Luxenberg.Info

Maximizing Your Benefits

2012-01-04T16:58:00.000-05:00

Social Security Seminar

I am speaking at the Ossining Library on Jan. 5, 2012. Social Security benefits are the bedrock of retirement for most Americans and I find that there are many misconceptions about Social Security. Understanding the basics of Social Security retirement benefits can make a big difference in the later years of retirement.

The Little Stuff Matters

2011-12-20T11:20:00.002-05:00

In Search of the Lost Decade

For several years analysts have been complaining about a“Lost Decade” for stocks. Judging by the big U.S. stock market indices, themarket has been flat for 13 years. But the Dow Jones Industrial Average and theStandard & Poors 500 reflect primarily the performance of large companies.

The picture is much different if one looks at the broaderstock market. According to an analysis by Standard & Poors, over the 10year period from March 24, 2000 (the peak of the tech boom) to December 2,2011, the S&P 500 declined by 19 percent.

As we’ve noted, the index counts big companies more heavily.Just 10 of the 500 companies account for 20 percent of the performance.

If instead you weighteach company in the index equally, the index would have climbed by 66 percent.To put this in actual dollar terms, if you had invested $10,000 in the S&P500 on March 24, 2000, you would have had only $8,100 left at the end of thedecade. If you had put equal amounts into each of the 500 stocks included inthe index, your investment would have grown to $16,600 --- more than double the$8100 if invested in the S&P 500.

This isn’t an esoteric discussion about constructingindices. It points out the dramatic benefits of diversification. Most people acknowledge that no one canpredict the future. If that is so, no one will know whether to hold bigcompanies or small ones, U.S. banks or Asian telephone companies.

Investing with wide global diversification increases thechances that the investor will own the stocks that do best. Over time owningthe winners helps more than owning the losers hurts. Often, a small sector or afew individual stocks can greatly influence a large portfolio over a decade.

In the recent decade, an analysis by Bloomberg showed thatenergy and resource stocks appreciated dramatically. After a twenty year bearmarket for oil stocks from the 1980 peak, energy stocks rallied by 242 percentin the five years after October 2002 while material producers appreciated by162 percent.

Meanwhile some of the biggest companies, which had done thebest in the 1990s, suffered throughout the decade. General Electric, once themost valuable company in the world, dropped by 67 percent during the decade.Cisco Systems, a miraculous growth stock in the 1990s, at its peak was also themost valuable company in the world and appeared to be heading to be the first“trillion dollar company.” Cisco hasdropped by 82 percent over the decade to $100 billion.

Most U.S. investors, whether by design or chance, now tietheir fate to the largest U.S. companies. According to S&P, some $1.3trillion is indexed to the S&P 500 while $5.6 trillion is benchmarked tothe S&P 500, one-third of total U.S. stock investments. If one counts“closet indexers,” the totals are even higher.

It could be that big U.S. stocks have been in the dog houselong enough. Their valuations appear much cheaper than those of smallercompanies. Small companies have had a good run and nothing lasts forever. Perhaps Emerging Markets or otherinternational companies will take the lead. Energy stocks might drop orprecious metals might pick up the mantle.

But the clearest lesson from this data is that by placingall your eggs in one basket, whether it’s the largest U.S. stocks or preciousmetals, investors can end up with egg on their face. True diversification meansparticipating in wide sectors of the global economy. Some funds buy thousandsand thousands of different stocks spread out around the globe. Over time, being widely diversified has typicallylowered risk and given greater appreciation.

(Calculations byStandard & Poors, http://www.standardandpoors.com/home/en/us;Bloomberg.com, Dec. 5, 2011, “No Lost Decade for Equal-Weight S&P 500,” http://www.bloomberg.com/news/2011-12-05/no-lost-decade-for-s-p-500-as-market-value-bias-masks-66-rally-since-2000.html)

Reasons for Optimism

2011-11-23T20:02:00.001-05:00

The Big Picture

Would you be frightened if someone told you that the stockmarket would drop one quarter of one percent this year? Of course not, butthat’s the record for the Dow Jones Industrial Average after the latest 250point drop. The headlines are scary and the future looks bleak. It’s hard tolook beyond the Great Recession and it’s easy to list overwhelming problems.The reasons for optimism are more elusive. While the stock market wasdisappointed in the outcome of the Supercommittee, consider this: thenon-partisan Congressional Budget Office now estimates that in the currentfiscal year the budget deficit will drop by $300 billion (one fourth), and inthe following two years by $460 billion and $235 billion. By that year, 2014,the deficit will reach 1.6 percent of domestic output --- below the long-runaverage --- under current policy, even assuming a weak recovery. Certainly ourfuture depends on more than the Federal budget deficit; Europe’s fate loomslarge. But investors shouldn’t get fixated on the problem de jour. Instead theyshould focus on the big picture. TheU.S. economy remains dynamic and diverse and given time is positioned to overcome policy errors and other disasters.

Stock Market Logic

2011-10-18T20:07:00.000-04:00

The End is Near

The stock market works on its own logic and smart people whoapply normal logic to it do so at their own peril. Most people have beenfearful about the market, despairing about the economy and disgusted with thegovernment. So what did the market do? The Dow Jones Industrial Average rosemore than 1,000 points in little over a week in early October. Did the outlooksuddenly improve dramatically? Not at all. It’s true the world didn’t end. Mostof the time it doesn’t. In the ashes of bear markets and terriblerecessions, great bull markets are born. The light at the end of the tunnelalways seems a long way off but we get there at unexpected times and sometimeswith surprising speed. Beneath the gloomy headlines, some positive news lurks.Major banks have reported strong lending for the first time in four years, theFederal budget deficit dropped $300 billion from the original estimates becauseof higher revenues and lower spending and it is expected to drop another $300billion next year, according to the U.S. budget office. Eventually the economywill heal and employment will improve and the stock market will lead. No oneknows when that will happen but it doesn’t pay to despair.

The Temptation to Panic

2011-10-04T20:13:00.000-04:00

The Most Dangerous Month of the Year

            August was the most dangerous month of the year for investors. That’snot because the world stock markets dropped precipitously. It’s not because ofalternate drops and spikes of hundreds of points in the major averages. It’sbecause of the temptation to panic.
            None of us can control whathappens to the world economy or the stock markets. What we can do is controlour reaction to those events.
            We’ve all heard that investorsalternate between greed and fear. But in relation to the stock market, whatexactly does this mean?
            When the stock market startsto drop, investors tell themselves that it’s only temporary and they stand pat.But the sky continues to darken. The news gets bleaker and the problems beginto look intractable. Eventually the news is overwhelming. There is no way out.The economy will never recover. Our way of life is ending.
            The pressure keeps buildingand there is only one way out. The investor must sell. He must act before it istoo late. And he does. He sells. He sells everything. He salvages a portion ofhis assets and he feels better. For a time. Perhaps a few days, maybe a fewweeks. Enough of these seesaw markets. He can’t take the pressure but hedoesn’t have to and he sells. Volume surges on the markets and the televisionshrieks more shrilly.
            But the satisfaction doesn’tlast long. Strangely, for no apparent reason, the stock market slide comes toan end. Still, for no good reason, it spikes upward and keeps going. It’sstrange. The problems are still there. The economy is still a mess. Our leadershave yet to don their superhero costumes. But there it is – the stock marketraces up and our investor is on the sidelines waiting for signs that theeconomy is improving and the market moves without him.
            I know it is not you. I knowyou would not panic or let greed drive you in a bull market. I know that eventhough “buy and hold investing” has become a dirty word, you stay thecourse. I know this is just a function of cable television. But manyother people did do this. Stock volume surged this August. Somebody was sellingat low prices. Somebody was panicking. Someone was looking to end the pain.
            There is a book called “OneWay Pockets: The Book of Books on Wall Street Speculation” by Don Guyon. It waswritten in 1917 by a broker who analyzed customer accounts. He found that theyowned the right stocks but bought them too late in the bull market and waitedtoo long into the bear market to sell. They owned the right stocks but stilllost money.
            Investor behavior neverchanges. The headlines do, at least a little bit. At one point every year, theworld is ending. What should an investor do?
            The advice doesn’t changeeither. Don’t try to outguess the markets. Have a plan for yourself and stickto it. Build a diversified portfolio. Determine a risk level that you can livewith for the long haul. Keep your eye on the long-term and stay off the rollercoaster.
            Don’t try to guess what willwork. The hero of the last bear market was John Paulson. He is a hedge fundmanager who was lionized in the book “The Best Trade Ever.” He made billionsspotting the problems in the subprime mortgage market and acting on it.Recently Bloomberg reported that Paulson’s fund is down 34 percent for the yearwhile the Dow Jones Industrial Average was down 1 percent.
            A study by JP Morgan Chase& Co. showed that mutual funds are trailing their benchmarks by the mostsince 1998. At the same time, Fidelity Investments studied their investors’401-Ks and found that those who exited stocks in the heart of the last bearmarket were up only 2 percent through the cycle while those who stayed instocks were up 50 percent.
            The lessons are clear. Don’ttake big bets and try to predict the market or the economy. Acting on youremotions does serious damage to investors year after year. Being an activetrader may be exciting and it may seem like the thing to do but in the endcooler heads prevail. A sound, well balanced approach is the surest path toinvestment success year after year.

