did mention in their report that one problem they saw was an unwillingness to raise taxes. One important thing to note here is that they are not in the job of writing economic policy. They would rather see the deficit gap close as quick as possible regardless of the long-term consequences - give the man another drink and he'll be quiet for a while.

In Summary

This too will pass. If the politicians won't adequately address the problem, the market will force the issue. This is a wakeup call to Washington. The president used to say that elections have consequences. This downgrade will have consequences too and it won't be financial but instead will be felt at the polls. We should all be furious with everyone in Washington who contributed to this mess. Good credit is nothing to play around with and is very hard to get back once you've lost it.

There Will Be Days Like This

By Charles Webb

It's never easy to sit back and watch the Dow drop five hundred points. But it happens. From a technical standpoint, the last two weeks have put the U.S. and most foreign stock indices in "market correction" territory (down 10%).

Yesterday's action was the culmination of a steady deterioration in the fundamental data over the last two months in the U.S. and continued liquidity uncertainty coming out of Europe. The primary emphasis here has been poor Jobs data and revised lowering of GDP for 2011. In Europe, it's just been more of the same - declining quality of sovereign debt.

From a technical trading standpoint, a number of key thresholds have been crossed on the downside leading to more momentum lower. All of this adds up to a glut of bad news and very little to look forward to.

After today's rout, most stock indices have erased their year-to-date gains and are now negative for the year. The Dow Industrials are down 1.67% and the S&P lower by 4.58%. Higher quality corporate bonds have been the place to be in the past four weeks with those indices up 4-5%.

There really isn't anything unusual about what is going on right now and we've seen plenty of days like this over the years. Admittedly, it's hard to remain optimistic after a big selloff, but our outlook for the year is still positive on stocks, although slightly less than we had at the beginning of the year. The problem now is that we don't see a catalyst for a change in sentiment in the near future. Until then, stocks are likely to drift lower.

So what can we do in the meantime? Since the economy crashed in 2007, our investment strategy has been to focus on increasing the cash flow in our client portfolios and adding predictability to the returns with bonds. Those efforts are still paying dividends today (literally). While many of our highest yielding securities have paid down over the last couple of years, our overall portfolio income remains strong and valuations less volatile. In most cases, our clients' portfolios are cash flowing around 4% and the values are back to the pre-crash levels. That's no small feat considering the Dow Industrials are still down 18% from the highs in 2007.

Going forward, we want to stay out of cash. You'll probably be hearing a lot in the financial press about cash being a safe haven. In real terms though, (taking inflation into account), cash balances only guarantee losses. The Federal Reserve has been pushing investors out of cash for several years in order to get that capital working in the economy. They've done this by keeping short-term rates near zero. We don't see that attitude changing anytime soon.

Instead, we'd like to keep everyone fully invested and slightly over-weighted in bonds. Our expectation is that stocks will struggle for the next month or two and then come back in the fourth quarter. We think the market needs to see two months of a positive trend in employment and GDP to really turn around. Growth is now just about flat and there are real fears of slipping back into a recession. We don't think that will happen but even if it did, it would likely be very short and shallow.

The best real-time gauge of market sentiment will be the news coming out of Europe. The Euro Zone economy is larger than the U.S. and thus is a significant global trading partner. The fear is that a significant slowdown in their economy would have a ripple effect around the world. This is especially a threat here in the U.S. and could be the difference between slow growth and no growth in our economy.

We of course will keep our clients informed as things change. For now we feel that everyone is situated about as best as can be hoped for. Once again, we think cash flow is the key to avoiding the need to sell into this market. Remember that the only two days you care about what something is worth is the day you bought it and the day you sell it. You don't want to be in a position to have to sell into this market. That's when investing becomes gambling.

Perspectives On The Debt Ceiling Debate

By Charles Webb

"For those who say further responsible spending reductions are not possible, they are wrong. . . For those who say more taxes will solve our deficit problem, they are wrong. Every time Congress increases taxes, the deficit does not decrease, spending increases." – Ronald Regan

The debate over the U.S. statutory debt limit has come down to the wire. The U.S. Treasury has stated that if an increase in the debt ceiling is not in place by August 2nd, they will run out of funds to pay all of their bills. Yet with just days left before the deadline, political brinkmanship in Washington shows no sign of letting up.

There are so many ways in which this political crisis can play out. Each one is further complicated by the fact that there is no way of knowing precisely how financial markets will react if this deadline is breached. For decades, U.S. Treasuries have served the global financial markets as an unquestioned source of liquidity. When this conventional wisdom is thrown out the window, the world looks like an unpredictable place and financial markets hate unpredictability.

As we see it, there are four possible outcomes. The first and most desirable outcome is that a consensus is formed around a spending plan that puts this country on a sustainable fiscal path. By contrast, the current path is quickly running out. The can has been kicked down the road so many times that the road has simply run out. Even the Congressional Budget Office acknowledges that our current situation is unsustainable.

