Perspectives on the US Debt Ceiling Debate

Today, I participated in a conference call with the senior economists from TD Ameritrade.  These notes are taken directly from this call.  I must credit TD Ameritrade for a great job in detailing the four most likely outcomes and the ramifications for each scenario. 
 
Scenario 1….”to dream the impossible dream”


In this scenario, congress finally agrees to the “grand bargain” whereby $3-4 trillion in financial austerity is agreed to. This is the most optimistic scenario and probably hard to achieve within the short time frame of only 4 days. But this agreement would yield the most positive financial market reaction. And a rough path would be carved out for a more sustainable US budget picture. But while the markets would calm down, this will come with a huge economic price as our GDP growth will slow down over the next several years. It will be a painful process as we move towards a balanced budget with expenditures not exceeding income and severely trimming the deficit. Something that absolutely needs to be done but folks, there will be pain in the process.

Scenario 2…”no harm..no foul”

In this scenario, a last minute deal is struck and government operations are not affected. However, this deal involves only an incremental increase in the debt ceiling in exchange for ongoing discussions of further reductions etc… Standard and Poor’s will most likely downgrade the current AAA status of the US government because they do not see a long term plan in place for reducing the deficit. Having said this, it will only have a benign impact on the US economy. Other rating agencies do not appear inclined to follow Standard and Poor’s. The markets should react favorably in the short run.

So, while we dodged the bullet in the short term, we still need to come up with a long term plan much like the “grand bargain” cited above. We have just kicked the can down the road.

Scenario 3…”a flesh wound”

In this scenario, no agreement is reached before the Aug 2nd deadline. S&P downgrade is certain and also the risk of downgrades by other rating agencies. We will have a double hit to the economy. Approx $135 billion a month would be withdrawn from the US economy (this is the current shortfall resulting from $165 billion a month in revenues and $300 billion a month in expenses). You can imagine the immediate impact of spending $135 billion a month less and how this will slow down the economy. The second hit would come from a rise in Treasury yields (our bonds would not be as credit worthy, so therefore we have to pay investors more to buy them). If the situation is only for a few days..a week at the most, the impact will not be disastrous. We clearly have the revenues ($165 billion a month) to pay our debt and the debt payments would receive first priority. So we would not default on our interest payments but other government expenditures would be severely cut back. Gee—maybe Congress would not get paid! But if allowed to continue for the entire month of August or later, then we could certainly be back in a recession. Bottom line is that this scenario would lead to short term financial turmoil that will weaken an already weak and fragile US economy. But not the end of the world.

Scenario 4…”a mortal blow”

In this scenario, there would be an actual default because Congress has been unable to reach any type of agreement and it has dragged on for too long after the 8/2/deadline. This would be considered a technical default as the Central banks understand this would be caused by bi-partisan politics and not the inability of the US to pay its debt. While we may receive grace from the financial markets, the rating agencies would lower our rating to “SD” which stands for selective default. This is unknown territory for the US. Interest rates on our government bonds would probably rise dramatically. Investors would flee from treasuries (once considered the safest investment in the world) and there would be a rash of redemptions. Stock market would tank and there would be a total freeze in the credit markets. We would be plunged back in to a deep recession.



So what do I think will happen? Much as I would love to see #1, I just do not think it likely due to the late hour but who knows…miracles do happen. I think there is a 75% chance that the#2 scenario will occur and 25% for # 3.

Changing Residency to Reduce Taxes

Many retirees or pre-retirees are desirous of having a second home in a more "tax friendly" state in order to claim residency in that state; thereby increasing their standard of living by paying less on taxes.  With California boasting one of the highest state tax brackets, this often can be a smart decision.

However, claiming residency in another state is not as easy as it sounds.  According to tax laws, "residency" is the location of your permanent home.  You are considered a resident of a state if you intend your main home to be in that state.  Your state of residency is determined by whether the time you spent in that state was permanent or temporary.

So...how do you prove that your new state is your permanent home and not your temporary home?  Here are some pointers:

• Register to vote in your new state
• Register your car in your new state
• Change your drivers license to your new state
• Plan on living in the new state over 50% of the year
• Move your primary bank account to the new state
• Change your permanent mailing address to the new state
• Apply for a property tax exemption on the residence that you purchase in the new state

Can changing a state of residency really save you that much on taxes.  Consider Nevada where there is zero state tax.  A retired couple with $75,000 of taxable income will pay approx $3300  in California state taxes.  However, by claiming residency in Nevada, they will pay no state taxes.  That is like giving yourself a monthly increase of $275.  That's a lot of golfing green fees! 

The Healthcare Reform Law and how it Affects Retirees

The health care reform law will bring a mixed bag of good and bad news—with many of the changes affecting benefits provided to retirees by former employers. Here's a look at the key trends that will impact retiree health care spending.