Saving Social Security

2011-09-16T16:40:00.000-04:00

Social Security is for Real

Lately Social Security has been pilloried in the news. Foryears people have said it’s bankrupt and won’t be there when the Baby Boomersretire. I believe that nothing could be further from the truth. Each yearSocial Security pays out hundreds of billions of dollars in retirementbenefits. According to the Social Security Administration, even without changes,it will be able to pay out 75 percent of retirement benefits forgenerations. Inevitably there will bechanges but changes are phased in gradually. The last major revamping of theprogram began under the Greenspan commission in 1983 and their changes will befully implemented by 2017 --- some 44 years later. As people live longer, thefull retirement age will likely be pushed up a few years although there willstill be early retirement options. The wages subject to Social Security taxeslikely will rise and the way inflation is calculated maychange. These changes amount to small cuts in benefits but are intended topreserve the program much as we know it now. Social Security is completelyintegrated into the fabric of American life and will probably outlive us all.Anyone planning their retirement would be foolish not to incorporate SocialSecurity into their thinking.

A Gigantic Casino?

2011-08-24T20:18:00.000-04:00

A Winning Hand

Some people think of the stock market as a gigantic casinoand worry about getting ripped off. Part of the reason is that they act as ifit is a casino. In the short term, the stock market goes up and down a lot,often for no apparent reason. Over the long term, the market moves with theeconomy and is much more stable, particularly if your portfolio is widelydiversified. If you hold one stock or a handful of stocks or trade a lot, youare taking big bets. If you spread the risk among thousands of companies aroundthe world, the risk of an unfavorable outcome drops dramatically. One of thebiggest mistakes people make is trading in and out of themarket based on today’s headlines. If you trade aggressively or if you hold onlya few stocks, you may win big. A lottery ticket will also pay off for someone.But do you really want to trust your future to a game of chance with slim odds?Why not use a thoughtfully designed portfolio instead? Skip the casino withyour investments and the chances of a winning hand will be much better.

Just Sit There

2011-08-12T20:27:00.000-04:00

A Zebra in Lion Country

Little captures the American spirit better than Nike’s “Just DoIt” slogan. Americans like to be positive and to take action. They are not goodat being patient. Many investors aren’t patient when the news is horribleand there seems to be no hope. The debate over the U.S. budget deficit hasshaken confidence around the world. But we know from experience that theeconomy goes up and down. We have good times for years with plentiful jobs andmarkets surge. Then everything falls apart and there is no light at the end ofthe tunnel. Over the last century recessions have generally lasted lessthan a year and often are followed by a steep market recovery. Trying to timethat surge is a losing battle. In the book “A Zebra in Lion Country,” RalphWanger describes trading frenetically during the stock market crash of 1987. At the end of the week he stepped back and found that he’d accomplishednothing. Pushing the panic button may bring relief but it’s no substitute forcareful thought and a well designed portfolio. “Just Sit There” soundsterrible but it’s saved many investors and eventually the turbulence will pass.

Mired in Despair

2011-07-25T20:29:00.000-04:00

A Glimmer of Hope

When I talk with prospective clients about their financial future,I find that their feelings range from apprehensive to despair. Few seem at allhopeful or optimistic. This is natural amidst the deadlock and acrimony inWashington and in the aftermath of a devastating recession and fitful recovery.And yet we know from history that we are likely to see better times in thefuture. It has been a modern conceit that we could override human nature andsuppress the business cycle. What we have shown is that with great technologyand modern communications, we can accelerate the business cycle and perhapsmake the downturns worse, not banish them. Still, just as we’ve experienced ahistoric bust, we’re likely to have a historic boom again at some point. Itpays to be realistic but not get mired in despair. Those who are too gloomy maymake bad mistakes and get disappointed yet again – when once again good timesroll. And failure to plan for prosperity can be almost as big a mistake asassuming that hard times will never come. Successful investing requiresbalancing prudent risks and that means balancing emotions too.

Illusion of Control

2011-07-07T20:33:00.000-04:00

Bad Behavior

“We have met the enemy and he is us.”That’s the famous quote from Walt Kelly, cartoonist who drew the Pogo series.It applies especially to investors. A study by the financial consulting firmDalbar showed that for the 20 years ending December, 2010, investors achievedless than half of the return for the mutual funds they participated in: 3.83percent a year for investors versus 9.14 percent for the funds. Why is this? Inlarge part because investors let emotions dictate their actions rather than putthought into what they are doing. They let fear and greed dictate buys andsells. Recently we sponsored a talk on a behavioral approach to investing. Thespeaker, Jay Totten of Dimensional Funds, used recent research to show theinherent problems investors have and how to counteract them. The problems hecited included overconfidence, illusion of control and aversion to loss. Hesuggested that one way to minimize these problems is to stick to a plan. Herecommends focusing on good decisions, not outcomes, and controlling what aninvestor can control such as diversification. That makes it easier to acceptwhat happens, which is partly a matter of chance.

A Haphazard Mess

2011-06-12T20:36:00.000-04:00

Neatness Doesn't Count

Years ago I learned that neatness doesn’t count in managing aninvestment portfolio. But recently I’ve seen lots of portfolios that are ahaphazard mess. Most people make investments one at a time and don’t considerthe whole. Sometimes I feel like an archaeologist studying layers of a siteinhabited by many different peoples. I see shifting themes and investmentsaccumulated while that theme was in force. The problem with investing this wayis that major drivers of investment performance – such as asset allocation,diversification, geography and style – operate on a unified portfolio. Manypeople rely too heavily on a single stock. In a bull market such as the stealthone we’ve had for two years, it’s harder to see the flaws in your portfolio. Anoverly cautious asset allocation means you are making less money, not losing.But the seeds of destruction are planted in good times and reaped when theinvestment skies darken. Too many people spend too much of their time worryingabout money and not mitigating the risks or planning for prosperity. If youknow what to look for, it’s not hard. If you don’t, these flaws are invisibleuntil trouble suddenly appears.

A Workable Plan

2011-05-26T20:40:00.000-04:00

Hope and Reality

Frequently I meet with people whose financeshave been devastated by the recent recession and stock market crash or who areelderly and nurturing a tiny nest egg. Sometimes I can’t do much. The seeds ofthis distress were usually planted years if not decades ago. People oftenignore basic tenets of financial affairs like proper diversification. Theyoften invest haphazardly or simply don’t pay attention or lack financialknowledge. But with most people steps are available that can put them on animproving path. Many people actually have enough assets and just don’t know it.They may only need to put their records together and come to a newunderstanding of their position. Often, though, I wish that I could have metwith them in their 20s, 30s or 40s. At that point, it’s much easier to developa workable plan and help people to understand how to achieve their goals. Nomatter what your predicament or situation, it doesn’t pay to sink into despair.The view of an objective professional who is trained in finance can outline thetradeoffs and opportunities and bring hope and reality back into the equation.

Chasing Yields

2011-05-05T20:44:00.000-04:00

The Right Risks

Interest rates are at historiclows and this presents challenges for investors.Recently, money market accounts yielded an average of 0.18 percent. At that rate it takes 450 years – five centuries – to double your money. After the recent financial crisis,investors are justifiably scared. In their search for guarantees and desire toavoid risk, many investors actually seek outhigher returns and end up taking on greater risks that they don’t understand. Higher yields come in only two ways – credit risk (the risk that you won’tget repaid) and duration risk(lending money for a longer time). Both risks have their place as long as you understand the risks and takethem as part of a balanced approach. It’s thesame with stocks. We know that the stock market can crash and sometimes individual stocks never recover. But overtime, the broad market has done well. On average for the last century, the stock market has returned 10 percenta year and doubles in seven years.That average rarely happens in the short run but in the long run, it hashistorically worked. Having a well constructed portfolio means takingthe right risks – not pretending thatyou don’t take any.

Global Investing

2011-04-14T20:51:00.000-04:00

It's A Big World

The world can be a scary place and for most Americans, there's no place like home. But for investors, not only is the world a place for adventure, it may also be the source for higher growth and returns. Since World War II, the U.S has dominated the world capital markets. With five percent of the world's people, the U.S. produces 25 percent of global economic output and, until recently, accounted for 50 percent of world stock market value. With growth abroad eclipsing that in the U.S., in the last seven years, the U.S. share of world stock market value has dropped to 42 percent, according to Dimensional Fund Advisors. Emerging market share has climbed to 14 percent from a low of 4 percent in 2003 as commodity prices soared. With disasters in Japan looming large and revolutions spreading, it's tempting to stay at home. Mark Twain dismissed U.S. travelers as innocents abroad. But over the last thirty years, investment returns have been higher abroad. Over the last 10 years, U.S. market returns were often negative while international stocks returned 7 percent a year and the MSCI Emerging Index was up 10 percent. There's no place like home but it could pay to shop the world.

