Jan
22
2010
We learn from a very early age the concepts of equal and fair. My children remind me of this every time I take one of them out for a one-on-one to get a treat somewhere. When we get back home, at least one of my other kids will say, “That’s not fair!” Even though I try to spread these trips around so that everyone gets an equal chance to hang out with dad, someone always feels cheated. The last time I did this, I told my son as we pulled into the driveway, “Make sure you hide your drink cup so that no one gets mad.” But it didn’t work. Somehow it slipped out that he got a treat, and for a few minutes all heck broke loose.
While going to get a burger and shake may not seem like a big deal, the stakes get much higher as children grow older and parents start making financial gifts, or giving financial assistance to them.
In personal financial planning, reducing a person’s estate is often a concern. Many people who are in a position to do so, will make financial gifts to their children for estate planning purposes. This is usually done when someone is trying to reduce their taxable estate, or just to let their kids enjoy some of their inheritance early. Additionally, parents will often give financial assistance to children when there is a need. While there is nothing wrong with giving money to your children, you need to be very careful in how you do this so that nobody screams, “That’s not fair!”
Equal gifts, but not equal needs
Every family that has adult children knows what it’s like to have at least one child who has a greater financial need than the others. Parents are often naturally inclined to want to help this child out a little more than the others. This is where it can get a little sticky. If a parent gives money to one child and not to the others, they take a chance of driving a wedge into the family. While you may think you are doing that child a favor, (and you are) your other children may not feel the same way about it when they find out. I have seen several situations like this where siblings who were better off financially felt left out, cheated, and maybe even less loved, because their parents didn’t give gifts equally. I’ve seen this drive a wedge between siblings, and between parents and children.
Leaving more to one child
I’ve also seen situations where parents left more of their estate to one child when they passed away. Again, this was a case where the parent felt that this particular child had a greater financial need and would benefit more from the larger inheritance. While this may have been true, the child who inherited less was left to feel left out and somehow less loved. Even though this is done with good intentions, it can really tear a family apart. The more well-off child resented the sibling that was left with a bigger inheritance, and at this point the two have not spoken to each other in about 10 years.
Is there a better way?
Only you can decide the best way to handle these situations. But I have seen some different things that people have done to try and make . In one situation, a child was having some financial difficulties and the parent wanted to help them out. They made an agreement that any money the parent gave them now would be deducted from their final inheritance when the parent passed away. I thought that this was a fair way to help the child out now, but still be fair to the other children in the family. I have seen other families require the child to pay back the money over time, but with little or no interest. This method helps the child out now and allows them pay the money back when they get back on their feet.
There are a lot of ways to deal with these situations that allow you to help out a child in need. While it’s easy to think, “My other kids don’t need this money”, you may not be doing them a favor in the long run. You may in fact be setting them up for family contention down the road if you don’t give equally to all of your children. Even if they don’t need the money as badly, if another child gets more, there could easily be feelings of resentment and bitterness towards the other child, and towards you. No one wants to be remembered that way.
Tags: Adult Children, Annual Gifts, Chaos, Chil, Dad, Drink Cup, Estate Planning, Few Minutes, Financial Assistance, Financial Gifts, Financial Situation, Financial Situations, Gif, Gifts, Giving Money, Heck, Inheritance, Last Time, Many People, Mcdonald, Parents, People, personal financial planning, Screams, Taxable Estate, Whe, Wor | 
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Comments (0) Jan
20
2010
I’m sure that you’ve already heard the buzz at the water cooler about converting your IRA to a Roth IRA this year. Roth IRA’s are an important part of personal financial planning for many individuals. So what’s all the excitement about converting to a Roth IRA you ask?
Pay Now
When you convert part of your IRA or 401(k) to a Roth, you have to pay taxes now on the amount you convert. Many people feel that tax rates are likely to go higher in the future (especially since our tax rates today are the lowest we’ve seen in decades). Everyone knows about our government’s debt situation…it’s not good, not to mention social security and Medicare. To pay for all these things, they’re going to have to increase taxes at some point. So to pay your taxes now may end being a pretty good deal.