Scenario 1

This best case scenario would immediately raise the debt ceiling, putting any short-term uncertainty to rest, and institute a fiscal austerity plan in place that would bring the country’s outstanding debt to within a reasonable percent of GDP. In the short-term, stocks would rally, Treasury spreads would narrow and the dollar would strengthen. Medium-term, this would put downward pressure on economic growth and slow the recovery. Four trillion dollars in cuts over ten years, it is estimated, would reduce GDP by about 0.5% per year for the next five years. This deleveraging cycle would be very similar to what we’ve seen in the private sector over the last three years; a sharp impact short-term but lasting benefits long-term. It would be the take your medicine now approach.

Scenario 2

Similar to the first, scenario two would have a last minute deal struck by Congress and government operations would not be interrupted. However, this deal involves only an incremental increase in the debt ceiling in exchange for ongoing discussions on a larger fiscal agreement. Standard & Poor’s has repeatedly stated that they would still consider downgrading the status of U.S. debt if they believe a credible long-term solution to the rising debt burden has not been found. However, even if this were to occur, it would likely have a relatively minor impact on the U.S. economy as other ratings agencies do not appear inclined to follow.

With the risk of a shut down in government operations and a debt default having been averted, we suspect markets would take a downgrade by a single agency in stride. Nonetheless, worries about the long-term prospects to deal with the fiscal imbalances would persist. This scenario would bode for continued weakness in the U.S. dollar, but not a sharp decline from current levels. Bond yields would be largely unaffected, as markets would go back to fretting about the sub-par pace of economic growth.

Scenario 3

The third scenario arises if the political impasse takes us past the August 2nd deadline. In all probability, this would eventually be followed by a ratings downgrade by Standard & Poor’s, and there would certainly be heightened risk of action by other rating agencies.

In this scenario, we end up with a double hit on the economy. The first hit comes from the direct impact of withdrawing government funds from the economy equal to their financing shortfall - estimated to be $135 billion for the month of August. The second hit comes from the indirect impact of a potential rise in Treasury yields and flight out of equities due to deteriorating market sentiment.

There is no way in knowing how long the political impasse would last if it were to occur. If we assume a political resolution is not found for the entire month of August, a reduction of $135 billion from the economy would equate to an annualized 1.5 to 2 percentage point drag on GDP growth in the third quarter. The market reaction would be serious. At the very least you would see a flight out of risky assets, like equities. Similarly when Congress initially failed to pass the TARP legislation in late 2008, the S&P 500 suffered one of its largest single day drops on record (-9%).

The likely public reaction would certainly lead to a quick compromise in Washington and much of the market reaction would reverse itself. However, the lost GDP would leave the economy in much worse shape than it is today. Overall, the impact would be directly related to the length of time past the August 2nd deadline it took to reach an agreement.

Scenario 4

In this scenario the U.S. government actually defaults by not making or is late in making its interest payments. This would be totally unimaginable and we don’t think there is a remote chance of this happening. This event would take us into uncharted waters in modern finance.

Financial markets would simply freeze. Every asset class would drop in value. Stocks, bonds and even money markets would take severe hits. It’s even uncertain what commodities like gold would do. An economic recession/depression would surely follow from the total freeze in U.S. credit markets.

A Little of Our Opinion

Depending on how long it takes Congress and the President to reach an agreement, the impact could range from a short-term negative to disastrous. The financial market’s impact will depend on how long this impasse takes to get resolved.

It must be recognized that federal spending must be sharply reduced to stabilize the debt to GDP ratio. As we’ve stated before, this is a spending problem and not a revenue problem. As such, this situation must be confronted from that perspective and there will be some negative economic effect from this deleveraging.

To try and address this issue by raising taxes is counterproductive in our opinion. It’s important to understand that there are three basic inputs to production (GDP): materials, labor and capital. These are not substitutes for one another but instead must be used together. When the government collects taxes or runs up debt, it is consuming capital that would otherwise be available to the private sector and thus retards economic growth.

In the current debate we’ve heard a lot about taking a balanced approach to fixing this crisis. This of course means raising taxes as well as cutting spending. Our objection to this is that taxes are already going up almost a trillion dollars beginning in 2013 due to the healthcare legislation passed last year. We don’t think that adding more taxes in this economic environment is a good idea nor do we think it would help long-term. Clearly government is necessary and must be funded, but to what extent? I’m reminded of the saying that traffic will always fill the roads, meaning that no matter how many times you expand the freeways, traffic will always increase to the road’s capacity. Government spending is much the same way. No matter how much is collected in taxes, politicians will always find a way to spend it – and then some. This is how votes are bought and constituents pleased.

The Bottom Line

We think that scenario 2 is the most likely outcome. We also think that the debt ceiling increase will get finalized at the last minute and maybe even a day or two after August 2nd. Expect the markets to be volatile over that time and the news to be disheartening. We strongly believe it would be a mistake to change or make any investment decisions based on this news. Whatever hedges that could be put in place would be destroyed once a compromise was reached.

