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THE BLUE MONEY REPORT.
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The Blue Money Report
"...contributors will only give money to challengers when they have a realistic chance of winning, and incumbents only spend a lot when they have a chance of losing"
~ Steven Levitt
Welcome to the Blue Money Report
Today's Commentary: 10.03.03 It is the first part of October. The Halloween decorations are up, transforming the house into a festively scary place. I should be outside blowing leaves before the weather gets wet. My wife found me sitting at my desk preparing to do a piece on taxes. When she dropped an open copy of AARP, the magazine, on my desk suggesting I read a column Mr. Money, written by Ric Edelman of Edelman Financial Services, I was more than happy to oblige. I really don't like to write about taxes.
Now I have to be frank with you. I tend to stay away from reading these types of columnists. They are all financial professionals who believe in what they do. I am sure Mr. Edelman is no different. He probably has little Edelmans running around at home to support. But the advice he doled out to Larry and Elaine in the November/December 2003 issue was a bit over the top. Setting the record straight seemed important. Not to say Ric's advice won't work out for this couple, it just didn't make any sense when I read it. Below is my rebuttal.
The column evidently takes sample fifty-plus-ers and profiles their financial strengths and weaknesses. Sounds simple enough. This month's sample couple are Larry and Elaine Fargo. Laid bare for everyone to see, their finances are examined. This is where Mr. Edelman comes in. This is nice work if you can get it.
This couple has about $90,000 in income, a home with $255,000 in equity, no debt and a live-in Mom. The mother evidently brings in a couple of hundred dollars and the two have haphazardly squirreled away $5,000 in some sort of Educational Savings Account. Ric gives them kudos for their lack of debt but slaps them about for their lack of savings.
There are a lot of fifty something couples out there in similar situations and trying to see yourself in the article would be downright dangerous. The set-up fails to mention whether this couple with two young adopted girls had been married for very long. The way Mr. Edelman approaches them, we assume that these two have been married for quite some time, spending freely in a childless world. They probably took vacations, furnished their home, tweaking it and remodeling to suit their lifestyle. Or they were recently married, adopted two kids and live in one of the other's previous home, combining incomes only recently and doing so with no plan. It is hard to say, but I am willing to go with assumption number two.
Ric's advice was what my wife was so irate with, so much so that she literally insisted that I also share her ire. I'll admit, that if this couple really were just starting out, with two kids, they have time and a healthy income on their side. Mr. Edelman first misstep was when he suggested that they take a hefty chunk of their equity and put it to various uses, none of which seemed to be very profitable.
This financial planner thought that the couple should take a $100,000 of equity and divide it up accordingly: $30,000 in a rainy day fund, $30,000 into a 529 plan, and set $40,000 away for retirement. To further break down that last chunk of money he suggests that they each deposit $3,500 this year and immediately upon the change of the calendar year, they should deposit and additional #3,500. The balance, Mr. Edelman advises the couple should be placed in a balanced mutual fund.
The "rainy day fund" is a good idea. But you shouldn't borrow money to do it. Think about it: you borrow at approximately 6% paying the fees associated with the loan. Then you put it away in an account that should be accessible but only for emergencies. That usually means a money market account. In California, their home state, some banks are paying a whopping 1.99% for a Money Market Account with a minimum $10,000 balance and a hefty 1.27% on a six month CD. This is according to BankRate.com. Deduct the taxes from even these minor interest payments and subtract inflation to come up with the real value of those dollars and poor old Larry and Elaine are actually losing money.
And then we address what the couple felt in the article was a "pressing matter". I have always had a difficult time with 529 plans. I have an even more difficult time with fifty-plus-ers beginning one. I believe that they are only worthwhile after your retirement is fully funded.
The couple adopted two young kids. A safe assumption is that these folks are not going to retire on time if they keep putting money away for a college education. My concern, not often held by the majority (or even the minority of financial planners) puts the children as the greater investment rather than the attempting to assuage the future value of higher education. Kids cost money. The house they live in costs money. Lessons and sports, clothes and camps, entertainment and vacations cost money. Those investments, while having a very real cost, tend to grow a much more rounded student. That student should understand the practical nature of life: "Life is what you bring to it".
Larry and Elaine should be focusing their time and efforts on their retirement fund. That will give them peace of mind. Focusing on grants and scholarships and working at keeping the cost of college down, will give them peace of mind in a very real and tangible way. College is changing and risking valuable retirement savings, a skill Mr. Edelman doesn't quite stress enough.
Ric has a plan for that sorry excuse for a retirement plan. He wants this couple to jump start their retirement. The article suggests that they do this by making a lump sum payment of $14,000 to an IRA without telling us how it is invested. The couple was supposed to put the remaining money in a taxable account. Once again I scratched my head at the logic. Once again, taxes, inflation and uncertain returns might eat away at those returns and don't forget to subtract the cost of the loan that went into that fund.
Their previous mortgage payment each month was in the neighborhood of $400. Based on the numbers given in the article, the monthly income is roughly $7,500. This is an enormous chunk of change, you might say, and you would be right. In relation to their debt, which we are told is none, one would have to wonder what these two were purchasing.
After the refinance, that mortgage is now over a thousand dollars a month. More importantly, this fifty year old couple now has a brand new mortgage with no real plan for continued saving.
There are better ways to approach the solution without creating additional debt. Time is on their side. Elaine is a librarian. Time wise, she could probably do that sort of work well into her eighties. She might even find it keeping her sharp and vital. Larry probably can't wait to retire. He's a logging crew foreman. It sounds dangerous, probably too much so to continue into his seventies.