Play later
Paying taxes at a lower rate today may sound nice, but the real benefits of the Roth IRA conversion are long term. As you know, Roth IRA’s grow tax free. That means that when you eventually pull your money out of the Roth at some point down the road, you don’t have to pay any taxes on ANY of the earnings! This is especially attractive for younger individuals who have time to let the money grow and compound tax free. In general you need to plan on the money growing for about 10 years or longer before you plan to use it in order to benefit from paying the taxes now. The more tax rates go up in the future, the sooner you will “break even” so to speak, and come out ahead.
Out of Pocket, But Spread Out Over Two Years
When you convert part of your IRA or 401(k) to the Roth you have to pay the taxes out of your pocket. You cannot have the taxes taken out of your IRA account. This can limit the amount you may realistically be able to afford to convert. If you have savings in an after-tax account, you could use money from that to pay the taxes also. The best part is, you can spread that tax payment over the next 2 tax years! So you don’t have to pay them all this year, which helps.
A Higher Tax Bracket?
Be careful as to how much you convert. Not only do you have to pay the taxes on it out of pocket, but converting to the Roth could bump you into a higher tax bracket for this year. Whatever amount you convert will be added as taxable income to the rest of your taxable income for the year. So if you make $80,000 at your job, and you convert $20,000 to a Roth, your taxable income is now $100,000 for the year. Be sure to consult a tax professional before you make a conversion so that you don’t regret doing it later.
Here are the 2010 tax rates:
| Tax Rate |
Married Couples Filing Jointly |
Most Single Filers |
| 10% | Not over $16,750 | Not over $8,375 |
| 15% | $16,750 – $68,000 | $8,375 – $34,000 |
| 25% | $68,000 – $137,300 | $34,000 – $82,400 |
| 28% | $137,300 – $209,250 | $82,400 – $171,850 |
| 33% | $209,250 – $373,650 | $171,850 – $373,650 |
| 35% | Over $373,650 | Over $373,650 |
Talk to your personal financial planner today to see if making a Roth IRA conversion might make sense for you in 2010.
Tags: 10 Years, 401 K Plans, Buzz, Debt Situation, Decades, Earnings, Excitement, Governments, Ira Account, Ira Roth, Ira Tax, Medicare, Money, Pay Taxes, Paying Taxes, personal financial planning, Real Ira, Roth 401 K, Roth Ira Conversion, Social Security, Social Security And Medicare, Tax Rates, Water Cooler |
Comments (2)
Comments (2) Jan
11
2010
These days, you really need to be shopping around for your healthcare and low cost health insurance just like you do for any other purchase. When you buy a new computer, you probably don’t walk in to the nearest store and buy what’s on the shelf. You check several stores, and maybe even check on-line to find the best price for the exact same product that you plan to buy.
Many people don’t realize that you can, and should do the same thing for healthcare related services and low cost health insurance. The reason most people don’t think of this is that for most services you receive, you just pay a co-pay and that’s it. Once you pay your co-pay, you don’t really care what it costs, and neither does the doctor. In fact, the doctor has more than one incentive to perform as many tests and scans as possible. The more he does, the less likely he is to get sued by you, and the more money he makes. However, depending on where you receive the service and how it’s billed, may be covered by a co-pay, or it may go towards your deductible (which means you’ll have to pay for it out-of-pocket).
Let me give you a recent PERSONAL example of this.
My wife was told by her doctor that she needed to go have a CT scan done. The doctor scheduled the appointment for her at an imaging center owned by the same hospital network that he worked for. Now this was after we had told him that we wanted to have to test covered by a co-pay if possible, and not have it go towards our deductible. We also told him that she had previously had some imaging done at a certain center where we knew it was covered by a co-pay. We thought that was the place he had scheduled the appointment. When we arrived at the imaging center for her appointment, she was not on the schedule. They made some phone calls and found out that she was scheduled at another nearby imaging center, the one owned by the same hospital network that my wife’s doctor was in. So we went over there and spoke to them, and found out that if she had the scan done there, it would go towards her deductible and would cost us about $2,000 out-of-pocket. But if she had the scan done at the other imaging center that was not part of that hospital network, all it would cost us is a $15 co-pay. What a difference!
