Standing on the Edge of the Fiscal Cliff

By:  Lori Eason, CFP(R) With the election less than two months away, emotions are running high among Americans as the two candidates battle for the Oval Office. The stakes are high as our country has been plagued with an ever increasing deficit, unemployment and a struggling economy for several years now. Our country sat back and watched as the Eurozone debt crisis unraveled with many of us fearing that we were next in line if we continued on our current path. In fact, for the past 18 months, the number one risk that worried money managers has been Europe's debt crisis. Until September, that is. In this month's Bank of America Merrill Lynch Fund Manager survey, the looming fiscal cliff in the U.S. took over the number one mega risk spot.    The fiscal cliff is the popular shorthand term used to describe the decisions Congress must make come December regarding the expiration of the Bush tax cuts and the scheduled spending cuts set to take effect in January. In 2010, Congress kicked the issues down the curb by extending the Bush tax cuts through December 2012 and postponing the spending cuts until then as well.    The Bush tax cuts are a series of temporary income tax relief measures enacted by President George W. Bush in 2001 and 2003. They lowered federal income tax rates for everyone, decreased the marriage penalty and increased the child tax credit. These cuts also lowered capital gains and dividend income rates. The estate tax gradually decreased until it reached zero in 2010. Phase-outs on personal exemptions and itemized deductions were eliminated which allowed millions of households to escape the alternative minimum tax. Another tax break set to expire that is not part of the Bush tax cuts is the 2% reduction of the Social Security payroll tax which President Obama enacted in 2011. Without an extension of these tax cuts, it is estimated that the typical middle class family would face an annual tax increase of over $2,000.    The spending cuts referred to are part of the Budget Control Act of 2011 which requires $1.2 trillion in budget cuts over 10 years. These automatic cuts will be split between security and non-security programs and include $500 billion in cuts to the Department of Defense. There will be no cuts to Medicaid and Social Security. The first $109 billion in cuts are set to take effect in January of 2013.    So Congress clearly has 2 choices: extend the tax cuts and delay the spending again or do nothing and see how things play out. With the impending election, the most likely course of action is to postpone the tax increases and spending cuts and thus kick the issues further down the curb. Let's take a deeper look at these options.    If Congress doesn't avert these tax increases and spending cuts, the Congressional Budget Office predicts that the U.S. economy will face a significant recession in 2013. The CBO estimates that the policies set to go into effect would result in a 1.3% contraction in the first half of 2013 (which meets the definition of a recession) and a 2.3% expansion in the second half. The estimated growth in real GDP for the year would be .5%. The CBO warns that as a consequence of the spending cuts, the unemployment rate is projected to rise from 8% to 9.1% by the end of 2013. Keep in mind that these figures are projections from one group and should not be taken as facts.    If you have read our past memos, you know that the United States' spending problem is one of our hot buttons and in our opinion, the number one reason our country is in such bad shape. At the end of September 2008, our total outstanding debt was $10,000 billion (I'm going to phrase this in billions because the word "trillion" seems to have lost its meaning lately). As of last month, the total outstanding debt number is now $16,000 billion. That is an increase of 60% in just 4 years! And what has all that spending done for us? Given such a dramatic increase in such a short period of time, surely our government can find some way to shave $109 billion off of next year's budget without bringing on a recession. To put it in perspective, the total outlay for this year is projected to be $3,796 billion.    Now let's shift our focus from the spending side to the tax revenue side. Allowing the tax cuts to expire would raise taxes by $316 billion on more than 100 million Americans. Maybe a better term is not fiscal cliff but taxmageddon. There's no way that this economy could digest a tax increase of that magnitude. The White House has called for a mixed deficit reduction plan which includes the extension of all the Bush tax cuts for all families who make less than $250,000/year as well as some spending cuts. Republicans disagree with the $250k income cap and argue that would be a tax hike on small business owners. Romney has proposed extending all Bush tax cuts and postponing all spending cuts until he get in office (if elected) at which point he would construct his own deficit reduction plan.    Here's our take on the tax situation. If Congress were to let the tax cuts expire for those who make over $250,000, the CBO estimates the additional tax revenue in 2013 would be around $42 billion. When facing the decision of whether to raise taxes, the cost-benefit analysis should certainly be considered. Ernst & Young predicts that tax increases on the affluent would cost around 710,000 jobs and cut wages. Raising taxes on the wealthy causes them to redistribute their capital and use it in ways that are not as beneficial to the economy in an effort to shelter those monies from taxes. The risk of higher unemployment and lower taxable incomes hardly seems worth the benefit of only reducing the current year's deficit by less than 4% ($42b/$1,130b). No amount of tax increase on the rich could ever get us out of our debt crisis. We have to get to the root of the problem which is overspending. Our government has proven time and time again that access to more revenue and credit only feeds its spending addiction.    Despite the fact that several members from both parties have said Democrats and Republicans will have to compromise to reach a deal after the election, no leaders from either party have shown any willingness to do so. And there is definitely a cost to indecision which will likely affect the economy before 2013 begins. Households and business will most likely begin to change their spending habits in anticipation of the changes, which could reduce GDP by .5% by the end of 2012 according to the CBO. One lesson to be learned over the last few years is that Americans do not respond to temporary fixes. All of these stimulus attempts over the last several years (from the random tax rebate checks we all received back in 2008 to First Time Home Buyer and Making Work Pay credits) have done nothing but delay the inevitable and add to our outstanding debt. We cannot spend our way out of this mess!    The bottom line is that with either choice, the U.S. will still be in a precarious economic situation for the foreseeable future. Our spending problem is going to take years to fix, but we have to start somewhere.  The election results in November will tell us a lot about this country and the direction it is headed.