 
Good News: Improved Medicare Prescription Drug Benefit----The Affordable Care Act (ACA) boosts the value of the Medicare D prescription drug plan by closing the notorious “doughnut hole.” That's the coverage gap that starts when a beneficiary's annual drug spending hits $2,830, and resumes at the catastrophic level ($4,550). Fidelity estimates that about 30 percent of seniors enter the doughnut hole in any given year.

Good News: Pre-65 Insurance Options Multiply--Workers who retire before age 65 – sometimes involuntarily – face some tough challenges replacing the group health coverage they enjoyed at work. The ACA creates new public health insurance exchanges that will open for business in 2014. Their aim is to create competitive marketplaces offering individuals high quality, affordable coverage. At the same time, insurers will be barred from turning away applicants due to medical conditions, or charge them higher rates – although they will be able to charge up to three times the differential between the oldest and youngest insured in the plan. Finally, the ACA offers a combination of credits and subsidies aimed at keeping policies bought in the exchange affordable

Mixed news: Health Savings Accounts Proliferate--Health Savings Accounts (HSAs) can help workers save money to offset health expenses down the road in the retirement. Created during the Bush years, HSAs have very attractive tax features: contributions and account growth are tax free—as are withdrawals, so long as the funds are used to pay for healthcare. Unused funds can be rolled over from year to year, and the accounts offer IRA-like portability. HSAs are gaining ground among workplace plan sponsors, mainly because they are tied to high-deductible insurance plans that reduce premium costs up to 30 percent. About 27 percent of retiree plan sponsors offer an HSA option, according to the Towers Watson/National Business Group on Health survey. But 25 percent of companies plan to convert their current retiree health coverage subsidy in the coming year But the jury's still out on HSAs as a retirement saving vehicle. Most participants use the accounts to fund current-year expenses, since insurance plan annual deductibles linked to HSAs must be at least $1,200 for individuals, or $2,400 for family coverage. And the deductibles can run much higher. As a result, Fidelity says only 24 percent of HSA accounts at plans it administers are used for long-term saving.And, since HSAs have only been on the scene a few years, average account balances are quite small, averaging $1,355 in 2010.

Bad news: Affluent Retirees Face Steep Hike in Medicare Premiums--The ACAACA freezes the threshold at 2010 levels through 2019, starting this year. The ACA also extends the income threshold formulas to seniors enrolled in Part D prescription drug plans. The changes will affect just five percent of Medicare enrollees this year, although that figure will rise to 14 percent by 2019 as more seniors jump past the frozen income threshold levels, according to the Kaiser Family Foundation, a non-profit health policy and research organization. High-income seniors who pay both Part B and Part D premiums could see their combined premiums rise anywhere from $300 to $700 per month by the end of the decade, according to Juliette Cubanski, associate director of Kaiser’s Medicare Policy Project. “That’s a considerable sum, considering that the base Part B premium for most people this year is $96.40,” she says. The new income thresholds also affect people who choose a Medicare Advantage plan (Part C). These are privatized managed care plans that replace traditional Medicare, and usually incorporate prescription drug coverage. Advantage enrollees typically pay the monthly Part B premium plus a supplemental premium to the Medicare Advantage plan; now, these premiums are being adjusted to factor in the higher-income amounts for Part B and Part D coverage, where applicable.

Credit to Mark Miller who is a journalist and author and writes about trends in retirement and aging. He has a special focus on how the baby boomer generation is revising its approach to money, careers and lifestyle after age 50.

Asset Location, Location, Location

Asset location is deciding what assets should go in which accounts.  Most investors have accounts that receive different tax treatment such as the following:

• Traditional tax-deferred account such as IRA , 401k, 403b, 457.  Contributions may be tax deductible and the growth and income are not taxed until the money is withdrawn.  Withdrawals then taxed as ordinary income ranging from 10-33%.
• Roth IRA or Roth 401k.  Contributions are not tax deductible but withdrawals are tax free
• Taxable non-retirement account.  The taxation of these types of accounts depends on the investments in the account.  Short term capital gains and interest from bonds and CDs are taxed as ordinary income, but qualified dividends and long-term capital gains are taxed at lower rates between 0-15%.

So..what types of investment should go in these different types of accounts to minimize taxes and create greater wealth?

• Traditional tax-deferred.  Corporate bonds, treasuries, TIPS, high yield stocks and commodity funds
• Roth accounts.  Small cap stocks, REITS, high turnover and/or high yielding funds especially if they have above-average growth potential.
• Taxable non retirement accounts.  Low-or non yielding stocks you plan to own for several years, low turnover stock funds (such as Index funds and tax managed funds), municipal bonds, US government savings bonds and maybe Treasuries. 

Remember:  It's not how much you make but how much you keep that matters in creating wealth. 