You’ll hear a lot of news about our AAA credit rating. While this shouldn’t be taken for granted, the reality is that there is enough demand in the treasury market that it will look through what is clearly a political event and not a true default.

In the end, the markets will trade on the fundamentals of the economy and not the headlines. That’s what we’re focused on when it comes to our clients’ portfolios. We still feel pretty good about the fundamentals.

The Almighty Dollar

By Charles Webb

A weak currency is the sign of a weak economy, and a weak economy leads to a weak nation - Ross Perot

In April, we wrote an article about this county’s exploding Federal debt problem. This month we’d like to expand on that topic by looking at a closely related subject -the dollar’s steep decline and its implications.

The quality of a country’s debt is directly linked to the value of its currency. The reason for this has to do with a specific type of risk associated with sovereign debt.

There are basically two types of risk when investing in foreign sovereign debt. The first and most obvious risk is credit risk, or the risk of outright default. That is to say that the country simply can’t make the interest payments and can’t repay the debt at maturity. Since most countries can print their own currency, the risk of outright default is very unlikely. The exception to this is if the country is part of an economic union such as the Euro and thus can’t print money at will – i.e. Greece, Spain, Ireland, etc.

The second type of risk associated with foreign debt is currency risk. This is the risk of a decline in the value of the currency of which the debt and payments are being made. It is possible for an investor to lose money on a foreign bond if its currency declines at a rate higher than the bond’s coupon. For example, if a bond pays 4% per year but the underlying currency depreciates at 5%, an investor would cumulatively lose around 11% over ten years. That’s not exactly a risk-free investment and is one of the reasons the international community is so concerned about the persistent decline in the value of the U.S. dollar.

So what causes the value of a currency to decline? There are many factors that lead to changes in the value of one currency relative to another. The biggest one, though, is greatly expanding the supply of that currency.

As we mentioned in the last article, in this electronic age, the money supply isn’t grown by the printing press but done so via the central bank’s open market operations. The current phrase for this is “quantitative easing”. The Fed does this by purchasing bonds (usually their own – i.e. treasuries) in the open market and paying for them by crediting the seller’s bank account.

Since the housing bust and the ensuing banking crisis, the Federal Reserve has attempted to support the economy by pumping billions of dollars into the banking system. These activities are in addition to the government’s fiscal activities or stimulus spending and have greatly expanded the money supply.

The flood of new dollars has created a kind of soft default on our debt that is calling into question the soundness of our Treasury bonds and their AAA rating. Foreign investors have become very concerned about what they perceive as an unstated weak currency policy which is leading to real losses on the trillions of dollars of treasury debt held by foreigners.

So why does this matter to us? After all we’re not taking the losses, it’s the other guy. Quite simply those are our creditors and we depend on their appetite for our bonds to fund our government’s spending binge. At some point, our creditors will lose faith in the soundness of the dollar and demand higher rates on our bonds to compensate for the currency losses. Those higher rates will affect everything from mortgage rates to business loans, not to mention how it will exacerbate the deficit.

A Breif History of the Dollar

Since 1945, most of the world has been on a dollar standard. Today, for emerging markets outside of Europe, the dollar is used for invoicing both exports and imports, it is the intermediary currency used by banks for clearing international payments, and the intervention currency used by governments. To avoid conflict in targeting exchange rates, the rule of the game is that the U.S. remains passive without an exchange-rate objective of its own.

After World War II, the Bretton Woods agreement put the dollar at the center of foreign trade by requiring the U.S. to exchange gold for dollars at the request of trading partner governments. Other countries would hold dollars in reserve to underpin their own currencies. The gold standard imposed discipline on the U.S. and gave everyone else a stable and liquid reserve currency.

The plan worked well until the 1960’s, when U.S. deficits led to a meaningful increase in the money supply. Wary trading partners then began to exchange dollars for gold until 1971 when the U.S. closed the gold window, refusing to trade gold for dollars.

Instead of switching to another reserve currency, the global economy kept on buying dollars. At that point, it was as if the U.S. was given a virtually unlimited line of credit from the rest of the world.

Americans proceeded to borrow more and more in the ensuing years. This addiction to debt crept into every level of society - from federal and state governments, to consumers and businesses. From 1970 to 2009, total debt in this country rose from 170 percent to 350 percent of GDP.

The Dollar Today

So why are foreigners still willing to loan us money? Quite simply, we’re the only game in town. Countries that run large trade surpluses with the U.S. find themselves with ever-growing balances of dollars on their hands. They have to do something with this cash and they find themselves with little alternative but buy U.S. treasuries with those dollars.

The lack of alternatives is the key. If there was an alternative, you would see an immediate drop in the number of investors lining up at the treasury auctions. With fewer interested buyers, rates would be bid up, leading to higher interest rates throughout the economy.