*All projections came from either the Congressional Budget Office or Treasury Direct.

Managing for the Total Return

It seems hard to believe that we are only a few months away from the fifth anniversary of the market collapse that marked the beginning of the economic malaise we still find ourselves in today.  The stock market as measured by the Dow Jones Industrial Average reached its peak of 14,165 back in early October 2007.  The following year and a half saw that average fall more than half and bottom out just above 6,500.  Since then, stocks have thankfully recovered much of those losses but are still roughly down 11% from the 2007 levels. 

It’s anyone’s guess when the stock market will have fully recovered, but we think that will likely happen sometime next year.  That implies that stock investors will have seen zero price appreciation in over five years.  That’s a long time.  It’s especially a long time if you’re retired and depending on some amount of appreciation to supplement your income.  In addition, this will have been the second time in less than a decade that stocks have experienced a 50% decline. 

When the tech bubble burst in 2000, stocks sold off for the following three years and then fully recovered (except the NASDAQ index) over the next two.  This means that any of the cumulative gains over the past dozen years have occurred in barely two years.  This has been a real problem for savers and has discouraged many people from investing in stocks at all.  This is understandable because if you spread those couple of years’ gains over twelve years, the per-year return doesn’t look so good.  In fact, it’s pretty lousy. 

Modern portfolio theory has constantly preached that the best real returns are to be had in the stock market over the long term.  The problem is that there isn’t a definition as to how long the long-term is.  Here lies the problem for anyone making regular withdrawals from their savings. 

As many of you have heard me say, the only time you care about what something is worth is the day you bought it and the day you sold it.  From this perspective, cash flow planning is where investment management and financial planning come together.  Successfully done, a good retirement plan will: 1. Provide a relatively steady income stream independent of the market 2. Allow you to adjust your income for inflation (maintain your purchasing power) 3. Do this for a lifetime.  These goals can only be achieved through a total return perspective - i.e. a combination of cash income and share price appreciation.  

