Economics Professor Explains

Sid Mittra, Emeritus Professor

About Sid Mittra

Sid Mittra, PhD, CFP®, is emeritus professor of finance in Michigan and the recipient of the Albert Nelson Marquis Lifetime Achievement Award 2017, for achieving career longevity and demonstrating unwavering excellence in his chosen fields. A past member of the Certified Financial Planning (CFP) Board, Sid features in several prestigious listings, including International Authors’ Who’s Who, American Men of Science, and Who’s Who in Finance and Industry. He is also widely quoted in Money magazine, Kiplinger’s Personal Finance, Financial Advisor, and other magazines and newspapers.

RETIREMENT INVESTMENT GETS A RARE GIFT

Posted on March 27, 2020 by Sid Mittra

As bad as coronavirus is, it does offer a rare gift for people investing for retirement.

What?

It’s true. If interested, please read on.

Since the time this virus was been declared as a pandemic, the U.S. stock market has tanked. From year to date retirement investments in 401(k), IRA, and other products have lost -10 to -25 percent as of March 27. Every time you look at these numbers you are shell shocked. And presumably the only thought that comes to your mind is, “why didn’t I get out of the market before I lost everything and ruined my retirement?”

You are not alone. Millions of people like you are feeling that way, and now some are even getting out of the market at the worst time just so they can sleep better at night. Does that sound familiar?

The situation is grim indeed, and assuming you can afford it, you might consider seeking advice from a professional investment counselor. But for the rest, I offer a set of simple advice to follow. And for clarity, I will use the word “plan” as an acronym for my presentation.

P: PREPARE FOR THE LONG HAUL

This constitutes the most fundamental rule of investment for retirement. That involves investing in stocks, bonds, and other instruments, typically by making monthly contributions to the familiar 401 (k), IRA, and other retirement investments. This point requires elaboration.

It is commonplace that the stock market fluctuates on a daily, weekly and monthly basis. It is also widely recognized that every so often the market significantly declines, sometimes as much as by 35 to 40 percent (at our low point, the S&P 500 Index was down -36%). Of course, at other times, it also reaches new highs as it did during the longest bull market in nation’s history (2009-2020). During these periods of market’s turmoil it is perfectly normal for you to feel nervous, wishing you had cashed out of the market in due time.

And therein lies the value of disciplined investing by regularly committing a pre-determined amount on a regular (hopefully monthly) basis. By doing so you avoid the task of having to decide when is the best time to investment in the market, thereby laying the foundation for achieving the best long-term results.

L: LEVERAGE MARKET’S FLUCTUATIONS

The second rule is an integral part of the first rule. An important result of your decision to make monthly contributions is that you benefit from adopting a time- tested rule popularly known as the dollar cost averaging strategy. This rule automatically takes advantage of market declines by purchasing more investments at lower prices. Note that you reap this benefit without attempting to time the market. And even though this strategy results in your buying less shares when the market goes up, that does not negate the benefits of this strategy over the long term. Put differently, it has been clearly demonstrated that, over the long-term, following this practice delivers far better results for your retirement investment than any other strategy that is available today.

A: ALL-IMPORTANT RETIREMENT AGE

Thus far we have dealt with issues that are straightforward. But now that we turn to dealing with flexible retirement ages, the treatment becomes a bit tricky. Let me elaborate.

It is widely recognized that, unlike the fixed ages of receiving Medicare and Social Security coverage, you have the right to pick the retirement age that is best suited for you. For instance, you may decide to retire at any age of your choosing. There are, however, two caveats that apply.

First, you can start withdrawing from your tax-deferred retirement investment account (without penalty) at the earliest age of 59-1/2. Second, you must begin systematically withdrawing from your retirement account when you reach age 72. This is known as the RMD, or required minimum distribution. Other than that, you are free to choose the starting of your retirement distribution date.

That said, here’s are the practical rules for managing retirement investment.

First, depending on your personal circumstances, fix the age when you wish to start receiving income from your retirement investment. Remember that you will begin receiving your Social Security income from age 66 (may go up to age 67). You will also have your Medicare coverage at that time.

Second, estimate the annual amount you wish to withdraw from your retirement plan for the long haul.

Third, three or four years prior to starting your withdrawal from your retirement account follow a predetermined plan of slowly shifting your investments from stocks to fixed income securities and other secure assets to reduce the overall risk of your retirement investment portfolio. By doing so you will slowly minimize the market risk as you get ready to start receiving your retirement income.

The idea for this strategy should be obvious. If you follow this rule, starting from your selected retirement age, you should be able to start receiving your predetermined retirement income without taking undue marker (market) risk. This is especially true if the market happens to decline for two or three years during this withdrawal period. If constituted properly, this strategy is very effective and brings the much-desired peace of mind during retirement years.

N: NEVER SUCCUMB TO TEMPTATION

And that brings me to the efforts some people make to time the market. After all, if you could buy when the market is low and sell when it is high, wouldn’t you have accomplished the best of both world(s)? You certainly would, except that no one succeeds in this mission.

There is a reason for this. Trying to buy low and sell high is a fool’s paradise. With rare—and I really mean rare—exceptions no one ever succeeds in following this strategy over the long haul. It is therefore best for you to avoid this psychological roller coaster altogether and stick to your routine investment strategy.

Bottom Line

The lessons learned from this brief discussion of managing retirement investment can now be summarized.

Contribute the maximum allowable amount to your retirement investment.
Encourage your employer to contribute the maximum allowable amount to your retirement fund.
Use the time tested dollar cost averaging strategy to make your investments.
Have your retirement investments managed by a competent planner using a long-term strategy.
Three to four years prior to your desired retirement age start shifting from equities to bonds and other securities with less risk.

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APPENDIX

A REAL WORLD EXAMPLE

In this section I will share with you my unique experience with retirement investment management which you will find both illustrative and informative. In this story, names and related references have been changed to protect the privacy of the participants. But the incident is real and is accurately presented.