Social Security Earnings

2011-03-29T20:58:00.000-04:00

Never Too Old

Manypeople continue to work and get paid past their normal retirement age. Nomatter how young or old people are, Social Security adds those earnings totheir lifetime earnings record. In turn, this 35-year earnings record is usedin determining their retirement benefits. If one has worked for less than 35years, zeros are added into the formula for years not worked.If one has worked more than 35 years, the lower earning years (adjusted forinflation) are dropped from the formula. A surprisingly large number of peopleare affected by this and should review their benefits. We know of child singersand teenage actors who have substantial earnings. We also have met many peoplein their 70s or 80s who continue to work and are well paid. Some womeninitially retired with a spousal benefit but continued to work. At some point, thewoman’s own benefit could eclipse the spousal benefit, which is at most half aslarge as the primary wage earners’. In the case of a divorcee, it may be alittle difficult to check, but it may be worth doing. With the help of theSocial Security administration, a review of your benefits is always available.

Tax Planning

2011-03-17T21:03:00.000-04:00

More Than An Afterthought

In the last minute rush to finish their taxes, many peoplethrow in an IRA contribution without much thought. Tax planning in general andIRAs in particular deserve more care and attention. In growing our assets andpreparing for retirement, we have four major levers: increasing income,spending less, improving investment results and minimizing taxes. IRAs can beuseful in two of those four categories. Since the huge bear market, it isgenerally advisable for most people nearing retirement age to try to increasetheir savings. Correctly using the best retirement vehicles is one of theeasiest steps to do this. Choosing which types of accounts to use is importantand varies with each person’s needs. For starters, using a Traditional IRAprovides a front end tax deduction for those eligible. Establishing a Roth IRAdoesn’t provide the initial deduction, but in most circumstances earnings fromthe Roth come out tax free. TraditionalIRA distributions are taxed at the ordinary income tax rate. Further, Roths don’t have a required minimumdistribution after age 70 ½ as do Traditional IRAs. Getting these choices rightand not running afoul of the complex rules can make a huge difference in howmuch money you accumulate.

Gift Taxes

2011-03-02T21:09:00.000-05:00

A Congress Bearing Unusual Gifts

For those inclined to be generous, Congress made it a loteasier last year. As part of the tax cut extension, Congress increased theestate tax exemption as well as increasing the gift tax exclusion. It is nowpossible for an individual to give $5 million without a gift tax. Each spousecould separately gift $5 million or for a couple, acting together, $10 million.The individual annual gift limit remains at $13,000. The extension is good fortwo years. No one knows what will happen afterwards. The $5 million figurecould stay, it could revert to the previous $1 million or it could be any othernumber. Although anyone who watches Congress closely soon learns that it isdifficult to predict Congressional actions, most observers believe thatCongress won’t make retroactive changes to the tax law during this two yearperiod. For wealthy individuals who are in a position to take advantage of thehigher gift tax exclusion, the next two years may prove to be a uniquelyfavorable period. Many possibilitieshave been opened up by these tax law changes and the window of opportunitycould shut as quickly as it opened.

Rule Change

2011-02-01T21:16:00.000-05:00

No More Social Security "Do Over' Rule

The Social Security Administration has ended the “do-over”provision.

The rule enabled people whose circumstances had changed --they found a new job or inherited money -- to stop receiving their SocialSecurity retirement benefits. In return,they would receive higher monthly checks when they did retire.

The do-over required repaying benefits in a lump sum with nopenalty or interest. In extreme cases, delaying benefits from the earlyretirement age of 62 to 70, the retiree’s monthly check would be twice as largecounting inflation adjustments. Over a lifetime the difference could totalhundreds of thousands of dollars if the retiree and spouse live into their 80s.

Only a tiny fraction of the 50 million Social Securityrecipients used the do-over clause. But there were rising concerns of potential abuse of therule. The financial press had emphasized the possibility of an “interest-freeloan.”

The rule change highlights the importance of carefullyanalyzing Social Security options before signing up for benefits. For nearlytwo-thirds of Americans, Social Security is their largest or second largestasset in retirement. Getting it right can make the difference in the financialsecurity they enjoy in retirement.

An Investing Bargain

2011-01-25T16:54:00.000-05:00

Try the Free Lunch

The best bargain in investing is diversification: its free.

Most people nod agreeably when they hear that but then do the opposite. They can't resist buying a 'hot' initial public offering of a promising company that could lead to riches. Or they look up which mutual fund manager has a hot hand and climb aboard.

Unfortunately most IPOs or other well considered stocks may not tum out as well as we hope. Managers with the hot hand often find that it cools off occasionally with dreadful results.

Three years ago many experts considered AIG among the safest insurance companies in the world. In September. 2008. stockholders found out otherwise.

Meanwhile. investors who placed their faith in widely diversified mutual funds fared much better. While diversified investors got hurt in the crisis. their funds probably recovered. Those who relied on a handful of stocks were at much greater risk of never recovering.

It comes down to the old story of the tortoise and the hare. While the hare might shoot ahead during the race. the tortoise is a much more reliable finisher. And if you want to take good care of your money. isn't that your aim?

http://www.lexingtonave.com/

A Cautionary Tale

2010-12-09T10:50:00.000-05:00

Losing a Bundle

A family frittered away a fortune in ten years. This story from the New York Times shows how easy it is for anyone to make poor financial decisions that make a big impact on their life.

http://www.nytimes.com/2010/11/26/business/26fall.html?_r=1&scp=1&sq=family%27s%20fall%20from%20affluence&st=cse

Social Security Rule Change

2010-12-09T10:38:00.003-05:00

Do-Over is Done

The Social Security Administration last week ended the “do-over” provision. The do-over rule enabled people whose circumstances had changed -- maybe they found a new job, inherited some money unexpectedly or had a change of heart -- to pay back the benefits they had received and to delay receiving additional Social Security retirement benefits. By doing so, they would receive much higher monthly checks when they did choose to retire.

The do-over involved repayment of the benefits received in a lump sum with no penalty or interest. In return, the recipient would receive the higher monthly benefits in the future. In extreme cases, by delaying receiving benefits from the early retirement age of 62 to age 70, the retiree could get a check twice as large counting cost of living adjustments. The total difference over a lifetime could amount to hundreds of thousands of dollars if the retiree and spouse live well into their 80s or 90s.

Only a fraction of the 50 million Social Security recipients were taking advantage of the do-over clause. The change in the rule was made after concerns were raised that it could be abused. The provision started receiving publicity in the financial press as an “interest-free loan.” The intention of the provision was not to provide people with interest-free loans, and therefore the SSA acted.

Only about 500 people a year were taking advantage of the rule and most were using it to adapt to their new circumstances. There was potential for abuse by people speculating with the money but that had yet to occur. Often overlooked by the press and commentators was that after taking taxes and the administrative hassles into account, the interest-free loan generally wouldn’t have appealed to speculators.

The rule change, while it did not affect many people, highlights the importance of carefully analyzing one’s Social Security options before signing up for benefits. For nearly two-thirds of Americans, Social Security is the largest or second biggest asset in retirement and getting it right can make the difference in whether they’ll have a comfortable retirement.

Unlike some of the proposals to make big changes in Social Security retirement benefits, this rule change doesn’t require Congressional action. It is a rule that has been published in the Federal Register and as such it is effective immediately. But there is a sixty day comment period and the Social Security Administration could amend the rule afterwards.

Generally, changes to Social Security retirement benefits have taken place over a long time. From its inception in 1935, the full retirement age was 65. It has been increased to 66 now and is climbing gradually to 67 by 2027. This adjustment has been phased in gradually since the last big reform of Social Security in 1983.

A recent proposal to increase the full retirement age to 69 would not take effect until 2075 – in other words for today’s four year olds. Early retirement today starts at age 62 but with lower benefits than one would receive at full retirement age.

A common concern is that Social Security is facing insolvency. However, the trustees of the Social Security Administration report that they will be able to meet all obligations for several decades without any changes to the current benefit structure or funding and they expect Social Security to be secure long into the future.

http://blogs.forbes.com/janetnovack/2010/12/08/social-security-administration-kills-do-over-to-boost-benefits/

"The Investment Answer"

2010-11-27T09:45:00.000-05:00

"A Dying Banker's Last Instructions"

The New York Times Business section has a front page article today about a long-time Wall Street banker who became a missionary for investing in a disciplined way with DFA index funds.

http://www.nytimes.com/2010/11/27/your-money/27money.html?emc=eta1

New Social Security Proposal

2010-11-11T14:10:00.000-05:00

Reform of Social Security Considered

The President's commission reported preliminary recommendations for reform of Social Security. They call for ensuring the solvency of Social Security for the next 75 years and could be the basis for action over the next few years. By the end of that period, the age for full retirement would be 69 and there would be other changes including adding benefits for the lowest paid workers. There would also be adjustments to the calculations for cost of living adjustments.http://www.nytimes.com/2010/11/11/us/politics/11fiscal.html?_r=1&hp

The Real Cost of Inflation

2010-11-09T14:21:00.000-05:00

Who’s Really a Conservative Investor?

My wife’s grandmother Libby would tell us how she and her husband could have a nice dinner and see a Broadway show in the 1930s for a few dollars.