I am sure Ric would agree that to snag the best financial deal for your kid's college, the amount of your debt will actually be helpful. Borrow the equity then if they haven't gotten scholarships and grants for excellence. Until then Larry and Elaine should save for themselves first.
Today's Commentary: 09.29.03
Doug is or at least I thought he was, a bond investor. Personality wise, he is often over the top, but he seemed to hold onto a conservative approach when it came to his money or at least those dollars destined for his retirement. Bumping into him the other day while I was watering my wife's garden (late September and the NorthWest is turning in 95 degree temperatures), I had to ask. I wanted to know if he rode out the bond downturn; whether he had shifted his positions; what he was thinking.
I was disappointed to find out that he had switched from bonds to mutual funds as he put it, "just when mutual funds were being skewered in the news". He shrugged his shoulders in a can't win-for-losing manner and headed off. I thought bond investors were long termers, so to speak, shuffling among bonds and bond funds, looking for deals, laddering their portfolios. I was surprised to find out that this is too often the case among the average investor, creating an atmosphere of frenetic outlooks and frantic trades.
Why does this happen? What prompts folks to desert a discipline that can continue to earn them money?
Let me tell you a little story first about investing.
The owner of the local corner market noticed Little Johnny start hanging out his store. The owner didn't know what Little Johnny's problem was, but the boys would constantly tease him. They would always comment that he was two bricks shy of a load, or two pickles short of a barrel. To prove it, sometimes they would offer Little Johnny his choice between a nickel (5 cents) and a dime (10 cents) and John would always take the nickel - they said, because it was bigger.
One day after Little Johnny grabbed the nickel, the store owner took him aside and said, "Johnny, those boys are making fun of you. They think you don't know the dime is worth more than the nickel. Are you grabbing the nickel because it's bigger, or what?" Slowly, Little Johnny turned toward the store owner and a big grin appeared on his face and he said, "Well, if I took the dime, they'd stop doing it, and so far I have saved $20!"
In the face of guaranteed returns, in zero-coupon bonds, Treasuries, and Treasury Inflation Protected Securities, the conservative investor has looked at the outsized gains mutual fund and stock investors have received of late and have grown envious. Moving their money around has caused a surge in equities that hides the underlying weakness in this market.
Let's begin with the dollar. It really will remain stable in the long run. Horizons short enough to fall into the period starting now until election time next year might find it difficult to stay put, but any dips in strength will be a result of a muddled policy without a clear voice. That policy favoring a weaker dollar without saying so out loud will do more damage to this economic recovery than I believe Mr. Snow, the Secretary of the Treasury realizes. The domino effect of such policy may be too blurred to see from where he is standing, most recently in Dubai.
With a weak dollar, imports cost more and let's face facts, we are importers these days, not exporters (unless you count jobs among exportable goods). Rising import prices add to the inflation many of us are feeling. Inflation is good for bondholders I would imagine increasing the opportunity to buy higher yield, lower priced issues.
I mention jobs in passing and that is probably not a good thing. The unemployment picture will not improve even as benefits begin to run out. The fragile state of this recovery is evident in the continued numbers of jobless and disparaged. Many businesses have reached a limit to the amount of employees they can jettison safely to protect a tenuous profit picture.
But bondholders have pumped enormous amounts of cash into the markets at precisely the wrong time. You would think they would simply know better, not bowing to the same emotional pressures that equity investors experience. Take away outsized returns in bonds and they are willing to board another leaky vessel.
Historically, September and October are bad months for equities. I have no reason to believe that that pattern will not continue. Folks are receiving their tax bills in the mail as you read this. Sticker shock will set in at the increases many local and state governments are requiring in order to offset years of poor fiscal discipline.
Mutual funds are about to take some profits off the table as their fiscal year ends on the 31st of October. This year especially will be difficult for these managers, many of whom are starting to show some real gains. Those returns will be heavily taxed though making investors skittish about equities as they begin to readjust themselves in November.
I will say this much about bondholders, they tried to purchase stocks that had something of value in them. In many cases, they unwittingly indexed their bets, a growing problem among stock mutual funds that claim to be actively managed. Staying close to an index like a dog on a short leash, fund managers have found that they can't get hurt too awfully bad if the market turns sour. Hanging out with the benchmark flies in the face of bullish sentiment from just about everyone you hear these days. Which leaves this recent run-up in the market at the whim of the speculators, those champions of trading without fundamentals.
It will not be the strength (or weakness) of the dollar and the subsequent trade deficits that will follow. It will not be the recovery or the lack of jobs to support it. It will not be the rising costs of living in this country. What will have the largest effect on available investment dollars is the belief that stability is not only possible but fashionable.
We have market of indexed investors holding companies that move in lock step with one another. With everyone else buying crazy valuations in companies that are low in profits and high in pension assumptions, a rush out of any kind of downturn in the coming weeks would be disasterous. In the attempt to recover ground lost in the previous three years, we may have set ourselves up for another accident.
Former bondholders like Doug worry me. These new equity investors will not be able to stomach a double percentage point drop as markets adjust. If they flee after having bought in at the top, they will create a downturn similar to those we experienced in the two previous years. All the little Johnny's and Doug's who jumped from a steady income to a volatile return are the hinge on this market. No longer pleased with a nickel they have instead asked for a quarter. That simply won't happen.
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