These higher rates would devastate consumer spending, the real estate market and business growth. In addition, the percent of tax receipts required to service $8 trillion of debt rolling over at these higher rates could easily double. This would create a death spiral of higher deficits leading to higher borrowings and yet higher rates and so on.

This is why it’s so important for the federal government to get its fiscal house in order. The United States has benefited greatly in many ways due to its standing in the financial community. The threat posed by our massive deficits that seem to have no end could permanently reduce our standard of living.

The key to maintaining our global prominence rests on the dollar’s reserve status. Because of the uncertainty of our monetary policy, long-term, the rest of the world is actively looking for an alternative. Fortunately for us there isn’t one. At one time it was hoped that the Euro would be become an alternative. Europe’s own debt crisis has dashed any hopes of that and has bought us more time to fix things here. Let’s hope Washington can get their act together in the meantime.

The Long-Term Care Gamble

By Lori Eason, CFP(R)

Over the last several months, we have received a lot of questions concerning long-term care insurance. Not only are many of us facing increased health care costs now (my health insurance premium is going up 20% this year), but the uncertainty in the coming years makes it extremely difficult to appropriately plan for health insurance costs during retirement.

With the average life expectancy on the rise, it's no surprise that the number of people who will need long-term care at some point in their lives has greatly increased. The Centers for Disease and Control state that the average life expectancy is over 78 years, and that number is a lot higher for those with good genes. The US Department of Health estimates that 70% of people over the age of 65 will require some form of extended healthcare during their lifetime. Although the average length of stay in a nursing home is 2.5 years, 20% will need care for more than 5 years. At an average of $80,000 a year with costs rising at about 6% a year, 5+ years in a nursing home can plow through a retirement portfolio very quickly.

Some of you may be thinking, what about Medicare and Medicaid? I'll briefly explain what type of long-term care these government programs cover, starting with Medicare. While Medicare does pay for some short-term nursing home stays, the requirements to qualify for benefits are very specific and it is not intended for long-term stays. Among the requirements is an inpatient hospital stay of 3 consecutive days or more. One notable illness that often does not meet this requirement is Alzheimer's because the patient is often physically in okay shape, but mentally unable to care for his or herself. If all requirements are met, Medicare pays the full cost of the nursing home for the first 20 days. For days 21 through 100, Medicare covers the cost after the patient pays a daily copayment, currently $141.50. After 100 days, Medicare pays nothing. The average daily cost for a private room in a nursing home is $219.

Medicaid, on the other hand, does cover long-term nursing home stays, but it comes at a hefty price, almost all of your assets (at least on paper) and potentially fewer choices when it comes to the quality of care. While long-term care insurance is for the elderly, Medicaid is for the poor. Medicaid is a combined federal and state program. The federal government provides funds to each state with certain requirements as to whom Medicaid benefits must be offered. However, the states administer the programs and each state has its own additional rules and regulations. No matter what state, there are stringent income and resource limitations. In Georgia for example, the income limit for nursing home eligibility is $24,264 per year and the resource limit is $2,000 in countable assets for individuals, $3,000 for couples. Some notable non-countable assets are your home, one car, personal possessions and assets considered "inaccessible." Most importantly absent from this list are IRAs and other investment accounts.

That being said, there is an entire industry structured to help the elderly get rid of their assets on paper, i.e. gifting to relatives or charities, in order to qualify for Medicaid. But even if you successfully eliminate your assets on paper, there are still quality of life implications of relying on Medicaid. To mention a few potential shortfalls of Medicaid, only certain nursing home facilities accept Medicaid patients and you do run the risk of being moved if your facility decides to stop accepting Medicaid or decrease the number of Medicaid beds. Also, you may end up with a roommate, and not by choice. Lastly, in many situations, home health care is a much more preferable option than entering a nursing home, but this benefit is limited through Medicaid if available at all.

So now that we have established that it's generally not a good idea to rely on Medicare and Medicaid for long-term care, I'd like to turn our focus to long-term care insurance. First off, here at Alder Financial Group, we are big advocates for individuals being self-insured, meaning they reach a point where their portfolio is large enough to cover their family's living expenses indefinitely, even in the event of disability or death. However, with health insurance costs raging out of control, long-term care insurance can certainly help mitigate the financial and emotional cost in the event that an individual needs long-term care. But it does come at a high cost and of course there is no guarantee that the policy will ever need to be used. While everyone's situation is unique, instead of trying to find a policy that will cover all long-term care expenses, I generally recommend figuring out how much you would feel comfortable paying out of pocket for long-term care based on your projected retirement income and purchasing a policy that would cover the difference. If you ultimately need long-term care, even policies that are designed to cover only a portion of your costs will be valuable. This is a way to hedge some of your risk without spending an unnecessarily large amount on premiums in case you don't end up needing long-term care.