June 17, 1999

It was a pleasant morning in Auburn Hills, Michigan. At that time I was the financial counselor of a multi-million dollar client named Joe, who was also the CEO and President of a prestigious financial firm. That morning he and I were having breakfast and discussing sports and music, the two topics Joe was passionate about. Suddenly, Joe said nonchalantly, “Sid, let’s talk about the Y2K problem. Even though we disagree on many things, I am confident we are thinking alike on this issue. I want you to confirm that today you will liquidate all of my retirement investments and hold them in cash until the crisis passes.”

A little background will help. As we were approaching the year 2000 it was predicted that on the day we reach the year 2000 our computers would record it as the year 1000. The only way to prevent that from happening was to manually alter each computer. But this country did not have that manpower; hence it was predicted that we were headed toward a disaster of colossal proportions.

Anyway, after Joe finished, I took a deep breath and spoke seriously: “Joe, I have no intentions of doing that. We will continue to manage your account as if nothing disastrous will happen.”

Suddenly, turning red with anger and frustration, Joe retorted: “You lose me. This is my money and you will do what I tell you to do. Get that?”

Absolutely, I replied, but only if you sign this note. I then wrote on a paper napkin: “You are fired” and asked Joe to sign it. He looked at me with rage, crunched the napkin in his hand and rushed out of the restaurant.

After returning to my office I instructed my secretary Jean to prepare the normal transfer papers so Joe’s investments could be transferred to another planner of his choice as soon as Joe calls us. Jean was flabbergasted but said she would oblige.

Joe never called.

January 4, 2000

On January 1, 2000 the Y2K crisis passed with no notable disruptions. I continued to manage Joe’s investments and he never brought up that subject again. Subsequently, I retired as a financial counselor and transferred his account to another agent of his choice. At that point I lost touch with him.

September 19, 2016

I accidentally ran into Joe and his wife Sue outside of a health clinic. He looked frail and withdrawn. But as soon as he saw me he smiled and said, “Thank you, Sid for saving me from Y2K fiasco.”

His wife Sue felt strange, since her husband uttered the words that didn’t mean anything to her and also that I hadn’t even said a word. But Joe knew precisely what he meant.

And so did I.

Travis Smith and Professor David Doane provided technical support for this article. However, the author takes full responsibility for the contents of this blog.

STRETCHING INHERITED IRAs AROUND SECURE ACT**

Posted on March 23, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

The SECURE (Setting Every Community Up For Retirement Enhancement) Act of 2019 was signed into law on December 20, 2019. It makes significant changes in how those who inherit an IRA account must make withdrawals from such accounts.

Before 2020, if an individual owned a qualified retirement plan account like an IRA and died, and the IRA went to a beneficiary other than a spouse (like adult children), the IRA distributions could be stretched over the lifetime of that non-spouse beneficiary (age 30, over 53 years; age 55, over 30 years). There was an opportunity for continued growth in the value of the investments because there was not a requirement for immediate distribution of the balance which could result in a large tax liability for the beneficiary, especially if the inherited IRA is received in the beneficiary’s peak earning years.

The new law provides that for non-spouse beneficiaries (spouses can still withdraw over their own lifetime), distributions are required over a 10-year period. These distributions do not need to be withdrawn every year, but the entire account must be withdrawn by the end of the tenth year following the death of the account owner. This will potentially result in a larger tax liability for the beneficiary, especially if the IRA is sizeable. Additionally, the opportunity for tax-deferred growth of the assets may be much smaller over 10 years rather than life expectancy. If the beneficiary is a minor child, the required distributions can be stretched to the age of majority (18 in Michigan) plus 10 years thereafter (maximum age 28).

Is there any strategy by which an IRA account owner can “stretch” out an inherited IRA in light of this new 10-year rule? There is, if an account owner has some charitable inclination!

Account owners may not want their non-spousal beneficiaries to receive their IRA proceeds within 10 years, but would like the idea of leaving a steady stream of income to their heirs over the heirs’ remaining lifetime. A testamentary Charitable Gift Annuity (CGA) or testamentary Charitable Remainder Trust (CRT) could be the solution. An individual can name a CGA or CRT as a beneficiary of their IRA account and the IRA proceeds will then be used to fund a testamentary CGA or CRT.

CGAs are most associated with a desire to create a level income payment for the beneficiary and are agreements between the account owner and a public charity which agrees to pay a fixed amount of money to the beneficiary for life or a set number of years (i.e. 20).

A CRT is often designed to annually pay the beneficiary a percentage (i.e. 5%) of the value of the trust and tries to capture investment market returns to increase the value of the trust and thus increase the annual payment to the beneficiary. However, if the marketable securities go down in value, so will the annual payment.

Upon the death of the beneficiary, the remaining principal of either approach belongs to the charity (CGA) or is paid over to a public charity (CRT).

While this article has explored two ways to “stretch” IRA inheritances, the SECURE Act touches on other tax and estate planning issues which would be beneficial to review with your financial advisor or estate planning attorney.

To explore whether a CGA or CRT meet your estate distribution goals, please contact the Office of Planned Giving at oconnor@oakland.edu or (248) 370-4389.

This information is not intended as tax, legal or financial advice. Consult your personal financial advisor for information specific to your situation.

Note: ® Reprinted from Oakland Always, the Planned Giving Newsletter of Oakland University.

The writer is John M. Dankovich, JD, CLU®, ChFC®, is a wealth coach at MKD Wealth Coaches in Troy, Michigan. John can be contacted at info@mkdwealthcoach.com.

CORONAVIRUS: END OF THE WORLD?

Posted on March 20, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

Coronavirus.

These days, that is the only noise that gets our attention. Naturally, facts and fears are inexorably intertwined, and people are wondering if we are reaching the end of the world.

Upon reflection, I came to a startling conclusion. While many issues have contributed to this world’s problem, the real culprit that makes our task extremely difficult is accumulation of “debt.”

What?