In today’s interest rate environment, this is becoming increasingly difficult to achieve because of the Federal Reserve’s monetary policy.  The Federal Reserve has pushed down short-term rates to all-time lows in response to the financial crisis and ensuing recession.  Even before the crisis, the Fed had set rates extremely low.  Many believe (us included) that the years of easy money policy have been a big contributor to the debt meltdown in the housing market and on Wall Street.  Now, in addition to holding down short-term rates, the Fed has embarked on “Operation Twist” which is a program to manipulate the long end for the interest rate curve too.  These policy goals are achieved through the Fed’s open market activities.  This is where the Fed actively buys and sells its own bonds and a select few other issues to influence the process in the secondary market.  Price changes in turn affect the yield. 

In the Fed’s defense, their actions are largely driven by the federal government’s atrocious fiscal policies and global economic condition.  The huge annual deficits and a lack of any long term tax policy has put the Federal Reserve in a difficult predicament of having to print money via quantitative easing and eroding the value of the dollar.  All the while they are risking the inflationary impact which undermines their price stability mandate.  Inflation has thus far been tame but only because of the crisis in Europe.  It’s only a matter of time before expanding the money supply will lead to higher prices.

Investors have now been put into a position where their traditional reinvestment opportunities are yielding less and less.  Every time a bond matures or a security gets called, investors are faced with lower and lower income prospects.  These policies have created a perverse situation where the most financially responsible individuals in the economy (savers) are being punished to benefit (bailout) the least financially responsible (debtors).  It’s a bad deal all the way around, but one we’re going to be faced with for a while.

As investment managers, we’re often asked by our clients what can be done about this.  It’s challenging to say the least.  The lack of stock market returns and increased volatility has led us to focus on current income over the last few years.  We’ve had a lot of success as evidenced by that fact that most of our client accounts have moved past their 2007 values.  We have accomplished this by focusing on mortgage related investments and bank preferred stocks.  However, as the mortgages continue to payoff and the preferred stocks are getting called, we have had to expand our universe of what we consider fixed income investments.

For now, that means taking on more risk in the effort to replace this income.   We accomplish this is by looking to use a greater amount of alternative investments such as master limited partnerships (MLP), real estate investment trusts, bank loan funds, high yield bonds, corporate bonds, and dividend stocks.  While each of these have their own set of nuances and challenges, they share the ability to potentially generate better levels of cash flow than can be produced by more mainstream bond-like investments.  Here’s an example of two of these:

Master Limited Partnerships (MLPs) - An example would be the ALPS Alerian MLP.  This exchange traded fund is the largest MLP ETF in the market with assets of $3.2 billion.  MLPs are a type of publicly traded limited partnership.  As a limited partner, a person provides capital, and in return, receives a periodic pay out from the company’s revenue.  These MLP ETFs typically track the performance of natural gas and crude oil pipeline operators.   We have chosen to begin adding this asset class because while the yield is excellent (currently 6.25%), it also offers us diversification in properties that tend to move independently of other asset classes such as stocks, bonds and commodities.

Bank Loan funds - An example of one we own is PPR (ING prime rate trust).  This exchange traded fund invests in senior loans that are typically issued by lower investment grade companies.  We typically own this asset class because it pays a healthy dividend (currently paying + 7%) and offers a floating interest rate.  This helps us two ways:  we make income now and have the potential to make more once interest rise in the future.

The only downside to these alternative investments is that they come with more short-term share price volatility than the traditional bond portfolio.  But we’re comfortable with this as long as we’re afforded the time to ride out those price fluctuations.  This is a similar strategy that we’ve used with several of the equity positions that we hold.  The international sector, for example, has been quite volatile in the past twelve months. It would have been nice to have avoided those price swings, but doing so would have meant guessing on timing those trades and giving up on an almost 4% income stream. 

We believe a total return perspective pays off.  A portfolio’s total return is the combination of both income and capital appreciation.  The two work together but in very different ways and over very different time horizons.  Don’t focus on one or the other but instead look at the cash flows over the short-term and the capital appreciation over the long-term. 

Obamacare Lives Another Day

Unless you spent the day adrift at sea, I'm sure you have heard that the Supreme Court upheld President Obama's health care reform bill. Even though the day was filled with plenty of news and analysis about this decision, we thought we'd chime in with ours too.