The subject of premiums brings up the most unpredictable component of long-term care insurance. The younger you are when you purchase the policy, in general the healthier you are and the lower the premium. According to the American Association for Long-Term Care Insurance, the average buyer is 57 years old and pays $2,150 in annual premiums. But unfortunately, double digit increases are standard. John Hancock recently asked state regulators for permission to raise premiums on many of its long-term care policies by an average of 40%! Many carriers assumed more policyholders would let their policies lapse than actually did which severely harmed their analysis. Two big providers, MetLife and Berkshire, recently decided to stop writing long term care policies.

While some insurers are shying away from long-term care insurance, we have already seen a couple new options surface. In response to customer and agent demand, some insurance companies have designed hybrid policies that combine the benefits of life insurance with traditional long-term care benefits. These policies offer heirs a tax-free payout if the beneficiaries don't use all the money for long-term care. Also, government partnership programs are now offered by many states and they offer individuals an incentive to buy long-term care insurance. For each dollar the policyholder receives in long-term care benefits, the state allows them to shelter one dollar from Medicaid limits.

This is a very turbulent time in the health care industry and we are all unsure of what changes will shake out of the health care crisis. For this reason, I don't think it's a bad idea to let the dust settle before purchasing a long-term care policy if you can afford to wait, but if purchasing long-term care insurance is a big cause of concern for you right now or if you are worried about declining health in the next couple years, now is a good time to do some research on policies. I could write a whole other article on what to look for when buying a policy. As a start, please click here to read an article that highlights the shortcomings to avoid when picking a policy. If you are a client of ours and would like to further discuss long-term care insurance, please let Charles, Alan or I know.

The Burden of Debt

By Charles Webb

Regardless of political affiliation, everyone should be extremely concerned by the level of debt that is being accumulated by our government. The projected deficit numbers are unprecedented by any historic measure.

Just two years ago, the total debt of the federal government was 69% of our gross domestic product. Last year it was 83%; this year it has risen to 94%. By 2013 or 2014, if we continue current economic policies, it will exceed 100%. And those numbers don't even include the tens of trillions of dollars in future Social Security and Medicare promises that are already with us (future unfunded liabilities).

How bad is it? Last year, the International Monetary Fund released its annual review of U.S. economic policy. Its summary contained these bland words about U.S. fiscal policy: "Directors welcomed the authorities' commitment to fiscal stabilization but noted that a larger-than-budgeted adjustment would be required to stabilize debt-to-[gross domestic product]."

Delve deeper, and you will find that the IMF effectively pronounced the U.S. bankrupt.

Section 6 of its July 2010 selected-issues paper says: "The U.S. fiscal gap associated with today's federal fiscal policy is huge for plausible discount rates." It adds that "closing the fiscal gap requires a permanent annual fiscal adjustment equal to about 14% of U.S. GDP."

The fiscal gap is the present value of the difference between projected spending (including servicing official debt) and projected revenue in all future years.

To put 14% of gross domestic product in perspective, current federal revenue totals 14.9% of GDP. So the IMF is saying that closing the U.S. fiscal gap from the revenue side requires, roughly speaking, an immediate and permanent doubling of our personal income, corporate and federal taxes, as well as the payroll tax. That also assumes those higher rates would have no negative impact on the economy, which of course they would.

So what is the solution? This debate is now raging on in Washington and clearly falling along party lines. On one side of the debate, the Democrats want to raise taxes on wealthier tax payers as a way to slow the deficit. I emphasize slow because the administration has not offered a plan that projects a balanced budget. Instead, there are only hopeful projections that show the deficit becoming more manageable.

The Republicans, on the other hand, believe that by cutting taxes the economy will grow its way out of this pile of debt. In truth, they're both wrong. I would summarize the two positions as tax and spend vs. borrow and spend.

Our problem is clearly in spending. The following table shows a breakdown of the federal budget over the last eleven years.

One interesting line item shown is Net Interest. Interest rates in 2000 were roughly 3 times higher than they are now. Yet the government's interest expense is now 27% higher. This shows you how much the country's debt expense has grown. It also gives you some idea of how bad an increase in interest rates would be on the budget problem. That number alone could easily double in a matter of a few years. The potential increase in taxes on the wealthy (however you want to define that) may simply go towards paying the higher interest cost and make no contribution towards closing the budget gap.

The relationship between economic growth and interest rates poses an interesting problem to a government in debt. The best way to tackle the debt problem is to grow your way out of it. Higher economic activity will lead to higher tax revenues. However, higher economic activity also leads to higher inflation and interest rates. Thus, the government's interest expense rises and consumes much of that additional revenue.

Attacking This from the Top Line

In 2000, federal tax revenues totaled just over 2 trillion dollars. Peak revenues topped out in 2007 around 2.57 trillion dollars. Even after the real estate bust and ensuing financial collapse, tax revenues only declined to 2.1 trillion - higher than any year before 2004.