It’s true. The world today has accumulated more debt than it had during the 2008 recession. And that is not all. The so-called zombies now play a significant role in the world economy. These companies earn negligible earnings and can’t even meet their interest payment obligations, let alone paying off their debt. So they survive by issuing new debts, compounding the crisis even further.

Truth be known, there is also a major shift of risky pools of debt from households and banks under supervision of the government to corporations around the world, making it much harder for the regulators to reign in on the current problem.

Of course, beyond debt, other factors that are also complicating the task of effectively managing the virus problem. Today I will use “debt” as an acronym for presenting the basic nature of our current crisis. I realize that by using this simplified approach I will miss many important issues which could be covered only by a comprehensive treatment of the subject. However, in the interest of efficiency, I will proceed with my simplified approach.

D E B T: Depression

We haven’t heard that dreadful word since the Great Depression of the 1930s, and don’t even know what it really means. Joachim Fels, PIMCO’s global economic advisor, defines a depression as “a combination of a prolonged slump of activity that last longer than just a few quarters, a very significant rise in unemployment, and mass business bankruptcies and bank failures.” Compare this to a typical recession when the S&P 500 declines from top to bottom by 28%. As of March 16, we have exceeded that limit. However, by that measure, we are far away from having a depression. But then, the jury is still out on the economic impact of this virus on the world economy and we have little choice but to wait until this nightmare is finally over.

D E B T: Earnings

An important factor complicating our ability to react effectively is the international nature of this virus (as opposed to the housing bubble confined mostly to the U.S. in 2008). Because of its very nature this virus is simultaneously affecting both the demand and the supply side of the equation, indeed a rare occurrence. China’s economic activity has considerably slowed down, and the same situation is expected to continue with the economies of Germany, France, Italy, Britain, and a host of other major countries of the world. It is impossible to guess how these activities will affect the earnings of our corporations. Regardless, we are all familiar with the expression, “it is the earnings stupid.” Given the traditional price/earnings ratios that generally apply, if earnings significantly drop, so will the stock prices over time.

Earnings, of course, are inextricably related to outstanding debt, and the picture is not encouraging. In the 1980’s, primarily because of falling interest rates and significant financial deregulation the world’s debt expanded rapidly. While there were occasional reversal of that trend, ultimately those short-term reversals did not materially help. During the period preceding the 2008 crisis, debt tripled to at least three times the size of the global economy. Not surprisingly, during our longest bull market, unprecedented low interest rates buttressed by major deregulation also revived the upward trend in world debt. The result was shocking, if expected. By 2020 the U.S. debt swelled to $23 trillion far exceeding our GDP, and the total corporate debt in the world surpassed $13.5 trillion. These numbers indicate that the valuable lessons we learned during the 2008 recession about controlling debt have virtually disappeared.

D E B T : Beyond Economic Policies

The time-tested rules for implementing monetary policy are straightforward: During an expansionary period the FED should maintain interest rates at high levels to fight inflation and sell government securities to mop up excess liquidity. The opposite actions are required when the economy begins to slow down. Fiscal policy rules should follow a similar pattern. During an expansionary period, the government should reduce its debt by balancing the budget and raise taxes when needed to prevent the economy from overheating. But when an economic slowdown needs a stimulus, the government should proactively increase its spending by creating a budget deficit in the process and consider lowering taxes to boost the sagging economy.

It doesn’t take a genius to recognize that during the longest expansionary period both monetary and fiscal policies were framed to do just the opposite. During the longest expansion in history interest rates were pushed down to historic lows, and federal debt was allowed to move past our total GDP. And now with interest rate approaching zero and the government debt above the GDP level, the fire power of both the Federal Reserve and the government appear to have been exhausted. This is even more critical, considering the fact that now is the time those fire powers are in the highest demand. In fact, President Trump just announced a stimulus plan that would cost the government an additional $1 trillion. Yes, ONE TRILLION DOLLARS. And that is not all. An additional $1 trillion of government expenditure is being heatedly debated by the Administration. Billionaire Ray Dalio was reported to have said: [The next economic downturn] would “lead to hitting the 0% interest rate floor with a lot of debt outstanding and big wealth and political gaps in the same way that configuration of events happened in the 1930s.” And that vaguely points the finger in the direction of another depression, doesn’t it?

D E B T: This Time It’s Different

I know you are saying, “Here we go again.” Every time we face a crisis we take great comfort in claiming that the crisis we are facing is different. But after the crisis passes, we realize that we had seen this movie before.

But believe me, there is a startling difference between previous recessions and this one. Let me elaborate.

A typical recession is measured by the negative growth of the GDP. So the sole purpose of fighting the recession is to use expansionary monetary and fiscal policies to reverse the trend and make the GDP start growing again. The main purpose of fighting any recession, then, is to revive the growth of demand which, in turn, helps the GDP begin an upward journey.

The current recession of course will be measured by the negative growth of the GDP during the second quarter of 2020 and beyond. But instead of taking steps to boost the lagging demand, this time our concentration is on restoring the health and welfare of our people, even when that means taking specific steps to negatively impact the GDP growth.

If you don’t believe me, consider this. If this were a typical recession the government would encourage small and large businesses to stay open longer hours and prep up consumer demand for goods and services. These activities would add to the GDP growth, our main objective in fighting a recession.

Now consider what we are doing today. In order to fight the coronavirus the government has ordered widespread closing of small businesses, restaurants, sporting events and a host of other activities, all of which will significantly reduce the demand for goods and services, thereby depressing the GDP even further. While that appears to be counterproductive, this unique policy is designed to improve the health and welfare of our people, fully recognizing that these actions will have adverse economic consequences.

Bottom Line

At present, no one knows how to evaluate the total impact of this policy on various aspects of the economy. And when we recall that almost 80 percent of our activities are service-related, and this virus is negatively hitting our service industry very hard, we begin to wonder what is in store for us, both in the short- and in the long-run.

Let me end where I began: Coronavirus: End of the World? My answer: Absolutely not. The world is resilient and our country has successfully faced many crisis and flourished. Still, we are currently experiencing the beginning of a vast economic adjustment that will test governments and businesses in ways we have never previously imagined.