This is why I am writing a blog post about saving money on healthcare on this personal financial planning site. Health care costs have become a huge part of a person’s finances, and it’s very important for everyone to understand how to save money on these services. The more you can save on healthcare and on low cost health insurance, the more you’ll have to pay off debt or invest for you future retirement. Healthcare professionals and hospitals are running businesses, and are trying to make them as profitable as possible. This recession is hurting the healthcare industry just like everyone else. Because of this, you really should not assume that your doctor is going to always act in your financial best interest. You need to take responsibility to do your homework and shop around to make sure you’re getting the best possible price for the service you will receive.
The fact that the same service could cost your either $2,000 or $15 depending on where you get it is ridiculous and should tell you that there is a lot of work to be done to straighten out our healthcare system. That would take a whole other web site to cover that topic. Maybe doctors need to start being worried about getting sued for charging a patient $2,000 for a scan when it could have been done for a $15 co-pay.
Nov
4
2009
If you are covered by a group health insurance plan at work, you’ve already seen the pattern of increased premiums and reduced benefits over the last several years. With health insurance premiums rising much faster than general inflation, all employers are having to find creative ways to reduce their cost of benefits. In many cases, employers are having to choose to reduce or eliminate benefits vs. laying off employees. One type of health insurance plan that is becoming more popular to offer employees is an “HSA Qualified High Deductible Plan”, also referred to as a “Consumer Directed Health Plan”. These plans do have lower premiums, but that’s because you are taking on more risk to yourself for the cost of your health care.
With an HSA Qualified plan, you have a higher deductible that must be met each year BEFORE the insurance company will cover anything. In many cases, once you meet this deductible, all of your healthcare expenses thereafter are covered at 100%. So if an employee can set aside enough money to meet that deductible, they will be just fine.
There is a great tax benefit here in that you can set aside money pre-tax into a “Health Savings Account” (HSA) that can be used to meet your deductible. The money in the HSA account grows tax free, and can be rolled forward to future tax years. In other words, it’s NOT a use-it-or-lose-it type of account. This allows you to build up a tax-free savings account that can be used for healthcare related costs down the road. Many banks now offer HSA type accounts, and there are also several providers who specialize in these types of accounts. Many of them will allow you to invest part of the money into mutual funds for longer term growth as well!
These plans can also be purchased by individuals and families who don’t have group insurance available to them.
The Caution
If you’re going to opt for this type of plan, you need to make sure you set aside money into an HSA savings account to help you pay for your medical costs. If your deductible is $5000, you’re going to have to pay the first $5000 worth of medical expenses out of your own pocket each year (including doctor’s office visits, medications, etc.). If you don’t do this, you risk putting yourself into debt to pay for medical expenses, and that is never good.
Here is a news story that one of the TV stations here in Charlotte ran this week on these types of plans…
“WSOC Channel 9 HSA Qualified Health Plans.” Please don’t laugh too hard at the goofy guy in the brown suit!
Tags: Caution, Consumer Directed Health Plan, Deductible Plan, Enough Money, Free Savings Account, Group Health Insurance, Group Insurance, Health Care, health insurance, Health Insurance Plan, Health Insurance Premiums, Health Savings Account, Healthcare Expenses, Inflation, Insurance Company, Last Several Years, Mutual Funds, Qualified Health Insurance, Tax Benefit, Type Accounts |
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Comments (0) Oct
20
2009
Today we live in a complex world full of investment opportunities. Many of them are very good, but many are investment scams. It has become very difficult for even experienced investors to recognize when one of these opportunities is legitimate, and when it’s a fraudulent scam. It seems that everywhere you look, you’re presented with some kind of investment idea. Solicitors may attempt to contact you via, telephone, U.S. mail, television, internet or email. In personal financial planning there are a few “red flags” to watch out for that will help you avoid investment scams. There are also some easy ways for you to “check-out” or verify that an investment opportunity or solicitor is safe to deal with.