On the other hand, congress' Office of Management and Budget is estimating expenditures to be 3.8 trillion this year and reaching 4.47 trillion in 2016. There is no way that deficits of these levels can possibly be addressed through higher taxes. By comparison, the total net worth of every billionaire in this country is estimated at 1.3 trillion. You could confiscate every penny of every one of those households and not even cover the deficit of one year.

The following table displays the current sources of tax revenues.

To put these numbers in the proper context, to close the budget gap, individual taxes would have to double, corporate taxes would have to quadruple, payroll taxes would have to more than double, or some combination of the three. Anyone who thinks this is possible or reasonable is simply out of touch with reality.

Tax policy has real economic consequences. It's unreasonable to expect that tax revenues will increase by simply raising tax rates. To be clear - tax rates are not the same thing as tax revenues. The more tax rates go up, the more those subject to taxes shift their resources from productive activities to areas designed to shelter their income. The reverse is true when high tax rates decline.

There is plenty of historical evidence of this reality. The best example of this was when top tax rates were slashed in the nineteen-eighties. Billions of dollars were freed up and directed towards productive activities when the top marginal rates were slashed. So much so that this country was pulled out of one of the worst economic situations ever faced.

When the wealthy shelter their income, they don't invest in things that create jobs. They also don't repatriate overseas earnings. Our comparatively high corporate tax rates are currently keeping billions of dollars in other countries. Simply raising tax rates is counterproductive.

What to Do

In our opinion there is only one way to tackle the deficit. The government simply needs to spend less. The deficits have become so large that these spending cuts are going to have to focus on the largest programs and agencies. This means pushing back the retirement age for social security, wrapping up military operations and getting healthcare costs under control.

We've written extensively about our thoughts on Social Security over the years so we won't rehash that now other than to say that the government needs to get out of the pension business. The wars will eventually draw to an end.

Healthcare is a trickier issue. What we don't think is that pushing millions of people on to Medicaid is going to do anything but bankrupt the states and lead to yet more bailouts. We've also written about healthcare reform so we won't get into that again.

The bottom line is that the biggest programs will have to be radically changed which will take political will. Beyond that, general spending needs to come down and only grow at the same rate as the rest of the country (CPI). It's inexcusable to see the percentage growth numbers in every category from 2000 to now. Keep in mind this was during some of the lowest inflation years in our country's history.

It appears that the market will ultimately force change. Yesterday S&P downgraded the rating on U.S debt. This was an unimaginable occurrence in our lifetime.

Market Flash (March, 2011)

Japan and the Markets
The news coming out of Japan has become pretty scary over the last few days and the global equity markets have reacted accordingly. As Japanese officials are trying to cope with the country’s worst destruction since World War II, investors are trying to sort what the impact of the world’s third largest economy will be globally. The initial reaction seems to be to sell first and figure it out later. It’s quite understandable that Japan’s near-term GDP is going to be severely affected by these events and the 11% drop in their markets yesterday is justifiable. What is far less certain is how this will affect their trading partners, energy demand, currency markets, commodities and the like.

Adding to the confusion, all of this news is on top of the ongoing chaos in the Middle East. Trying to digest all of this news and information in real-time is, to say the least, a bit overwhelming. Therefore, we think it’s important to step back and look at the bigger picture and not try to assess the impact of every piece of news coming out of Japan hour by hour.

The Big Picture
Near-term, there will certainly be supply chain and distribution interruptions. These will likely cause manufacturing headaches over the next month or two. Japanese domestic manufacturing will likely be slowed considerably throughout the country. This is not just due to the direct damage but also to their reduced power generating capacity. Longer-term, the rebuilding efforts will require massive amounts of materials and equipment. We’ll likely see higher commodity prices of specific goods when those efforts get underway in earnest. Lastly, the Bank of Japan has already promised that it will provide all the liquidity needed to soften the economic blow to Japan.

In addition to these foreseeable events, there will also be a number of significant energy policy discussions that will come out of all this. There’s no way to project the outcome, but surely we’ll hear a lot about alternative energy vs. conventional sources. There will be winners and losers in this debate. Those will be nuclear plant and equipment manufacturers, oil and gas producers and wind/solar firms.

My Portfolio
Beyond the human concerns, the next most obvious question is how this will impact our clients’ portfolios. Our best guess is very little. Last year’s stock market performance was driven by improved earnings and the Fed’s easy money policy. Those two forces are still very much in place. This is the reason we were optimistic about 2011’s potential and still are. There will undoubtedly be a good bit of volatility, both up and down, as the news out of Japan swings from bad to better. Our guess is that six months from now this volatility will have passed and the markets will be refocused on economic matters.

We think the more relevant economic news is what’s going on in the Middle East. Oil supply disruptions are of a far greater concern in our opinion. We hope that the Japanese crisis doesn’t take the international focus off the fighting in Libya. Oil prices above $100 per barrel are a more immediate threat to the economic recovery here and in Europe.