It seems comical now but we all have some sense of what inflation is. During our lifetimes, prices have generally gone up, often dramatically. Stamp prices make this especially clear. At the end of 1975, it cost ten cents to mail a letter. Now it’s 44 cents, a four-fold increase.

Meanwhile, the Dow Jones Industrial Average has climbed from 800 to 10,000, an increase of twelve times, not including dividends. Over the decades, stocks have kept up with inflation and more.

Investments often considered “safe” investments – bonds and money market instruments -- have not. People who rely exclusively on bonds and bank deposits often consider themselves conservative investors. In reality, it’s not being safe to sit back and watch their purchasing power decline over time.

Another trap, in an era of low interest rates, it’s tempting to take more risks in bonds to get higher yields. Many banks did just that in recent years and lost billions. Consider what the true risks are before you invest, not afterwards.

Women and Social Security

2010-10-21T16:46:00.000-04:00

Maximizing Your Social Security Benefits

Women have a vested interest in learning more about Social Security and making sure they and their spouses or other family members have made the right choices.

Women on average live longer than men and often find themselves alone in the later years of retirement. Social Security benefits are designed for survivors and for those who haven’t fully participated in the work force. Often, though, when considering what to do about Social Security benefits, people analyze the impact on one spouse in isolation and don’t look at the affect on the other spouse. Also, too, a complicated marital history needs to be carefully examined.

Many women drop out of the workforce during part of the child rearing years. In some cases, returning to the paid labor force in later years can still have a big impact on their 35 year Social Security record. In other cases, they may rely on their spouses’ earnings for their benefits.

In any case, their decisions about when to take benefits and whose record to rely on can be complicated and yield significantly different results – often amounting to hundreds of thousands of dollars. Many people take benefits too early and it can be a costly mistake.

Generating Tax-Free Income

2010-09-30T09:33:00.000-04:00

Roth Conversion Seminar

What You Need to Know About Roth Conversions Now

Thanks to the new 2010 Roth IRA conversion rules, anyone can create a tax-free
income stream in retirement. We’ll show you how to decide if a Roth is right for
you.

Wednesday, October 6, 2010
7:30 to 9 p.m.
Hilton Garden Inn
270 Route 59 West
Nanuet, NY 10954
(845) 623-0600

Featured Speaker: Larry Luxenberg

Larry is a Chartered Financial Analyst with 28 years experience as an institutional investor and
financial consultant. Larry specializes in retirement planning for Baby Boomers and strategies for
maximizing benefits for Social Security. A frequent speaker on retirement topics, Larry previously was
a securities analyst, mutual fund manager and hedge fund manager. He founded Lexington in 2001. He
has been widely quoted in newspapers and magazines and has appeared on CNBC and other television
and radio programs.

About Lexington Avenue Capital Management:

Lexington Avenue Capital is a full service
financial advisor offering financial planning and investment management specializing in retirement and
Social Security strategies. Investment Advisory Services provided through Partnervest Advisory
Services LLC, a Registered Investment Advisor. Lexington manages portfolios relying on institutional
class funds from Dimensional Fund Advisors (DFA). DFA manages assets exclusively for institutional
investors and clients of a select group of financial advisors. As of December 31, 2009, DFA assets
totaled $165 billion and it ranked among the top 10 U.S. mutual fund companies.

For additional information contact Lexington at luxenberg@lexingtonave.com

An Attractive Vehicle

2010-09-17T15:18:00.000-04:00

A Roth IRA and Private Stock

Roth IRAs haven’t been embraced as fully as they should. They are an extremely attractive vehicle for many Americans. Part of the problem is that the reward comes after many years and patience doesn’t rank high among American virtues. Also, Roth conversions may require writing a check to the IRS sooner rather than later.

Recent tax law changes have made Roth’s particularly attractive for upper income households. Starting in 2010, the rules for establishing Roth conversions have been eliminated (limits for regular Roths are still in place).

We have found Roth conversion accounts are a great place to hold private stock or other long dated assets that have a chance of significant appreciation. The drawback of this option is that an investor loses the potential tax benefit of capital losses if the investment becomes worthless. If the investment appreciates significantly, though, the tax savings can be enormous. Using a Roth for this purpose also entails some attention to detail and additional paperwork. While the law permits this use, most custodians shy away from it because of the added complexity. Some custodians do however specialize in non-standard assets and the effort to set this up can yield great returns.

Maximizing Benefits

2010-09-01T11:06:00.000-04:00

Taking Social Security Seriously

For almost two-thirds of Americans, Social Security is more than half of their income in retirement. For most of the rest, it is an important part of their retirement spending. Despite the concerns we've seen reported in the press, Social Security is on a sound financial footing. With changes that we expect to happen over the next decade, the program should be around for a long time. Each year Social Security sends out $700 billion in monthly checks.

Given its importance, Social Security should be an integral part of everyone's retirement planning. Knowing the options for receiving Social Security payments and when to sign up is often complicated, especially taking into account the different ages of spouses, marital histories and other factors. We look at 13 variables in planning strategies for Social Security payments.

Getting the strategy right can make a difference of hundreds of thousands of dollars in lifetime benefits; sometimes between a comfortable retirement and concern in later years. Benefits are calculated based on a complex formula that involves a 35-year work history. Examining that record and taking corrective action years before retirement, can be important for many people.

Investing for the Long Term

2010-07-21T11:27:00.000-04:00

The Power of Postponement

Although recent experience has been discouraging, compounding investment returns over many years yields truly amazing numbers. Consider how money grows in an IRA for a young person who leaves the money alone until retirement.

The maximum contribution to an IRA is $5,000 a year for someone under age 50 (the money must come from earned income although parents can replace the contribution). Take a 20-year-old who earned and saved enough to put $5,000 in an IRA. Let's invest that money in a broad index that gets 10 percent returns, the average of stocks over the last century. After 50 years, the account would be worth $587,000 (this doesn't factor in inflation).

If he waits ten years, until age 30, the total at retirement would be less than half, $226,000. At 40, it would be $87,000; at 50, $34,000 and at 60, the total grows to $13,000.

These are average figures and the results could differ significantly. But this shows three things: how long you invest - whether for yourself, your children or grandchildren - is critical; the benefits of tax deferral make a huge difference; and achieving the broad stock market returns has been a great goal.

Gloom and Doom

2010-07-12T16:38:00.000-04:00

Is it a Good Time to Invest in the Stock Market?

We never know when to buy stocks. The future is always murky. There are always plenty of things to worry about. And yet we know that over the long term --- 10 – 15 – 20 years --- stocks have almost always done very well. Over the long term, there are few other ways to keep with up with inflation and to accumulate any wealth.

The public attitude toward stocks has soured recently because stocks have not done well. Since the recent high in late April, the broad U.S. stock market is down 14 percent with much of that coming in several spectacular and scary drops. The most recent decade was the worst for the stock market in at least 100 years – worse even than during the Great Depression of the 1930s.

The world economy has suffered through a prolonged global downturn; the worst since the 1973-74 global recession and possibly since the 1930s. Recently Nobel Laureate Paul Krugman, in his column in the New York Times, predicted that we may be in the early stages of the third prolonged global Depression of the last 150 years.

Should we be depressed? Should we avoid stocks? Should we put our investment dollars under the mattress, buy gold, party because the end is near?

Such gloom may be warranted but we like to look on the bright side. We would agree that the global economy was on the precipice in September 2008. It’s possible that we could have a serious relapse into recession but the odds favor a subdued but durable recovery.

Based on U.S. history and lessons from around the world, it’s likely that high unemployment will persist for at least several years. Even so, the U.S. recovery seems to be well established and likely to persist. The sluggish nature of the recovery, perversely, is likely to extend its duration as happened during the 1990s. But lacking a crystal ball, we cannot discount a second dip recession or some other massive economic mishap.

Why then are we so sanguine about the long-term prospects for stocks? For twelve years, the Dow Jones Industrial Average has hovered around 10,000. In inflation adjusted terms, the Dow has suffered a serious decline. By historical standards this is a long time for the stock market to stagnate. Meanwhile, Gross Domestic Product – the source of profits and ultimately the bedrock of stock valuation – has climbed by more than 60 percent.

While we don’t know when the stock market will break out of its funk, we are confident that it will eventually. Only long-term investors, those with horizons of five years or more, should normally participate in the stock market and over the long-term we see little to suggest that stocks will depart from their historic upward trend. If we are eventually to return to that trend, the very bad period that we’ve been stuck in for so long, actually augurs well for the future.

We consider a key to participating relatively safely in any stock market uptrend is to craft a broadly diversified global portfolio, which is a mainstay or our investment approach.

A Brighter Future

2009-12-21T08:51:00.000-05:00

The Recovery

After a tumultuous year in 2008 and a two-year recession, the global economy has begun to recover. People naturally are impatient with the slow pace and worried that the future is murky. No one knows whether the economy will slip into another recession or we’ll have a sluggish and jobless recovery. But it’s also possible that the recovery that has been sneaking up on us may turn out to be a strong and durable one.

What we do know for sure is that the stock market has not yet discounted a robust future. The Dow is no higher than it was 11 years ago. The market has not even climbed back to the levels of the dark period of last fall. If the historical trend of 10 percent annual growth had taken place over the last decade, the market should be more than double the current level. Over the last decade, we have had the worst stock market returns since reliable data became available in 1926. The market returns this decade are worse even than the ones during the Great Depression in the 1930s. The good news is that frequently the stock market does well following bad periods.