While there were several parts of the law that were under review by the Supreme Court, the most controversial part surrounded the individual mandate. Just to refresh your memory, here's a quick recap on the individual mandate. The Patient Protection and Affordable Care Act was signed in 2010 and imposes a health insurance mandate set to take effect in 2014. This mandate requires all individuals who can afford health insurance to purchase a comprehensive policy that meets minimum coverage requirements. Traditionally, many healthy (and usually young) Americans have opted to carry no insurance or high deductible insurance (catastrophic policies) in the past. This was obviously a financial decision because those people felt they could pay out of pocket for the minor things and either didn't think something bad would happen or had insurance to cover the really expensive healthcare. Those choices are no longer legal. The law states that individuals who can afford health insurance (defined as those above the poverty line for whom the minimum policy will not cost more than 8% of their monthly income) must purchase minimum coverage. Those who can't afford it will be provided that insurance, paid in part or entirely by the Federal government.

From day one, this act has been very controversial with the biggest question being whether or not the act violates the Constitution by requiring everyone to purchase something in the private sector. The authors of this law depended on the Commerce Clause in the Constitution to legitimize this requirement. The clause states that the U.S. Congress has the power "To regulate Commerce with foreign Nations, and among the several States, and with the Indian Tribes." Opponents of the mandate claim that the decision not to do something (i.e. not buy health insurance) is economic inactivity and therefore not a behavior the federal government can regulate. Supporters of the mandate argue that the decision not to purchase health insurance has an economic impact and therefore can be regulated.

While yesterday a divided Supreme Court did uphold the constitutionality of the individual mandate, they also made a very important clarification. The court concluded the "penalty" for not purchasing insurance is in fact a tax. As a tax, the mandate is allowable under Congress' taxing authority. This is something that supporters had blatantly refused to admit. In an interview with George Stephanopoulos back in 2009, when asked if he rejects that the individual mandate is a tax increase, President Obama's response was "I absolutely reject that notion." Never mind the fact that the penalty is based on your taxable income and collected by the IRS.   As the saying goes, if it looks like a duck, swims like a duck and quacks like a duck, it's probably a duck.

Because this debate has centered on the healthcare law, most of the news and analysis has been focused on upholding the individual mandate. However, I think the real story here is that this is the first time that the court has established a boundary to the Commerce Clause which has been one of the most congressionally abused sections of the Constitution. For decades, Congress has used the Commerce Clause to justify all means of regulation. They have said that their power to regulate is given due to the fact that whatever they were trying to regulate had an economic impact and thus fell under the Commerce Clause. Economic impacts are unavoidable. Every day that you get out of bed you create some economic impact, no matter how small. When you turn on a light switch, you've just purchased electricity. When you brush your teeth, you've just purchased water and toothpaste. You have to eat and so on. So you can see that taken to the extreme, there is no end. This decision has at least recognized a limit. Chief Justice Roberts writes that construing the Commerce Clause as the Obama Administration argued "would open a new and potentially vast domain to congressional authority. . . . The Framers gave Congress the power to regulate commerce, not to compel it, and for over 200 years both our decisions and Congress's actions have reflected this understanding."

Taxing people for not doing something is an interesting concept, however, and I think this is going to open up a whole other can of worms. According to Chief Justice Roberts, the penalty is merely a tax on not owning health insurance, no different from "buying gasoline or earning income," and it thus complies with the Constitution. This is a large loophole though. The result is that Washington has unlimited power to impose new purchase mandates and the courts will find them constitutional if Congress calls them taxes, or even if it calls them something else and judges call them taxes.

The more immediate impact of the Supreme Court decision is that, barring a political party change, the Affordable Care Act will continue to move forward. This, honestly, worries us. Anyone who has read what we've written in the past couple of years knows that we view the explosion in deficit spending and borrowing as the single biggest threat to this country's prosperity and our client's long-term retirement. The ironically named Affordable Care Act will do nothing to make healthcare more affordable. More specifically, it won't bring down the cost of healthcare. It will make it more affordable to those who will receive free or subsidized insurance, but the rest of us will continue to see our premiums rise. Those changes will occur at the payer level (insurance companies) but not at the provider level (doctors and hospitals).