Living an Extraordinary Second Half

With over 76 million baby boomers entering their "golden years", some folks find it a little daunting to imagine what life will be like during retirement.  This is a compilation of some strategies and ideas that I have gleaned from my readings:

1)  Money is all about numbers.  Happiness is all about attitudes and behaviors.
2)  Live below your means if you want to be comfortable in retirement.  Pay yourself first and build your lifestyle around these two habits. 
3)  Have a plan.  A road map to retirement is as necessary as breathing oxygen. 
4)  Start saving early.  But remember that it is never too late to try and catch up. 
5)  Take care of your health.  A nutritious and low fat diet combined with exercise and stress reduction will ensure that you make it to retirement.
6)  Hang out with people who make you feel good and enrich your life.  Ditch the negative influences.
7)  Invest like a millionaire.  Work with a fee-only advisor with no conflicts of interest.  Take a long term view and keep your costs as low as possible.  Don't chase the "hot tips" your friends or the media tout. 
8)  Stimulate your brain with constant learning, taking trips, reading, trying new things, making new friends. 
9)  Create your bucket list.  Go for it.  Be engaged in life. 
10)  Give back with your time, talents and treasure.  Create a legacy

Following these ideas will truly allow you to enjoy those golden years and live a full and glorious life.

Warren Buffet’s Annual Letter to his Shareholders

 

I am a huge fan of Warren Buffet and always enjoy reading his annual letter to his shareholders.  I am convinced that if every CEO and company in the US had the same guiding principles and integrity that is the hallmark of Buffet, we never would have the economic problems that we do today.  Here are some of my favorite highlights, all quoted from his letter:

• Money will always flow toward opportunity and there is an abundance of that in America.  Commentators today often talk of “great uncertainty” But think back, for example, to December 6, 1941, October 18, 1987 and September 10, 2001.  No matter how serene today may be, tomorrow is always uncertain. 
• Our citizens now live an astonishing 6 times better than when I was born.  The prophets of doom have overlooked the all important factor that is certain; human potential is far from exhausted and the American system for unleashing that potential…remains alive and effective.
• A housing recovery will probably begin within a year or so. 
• If home buyers throughout the country had behaved like our buyers, America would not have had the crisis that it did.  Our approach was simply to get a meaningful down payment and gear fixed monthly payments to a sensible percentage of income..
• Home ownership makes sense for most Americans, particularly at today’s lower prices and bargain interest rates.  All things considered, the third best investment I ever made was the purchase of my home (the two best investments were wedding rings).  For the $31,500 I paid for my house, my family and I have gained 52 years of terrific memories with more to come. 
• But a house can be a nightmare if the buyer’s eyes are bigger than his wallet and if a lender—often protected by a government guarantee—facilitates his fantasy.  Our country’s social goal should not be to put families into the house of their dreams, but rather to put them into a house they can afford. 
• The fundamental principle of auto racing is that to finish first, you have to finish first.  That dictum is equally applicable to business and guides our every action at Berkshire. 
• Unquestionably, some people have become very rich through the use of borrowed money.  However, that’s also been a way to get very poor.  But leverage is addictive.  Once having profited from its wonders, very few people retreat to more conservative practices. 
• We can afford to lose money—even a lot of money.  But we can’t afford to lose reputation—even a shred of reputation.
• America’s best days lie ahead! 

Gotta love this guy! 

Meet Judy Stewart!

Judy Ann Stewart is the owner of Stewart Financial Services.  She has been offering life-centered and comprehensive financial planning services for 10 years.  She became a Certified Financial Planner (CFP) after serving as the President and CEO of Rancho Vista National Bank, a community bank that she and others founded in 1982.  Ms Stewart has a Masters in Business Administration and is an Enrolled Agent licensed by the IRS.  In 2003, she was honored to be named as one of the top 100 Financial Advisors in the Untied States by Mutual Funds Magazine. And in 2009, Ms Stewart is reconginized as one of the 2009 Five Star Wealth Managers in San Diego.
Ms Stewart is a member of Cambridge Advisors; a national network of fee-only financial advisors committed to serving the financial planning needs of Middle-America and is also a member of The National Association of Personal Financial Advisors, the largest fee-only financial planning association in the world. 
She attends and serves at Generation Church in Oceanside, California, and has traveled to Uganda in 2007 and 2008 to teach men and women basic business classes so that they can help lift themselves out of poverty. She resides in Oceanside, Ca., and Borrego Springs, Ca., with her husband, Bill and their two pets, a cat named Daisy Mae and a dog named Dakota.