Red Flags
We’ve all heard the timeless admonition, “If it sounds too good to be true, it probably is.” While this is great advice, it can be hard to know the difference between “good” and “too good”. Investment fraudsters make their living by making deals sound both good and true. Here are a few tactics to watch out for:
- The “Phantom Riches” Tactic — dangling the prospect of wealth, enticing you with something you want but can’t have. “These oil wells are guaranteed to produce $5,500 a month in income.”
- The “Source Credibility” Tactic — trying to build credibility by claiming to be with a reputable firm or to have a special credential or experience. “Believe me, as a senior vice president of XYZ Firm, I would never sell an investment that doesn’t produce.”
- The “Social Consensus” Tactic — leading you to believe that other savvy investors have already invested. “This is how ___ got his start. I know it’s a lot of money, but I’m in — and so is my mom and half her church — and it’s worth every dime.”
- The “Reciprocity” Tactic — offering to do a small favor for you in return for a big favor. “I’ll give you a break on my commission if you buy now — half off.”
- The “Scarcity” Tactic — creating a false sense of urgency by claiming limited supply. “There are only two units left, so I’d sign today if I were you.”
Other signs to be cautious of would include:
They want you to make an immediate decision. If they are calling you, they might even have a courier in the neighborhood ready to pick up your check right then.
- Calling it a “guaranteed” investment, with little or no risk, or “as safe as a bank CD”. (Keep in mind that I’m talking about securities here, not insurance products like fixed annuities.)
- Recommendations based on rumors, tips, inside information or an unannounced breakthrough.
- Recommendations based on the seller’s ability to predict future events.
- Requests for your credit card number for any reason other than to make a purchase. Requests made for “identification purposes” or “verification purposes”.
- Unwillingness to provide written information, state securities registrations, or verifiable references.
- Investment opportunities in another country or that involve an offshore bank.
- Unwillingness to let you discuss the investment with a third person. Many times they want you to keep the investment a secret.
- They might send out account statements or letters that are not on company letterhead.
Check out the seller
Ask the person if they and their firm are registered with FINRA? The SEC? A state securities regulator? If so, which ones? And then, verify the answers. To check the background of a broker, use FINRA BrokerCheck or call 800-289-9999. For an investment advisor, use the SEC’s Investment Adviser Public Disclosure Web Site. Many advisors today are not securities licensed, nor are they Registered Investment Advisors. In this case they may be licensed to only deal with insurance products like fixed annuities and life insurance. You can check out these advisors with your state insurance department to see if anyone has filed complaints against them, etc. And it’s always a good idea to check out some of the person’s references too.
Check out the investment
Ask the person if the investment is registered with the SEC or with your state securities regulator. Then use the EDGAR database of company filings to confirm what the salesperson is telling you. Also call your state securities regulator to find out what they know about the company. Call a few of the company’s big customers and suppliers to make sure that they are really doing business together. If the investment is an insurance product it would not be registered with the SEC or state securities regulators, and you would need to check with your state insurance department. They will have a list of insurance companies that are licensed to do business in your state. Make sure the company is licensed, and then check out their financial strength ratings through A.M Best, Moody’s or Standard & Poors.
There are many legitimate investment opportunities, and legitimate sales people out there who want to help investors. But unfortunately there are also those who would take advantage of you. And as we have seen in recent happenings, it’s often difficult to tell the difference between the two. When it comes to making a new investment, it’s always best to listen to your instinct, and not rush into anything. A good deal will still be a good deal tomorrow. And there is always plenty of time for you to do research to make sure you’re dealing with a good source.