I'm certain that the real goal of this whole process was to expand healthcare services to as many people as possible and had little or nothing to do with controlling the cost. There's probably no better evidence than the fact that the law will impose a new 2.3% sales tax on medical equipment. Why would you raise the price of something that you're trying to control the cost of? Obviously this is to help pay for the real goal of expanding coverage.

The government is now going to start picking up the tab in part or in total for approximately an additional 16 million people. This is going to be very expensive. While all the additional taxes (everything from medical devices to tanning salons) will help offset some of these costs, they will in no way come close to covering them. There is no way of estimating the cost of this new entitlement or how much those costs will change over time, but there are a couple examples - Medicaid and Medicare. These two examples are not pretty. Both are the single biggest budget busters at the state and federal level. Many of the new insurance recipients will be placed into the Medicaid program which means the government will be directly paying for their healthcare. The others will have most or some of their premiums paid by the government. Very few of the current uninsured will pay their entire premiums.

The total amount spent in the U.S. on health care as a percent of GDP is 17.4%, which is higher than any other nation. Medicare spending accounts for 3.7% of GDP and this number is increasing at an alarming rate. A recent CBO study estimated that Medicare will cost $1 trillion annually and be bankrupt by 2022. Meanwhile states are desperate to get their budgets in balance but Medicaid spending has nearly doubled over the last decade. On top of already skyrocketing costs, the Affordable Care Act seeks to expand Medicaid eligibility from those with income up to 100% of the poverty level to those with income up to 133% of the poverty level. However the Supreme Court just ruled that participation in the expanded Medicaid program must be voluntary and several state governments have declared they will not participate. The bottom line is without drastic changes in healthcare costs, both Medicare and Medicaid are simply unsustainable and will cripple our economic growth. For a country that is running 1.2 trillion dollar deficits and borrows 40 cents of every dollar it currently spends, this does not portend well.

In conclusion, I think most would agree that providing healthcare access to as many as possible is an admirable goal. There are aspects of this law which many will benefit from. My personal belief is that because, as a society, we won't let people just die on the street but instead will take care of them, as a member of that society everyone should be required to contribute towards that care in the form of carrying insurance. Bankrupting the country in pursuit of this is not going to help anybody.

Medicare: What Every Boomer Must Know

By:  Lori Eason, CFP(R)

According to recent studies, an alarming percent of the population has no clue how Medicare works, how much it costs or what health care costs it covers. 56% of pre-Medicare boomers age 47-64 have a poor understanding or know nothing about Medicare costs and benefits. We all know that health care costs are out of control in this country. Unless you have your head buried in the sand, you have also realized that as the population ages, Medicare in its current form is simply not sustainable. I'll save that topic for another day and shift today's focus to 5 important facts everyone needs to know about Medicare.

Medicare Part A is mandatory.

Most people are aware that at age 65, you are eligible for Medicare. But many people do not know that Medicare is mandatory once you're retired. The only exception is people who are part of an employer plan that covers 20 or more employees.   This does not include retiree plans.

Medicare Part A (hospital insurance) is free for the vast majority of people. Anyone who paid into the Social Security system for 10 years or is a dependent of someone who did is covered.   Although Social Security law does not require participants to accept Medicare and Medicare law does not require participants to accept Social Security, any senior who withdraws from Medicare also loses their Social Security benefits. This is the result of the Clinton administration tying the two programs together in 1993. Just this past February, an appeals court ruled that seniors can't reject Medicare and receive Social Security in a case that originated a few years ago. Click here to read more about this case.

Medicare is the primary payer for all patients over 65. Every claim for a patient over 65 is submitted to Medicare and only after Medicare pays its share is the claim submitted to private insurance. Private insurance will not pay unless Medicare pays their share.   As mentioned above, the only exception is group plans with 20 or more employees. Private insurance that doesn't pay second to Medicare is either too expensive or unavailable.