So, with cautious optimism, I say that even though the jury is still out, let us hope that everything will turn out for the best. In the meantime, please stay tuned.

Professor David Doane provided technical support for this article. However, the author takes full responsibility for the contents of this blog.

IS ESTATE PLANNING ONLY FOR THE RICH?

Posted on March 12, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

At the beginning of 2020, 64 percent of Americans did not have a valid will. Among those who did, the majority did not have a functioning estate plan. And among the relatively few who had such a plan, presumably many had not updated their plan to match their changing family conditions. That does not bode well for us as an advanced nation.

Who Needs Estate Planning?

An important reason for this apathy is the widespread belief that estate planning is only for the rich with large estates. And yet, nothing could be further from the truth. Thanks to our elaborate legal system, even people with modest assets need a written will that specifies how upon death those assets will be distributed, to whom, at what time, and under what predetermined conditions.

Creation of a legally valid estate plan resides strictly in the domain of qualified attorneys. However, that does not absolve us from the responsibility of learning about the subject matter so we can clearly express our preference for handing our estate.

Our objective today is to briefly describe the four key estate planning instruments. We sincerely hope that this presentation will persuade you to pick up the phone right now and arrange for a consultation with an estate planning attorney. You will be very happy if you do.

Here are the five essential estate planning tools:

Will

A will lets you direct how your assets should be administered, under what circumstances your assets should be distributed, and to whom. Also the will specifies who should manage your assets and act as a guardian for your children after you are gone. Just so you know, if you do not have a valid will, upon death your representative will have to go to court (called probate)to prove ownership of your assets, indeed a highly time-consuming and risky chore. Even worse, without having any knowledge of what you really wanted, the judge will make all his or her decisions by following the law, frequently leading to unwanted consequences.

Trust

A trust creates a legal representative who will handle your estate upon your death. You can provide direction about how the trustee should distribute these assets, when, to whom, and following what procedure. Since your wishes are clearly spelled out in the trust document, you can rest assured that your wishes will be fully honored by the person you have selected as a trustee.

Since the trustee begins working for you after your death, it is critical that you exercise caution in selecting one. Interestingly, the law gives you the choice of replacing the trustee of a “revocable trust” with another person. However, if for any reason you never wish to exercise this choice, you can appoint an irrevocable trust so the trustee can never be replaced. You can design trusts to be as flexible or as restrictive as you wish. You can have them last for the life of your beneficiaries or for a shorter period of time.

Joint Ownership

The gross estate consists of those assets to which a person has title or legal rights of ownership. These rights depend not only on the method by which the property was acquired but also on state statutes governing marital property.

Joint Tenancy with Rights of Survivorship. This type of ownership can be set up by any two or more persons. Each owner is known as a joint tenant and owns an equal share of the property. When death occurs, the share of the deceased owner automatically passes to the surviving joint owner.

Tenancy by the Entirety. This can be established only by married couples. Neither spouse can sell or give away any property without the consent of the other. When death occurs, the deceased’s share passes to the survivor.

Tenancy in Common. This type of ownership directs all property not to the co-owners but rather to the heirs named in the will. Each tenant in common owns an undivided interest in the property. Consequently, its major objective is to insure that all assets pass through probate court.

Transfer on Death Deed

This deed allows you to name a beneficiary to own a real property after your death. No probate (or legal proof) is needed to transfer the real property. In combination with other non-probate transfers, such as pay-on-death bank accounts and transfer-on-death stocks, many people can develop a simple estate plan that avoids probate entirely.

A great benefit of the transfer-on-death deed is that you may revoke or cancel it at any time. You revoke the deed by recording a new transfer-on-death deed, or by selling your property.

As stated, the deed is not effective until death. Therefore, you do not need the beneficiary’s permission to sell or mortgage the land. Equally important, you are not subject to the beneficiary’s debts.

Lifetime Gifts

During one’s lifetime, the law allows every person to gift up to $15,000 each year tax-free to any person, or $30,000 for a gift split between husband and wife. However, gifts exceeding these threshholds are considered taxable gifts. When a gift exceeding $15,000 per person per year (or $30,000 per couple per year) is made during lifetime, a gift tax becomes payable. When a gift exceeding $15,000 per person per year, or $30,000 per couple per year, is made during a given year, a gift tax becomes payable during that year. However, instead of actually paying the gift tax when due, a special IRS provision allows the taxpayer to skip making the gift tax payment while simultaneously reducing the allowable lifetime unified credit amount by the gift tax due.

In conclusion, our sole objective today is to underscore an important point: Today is the day for seeking the assistance of an attorney to put your estate planning house in order. While that task might not appear be on your “to do” list today, by doing so you will be making one of the most far-reaching financial decisions of your life.

______________________________________________________________ Travis Smith, CFP, provided technical support for this article. Freelance editor Katy Koontz provided editing. However, the author takes full responsibility for the contents of this blog.

INTRACTABLE BUDGET PROBLEM CAN BE SOLVED

Posted on March 12, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

In Washington, D.C., the popular annual festival, a.k.a. the budget battle, has just begun. With great fanfare, on February 10 the Office of Management and Budget delivered the President’s proposed budget for the 2021 fiscal year to the House Budget Committee. It was the largest budget ever–$4.3 trillion with an expected deficit of $1 trillion for the first time in U.S. history. Some saw the Budget as marked dead on arrival, while others claimed it was the most creative budget any president has ever created.

And with that, the battle lines were clearly drawn.

Contours of the 2021 Budget

The Congress ultimately decides what to fund and how much is allocated for each program. However, record shows that the President has occasionally found ways to circumvent Congress’s budget allocations. Examples include: spending military budget to build a wall and by refusing to spend the money for a program that Congress allocated. Still, the document does provide a window into the White House’s spending priorities. Of course, past experience dictates that once government programs are created, they’re virtually impossible to eliminate, even if they are no longer useful or have become wasteful.

Here are the key elements of President’s priorities.