Tags: Admonition, False Sense, Investment Idea, Investment Opportunities, Investment Opportunity, Investment Scam, Investment Scams, Mail, Oil Wells, personal financial planning, Reciprocity, Red Flags, Reputable Firm, Savvy Investors, Scarcity, Senior Vice President, Sense Of Urgency, Small Favor, Social Consensus, Solicitors, Source Credibility, Television Internet |
Comments (5)
Comments (5) Oct
5
2009
This was just a great story in the Wall Street Journal today, and I couldn’t agree more. Everyone in the personal financial planning community could benefit by using less jargon, and speaking more plain english!
NEW MILLS, England — A few months ago, 71-year-old Chrissie Maher got a mailing from her bank titled “Personal and Private Banking — Keeping You Informed.” Baffled by its blizzard of terms such as “account facility limit,” Ms. Maher replied in simpler language.
“The leaflet needs much more thought if it is to be understood by your customers,” she said in a letter to Royal Bank of Scotland Group PLC. “As it stands, it should be renamed ‘Keeping You Confused.’ ”
After critiquing the pamphlet’s “tortuous and ambiguous sentences,” she redrafted it, changing terms like “maximum debit balance” to “the most that can be owed.”
RBS may have picked the wrong woman to target with financial mumbo jumbo. Ms. Maher is the founder of the Plain English Campaign, a 30-year-old group whose stated goal is to stem “the ever-growing tide of confusing and pompous language” that “takes away our democratic rights.”
Over the years, Ms. Maher and her group have battled police agencies, expansion planners at Heathrow Airport, and the “frequently bizarre language” of the European Union. (At issue: phrases such as “unlock clusters,” “subsidiarity” and “sector-specific benchmarking.”) She has blasted local government on the use of “worklessness” to refer to unemployment and once attacked the president of the U.K. Spelling Society over his claim that the apostrophe is “a waste of time.”
Now a grandmother of 11 who works out of a small farm in the hills outside Manchester, Ms. Maher is focusing on the current scourge of financial jargon.
In Plain English
Examples of Plain English’s suggested changes to government and business financial jargon:
From U.K. tax regulations:
Before: “The revocation by these Regulations of a provision previously revoked subject to savings does not affect the continued operations.”
After: “If a provision (requirement) which would have produced savings has been revoked (cancelled), it does not prevent the savings being made in another way.”
From the small print on a bank account agreement:
Before: “Interest earned on balances of less than £50,000 will be paid subject to tax status. Interest on balances of £50,000 or more will be paid without the deduction of tax.”
After: “We will pay interest on balances of less than £50,000 depending on your tax circumstances. We will pay the interest on balances of £50,000 or more without taking tax off.”
From a bank customer mailing:
Before: Without prejudice to condition 2.1 (b), the maximum debit balance allowed on each account is the cardholder credit limit.
After: The most that can be owed an each account is called the cardholder credit limit.
From a typical government document:
Before: “If there are any points on which you require explanation or further particulars we shall be glad to furnish such additional details as may be required by telephone.”
After: “If you have any questions, please phone.”
– Source: Plain English Campaign
“Families are losing their homes because of jargon-filled credit agreements,” says Ms. Maher, an energetic presence in a crocheted sweater and eyeglasses. “Language has been misused and has contributed to the economic disaster.”
An RBS spokesman acknowledged that the wording in the mailing sent to Ms. Maher “was not as clear as it might have been,” and that as a result of her letter, the bank is taking steps to improve the clarity of such pamphlets.
But Ms. Maher says specific regulation is needed. Earlier this year, she wrote to Prime Minister Gordon Brown urging that regulatory bodies such as Britain’s Financial Services Authority establish standards of “plain English” for banks and businesses, and fine them for “churning out…incomprehensible gobbledygook.” A spokesman for Mr. Brown’s office declined to comment on the prime minister’s correspondence.
The U.S. Securities and Exchange Commission codified good writing in 1998 with its Securities Act Rule 421(d) — or in plain English, the “Plain English Rule” — which applies to the cover page for a prospectus. The rule outlines six principles for good writing, including using the “active voice” and not using “multiple negatives.”