Value Based Financial Planning: An Hour to Change Your Life

It’s important to think about the big picture, but you can’t control the global economy. You can, however, control how you handle your personal financial situation and that’s what we do at Lexington Avenue Capital. It’s common not to have a plan for your financial future and little idea of exactly what your goals are. Most investment portfolios are a hodgepodge of accounts and securities. Frequently spouses fail to communicate on their finances. With value based financial planning, we try to bring order to this chaos. Everyone has unique needs and desires and resources. We help you clarify your goals, understand the trade offs and develop a financial road map to help you reach your most important objectives with the highest probabilities of success. While we want to help you define the big picture, we’ll handle the little details too so we can lower your stress and spare you some worries.

Taking Social Security Seriously

Frequently we work with people approaching retirement and we find that until they are actually on the threshold of filing for Social Security benefits, they don’t take it seriously. For most people, Social Security will be an important part of their income in retirement. Making sure that both spouses maximize benefits can be a complicated process and people should begin understanding the ramifications in their 50s. At that age, it’s still not too late to influence their individual Social Security formula, which is based on an adjusted 35-year earnings history. Recently we posted an article on our blog that goes into more detail about this. http://luxenberginfo2.blogspot.com/2009/12/taking-social-security-seriously.html

Year End Actions to Lower Taxes

Before year-end, it’s sometimes possible to take actions to lower taxes. One possibility given the big bear market, is to realize tax losses on securities. This can be done by selling individual securities or mutual funds, which may be lower in price than when they were purchased. These losses can offset capital gains on other securities or be saved for future years. Also, $3,000 of such losses can be used each year to offset ordinary income.

Roth IRAs in 2010 – One Time Only Conversion Opportunity

Soon we will be hearing a lot about the opportunity to convert retirement savings to Roth accounts in 2010. In one of the earlier tax bills, Congress approved a one-year opportunity for high bracket earners to convert portions or all of some retirement accounts into Roths. In doing so, people will have to accelerate the taxes due on these accounts but the payments can be divided between payments in 2011 and 2012. Once accounts are converted to Roths and held for five years, no taxes will be owed when the money is distributed. Also, unlike ordinary IRAs, there are no required distributions from Roths so they are a good estate planning vehicle. This shift is especially beneficial if one has money outside of retirement accounts to cover the taxes. This opportunity should be evaluated on an individual basis and we are geared up to help with that decision.

Lexington Avenue Capital Management

Unbiased, fee-only advisors working with individuals to help them develop sound financial strategies to reach their most important goals. Call us today for a complimentary Financial Road Map planning session or other financial questions.

Larry Luxenberg
luxenberg@lexingtonave.com
845-708-5306
www.lexingtonave.com

Investment Advisory Services provided through Partnervest Advisory Services LLC, a Registered Investment Advisor. Past performance is not indicative of future returns. Products with issuer guarantees carry the risk of issuer default.

Taking Social Security Seriously

2009-12-12T18:26:00.002-05:00

A Key Decision for Retirement Planning

Most people who are younger than age 62 do not take Social Security seriously. For decades, the media has hammered into people that Social Security is going bankrupt and they cannot depend on it for retirement. Changes in the program will be necessary to keep it solvent but that has happened in the past and will likely happen again. The most recent major reforms occurred in 1983 and changes are needed again as life expectancies increase and major changes occur in Americans’ work habits.

Still, each year the Social Security Administration sends out more than $600 billion in benefits and nearly all Americans depend on the payments as one of their top four assets in retirement. Understanding the program is vitally important for most people.

One of the most important decisions people make about retirement is when to begin receiving Social Security benefits. And yet many people either do little analysis or only simple calculations. Delaying benefits can sometimes result in doubling monthly payments so it’s worth spending time on the decision. Many current retirees will collect more than $1 million in benefits from Social Security.

Ideally, Social Security should be part of your total retirement planning and should begin 10 to 15 years before full retirement age, now 66. Benefits are based on reported income during your top 35 working years. The formula is skewed toward average wage earners so people in their 50s can still influence benefits. In some cases people might want to take part-time jobs or even decline to use deductions and pay more taxes to maximize future benefits.

To the extent people analyze the decision, most use a simple break-even analysis that calculates when the higher payments received at a later age would surpass the smaller payments received for more years. This analysis ignores many factors and it’s potentially misleading. Frequently, people using this analysis underestimate their life expectancy. One quarter of the people who start Social Security at full retirement age will live into their 90s. A mistaken analysis will cost them dearly for decades.

The critical ages for influencing Social Security benefits are the decades of the 50s and 60s. By age 70, everything will be cast in stone. The Social Security formula is skewed toward modest earners, so people in their 50s can still greatly affect their Social Security benefits. Self employed professionals and spouses who left the workforce to raise children are among those who could benefit most from an analysis.

The analysis is complicated for one person but it is much more complicated for a couple, particularly when the ages and earnings histories diverge. Other factors to take into account are that benefits are cut between ages 62 and 66 if the person continues to work; one spouse can receive half the benefits of the other upon reaching full retirement age; and a survivor receives the highest benefits of either spouse. Social Security benefits are also taxed once the retiree reports income above a certain threshold. Those taxes now begin on couples with incomes about $32,000 and as much as 85 percent of the benefits are subject to taxation if their combined income is more than $44,000.

Each person or couple’s situation is unique but a proper analysis of when to apply for Social Security benefits should weigh at least 13 factors: age of each spouse, health, family history, joint life expectancy, previous marriages, current and future spending, retirement plans, tax bracket, reduction in benefits if they work before full retirement age, current assets, future sources of income such as pensions or inheritances, and life insurance. The Social Security website, www.socialsecurity.gov, provides a wealth of information and calculators where one can access his own earning history, but no one source of analysis takes everything into account. An accountant or financial advisor should be able to calculate different scenarios and advise on the risks and advantages of each. It is a complicated topic; long academic papers are being written on the subject.

In all cases it pays to begin taking your own benefits by 70 or spousal benefits at full retirement age. If you receive retirement benefits early, between 62 and 66 now, the benefits are permanently reduced by as much as 35 percent depending on year of birth. Between 66 and 70, your own benefits increase by 8 percent a year. Spousal benefits, which are a maximum of 50 percent of the higher earning spouse’s, cannot increase past full retirement age. However, survivor benefits do increase. Once the higher earning spouse dies, the survivor receives benefits equal to those of the higher earning spouse so it’s important to take joint life expectancies into account.

It’s not uncommon for people today to underestimate their life expectancy and outlive their assets. This is particularly important for women, who on average outlive their spouses and will end up relying on one Social Security check in their later years. Getting the best possible answers on Social Security could make a big difference in the comfort of one’s retirement.

Madoff and the Mattress

2009-07-01T13:58:00.001-04:00

Choosing the Right Course

Two stories in recent weeks drove home to us how truly difficult a period this has been for investors. No matter how sophisticated or naïve you are, it has been tough to avoid disaster. This week Bernie Madoff drew a sentence of life in prison for running the biggest financial fraud in history. People gave their life savings to one of the most sophisticated investors in the world, a pillar of Wall Street, and it all vanished. One of his investors was a university that gave him a big chunk of its endowment. Among the contributors was the estate of a single woman who had lived frugally and invested in Blue Chip stocks for 70 years. A career civil servant, she had given the university more than $20 million dollars. A lifetime of successful investing was squandered in one poor decision.

At the other extreme was the classic person who did not trust financial institutions at all. Instead she stuffed all her spare money, almost $1 million, in a mattress. So secretive was the elderly woman, that even her grown daughter wasn’t aware of her savings habits. That backfired when the daughter decided in early June to surprise her mother and replace the lumpy mattress with a brand new one. When they realized the next day what had happened, they scoured the local garbage dump but with 2,500 tons of new garbage each day, the missing mattress was nowhere to be found.

There are risks everywhere and it’s difficult for even the most sophisticated investors to strike a proper balance. We draw on our three decades of institutional investment experience to spot the pitfalls and help you achieve your financial goals and dreams.

www.lexingtonave.com

Starting Young

2009-06-26T11:20:00.002-04:00

The Power of Postponement

Many people have heard of the power of compounding. But it’s another thing to take a fresh look at the actual numbers. Consider how money can accumulate in an IRA for someone who starts young and leaves the money untapped until retirement.

Right now, the maximum contribution to an IRA is $5,000 a year for someone under age 50 (your income must be at least that high; the source of funds can’t be a gift). Let’s look at what would happen if by the time someone turned 20, they had saved and earned enough to put $5,000 in an IRA as a one time only contribution. Now let’s invest that money in a broad stock market index and earn the average return of stocks over the last century, ten percent. After 50 years, the account would be worth $587,000 (remember this doesn’t factor in inflation).

Now if that same person waits ten years, until he’s 30, to invest, the total at retirement would be less than half, $226,000. At 40, it would be cut to $87,000. At 50, it would be $34,000 and waiting till 60, the total would be only $13,000.