Sign up on time to avoid late enrollment penalties.

I cannot express how important it is to not miss your initial enrollment period for Medicare which begins 3 months before your 65th birthday and ends 3 months after.  For those already receiving Social Security benefits at age 65, enrollment is automatic for both Parts A & B (medical insurance).  For those not receiving Social Security, failure to enroll on time will result in costly penalties that last the rest of your life!  You will have to pay a 10% penalty for each 12 month period that you could have had Part B but didn't enroll. There is also a late penalty for failure to enroll in Part D (prescription drugs) on time unless you are covered by other creditable coverage. There is a justified reason for these hefty penalties. In the world of insurance, you absolutely cannot let people go without insurance and sign up only when they become ill. That defeats the purpose of insurance which by definition is managing uncertain risks, not known issues.

Since you must pay a monthly premium for Part B, you are given the option to opt out. Although Part B is not mandatory, it is extremely expensive and very difficult to obtain a private plan beyond age 65. I think it's safe to say that it never makes sense to seek private insurance instead of Medicare under our current healthcare system. Now you do need to obtain supplemental coverage on top of Medicare, but not in lieu of it. This leads me to the next fact.

Medicare doesn't cover everything.

An alarming 62% of pre-Medicare boomers don't understand what benefits will be for doctor or hospital visits. Unfortunately, many people who had comprehensive coverage will be surprised to find out all the things that are not covered such as dental, vision, hearing aids, alternative medicine (chiropractic, acupuncture, etc.), and any amounts over Medicare-approved coverage. 77% of Medicare recipients have some form of supplemental insurance because Medicare Part B simply leaves too many gaps. You have 2 options when it comes to supplementing Medicare: Medicare Advantage (also known as Part C) or MediGap policies. Both of these help cover costs not paid by Parts A & B including deductibles, co-payments and coinsurance.

Medicare Advantage plans are HMO or PPO plans offered by private companies and approved by Medicare. These plans combine Parts A & B and most likely Part D as well. On top of this, extra coverage such as vision, hearing, and dental are commonly added. You usually pay an extra premium on top of the Part B premium and these plans vary in cost and coverage by area.

Another option is purchasing a MediGap policy which is private insurance designed to supplement original Medicare (Parts A & B). MediGap policies are standardized and you have 10 levels of coverage to choose from. You'll also need to enroll in Part D separately. These plans also vary by area.

A lot of thought must go into choosing your supplemental coverage since there is a wide range of options that must be sifted through to find the plan that best meets your needs.

Your out-of-pocket health care costs in retirement will most likely be higher than you expect.

In the average Medicare household, 14.9% of gross spending goes towards health care. Recent studies show that most Medicare beneficiaries are actively pursuing ways to cut costs. For example, 69% have switched to generic drugs.

While 58% of pre-Medicare boomers know that you have to pay a premium, it is quite scary that 13% think Medicare is completely free. Those who think it's free are in for a rude awakening. When Medicare was created in 1965, the Part B premium was a mere $3/month. Now the premium is $99/month (for those not subject to an income-based surcharge), down from $116 last year due to the Affordable Care Act. You can be sure that these premiums will continue to rise without drastic reform.

It is also important to point out that Medicare premiums are means tested. Individuals with income over $85,000 and couples with income over $170,000 pay more. At the max tier (joint MAGI over $214,000), you pay $220/month more for Part B and $66/month more for Part D. But even at this level, Medicare is still cheaper than seeking a private insurer which would charge $1,500-$2,000/month per couple.

Medicare does not cover long term care.

57% of pre-Medicare boomers don't know if long term care at home or in a facility is covered and almost 30% think it is. Medicare exists to help keep seniors well and to nurse them back to health if they get sick. However, it was never meant to provide long term nursing home care for a patient who will never recover. While Medicare Part A will cover a brief stay in a skilled nursing facility if certain criteria are met, it will not pay for long term custodial care which is care that helps you with activities of daily living.