Rising Oil Prices and Falling Dictators

The headlines and talk shows scream at us about the rising oil prices and Mideastern dictators falling like dominos. The stock market is scared and so the S&P500 has fallen 5% in the past week. Here we go again, you might say. Are we sliding back into another recession? These are very legitimate concerns but let’s look at the facts:



• The demand for oil is at an all time high. With the emerging markets of India and China coming on strong, they have an enormous appetite for oil. Increased oil prices should not be a surprise. It’s a fact of life and reflects our utter dependence on oil. Most economists will tell you that oil demand is on a continually upward sloping line so it stands to reason that oil prices will go up. And most economists are still bullish about the recovery and predict that gross domestic product (GDP) in the US will grow by 3.2% in 2011 and 2012. However, all bets are off if oil climbs to over $125/barrel. But that’s a long way to go.

• The fed is still predicting benign inflation for the next few years. How can this be with the rising oil prices? And food prices keep rising? If you look at food and energy costs as a percentage of family expenses, it comes to 13%. That is a small part of the whole pie. Housing and healthcare represents 38% and housing costs are sure not going to be inflated any time soon.

• Corporate earnings drive the stock market. Yes, the market has periods of increased jitters like we are seeing now but in the end and over time; it is corporate earnings that make the line go ever upward. And corporate earnings are expected to be 9-10% this year. Price earning (P/E) ratios for stocks is at 13 and the long term P/E ratio is 15. Stocks are still underpriced when you look at historical averages. Most economists predict another good year for stocks.

• The best mouse trap ever devised for creating wealth is an appropriate asset allocation financial plan. That means that you hold a combination of stocks, bonds, cash and real estate. That combination is dependent on your goals, your age and your risk tolerance. You own a diversified portfolio and you rebalance this portfolio every year. So, in a year when your stocks do well and you are now over allocated to stocks, you sell them and put the money into bonds. This is a disciplined non-emotional strategy and allows you to sell high and buy low. By doing this year after year, you ride the ups and downs but your portfolio steadily grows. More importantly, you sleep at night!

San Diego's A-List of Wealth Managers

Once again, I am very proud to announce that I have been chosen as a 'San Diego 2011 Five Star Wealth Manager' by San Diego Magazine. I love serving San Diego county, now including Borrego Springs! Thank you for everyone who voted for Stewart Financial Services. We work really hard to make your financial dreams a reality. 


From the article...


"With more than 11,000 wealth managers in the San Diego area, how do you find someone who listens to you, represents your interests and operates with an emphasis on integrity and service?


The resulting list of 2011 Five Star Wealth Managers is an elite group, representing less than 4 percent of the wealth managers in the San Diego area."


Thank you again San Diego! We continue to look forward to serving you in 2011! 

Tidbits from the TD Ameritrade Conference

Cheryl and l recently attended the annual TD Ameritrade National Conference in San Diego.  I can truly say that it was one of the best conferences I have ever attended.  While I will be sharing more specific information with clients one on one at meetings, here are some of the highlights:

 

General Colin Powell---He has unwavering faith and confidence in our nation and our people.  He sees great wealth created in certain countries over the next several years, countries like China, India and some of the Latin America countries.  This is good for the entire world because stability in the government and the economy is needed to create wealth.  We should not fear these emerging countries but rather embrace them.  The US is still the best place in the world to invest wealth.  Their success is our success.

Jeremy Siegel is a professor at the prestigious Wharton School of Finance in Pennsylvania.  Professor Siegel is still very bullish on stocks for the long run.  He showed charts that illustrate the real return (after taxes and inflation) of stocks from 1802-2010 is 6.7%.  The past 20 years from 1990-2010 (which includes the horrific recession of 2007-2008) shows the exact real return of stocks is 6.7%.  Cash and bonds cannot deliver this kind of return so it is prudent and imperative that in order to create wealth, an investor must be willing to invest in stocks.  He thinks the US market of good quality companies is poised to deliver strong returns over the next few years.  Price earning ratios are below the long term average and corporate earning are strong so therefore the price earning ratios will be rising.  He also showed charts that made a compelling argument to be investing in stable emerging markets such as China, India and some Latin America countries. 

Craig Alexander is Senior Vice President and Chief Economist for TD Ameritrade.  He said the US economy is on the mend.  We still have a long way to go but it is encouraging that we are on the road to recovery.  There are three key factors that will determine our recovery.  1.  Housing –currently we have approx 9 months supply of houses on the market versus 2005 when the supply was only 4 months.  We have too much product and there is more coming with short sales and foreclosures.  The housing market still has another 5% to decline in value before we hit bottom.  2.  Unemployment remains high at over 9% but he was optimistic that jobs are coming.  Companies have squeezed expenses all they can and are now experiencing growth due to increased demand for products and more access to credit.  This will result in slow job creation.  3)  State and local governments are struggling with reduced revenues and high liabilities to service.  Some states are worse than others like New Jersey, California etc… 

Bottom line is that Mr. Alexander also confirmed what Professor Siegel stated, the next few years will be good for equities.  Bonds will suffer and interest on cash will remain low but stocks will reward the wise investor.