These are, of course, average figures and the results generally would differ significantly from this illustration. But this does make a number of important points. First, the length of time you invest – whether it’s for yourself, your children or your grandchildren – is critical. The benefits of tax deferral make a huge difference. And achieving the returns of the broad stock market has been a great goal.

Stock Market Blues

2009-03-19T08:15:00.000-04:00

It's So Bad

The stock market has been so bad this year -- and since mid-September -- that it seems like a tremendous accomplishment that the S&P 500 is now down only 12 percent year to date. Last Monday it was down 25 percent year to date. To keep these numbers in perspective, the S&P was down 38 percent last year and 22 percent in 2002. Other than that, you have to go back to 1974 for a year when the S&P was down as much as 12 percent. While the economy is terrible, the stock market has been discounting a lot. We will only know in retrospect when the bottom hits. But the results of past financial crises show that once the crisis passes, stock markets have had significant rebounds within the first two years.

Some Positive Signs

2009-03-16T09:16:00.002-04:00

Harbingers of Spring

Like the flu, a recession is mostly bad. Like a recession, it's also hard to spot the good sides of getting the flu, particularly since it can be fatal. While it's easy to spot the misery of a recession, today I heard three positive things about this one. First, more people are planting vegetable gardens to save money. A side effect will be to have healthier food and some enjoyment. Traffic is down, leaving roads less congested. Finally, I heard an economist say today that because the job losses in this recession have happened so quickly, the recovery in jobs could be equally quick. He predicted that the recovery in jobs could start by late summer. He may not be right but after all the gloom recently, it's nice to hear an optimist.

The Last Stand

2009-03-14T09:31:00.000-04:00

Guarding the Federal Treasury

The underlying assumption of all the economic rescue plans, is that the U.S. Government remains an unassailable credit. In the economic textbooks and financial theory, the interest rate on short-term Treasury securities is the "risk free rate." That is the bedrock upon which sits the world credit markets and indeed the entire superstructure of the global economy. There is no more powerful term of art in the financial markets than the guarantee that comes with "the full faith and credit" of the U.S. Government. As we spend voraciously to stimulate the world economy, this requires careful attention.

If for a second, this assumption is shattered, woe be to all of us. The last line of defense cannot be breached. This goes by different names: a dollar crisis, runaway inflation, a systemic crisis. It all boils down to the same thing. In a modern economy, everything depends on faith and confidence and most importantly faith in the U.S. Government to have the capacity and will to honor its debts. The remarks by China's Premier Wen Jiabao on Thursday were an early warning. When you owe someone $1 trillion, it pays to listen. Of course, he also needs to be careful or we won't be able to pay him.

Debtors generally lose their standing not when they have too much debt but when their liquidity runs out; they have no more capacity to raise additional funds to service their debts. The U.S. borrows for the long term, as long as thirty years, to finance highways and airports and all types of infrastructure -- many projects that won't pay off for years or decades. Over time those debts have always been paid but they cannot all be paid today. The danger is when the debts mount so high and rapidly and when funding dries up. Even the mightiest borrower can be brought down if they have not carefully planned for such a rainy day.

The U.S. must guard against this possibility in every available way. The U.S. Government balance sheet -- it's tally of cash and borrowings -- is the critical defense against the economic troubles spreading around the globe. If the Federal balance sheet is perceived as shaky, there is no saving the global economy from complete disaster. While this sounds dire, it is, but it is also highly unlikely if proper precautions are taken.

Part of the recklessness of this decade has gone largely unmentioned. While the Federal debt has roughly doubled, the average payment period has halved. This seemingly technical point is in fact a major risk factor that should be reversed as soon as possible. At one point early in the decade when debt was low, the Treasury briefly stopped issuing its longest bonds, 30 year maturities. The average debt maturity shortened to only three years. That means that every year the Treasury had to raise enough money to cover one-third of the debt. Between the shortened maturity and the rise in debt, annual funding needs more than quadrupled.

The Government's action was comparable to a homeowner putting his mortgage or car loan (typically four to seven years effectively) on their credit card, whose balance is payable in full on demand.

Why did this happen? Interest rates were historically low and short-term borrowing was a lot cheaper than long (the yield curve was historically steep). Now interest rates for the Government are even cheaper and it's still beneficial to borrow for short term -- months rather than years.

The Government should resist that temptation and step up the longer-term borrowing. One expert has even proposed 100 year borrowings to get us over the hump of baby boom retirements. In the short-term it will be more expensive to extend borrowings. But if we put too much pressure on the credit markets by constantly coming to market with tens of billions of dollars of short-term borrowings, it raises the likelihood of the credit markets balking. By taking precautions, that need not happen. Once it happens, there's no turning back so we should sacrific whatever is necessary to avoid that possibility.

Famous Last Words

2009-03-09T09:25:00.000-04:00

Irrational Exuberance Anybody?

When Alan Greenspan gave his famous testimony to Congress and questioned whether the U.S. was in a stock market bubble characterized by "irrational exuberance," the Dow Jones Industrial Average was at 6,437. That level on Dec. 5, 1996 had climbed 24 percent over the previous year and nearly doubled in three years. It would double again before the next major bear market began in 2,000.

Now that we are back at that level of 13 years ago, does anyone feel irrational or any exuberance about the stock market or the economy?

More Bad Numbers

2009-03-06T10:01:00.000-05:00

It's Bleak but not Hopeless

Boeing announced that in February they only received four orders for freight and passenger jets. The previous year they got 125 orders. That's a year over year decline of 97 percent. In good years, Boeing is the single largest U.S. exporter. So this is bad news for manufacturing jobs and our trade deficit. Orders are a forward looking indicator with new orders delivered years in the future, so this doesn't mean a collapse of current production. Anyway you look at it, it's not good. The only plus is that across the board, inventories are getting leaner and eventually people will want stuff again.

Planning for Sunnier Days Ahead

2009-03-03T12:17:00.002-05:00

Comeback Insurance for the Stock Market

Some day the sun will shine and the flowers will bloom and the economy will recover. Companies will still be in business and begin to grow profits and the stock market will rise again. It's hard to look past the current carnage but how do you prepare for a brighter future? Do you abandon the stock market permanently as two generations of Americans did after the Great Crash and the Depression? Or do you participate as did the people who reentered the market and enjoyed a two decade bull market after World War II.

One way to participate is to put together an ultra-diversified portfolio. Think of an ultra-diversified portfolio as comeback insurance for the stock market. In normal times, diversification is seen as a luxury or something that prevents you from racking up big gains. In tough times, it may be the difference between riding out the storm and getting permanently sunk.

What is ultra-diversification? In simple terms it means buying lots and lots of different things. So far in this super bear market, everything has been falling and falling a lot. It hasn't mattered what stocks you owned anywhere in the world; they've all gone down. Usually that's not the case and this is unlikely to last forever.

Even now financial stocks -- primarily banks -- have been hammered mercilessly. While the broad averages are down roughly in half since the bear market began, Citicorp is down more than 95 percent from its peak of the last year and many formerly blue chip stocks are down nearly as much. While they may regain prior values, it will be a long tough slog and many may never regain their formerly lofty heights.

Trying to foresee the future is always difficult. Now it's impossible. The carnage of a bear market and steep recession obscure the good things that are happening in the economy. By the time they become apparent, the next bull market leaders will have already made big gains. The best way to capture those gains is by holding broad batches of stocks.

While some fallen angels will recover, it's much more likely that the broad market averages will benefit fully from the eventual economic recovery. Oftentimes, only a handful of stocks, industries or geographies benefit from a market move. In 1998, the S&P 500 rose more than 20 percent. That increase was accounted for entirely by fewer than ten stocks, mostly big technology companies. Without those, the index actually would have been down slightly for the year. Picking them out ahead of time was nearly impossible. Two years later to do well one needed to hold small cap value stocks and no technology. A few years later, the ticket was energy stocks.

Who is that nimble? Who is that adroit?

By the sheer law of large numbers -- if enough monkeys press on the keyboard, they'll eventually produce Shakespeare -- someone will appear to be doing well. Is it luck or skill? It may be skill in some small number of cases but even if it is, it's nearly impossible to identify that skill ahead of time. Those who persist in trying to find that rare skill more likely hold themselves open to scams or legitimate but equally devastating disappointment.

The solution is easy. Hold everything. Hold a little bit of as many securities as you can all over the world. You'll capture the best and the worst but over time these returns have been robust. Including the Great Depression of the 1930s and the current unpleasantness, stocks over the years have returned more than 10 percent a year on average. That means that a portfolio doubles every seven year on average merely by matching the market returns. While no year is average, over the long term -- 10, 15, 20 years -- returns begin to converge on those averages. That may seem like a long time but investing, as opposed to speculating, is a long-term proposition. For those who truly want to invest, the wait is worth it and the returns that accrue are spectacular. It just takes patience and heeding the fundamentals of investing.