I won't spend a large amount of time on this subject because I wrote a memo on long term care just last year. If you missed out on that one or if you'd like to refresh your memory, you can read it here.

I hope this article has helped shed some light on Medicare and its benefits and shortcomings. It is so important to remain informed about this program since it will greatly impact your quality of life in retirement. 

The Federal Debt Bomb

Annual income twenty pounds, annual expenditure nineteen six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. - Charles Dickens

While everyone has been cheering the market gains so far this year, the European debt crisis which fueled last year's volatility is still very much on the minds of the financial markets. The recent calm has been largely driven by the bailouts of European borrowers and banks. All of this has been made possible by a debt market awash in cheap money. These bargain rates have also greatly helped the world's biggest borrower, the U.S.

Over the last several years, the United States has been quietly benefiting from historically low interest rates. These ultra-low rates have masked a budgetary challenge to service this debt in the future. The issue deserves more attention as the nation will be stuck paying the bill when rates inevitably rise.

First, a couple facts: The U.S. Treasury currently has $10.8 trillion in outstanding publicly-held debt, and more than $8 trillion of it must be repaid within the next seven years. More than $5.5 trillion falls due within the next three years.

This relatively short-term debt due is no accident. Like a consumer opting for a low teaser rate, the government has structured its debt to keep the current interest payments low. This is a political temptation for every administration because it means lower budget deficits on its watch.

The government has added close to $5 trillion in debt in the last four years alone. To keep the interest payments low, it much prefers to finance all of this at a rate of 0.3% in two-year notes than at 2% in 10-year notes. Even though the federal debt has soared during those years, the net federal interest payments are lower than they were in 2007. In nominal dollars, the interest payments are even less than they were in 1997 when public debt was a mere $3.8 trillion. This year the debt is expected to reach a whopping $11.58 trillion.

These low rates have disguised the magnitude of the debt threat that is building for future taxpayers. The Congressional Budget Office (CBO), for example, forecasts that in the period 2014-2017, the average rates on three-month Treasury bills will rise to 2% from less than 0.1% today. The CBO expects average rates on 10-year Treasury notes to climb to 3.8%, from 2.03% now. The CBO adds that every 100 basis-point rise in government borrowing costs over the next decade will trigger almost $1 trillion in additional interest expense, which of course will be paid with yet more borrowing.

As of January 2012, taking into account all the various notes and bonds issued by the federal government to the public, the U.S. is paying an average interest rate of 2.24%. The government expects to spend in the neighborhood of $225 billion this year on those interest payments.

That may seem like a large sum, and it is, but consider what happens if rates quickly rise back toward their historical norms. As recently as early 2007 the government was paying 5% on its debt, which is the average of the last two decades, though rates could always go higher of course. During the 1990s, the average was well above 6%.

If the government had to pay the 5% rate that it was offering before the financial crisis on today's debt, the annual interest payments would be $535 billion, twice CBO's projection for total federal spending on Medicaid this year. If the government had to pay 6% on its debt, the annual interest payments of $642 billion would surpass total federal spending on Medicare, currently $484 billion.

There has been far too little talk of the impact on our federal budget when (not if) interest rates normalize. These numbers will only get worse with the one point something trillion dollar deficits that are currently being run up every year. The situation has become so extreme at this point that even if all the tax increases being discussed were enacted, they wouldn't even cover half of these higher interest payments - let alone reduce the deficits.

The Treasury Department says it's aware of this risk and has stated that it is making changes to its debt structure. In the past year and a half, the Treasury Department has reduced the debt maturing in three years from 55% to 52%, but the short term outstanding debt is still far too and the move to rebalance the maturities far too slow.

The Fed has been buying its own debt in the open market through its "Operation Twist". In addition to greatly increasing the money supply, it is also purchasing 30 year bonds in part to keep longer term rates down. Eventually this will have to end. When it does, rates will start to rise to historically normal levels. The question remains, how quickly will the debt bomb go off after that?

We've seen what the future looks like - Europe. Crushing debt loads greatly reduce economic growth and employment. They also force a nation to be beholden to their creditors. In our case, that is looking more and more like the communist Chinese.