Cuts to Safety Net Programs. The Budget proposes about $2 trillion cuts in most safety net programs. These reductions encompass, but are not limited to, the following programs: Medicaid, federal housing assistance, food stamp recipients, federal disability insurance benefits, student loan programs, foreign aid, public broadcasting and environmental programs.

Increased spending. Several projects are expected to get higher funding. The President wants lto boost the defense budget so we can develop state-of-the-art weapons. He also wants to spend more money on areas like restricting immigration, including an additional $2 billion for his wall along the southern border.

Medicare Tweaked. The budget includes more than a dozen proposals to streamline the program. But the changes do not represent major structural changes to the program that would reduce benefits or limit who would be eligible for the programs.

Deepest Program Cuts. Several programs suffer deep cuts, revealing their disapproval by the President.

The budget once again calls for eliminating subsidized federal student loans and ending the public service loan forgiveness program, an incentive for teachers, police officers, government workers and other public servants that cancels their remaining federal student loans after a decade of payments.
The President reserved some of its deepest cuts for the Environmental Protection Agency, which would face a 26 percent reduction in funding and the elimination of 50 programs deemed wasteful.
The President once again suggested cutting funds for America’s primary food assistance program and continued an effort to reduce the number of adults who can qualify for the Supplemental Nutrition Assistance Program, or SNAP.
The administration again proposed to cut funding for the Department of Housing and Urban Development, including programs that help pay for rental assistance for low-income people.
The proposed budget slashes discretionary funding for the Commerce Department, which monitors the weather, collects economic data, promotes exports, issues patents and other duties, by more than 37 percent, the largest single cut to any agency.

True Nature of the Problem

Insofar as the passage of the Budget is concerned, the party preferences are clearly established: More defense spending, lower taxes and drastically reduced regulations for the Republicans, and for the Democrats higher spending for domestic programs and no cuts in the established safety nets like Medicare and Social Security.

Now superimpose this built-in conflict on our legal structure and you will have a sense of what is at stake. First the budget has to be approved by the House which currently has a Democratic majority. Then it has to pass through the Senate which has a Republican majority. Finally, the President has to approve the budget passed by both Houses. If he vetoes it, the Congress can override his veto, throwing the country into chaos.

Of course, the good news is that eventually the Budget will jump through all the hoops so the Congress can approve it and the President can accept it. Failing to do that will mean government will come to a standstill, a situation none of us can comprehend.

Highlights of Budget Problems

A. The deficit issue. The Budget deficit is expected to reach $1 trillion, which I feel is not sustainable in the long run. The reason is that this deficit is expected to occur during the longest continuous growth of the economy. What would happen when we experience a recession? Also, the size of this deficit is based on rosy economic growth picture. When a realistic number is substituted, the deficit inexorably balloons.

B. President’s Preferences. The magic wand the President uses to reduce the deficit is to substantially cut domestic programs and trim everything else. His budget would slash the amount spent on domestic discretionary programs by about a third by fiscal year 2030, reducing such spending as measured as a share of the GDP by nearly half to a mere 1.6 percent. He would also cut Medicaid by nearly 20 percent in 10 years and reduce other mandatory program spending by about 12 percent.

At this point it is important to add a caveat. Even if all of Trump’s proposed cuts were implemented, these cuts appear minuscule (only 7% of GDP) when compared with total projected spending of $60 trillion over the decade.

C. Preference of Republicans. Republicans, too, are determined to veto the President’s plan for reducing the defense spending from the current level of 3.4% of GDP to a mere 2.2% of GDP by 2030. If implemented, that spending would then be less than what China and Russia spend and would be at par with European countries like France and Britain. Republicans would never allow the President to dethrone our powerful country by taking such a drastic measure.

D. Deficit Reduction. I have stated that the expected budget deficit is not sustainable. If in the future the economy slows down, or interest rates rise, or even if dollar is no longer universally accepted as the world’s reserve currency, the deficit will skyrocket, ultimately leading to disastrous consequences.

So, what’s the solution?

Proposed 2-Cs Solution

After examining various options currently available, I have concluded that only two options are viable, which I prefer to call the 2-Cs Solution.

C-1: Compromise

Yes, even though the country is split between two political parties, a budget compromise constitutes a winning strategy. This is possible if both tax hikes and domestic spending cuts are on the table. While delicate and thoughtful negotiations are at the heart of this strategy, both sides can begin to prepare for their jockeying positions, recognizing that this is their best chance for getting what they want while agreeing to allow members of the other party what they value most. Once that delicate balance is reached, a general agreement, or a consensus, will become a reality.

C-2: Crisis

If the country suddenly faces an unexpected crisis, all bets are off. Depending on the nature of this crisis, the government will justifiably abandon the normal budget constraints and take drastic measures to quickly end the crisis. In such an environment, both parties will come together, as they always have in the past, and mutually agree on a consensus plan.

The Bottom Line

As is always the case, the nature of the final budget will largely depend on the way the presidential election will ultimately shape up. So, for n ow, we conclude that the he jury is still out.

Please stay tuned.

Travis Smith, CFP, provided technical support for this article. Freelance editor Katy Koontz provided editing. However, the author takes full responsibility for the contents of this blog.

Travis Smith, CFP, and David Doane, Emeritus Professor, provided technical support for this article. However, the author takes full responsibility for the contents of this blog.

INVESTMENT POLICIES FOR TROUBLED TIMES

Posted on March 12, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

With 1,000+ points of daily swings on the Dow becoming normal, I have come up with a winning market strategy: Buy stock, sell it when it goes up. If it doesn’t go up, don’t buy it.

Okay, enough with the joke. Now let’s get serious.

In a direction-less, extremely volatile market, pundits ask us to play it safe by having infinite patience and sitting tight until the dust settles. Sounds profound, but I reject that idea because it completely misses the challenge of the times. So, my approach is to divide the task into five distinct categories, as described next.