Ultra-diversification means holding thousands of securities around the world. The most widely held index funds, those based on the S&P 500, naturally enough hold 500 of the biggest U.S. stocks. That's good most of the time but what about when small stocks do well or Asian stocks? In the early 1970s you needed to own big fast growing stocks. In the late 70s it was commodities and small stocks -- how to know that ahead of time? How to know to jump off commodity stocks in 1980 after a great five year ride and not get back on for more than twenty years. How to know to get off small stocks in June 1983 after a great eight year ride and not get back on for almost a decade. Who knew that tech would be a disaster for most of the 80s and the ticket in the 90s before being a disaster again?

A guest on television got it right last summer. He said that if you think you know what's going on, you're just not paying attention. He was being honest and right.

No one knows where the winners will come from and the best chance to hold them is to buy as many different securities as you can all over the world. A few mutual funds hold thousands and thousands and they are well worth searching out. Look at the actual holdings, not the names. Just because something says "world" or "total" doesn't mean it has as many names as possible. No one knows the optimal number to be properly diversified, but if the cost is reasonable, more is better. And remember, a few holdings, those needles in the haystack that can rise 10 - 50 - 100 times, can make all the difference and just make sure you have them.

The Silver Lining

2009-02-04T04:43:00.019-05:00

The Yin and Yang of Economics

Everything is bleak. It seems that forever the business news has been a sea of gloom. Companies announce layoffs by the tens of thousands. The stock market had its worst start to a year ever. People criticize the proposed stimulus plan as something that will take too long to work. Concerns rise that with interest rates already close to zero, monetary policy can't help. It's easy to see what industries --- autos, housing -- are struggling. It's much less clear what will lead us out of the mess.

But big problems lead to big solutions. It's the yin and yang of economics. In good times, problems accumulate and they are dealt with in bad times. The seeds of prosperity are planted in the bad times. In recent decades, the U.S. has been fortunate. The down parts of the business cycle, recesssions, have been short and mild compared to earlier periods. In the 1980s and 1990s we had record post-war expansions. In the 1990s growth and productivity accelerated to levels that many thought were no longer possible given the size and maturity of the U.S. economy.

The bad news will continue for a long time, likely several more years. Already, though, there are many encouraging signs. We won't know for some years when the economy hits its trough and the shape of a recovery are still a matter of conjecture. But many important things are clear.

The best news is that it's likely that the greatest systemic risk is well behind us. In mid-September, panic raged globally. In one week in mid-September at least one huge event happened every single day that I never thought I'd see in my lifetime. That week Lehman Brothers failed, AIG and money funds needed to be bailed out, Merrill Lynch, Goldman Sachs and Morgan Stanley needed to be rescued and put under the cover of commercial banks and the TARP program initiated and the stock market had its worst week every. That week was perilous to the system. Each misstep carried the risk that panic would so dominate the system that confidence would be crushed and recovery would be measured not in months or years but decades.

Subsequent weeks were not as bad but the cumulative effects of the financial crisis kept building. Matters hit a head over Columbus Day Weekend. By then various rescue plans had come and gone and global markets kept shrugging them off. Risk aversion and fear reached record levels. The danger was that these bad impacts become self-reinforcing and would not burn out of their own accord until they laid waist to large swaths of the world economy.

Over that weekend, Britain took the lead by directly injecting capital into its banks and the U.S. and others followed. That Monday, Columbus Day, the global markets responded favorably and the cycle of fear and panic was temporarily broken. The peak period of fear, while diminished, lasted another month but the greatest danger of widespread failure was past.

People are creatures of habit and fear can remain at extreme levels for only a short period (it's unusual for peak fear in the markets to last two months). Then they revert to their normal routines. People adjust and behaviors change but the strongest habits persist as long as the environment permits.

Outwardly, daily life for most people has changed little but in some ways economic life has had drastic changes. A generation will retire later. Many people will lose their homes, move, switch industries, require further education and have much diminished lifestyles.

But out of this widespread pain, many opportunities will arise. Just as a forest fire enriches the soil and opens sunlight for new plants, an economic downturn creates new opportunities. It forces people and businesses and the government to rethink old and outmoded ways of doing things and be open to new opportunities. In good times,it's hard to shed old habits. In bad times, people have to change. The U.S. had grown fat and happy, now it's time to switch to lean and mean.

It's easy to see where the difficulties lie. The financial system, judging by past bubbles, will not fully regain its vibrancy for many years if not a decade or more. But new industries will take its place. It's less obvious where the new leadership will be. Starting off the 1990s, no one predicted that high technology will play the leadership role that it did and the Internet did not begin to shine until midway through the decade. The New York Times had a cover story this week exploring where the new opportunities lie, http://www.nytimes.com/2009/02/01/magazine/01Economy-t.html?_r=1&ref=magazine.

A possible encouraging sign is that this downturn has been so fast and so sharp that the economy may have overshot to the downside. Car production is down by nearly half and home building has plummeted. The same happened in many industries but to a lesser extent. As a consequence, inventories may become too lean sometime in the first half of 2009. With hundreds of billions of dollars parked at near zero interest rates and the stimulus package underway, a reversal of the extreme risk aversion could get economic activity flowing rapidly again.

The rebounds from the past few recessions have been sluggish but this is the sharpest and longest decline in a long-time. The rebound, whether it begins this year or next year, could be equally abrupt. Even if its not, the financial markets have been beaten down so much that their response could be surprisingly swift.

Saving the TARP Bad Asset Buyout

2009-01-27T19:10:00.020-05:00

Turning Bad Assets Good

The heart of the response to the U.S. financial crisis last fall was the $700 billion TARP program. The on again, off again program was to buy bad assets from banks and free them up to lend again and reinvigorate the economy.

A few weeks after arguing that this program was essential to saving the world economy, the Treasury and Federal Reserve backpedaled and decided to use the money to inject equity directly into the banks.

While that was a worthy objective and essential to enabling the banks to resume lending, it left the financial markets puzzled. What was the Treasury really thinking and did they know what they were doing? If the bill was named the Troubled Assets Relief Program, why wasn't it dealing with troubled assets?

Dealing with an unprecedented crisis strains, the financial markets were panicking and the critical thing in shortest supply was confidence. Treasury's flip flopping and floundering squandered whatever confidence was left.

In reversing its decision to purchase bad assets, the Treasury cited as their biggest obstacle figuring out how to price assets. That's a question that Treasury and the Fed had danced around during Congressional testimony in September and later.

The problem in a nutshell is this. Because no one wants to hold illiquid assets now, prices have plunged. In a few years, when institutions are more willing to assume normal risks, these assets may rebound significantly if their intrinsic value remains the same. The Federal government can add these assets to its balance sheet now and wait a few years for the increase in price and an expanded number of buyers.

But which price should the Government pay? The current low market price, the expected higher future price or something in between?

The answer is critical because the idea is to help these financial companies recover so they can provide the wherewithal to get the economy moving again. If the Government pays too little, it won't help the banks. If it pays too much, it will feel like a chump and taxpayers will be taken for a ride.

The real answer may be that the Government should inject money now and worry about the price later.

Here's how that would work. Think options. The Government would pick an arbitrary middle price and pay the banks that money now. That would help the banks get back to work, lending money to sound borrowers. The Government would sell the assets it is acquiring over a period of years. If the Government got good prices, it would split the upside with the banks. If it realized lower prices, it would collect some of the difference from the banks.

This would accomplish three major things. It would help repair the balance sheets of the banks now and restore confidence. We would avoid the thorny problem of pricing for now but a market-based mechanism would be used in the future. This would avoid the problems and possible corruption of arbitrarily setting prices. Finally, this would bring transparency to the process and boost investor confidence which is a critical step toward recovery.

Stock Market Suffering a "Lost Decade"

2009-01-25T17:14:00.004-05:00

Once in a Lifetime Financial Crisis

Most people now agree that the current financial crisis is a once in a lifetime collapse of the world economy. While we don't yet having any way of knowing the ultimate depth of the contraction, the threat to the world economic system has been the greatest since the Great Depression of the 1930s.

In a single week in mid-September, the last of the major Wall Street investment banks failed or became commercial banks, the largest U.S. commercial insurance company had to be bailed out with more than $125 billion, money market funds began to fail and needed to be guaranteed to prevent a run and Congress debated a bailout of the commercial banking system. In short, in one week, under a conservative Republican laissez faire administration, the U.S. went from a regulated but free market financial system to a heavily government run network of financial intermediaries. And everyone could only hope for the best.

That week turned out to be the worst in stock market history with a decline of about 18 percent in the broad averages. As one commentator put it a few months earlier, "If you think you understand what's happening, you aren't paying attention."

To put stock market performance in perspective, the stock market is flirting with declines that challenge the worst performance since we began keeping good records in 1926. That includes the current record-holding period of the 1930s, when the brunt of the Great Depression hit. Depending on which of the broad averages one uses, last year's decline was about one-third, which was the worst calendar year performance since 1931 or 1937 (the S&P 500 and Dow Jones Industrial Average respectively). All told, about $7 trillion of stockholders' wealth vanished in the U.S. (wiping out the gains of the last 6 years) and approximately $26 trillion disappeared worldwide.

By some measures the market could still decline further based on estimates of market declines during past financial crises. A study by economists Carmen Reinhart and Kenneth Rogoff of past financial crises, http://www.economics.harvard.edu/faculty/rogoff/files/Aftermath.pdf, would indicate a further ten percent decline is possible.