Are You Audit Worthy?

Since we are currently in the midst of tax season, I figured a tax-related article would be appropriate this month. And what could possibly be a more fun topic than tax audits? I think it goes without saying that our government is hurting for cash right now. Increasing tax revenue is always the first place the government looks to help balance the books. This year the IRS is focusing on ways to collect more money without actually raising taxes.

On a positive note, the number of tax filers that gets audited is very low. In 2011, only 1.11% of total individual tax returns filed were audited. But business owners who file Schedule C Forms were audited at a rate of slightly more than 4 percent. High-income taxpayers are also a target; for those earning more than $200,000 in 2010, the audit rate was 3.1 percent, and for taxpayers earning more than $1 million, it was 8.1 percent.

The IRS has three computer systems that use different types of analysis to determine which tax returns to audit. The Discriminant Function System gives each return a score based on the likelihood that it is accurate. It is believed that deductions and exemptions carry the biggest weights but the actual formula used is top secret. The Unreported Income Discriminant Function scores people based on their expense to income ratio. High expenses relative to income raise suspicion that there may be unreported income. The Information Returns Processing System stores information reported from third parties such as employers, banks and brokerage firms (W-2s and 1099s for example). The IRS also uses non computer related analysis as well.

Now that you have a general idea of some items that may raise suspicion from the IRS, let’s take a look at some specific red flags increase risk of an audit.

First off, make sure your return does not contain any mathematical errors. Even a simple mistake can cause the IRS to take a second look at your return and determine that it should be audited. Similarly listing incorrect basic information such as mistyping your Social Security number can also trigger an audit.

Another common culprit is high itemized deductions that exceed the typical IRS ranges for your income group. The IRS does not publicize these target ranges but it does release statistics that show the average amount of deductions claimed according to reported income.

Deducting automobile expenses is one of the biggest and most commonly audited items. It is crucial that those using a personal car for business keep a meticulous daily log of business mileage that includes odometer readings, dates, locations and meeting details.

Home office deductions are another flag raiser. If you work at home intermittently, it’s best to forego this deduction. The rules are very complex and you should consult a tax expert to determine if you qualify.

Another eyebrow raiser to the IRS is large charitable contributions relative to income level.

While there are certainly other red flags, I’ll conclude with the new 1099-K that the IRS plans to use this year to take a closer look at online income from E-bay and other auction sites. While I highly doubt any of you will receive one of these 1099s, I thought you would find it interesting. This 1099-K is the result of a new law that requires payment settlement companies (such as PayPal) to report amounts received by merchants to the IRS. For now this only applies to merchants who receive over $20,000 in payments or over 200 transactions.

If you ever become one of the unlikely (and unlucky) recipients of an IRS audit, you will be notified by mail and the letter you receive will specify they type of audit they will conduct, either a correspondence audit, an office audit or a field audit. In a correspondence audit, the IRS sends you a letter that asks for more information about certain items on your return and you respond by sending the appropriate documentation. This is the most common type of audit. During an office audit, you are required to go to your local IRS office to meet with an auditor. The IRS determines the time and the particular documents that you need to bring. If you have kept detailed records and can back up your tax files, you can go and take care of it yourself. If not, you may want to hire a professional. Lastly, during a field audit, the IRS agent makes a visit to your home or business to perform the review. This is the least common and is only used if the individual or business being audited earned well over $100,000.

To conclude, it is important to note that the IRS has 3 years from the date you filed to collect extra tax. They have 6 years to collect if the taxpayer didn’t report more than ¼ of his or her income. And for those who evade tax or file fraudulent returns, there is no statute of limitations and an audit can take place at any time.

By keeping complete and detailed records, you can greatly lessen your risks and stress should the IRS decide to take a closer look at your tax files. If you think the IRS may question a large tax deduction or tax credit, you may even want to attach an explanation to your tax return when you file it. While it may be impossible to avoid all of the red flags, it is beneficial to at least know what they are.

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.