1. Short-term Cash Needs

Begin by setting aside sufficient liquid funds to meet the short-term liquidity needs of the family. Besides the normal monthly household expenses, these will include college tuition payments, scheduled vacation expenses, emergency home repairs, estimated uncovered (by insurance) medical expenses, and other short-term financial commitments. These liquid funds can be parked in bank savings accounts, money market and other safe, short-term investments that can be quickly liquidated without the loss of principal.

2. Long-term Retirement Investments

Next, turn to your IRA, 401(k) and other retirement investments. Normal rules for handling them are as follows:

i) Continue to make normal monthly contributions to your 401K and IRA funds disregarding market fluctuations. Following this principle, by making your contributions on, say, the first of every month, you will buy more shares when the market is down and less when the market is up. This is known as the Dollar-Cost-Averaging technique. Over time this principle has been demonstrated to yield satisfactory results.

ii) In addition to the regular monthly contributions, if desired, make additional retirement contributions if there are provisions to do so. These contributions, made when appropriate, will grow tax-deferred for long periods, delivering dramatic results.

3. Educational Funding
Next, turn your attention to College Funding Program. If you have already set up such a program, then fund on a regular basis. If not, set one up (529 program, for instance) and set aside resources to fund it on a regular basis.

4. Additional Funding.

In case you have to take care of your aging parents or in-laws, it is best to set aside the funding needed to meet these obligations. Similarly, an urgent home repair, expensive orthodontist service for your children, a planned vacation, preferred charitable donations—all of these need to be financed with funds that are carefully set aside in advance.

5. Personal Investment Management.

Once you are done taking care of “house-keeping operations,” you should turn to developing a sensible investment plan for the balance of your available funds. At this point it is best to recognize the extreme volatility and uncertainty surrounding the stock and bond markets today, making the task of investment manage extremely challenging. So, unless you are well-equipped to handle this task, it is best to seek the assistance of an investment manager (CFP) to manage your investments. But for those who wish to manage their own investments, I present below a simplified 4-Ps model I have created to help achieve your personal investment goals.

Principled Approach

Investment textbooks are loaded with hundreds of fundamental and technical rules and theories applicable to stock market investment. Since these complex theories are better left for the professionals, I will identify only a small number of fundamental rules you can follow to achieve your desired long-term results. These include: the ideal ratio of stock and bond holdings, the desired exposure to different kinds (large, small cap, and mid-sized) of domestic stock, global stock and fixed income securities, duration of fixed income bonds, and the prevailing national and international economic outlook. For further information and detailed analysis of each of these principles please consult any scholarly textbook, such as, Practicing Financial Planning for Professionals.

Price/Earnings Ratio

Professionals firmly believe that in the long run, the price of a stock gravitates toward a reasonable multiple of its earnings. So if ABC company expects to earn $3 during the next year and the traditional P/E (price/earnings) multiple for this company is 15, then the expected stock price should be around $45 ($3 x 15 = $45). While on a day-to-day or a short-term basis the price could significantly deviate from the “norm,” the buy and sell decisions for that stock should still be based on the expected P/E ratio.

Personal Needs

A carefully-crafted investment portfolio should address the personal needs as the investor moves from being a teen-ager to starting employment after graduation, raising a family, becoming a successful professional between ages 40 to 60, and finally approaching the golden retirement age of 65. In each of these phases, investment structures should be modified to underscore the investor’s special needs. Here again, consultation with a professional financial planner can be of immense help in creating a successful investment plan.

Perseverance

Personal investment can be compared with an ocean’s ripples and waves. While it is human to concentrate on daily ups and downs (ripples) in investment values, the more meaningful approach is to concentrate on the long-term results (waves). Perseverance appears to be the ideal quality to achieve the desired results in the long run.

A word of caution is in order. Since my 4-Ps model has not been market-tested, caution is advised in uncritically applying it to your personal situation. And as I said before, if you can afford it, by all means consider engaging a professional financial planner to perform the task for you.

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Travis Smith, CFP, provided technical support for this article. However, the author takes full responsibility for the contents of this blog.

INVESTING IN THE DECADE OF 2020: 4-Ps MODEL

Posted on February 9, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

Recently a sophomore in the Economics Department in Delhi University, India sent me the following note: “Professor Mittra, in doing my research for a term paper I discovered that during the decade ending in 2019, the U.S. stock market jumped a whopping 200%, whereas the market of the second highest country barely crossed 50%. Is this true? And if so, why?”

This note intrigued me because the student was close to the facts (Standard& Poor’s increased by 185%). But she neglected to mention another important item. Never has there been a situation where the same country has been at the top during two consecutive decades. In fact, in every case the country at the top during one decade was virtually at the bottom of the next decade. Hmmmm. Interesting, isn’t it?

Multiple Choice Quiz

Here is an interesting multiple-choice quiz for you, addressing the question of how best to invest in the stock market during the current decade:

Liquidate all your stock market investments and bury the proceeds under your pillow.
You will become fully invested if Dow Jones gains 200% by the end of the decade.
You will consider investing 90% of your money in international markets.
You will plan to invest cautiously and take nothing for granted.
Trust your financial counselor’s long-term approach to investing.
Keep electing people in Congress who will aggressively support tax cuts, massive federal budget and trade deficits, and other stock-friendly steps to help the market reach unprecedented heights.
None of the above.

Now tell me what your pick is. Mine is No. 7.

My Preference

Having picked #7, I came up with what I call 4-Ps Plan. This plan rests on a platform with four pillars representing 4-Ps, which would provide the framework for structuring and nurturing our investment policies during the current decade.

Principled Approach

Investment textbooks are loaded with hundreds of fundamental and technical rules and theories applicable to stock market investment. Since that is beyond our scope, we will identify here a small number of fundamental rules that can produce desired long-term results. These include: The ideal ratio between stocks and bonds, the relationship between different kinds (large, small cap, and mid-sized) of stock, global stock and fixed income exposure, duration of fixed income, and the prevailing national and international economic outlook.