Using another measure, however, this is already one for the record books. Over time the stock market has trended upward at a pace of about 10 to 11 percent per year. That trendline is consistent over long periods. Individual years differ widely with gains as high as 54 percent (S&P 500 in 1933) to a decline of 43 percent (S&P 500 in 1931). Over longer periods, the market, which reflects economic activity, is much more consistent. Good decades make up for bad decades and the returns catch up with the long-term trends.

Prior to the current decade, the worst decade, not surprisingly was the 1930s, with an annualized return of -0.1 percent per year, or nearly flat. In the 1940s, spurred by a post-war boom, the annualized return was +9.2 percent, followed by an ebullient market in the 1950s, returning +19.4 percent per year. The first half of the 1960s was relatively strong followed by weakness later in the decade as inflation hurt the economy. For the decade, the annualized return was +7.8 percent. In the 1970s, which had two big recessions and rampant inflation and a big bear market mid-decade, the return for the whole decade was still a positive +4.6 percent. In the 1980s, a two-year recession gave way to a long-term recovery and bull market and a +16.1 percent annualized return. The 1990s followed a similar pattern with an early recession giving way to a record peace-time expansion and an annualized return of +17.9 percent.

Now we are nearing the end of what may turn out to be the "lost decade." The Dow, the most popular market barometer, breached 10,000 in 1998. It now hovers around 8,000 or a decline of 20 percent. For the decade of the 2000's, the annualized return to date of the S&P 500 is -6.8 percent. Using the S&P 500, the broadest major indicator, and calculating by decade, this will be the worst decade in the 80 years of modern record keeping unless the market returns to near record levels and rallies by close to 75 percent this year. While possible, it certainly doesn't seem likely and this period is likely to go into the record books as the worst decade for the market in the modern era.

The silver lining in this debacle is that the market tends to revert to the trendline over time. That means good periods eventually follow bad ones. Great bull markets are borne in the ashes of terrible bear markets. While the sunshine won't necessarily break through soon, eventually the storm will depart.

Super Bowl Indicator Bodes Well for Stock Market

2009-01-22T10:19:00.007-05:00

Steelers, Cardinals Provide Grounds for Optimism

The Pittsburgh Steelers should bring back cheer to Wall Street. For many years investors have tracked the outcome of the Super Bowl as a strong indication of whether the market would go up or down for the year. Despite the silliness of the linkage, it has proven a more reliable indicator than most expert predictors. Over the years, the indicator works about 80 percent of the time. Chance alone would mean it should work only half of the time.

The indicator holds that when a team from the National Conference or an original NFL team is the winner, the market will go up. If an old AFL team wins, the market will go down. Views differ on how to treat expansion teams that have joined the league since the AFL and NFL merged in 1970.

Both the Arizona Cardinals and the Pittsburgh Steelers should lead the market up this year and we certainly could use that after the worst calendar decline in more than 70 years. The Steelers seventh appearance in the big game augurs even better. After their six previous appearances, the Dow has always risen.

This is the first appearance in the Super Bowl for the Cardinals so they are an unknown for the stock market. However, their status as the NFC representative is a good omen.

The Steelers have won five previous Super Bowls tying them with the San Francisco 49ers and the Dallas Cowboys for the most championships in modern football history. If the Steelers win this Super Bowl -- and they are favored -- they would stand alone as the most successful NFL franchise.

Along with that record of on field performance, they have a chance to be the best talisman for the stock market. In five appearances in the Super Bowl, the 49ers were victors each time and the Dow rose an average of 20.7 percent but there was one losing year for the market, 1990. The Cowboys have made a record eight appearances in the game and the Dow has risen 10.2 percent per year, slightly below the long-term average, and there was also a losing market year in 1978.

The Steelers alone have never ushered in a losing year in the Dow and their long-term average return is 19.6 percent. If the market rises 27 percent this year they will eclipse the 49ers in every market related way. While that would require a big rally, last year's 34 percent drop was one of the biggest in market history. A 27 percent rally would only bring the Dow to 11,146, the closing level in mid-September 2008.

New York Giant fans may be disappointed that they did not repeat their trip to the Super Bowl but market participants should be relieved. Their victory last year should have led to an up year and instead the big drop was one of the biggest dents so far in the indicator. In four trips to the Super Bowl, the Giants have left behind disappoint markets, averaging a drop of nearly five percent.

While all of this may seem overly whimsical in the midst of a serious financial crisis, most American market participants do take their pro football seriously. And while there is no reason to assign any cause and effect to the Super Bowl Indicator, people move billions of dollars every day on flimsier evidence than this. In any case, all investors would be well served by joining the legions of Steeler fans around the country in a hearty chorus of Go Steelers.

Overcoming Fear

2009-01-09T22:08:00.002-05:00

Learning the Wrong Lessons from the Stock Market Crash

Investors always gravitate between fear and greed. The pendulum had swung too far toward greed in recent times. Now investors have been traumatized and the danger is that they will stay fearful and lose opportunities.

Both extremes are bad. Being too fearful is less destructive than taking too much risk but it is still a huge problem. Whether someone is saving for their first house, to send children to college or to have a secure retirement they must invest prudently. But to do that, they must accept prudent risk. Every investment carries some risk whether an investor identifies that risk or not.

A measure of the level of panic is the investment posture of major institutions. Short-term treasury bills are being issued at close to zero percent interest. What that means is that major market players are willing to hand over their money to the biggest borrower in the world in return for -- nothing. There are trillions of dollars under the government's mattress and major institutions are asking for nothing in return except for a piece of paper that says the U.S. government will give the money back, with no interest, at a specific time.

So if the big institutions panic, should individuals panic too? While panic was certainly justified for several months in the fall -- just because I'm paranoid doesn't mean someone isn't out to get me -- one should examine the current environment in weighing investment decisions.

It's highly likely that the world economy will go through a brutal slump for most of 2009 and recovery for late 2009 or even 2010 is problematic. While there are some grounds for being more optimistic, it's not necessary to rely on that to chart an investment course.

Going back as far as we have good records, to 1926, the broad stock market has increased on average by more than 10 percent per year. That takes into account the 85 percent drop during the Great Depression, the dark days early in World War II when the Germans and Japanese raced toward victory, the brink of nuclear war in the Cuban missile crisis, the ravages of inflation and the prolonged economic slump of the U.S. in the 70s and early 80s and the tech stock collapse at the dawn of the millenium. Through all that, the stock market has recovered and grown in line with the economy.

On average through all those bleak periods and boom periods, the stock market has doubled every 7 years and quadrupled every 14 years. It's never smooth and never guaranteed but it has worked for a long time. While there were periods this fall when it looked like the world economy could completely derail, the greatest danger seems past. Now it is a matter of being patient and enduring pain but the outcome should be similiar to that of all the many times over the last century.

Most investors do not have access to anything that can equal the returns of stocks over the long term. Investing in a broadly diversified representation of the stock market makes it possible to realize those returns with the least risk. Investors should not abandon that avenue as part of their investment arsenal just because of some recent trauma -- the second worst year of the last century. This too shall pass. From past experience we also know that whenever the market does recover, it is likely to be suddenly and with big moves. A big part of the gains will be concentrated in a short period and few people will realize what has happened until after it is over.

Wild Numbers

2008-12-03T10:34:00.005-05:00

A Mixed Picture

Amazing Volatility

The Dow Jones Industrial Average has moved up and down by an amazing average of 517 points each day over the last two months and for much of October by a record 600 points.

Mortgage Refi Rebound

Mortgage applications for purchase or refinance rose by a record last week as lending rates plunged after the Federal Reserve agreed to buy mortgage-backed debt. The Mortgage Bankers' index jumped 112 percent to the highest level since March. The refinance index rose 203 percent while the purchase index rose 38 percent.

The Fed announcement on Nov. 25 that it would buy $500 billion of Fannie Mae and Freddie Mac debt sent mortgage rates to a three-year low. 30-year fixed-rate loans dropped to 5.47 percent from 5.99 the prior week. 15-year fixed mortgages dropped to 5.13 percent from 5.78. One-year adjustables fell to 6.61 percent from 6.87. The Refi share of applications rose to 69 percent from 49 percent the prior week.

Meanwhile, the housing slump continued. Combined sales of new and existing homes in October were at a 5.4 million annual pace, down 36 percent from their July 2005 peak. Housing starts in October fell to their lowest since records began in 1959.

Harvard Endowment

Harvard officials say the largest college endowment fund lost at least 22 percent or about $8 billion in the four months since the fiscal year began. The endowment was worth $36.9 billion on June 30. The fund is considered an innovator and one of the best managed college funds.

Stock Market Still Not Cheap?

Bill Gross, manager of the world’s biggest bond fund, said stocks aren’t as cheap as they appear given that the era of high leverage, low borrowing costs, deregulation and low corporate tax rates is over. He argued that corporate bonds are better investments.

The S&P 500 has fallen 46 percent since its record 14 months ago as losses at financial firms approach $1 trillion and economists forecast that the recession will be one of the worst since World War II. The U.S. government has pledged more than $8.5 trillion in all around help during the past 15 months.