As always, we’ll continue to monitor the news and invest accordingly, but for now we don’t see a need to change our strategy. If anything, our goal of emphasizing portfolio cash flow over the last few years should help smooth the returns in times like this as well as directly meet our clients’ monthly income needs.

Modern Day Gold Rush (February, 2011)

By Charles Webb

The Modern Gold Rush

We're often asked by our friends and clients if we think something or another is a good investment. That something or another is usually a security or asset class that has had a meteoric rise in value the year before. Over the past year, we have fielded a lot of questions about gold. This should be no surprise to anyone who is familiar with what gold prices have done over the past couple of years. Therefore, we felt this would be a good topic for this month's memo.

I think it's first important to discuss what an investment is because that word is used pretty loosely these days. An investment is something that will either provide you income or increase in value. If the investment is something that generates income, it has to have some sort of earnings that generates the cash flow. Investments that increase in value usually have an earnings stream too. That's what makes them more valuable over time. But not all appreciable assets are backed by earnings. Instead, they are scarce in supply and high in demand. Commodities, gold included, are a good example of this. Collectibles are another good illustration of scarce assets with high demand. So if you want to invest in something, it needs to fall into one of these camps - income or appreciation.

Too often money is directed towards things that on the surface look like investments but in fact are something else. Two common examples are insurance and options. These are really risk management tools and not investments. Another area that we see money flow into is various stores of wealth. These assets are parking places for wealth. Currencies are the best example of this and you'll often see money flow into different currencies in times of political turmoil. Precious metals are another popular parking place for wealth.

This is where things get a little confusing because some things are both commodity investments and stores of wealth. So the question of should I buy gold, silver, platinum, etc. really depends on what you're trying to accomplish. If you truly want to invest in gold, you should do so because you think the demand is rising. The question then becomes what is the best way to buy the gold? In our opinion, exchange traded funds (ETF's) are the best way to own it. These are shares issued against actual gold deposits held in a vault at a bank. Probably the least efficient way to own gold would be through the futures market. This is because you don't own the gold but instead own the right to purchase it at some predetermined price over some period of time.

In most cases though, we are asked about owning gold as an inflation hedge. This is more akin to using it as a store of wealth. The appeal here is that it is believed gold's value will change with inflation and thus as a store of wealth, your wealth in gold will rise or fall with inflation. As Americans, our wealth is stored in the U.S. dollar. Your bank accounts are held in dollars. Your stocks and bonds are priced in dollars. Whenever you sell something, you receive dollars. Many people today are worried about the value of the dollar and are looking for something else. Foreigners also own a lot of our currency. They too are nervous.

These concerns arise because of the budget crises and the huge increase in the money supply promoted by the Federal Reserve. In theory, as the money supply is increased, the value of each dollar is diminished. It's simple supply and demand. Over the last few years, we have seen some decrease in the value of the dollar but nothing dramatic. The reason for this is that there has also been a corresponding increase in demand for our currency, keeping things in check.

So we've identified two possible reasons why you might like to store your wealth in gold. The next question is how good is gold at addressing these concerns? As it turns out, gold doesn't do a good job at all. As a reserve currency, there quite simply isn't enough of it to fill the need. Since the beginning of time, it is estimated that 165,000 tons of gold have been mined. At $1,200 per ounce, that is only 6.6 Trillion dollars. That's only a tiny fraction of the value of the worldwide economies.

As an inflation hedge, time and time again, gold's price has shown itself to march to the beat of a different drummer. There is no better example than today. Inflation and interest rates have been at record lows for years. Yet, in spite of this, gold's prices are at record highs. Clearly, something else is driving the price. In addition, it is completely impractical to transfer enough of your wealth from dollars to gold to make much of a difference in your finances.

The thing really driving gold prices is the aspect of gold as a commodity. The consumption of gold produced in the world is about 50% in jewelry, 40% in investments, and 10% in industry. India is the world's largest single consumer of gold, as Indians buy about 25% of the world's gold, purchasing approximately 800 tons of every year, mostly for jewelry. What I believe is the real driver of gold's price lately is the 40% used for investment. This smells a lot like a bubble.

Gold is being bought just for the sake of owning it. Without a corresponding increase in industrial demand, it's reasonable to wonder what will be the underlying support to the price. Through modern finance, it's incredibly easy for large sums of money to flow in and out of any asset. When the crowd moves away from gold, you have to wonder what that will mean for the price.

Like any asset bubble, there will be those who win big. There will also be those who lose big. The problem is you can't research, forecast or model the crowd. At this point you have to ask, is this investing or gambling?

What's Your Number?

By Lori Eason, CFP(R)

With the recent credit crisis, it has become much more difficult to obtain credit making your credit history and credit score more important now than ever. I have always wondered, what exactly is a credit score? How is it determined? What can I do to improve it? I figured some of you might have similar questions as me so I decided to research the topic and share my findings.