Price/Earnings Ratio

Professionals firmly believe that in the long run, the price of a stock gravitates toward a reasonable multiple of its earnings. So if ABC company expects to earn $3 during the next year and the traditional P/E (price/earnings) multiple is 15, then the stock price should hover around $45 ($3 x 15 = $45). While on a day-to-day basis the price could significantly deviate from the “norm,” the buy and sell decisions for that stock should still be based on the expected P/E ratio.

Personal Needs

A carefully-crafted investment portfolio should address the personal needs as the investor moves from being a teen-ager to starting employment after graduation, raising a family, becoming a successful professional between ages 40 to 60, and finally approaching the golden retirement age of 65. In each of these phases, investment structures need to be carefully modified to underscore the investor’s special needs.

Perseverance

Personal investment can be compared with an ocean’s ripples and waves. While it is human to concentrate on daily ups and downs (ripples) in investment values, the more meaningful approach is to concentrate on the long term results (waves). Perseverance appears to be the best quality to achieve the desired results in the long run.

Value of the 4-Ps Model

A word of caution is in order. Since our 4-Ps model has not been market tested, extreme caution is advised in uncritically applying it. Of course, if you have a different approach, or would like to modify it, we would love to hear from you.

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Travis Smith, CFP, provided technical support for this article. However, the author takes full responsibility for the contents of this blog.

Posted in: E: Ever-changing Complexity of Investment World

SOARING FEDERAL DEBT: THE UNSTOPPABLE BULL

Posted on January 30, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

Introduction

The title of this blog post sends an ominous signal because a healthy economy should lead to a shrinking federal debt—not the other way around. By New Year’s Day, the U.S. economy had recorded the longest uninterrupted growth of 127 months. But on the same day, U.S. federal debt totaled a whopping $ 23.2 trillion, far exceeding our current annual GDP. This sure looks like an oxymoron.

Federal Debt Basics

Except for periods of wars and recession, the U.S. federal debt had historically been held in check for centuries. Beginning with President Reagan in 1980, however, and continuing through every administration thereafter, the federal deficit has recorded a dramatic rise. The biggest reasons for rising debt have included tax cuts, increasing health care costs, an aging population with growing needs, and enormous growth in many sectors of government spending.

What’s going on?

The news media is ecstatic about the way the economy is currently behaving. The unemployment rate is at 3.5%, a 49-year low. The economy is healthy and growing at a solid rate. The U.S. consumer spending is at an all-time high, and the average U.S. wage has grown between +2% to +4% every year since 2012. Additionally, all the major U.S. stock indices are at an all-time high, and even inflation has been historically low. Because of all these factors, the widely-followed U.S. Consumer Confidence Index recently hit the highest levels we’ve seen in more than 19 years.

Unfortunately, however, not every American has reaped the benefits of our long and robust economic expansion. The reason? The fruits of the longest bull market and strong job market haven’t reached all Americans. Only 33% of American workers put money into a 401(k), and only 35% of average consumers actually have the minimum 3-5 months of emergency savings. Worse still, only 18% of Americans can manage to get by for six months. In the future, such a divergent economic picture can have serious consequences for the growing federal debt.

Putting Federal Debt into Perspective

Our government should resort to massive budget deficits when the country is at war or when fighting a recession. But it is also responsible for fully funding social programs like Medicare, Medicaid, and Social Security. So, when the collected taxes fall short of the necessary outlays, the government has little choice but to generate massive budget deficits to keep these programs (and others) alive.

Are you for Real?

I know you are saying, “You just told me that our federal debt has been growing uninterrupted since 1980. Well, in the last four decades I have not seen any signs of doom and gloom. So, why should I believe you?”

Unfortunately, it is beyond our scope to delve into the theoretical reasons for our concern. So we would simply mention here that during the last 40 years several unexpected economic developments have taken place that have kept buried the evils of rapid growth in foreign debt. One such event relates to China’s willingness to accept billions of dollars’ worth of U.S. government bonds as payments for massive trade deficits. While that is well and good, it is best not to get permanently duped by such untenable developments.

Finally, Back to You

The deteriorating federal debt problem is like a hidden cancer cell that secretly affects various parts of a patient’s body. But the risk is real and failure to recognize this condition can be fatal.

There are at least four major ways in which your financial welfare is adversely affected by an untenable growth in government debt.

A. Affecting Future Generation

Government finances its annual deficits by borrowing money, promising to pay back its debt to the lenders sometime in the future. But when that time comes, the government may not have funds to honor its commitment. What then?

Higher Tax Rates

Because of existing conditions, sometimes the government has little choice but to raise taxes so as to reduce the unsustainable debt. This, too, could instantly impact your pocketbook, but you will have no additional income to counter this hit in your finances.

Cut in Social Programs

Next, to curb further increases in federal debt, the government can cut (or limit) Social Security and Medicare, reduce the benefits of retirement plans, and extend the retirement age for all Americans. We have already seen some of these measures put into place—adversely affecting many.

Taxing through Inflation

The economic theory claims that rising debt ultimately leads to an increase in money supply—without a simultaneous increase in the goods and services. This means the higher debt rises, the greater the chance of higher inflation down the road. Higher inflation is detrimental to all because it is, essentially, a hidden tax that reduces your purchasing power.

Bottom Line

Now that you know the whole truth, we are sure you appreciate how the growing federal debt can impact your long-term financial well-being, despite the healthy economic picture existing today.

So the $64 question is this: Now that you know the whole truth, what are going to do about it? Any bright ideas?

Travis Smith, CFP, provided technical support for this article. However, only the author is responsible for its contents.

Appendix

Image result for national debt graph since 1900

MAJOR CHANGES ROCK SOCIAL SECURITY

Posted on January 30, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

If it is January, you know it’s time for visiting Social Security. This year, it’s an even a bigger deal since besides the traditional ones changes include other major topics like a change in the FRA (full retirement age).

Traditional Changes

With the passage of the Securing Every Community for Retirement Enhancement (SECURE) Act the traditional changes were pressed into action. Here are the key changes.

