A Different Perspective


By Henry K. Hebeler

12/9/02 with 4-28-08 note


The federal and state governments would love to have you spend more money.  Spending bolsters tax revenues and improves short-term economic conditions.  It creates jobs and reduces unemployment.  It improves company earnings which then increases stock prices.  But spending more means saving less. National savings rates are just a fraction of what they were in decades past.  This is going to come at a huge social cost in future years.


Saving less leads to long-term economic problems as more and more of the population ages and must live on social security alone.  We have greater life-expectancy than ever before.  Living longer has several adverse long-term economic effects:  (1) It increases the fraction of the population that depends on social security while reducing the fraction that provides the funds to sustain social security, (2) to the extent that older people consume less than younger people, it reduces economic expansion, and (3) it increases the needs for medical assistance.  Medicare and Medicaid are already stretched to their limits.  Employers are cutting back on health insurance coverage so that employees must take up more of the burden.  This too further reduces savings.


Then there is the subject of debt.  Debts are at record levels in virtually all categories including the national debt, state debts, company debts, mortgage debts, credit card debts, auto purchase debts, etc.  Personal debts excluding mortgages are about $6,000 for every man, woman, and child in the US.  Credit card debts are over $8,000 for each credit card holder.  Bankruptcies are also at record levels as individuals and companies canít make their interest payments.


Interest rates are at a 40 year low.  That has encouraged people to get more debt.  Interest rates can either go up or down. Automobiles are often sold with zero interest rate loans, never mind that the price is higher.  The higher price effectively hides the real interest cost.  If interest rates continue to go down, we could be in an economic funk just like Japan.  If interest rates go up with the record levels of debt, weíll have record interest payments taking a bite out of the economy and even more bankruptcies as people fail to come up with the payments.


Wall Street canít make any money unless we buy and sell stocks.  When you buy, itís a better deal for Wall Street because it knows you have money invested and can be encouraged to trade for some alternative.  When you sell stock, the broker gets a commission, but the funds may leave the investment firm for parts unknown.  Stock trades make more money than bond purchases because bond-holders tend to make very few transactions.  Still, every trade helps fund the $300 billion annual cost of national brokers and the financial community.


Therefore, itís important for Wall Street to continue to predict a bright future for the economy and stocks.  People often forget that stocks are better for very long-term investments.  Long-terms can mean significantly more than five-years.  There have been numerous periods in history where retirees have paid dearly for substantial stock holdings.  For example, those who retired around 1960 generally had disastrous results both from the market and inflation.  The same may turn out to be true for those who retired in 2000.


Therefore, itís important for retirees not to get swept up with Wall Street mediaís pleas leading to substantial stock purchases.  When retirees reach ages where life expectancies approach ten years, portfolios heavily weighted with stocks are likely to be bad choices.  Many of the major investment firms have toned down their model portfolios for retirees, but, out of their own need for continued sustenance, still push the upper limits of what may be prudent.


Itís always been hard to find investments that turn out to be winners.  Itís probably more so now than in a very long time.  The main investment playing fields are stocks, bonds, real estate, and insurance products.  Since no one can foresee the future, the wisest course is probably to have a widely diversified portfolio.  There is a lot of theoretical work (ďefficient frontierĒ) to try and predict the optimum split between stocks and bonds, but even that has numerous shortcomings.  The picture gets even more murky when you add in real estate and insurance products.  Your age and personal knowledge of a particular field of investments should weigh heavily in your choices.


In order to make the price to earnings (PE) ratio look favorable, analysts make a guess of future company earnings and quote a ďforwardĒ projection after leaving out the costs for stock options, pension costs and write-downs.  The current forward projection is now about 17.  Never mind that the PE based on last yearís core earnings is about 48.  Remember that the historical price to earnings used to be considered high when above 20 and low when below 10.  More than ever, itís important to remember that stocks are for the long-term.


Interest rates on fixed income investments are so low that itís hard to get enthusiastic.  If you buy a bond fund and interest rates go up, you will lose the value of your principal quickly.  On the other hand if you buy the actual bonds instead of funds, you wonít get hurt with the loss of principal if you hold the bonds to maturity, but you may miss out on higher rates that might occur in the meantime.


Real estate as an investment is not for the novice because it almost always involves debts that can turn to losses rapidly when property values slump.  Vacancies reduce income, but expenses continue to roll.  Real estate partnerships have even more hazards and are extraordinarily difficult to retrieve your money.  Real estate investment trusts (REITs) offer liquidity and high dividends but are subject to the additional uncertainties of both the stock and bond markets.


Insurance products are notable for their high costs that now are a lot more visible with the basic returns being so low.  Annuities offer much smaller payouts than in just a few years past and commit you to those rates till you die.  The various forms of life insurance are more suited for your heirs than your retirement.


Many people are putting more of their portfolios into money markets.  In effect this is a form of market-timing if the intention is to invest the money in the stock market when stocks get to be a safer place.  History shows that very few people get lucky with market-timing and stocks often go up when least expected and often fast enough that you can easily buy at a local peak instead of when prices are low.


Right now I like government savings bonds and I (inflation) bonds.  The major limitation for some people may be the $30,000 purchase maximum each year, but even then, a couple can invest a tidy $60,000 per year this way.  If interest rates go up, the savings bonds may get a little kick while if inflation goes up, the I bonds will get the boost.  With either, you donít have to worry about losing your principal so savings and I bonds can be either a short or long-term investments depending on how your future plays out.  By buying either of these bonds you are making some money off the federal governmentís indebtedness.  That wonít provide much comfort, but the thought is nice anyway.


4-28-08 note:  On 1/1/08, the government limited the amount of I bonds you can but to $5,000 per Social Security number per year from a bank, but you can buy an additional amount of $5,000 from TreasuryDirect.gov.  That could give a total of $20,000 per year for a couple.