Last week, I decided it was time for me to pull my credit history and make sure there are no signs of identity theft. We have all been warned about the increasing risk of identity theft with technology advancing. It had been over a year and a half since I looked at my credit report and I remember that being a trying process. I had been misled by the ads of FreeCreditReport.com, the ones with the obnoxious lyrics that get stuck in your head! I mistakenly thought that it was actually an easy process to get my “free” report. Everything went fine until I saw a charge of $14.95 on my credit card statement. Of course I called the company and after getting very firm, they agreed to remove the charge. I later found out that other friends of mine had the exact same experience. In fact, there have been multiple lawsuits concerning those advertisements.

This time around, I decided to research the ways to get a copy of my report and came across the Federal Trade Commission’s link to AnnualCreditReport.com. I read about my right to receive a copy of my credit report from each of the three reporting agencies, Experian, Equifax, and TransUnion, once every 12 months due to the Fair and Accurate Credit Transactions Act of 2003. I had heard about this rule before, but didn’t know the best way to go about getting my report. This website was clearly where I needed to be. I chose one agency and looked over my report and everything appeared to be fine. But one thing was noticeably absent from my report, my FICO score. Of course, you have to pay for that feature!

So what exactly is a credit score? It its most general sense, a credit score is a number used by lenders to estimate the likelihood that a person will pay his or her debts. This number not only impacts whether or not you are approved for credit, but can also impact the interest rate you receive when you finance a purchase. The most widely used credit score is the FICO score, an acronym for the creators of this score, the Fair Isaac Corporation. This score takes into account various factors in five areas: payment history, current level of indebtedness, types of credit used, length of credit history, and new credit. Mathematic models are used to calculate a number between 300 and 850. Generally, a score above 650 indicates an individual has very good credit history.

So as I mentioned, there are 5 areas that are evaluated in determining your FICO score. I’d like to give a little insight into what each of these encompasses and which ones have the biggest impact on your score. Payment history is the biggest component, making up 35% of your score. But the definition of a late payment warrants further explanation. The credit bureaus are only notified if your payment is more than 30 days late. Payments that are between 30 and 60 days late can lower your credit score, but the negative impact is generally temporary and only harms your score for a couple months, assuming only one or two payments are that late. Payments over 90 days late severely hurt your credit score and can damage your credit for up to 7 years.

The second biggest component is current indebtedness also known as credit utilization, making up 30% of your FICO score. This is the ratio of current revolving debt (such as credit card balances) to the total available credit limit. It is perhaps the most interesting component. You can improve your FICO score by paying off debt and lowering this ratio OR by applying for and receiving a credit limit increase. Closing existing revolving accounts typically has a negative impact on your score. This is kind of a Catch-22 as it in a way encourages individuals to obtain unnecessary credit and leave inactive accounts open, which is not a very safe practice due to identity theft.

Length of credit history is the third most important component, making up 15% of your total FICO score. This includes time since accounts were opened and time since account activity. A longer credit history provides more information and offers a better picture on long-term financial behavior, which hopefully is a good thing and will help your score! It is impossible for a person who is new to credit to have a perfect credit score and in fact, many new college graduates have a very difficult time getting a credit card or financing a purchase at first because they have no credit. This is one instance when student loans actually help you!

The fourth and fifth components each make up 10% of your FICO score. There are several types of credit and you can benefit by having a history of managing different types. Some examples are installment, revolving, consumer finance, and mortgage. The last component is new credit. Credit inquiries for new credit can hurt your score, but inquiries that were made yourself to check your credit, by your employer for employee verification or by companies initiating prescreened offers of credit or insurance do not have any impact on your credit score. They will still show up on your credit history report. Also, individuals shopping for a mortgage or auto loan over a short period will likely not experience a decrease in the scores of these types of inquiries. That being said, it is a good practice to avoid opening too many credit cards in a short time frame because such behavior could suggest that you are in financial trouble and need access to a lot of credit. You should especially avoid opening new lines of credit if you are in the midst of buying or refinancing a home or financing some other large purchase.

While the actual formulas used to calculate credit scores are not public information, this breakdown of the 5 components and their allocations was disclosed by FICO. Each of the three credit bureaus mentioned above, Experian, Equifax, and TransUnion, have a slightly different method of calculating FICO scores and thus your score may vary slightly between the three.

To conclude, I definitely think it is a good practice to check your credit history report at least once a year. There are two main reasons for doing so, protection and accuracy. You need to make sure that there are no signs of fraudulent activity and that everything listed on your report is in fact credit you applied for or at least are aware of. Also, it is not uncommon for incorrect information to be reported that could potentially harm your credit. The only truly free and federally sanctioned website for requesting your credit report is www.AnnualCreditReport.com. On any other sites, you really need to read the fine print. The same goes for obtaining your credit score which is not part of your free credit report.