Cost of Living Adjustment

In 2020, the cost of living adjustment (COLA) applicable to Social Security and Supplemental Security Income (SSI) benefits increased by 1.6%, raising the average retired worker’s monthly income by $24. Incidentally, the maximum Social Security benefit a worker retiring at full retirement age will receive is up from $2,861 to $3,011 per month, indeed a sizeable monthly increase.

Taxation of Social Security Income

For employees, the combined tax rate for Social Security and Medicare is 7.65% (6.20% on Social Security Income and the rest on Medicare). The Social Security portion (OASDI) is 6.20% on earnings up to the applicable taxable maximum amount. That amount has been raised from $132,900 in 2019 to $137,700 this year. It is estimated that 11.8 million people will be affected by this taxable maximum increase.

Incidentally, with your free, personal MySocialSecurity account, you can receive personalized estimates of future benefits based on your real earnings.

c) Cost of Living Adjustment (COLA)

In 2020 Social Security and Supplemental Security Income (SSI) benefits for nearly 69 million Americans have increased by 1.6%. It is estimated that about 63 million recipients will benefit from this increase. .

Additional Changes

Besides the traditional changes there are other modifications that deserve attention.

Social Security Qualifier

People not on Social Security are required to present qualifying evidence before they can start receiving this income. Every applicant must submit proof of having earned 40 quarters of Social Security credit. Earnings of $1,410 are required to earn one quarter of credit.

Taxing of Retirement Earnings

This is both tricky and somewhat annoying. Social Security income recipients who have not yet reached the full retirement age of 66 are penalized as follows. Social Security deducts $1 from benefits for each $2 earned over $18,240. Also, the earnings limit for people turning 66 in 2020 has increased to $48,600. Social Security will deduct $1 from benefits for each $3 earned over $48,600 until the month the worker turns age 66.

FRA Is Changing

Full retirement age is the age at which a person may first become entitled to full, or unreduced, retirement benefits. But your FRA depends on when you were born. For those born in 1960 or later it is 67. For those born 1943-1954 it’s 66.

Best Time to Start Social Security Income

The answer is complex and beyond the scope of this blog. We will therefore simplify our response by selecting three different times for ideal retirement.

Retirement at FRA

Today’s full retirement age is 66 but for people born in 1960 and later the FRA will change to 67. People can begin receiving their full income by starting at their FRA. But there is a caveat. If you start receiving social security before your FRA, then for every $3 of income you earn above the $48,600 threshold, the Administration will reduce your social security income by $1. Of course, once you reach your FRA, there is no reduction in social security income, no matter how much your current earnings are. .

Retire before FRA

The earliest age a person can begin receiving social security income is 62. The catch is that because you started early your monthly social security payments will be permanent reduced for each month of retirement before your full retirement age.

If you start receiving social security before your FRA, then for every $3 of income you earn above the $48,600 threshold, the Administration will reduce your social security income by $1. Of course, once you reach your FRA, there is no reduction in social security income, no matter how much your current earnings are.

Also if you continue to work after your FRA, your benefits are subjected to earnings limitations. Currently, those at FRA can earn up to $18,240 without penalty. If your earn more, then $1 of benefits is withheld for every $2 earned above $18,240. It is conceivable that if your earnings are very high, you could conceivably lose all of your social security income.

Retire after FRA

If you postpone social security income beyond FRA (known as Delayed Retirement Credits or DRC), then DRC will permanently bump your monthly income by 8% per year until you reach age 70. After that, there is no additional benefit to postpone your social security income.

As mentioned, these are complex issues and you might be wise to consult a certified financial planner before making your final decision.

Travis Smith, CFP, provided technical support for this article. However, the author takes full responsibility for the contents of this blog.

Buy, Buy, Save, Save: Give me a break

Posted on January 12, 2020 by Sid Mittra

Sid Mittra
Emeritus Professor

Erik Gambier, 28, is no dummy. He is a graduate in Electrical Engineering from the University of Michigan and has an MBA from Wharton. He holds a responsible position with GM, earning an annual salary of $80,000. He is married, has one son and another child on the way.

Everything is perfect in Erik’s life, except for one spoiler. When he listens to the advice of financial consultants, he gets thoroughly confused. The non-stop commercials on TV and in newspapers tell him to continue buying. But other ads and financial gurus keep remind you to secure your financial future by saving more. Who is right?

Erik is not alone. Millions of Americans experience similar confusion, and most simply choose to ignore it. And that can result in avoidable outcomes.

The confusion is not that difficult to clear up. But given the prevailing barrage of ads in the media covering both topics, the task is not that simple, either.

The “Buy” Syndrome

Non-stop commercials aside, buying, or consumer expenditure, is the backbone of our financial system. Almost seven-tenths (69%) of our national wealth is created by consumer expenditures. By contrast, the government creates only 19% of the wealth.

In this scenario, if our buying slows down, so does the growth of our economy. That’s why the authorities try hard to make sure that the nation’s consumer expenses remain close to the seventy percent level.

The “Saving” Confusion

Okay, you say, I got that much. But my financial advisors keep bugging me for generating more savings. I can only save if I cut down on my buying, hurting as you say the future growth of the economy. I don’t get it.

Calm down. Your confusion will disappear if I introduce two missing pieces. First, when you place your savings in a bank or invest them in the stock market, in essence you make your savings available to potential borrowers who will quickly put your savings back into the income stream. These business people are anxious to invest (spend) your savings in creating factories, technologically superior production units, conducting advanced research to invent better production units, and so on. All of these activities place our private businesses in a superior position to produce in the future higher quality consumer goods in increasing numbers. And that creates the win-win situation for everyone.

So, in essence, your savings, only temporarily, leave the income flow. They merely take a circuitous route, and enter the national circulation flow with renewed vigor.

Bottom Line

Now that you can see that both buying and saving are desirable activities for you, let’s change the mood of the two gorillas we saw earlier.

Well, here they are, embracing each other in great comfort.

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Travis Smith, CFP, provided technical support for this article. However, only the author is responsible for its contents.

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