In July, Ms. Maher’s group testified before a Parliament committee holding a public hearing on language use in government. Members of the public submitted complaints over what one called “eye-wateringly arcane” language such as “conventional procurement” and “optimism bias” used to describe government financial initiatives. Another lamented the use of the word “investment” when the government means “spending.”
While the clear-language campaign has worked over the years with banks and insurance companies, it was the financial crisis that sent Ms. Maher into the deep weeds of complex financial terms. Her team has sought to crack the meaning of tough nuts like collateralized debt obligations, or CDOs, seeking to break their code by isolating their elements: “We are not pretending that a Plain English definition of CDOs would have saved us from recession,” Ms. Maher’s Web site says. “This is the plain English attempt at defining what is at the heart of CDOs: Collateralized debt obligations are commitments to repay debts that are secured on assets.”
She has also put together a glossary of financial buzzwords including “asset sweat” (making assets work harder and more efficiently). She was initially mystified by the U.K. government’s term “quantitative easing” — the central bank’s effort to put more money into the economy.
“It sounded like something heavy was moving, but what and where?” she says.
Some people think the financial industry has been making a better effort than Ms. Maher gives it credit for.
“I have observed institutions trying very hard over the last 20 years to avoid jargon,” says Chris Higson, a visiting associate professor of accounting at London Business School. But he acknowledges that “there is something about banking and financial services that goes deep to consumers’ sense of anxiety.”
Ms. Maher grew up poor and often hungry in Liverpool and didn’t learn to read until she attended night school at the age of 15. But she says her background motivated her to help ordinary people intimidated by high-level language. “I know what it’s like to feel isolated because of words,” she says.
She began campaigning for clear language in the early 1970s, when she saw that impoverished people in Liverpool were having trouble deciphering benefit forms. She formally started the campaign in 1979, and achieved a success in the 1980s when the government agreed to rewrite thousands of forms.
The group became known for its “Golden Bull” awards for the worst examples of official jargon. Past winners have included a definition from the U.K.’s financial-services watchdog that read, “An unsolicited real time qualifying credit promotion is a real time qualifying credit promotion which is not a solicited real time qualifying credit promotion.” Another winner: a sign at Gatwick Airport saying “Passenger shoe repatriation area only.”
This year, a front-runner is a 102-word sentence issued by a police chiefs association containing phrases such as “authentic answerability” and “amorphous challenges.”
“Amorphous challenges — is that wrestling with a jellyfish, maybe?” the Web site asks.
Soon after founding the campaign, Ms. Maher hired a team of editors and launched a consulting and training service for businesses. Profits go to fund the group’s advocacy activities. Ms. Maher lives on her pension and salary from the campaign’s training and consulting activities.
Ms. Maher also fields questions in the small town of New Mills. About a week ago, a 16-year-old rode his bicycle up to her farmhouse because he wanted to open a checking account but was thrown by terms in the bank’s pamphlet such as AER — or annual equivalent rate, which is an interest rate with annual compound interest.
At a recent gathering for tea and cookies before church, Ms. Maher said, a woman came up to her waving a letter “with minuscule print” about her mortgage and asked for help understanding it. Ms. Maher said it had so many footnotes, asterisks and crosses, “it looked like a game of snakes and ladders and you needed a magnifying glass.”
Some, she says, have given up on banks entirely: “One older lady I know, she took her money and put it in a plastic bag and buried it in the garden.”
—T.W. Farnam contributed to this article.
Write to Sara Schaefer Muñoz at sara.schaefer@wsj.com
Tags: Ambiguous Sentences, Apostrophe, Bank Of Scotland, Chrissie Maher, Debit Balance, Democratic Rights, Financial Jargon, Heathrow Airport, Mumbo, personal financial planning, Plain English Campaign, Planning Community, Police Agencies, Private Banking, Rbs, Royal Bank Of Scotland, Royal Bank Of Scotland Group, Royal Bank Of Scotland Group Plc, Scotland Group Plc, Subsidiarity, Wall Street Journal, Wrong Woman |
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Comments (0) Sep
30
2009
We saw today the effects that a tsunami in the south pacific can have on a civilization, which can be devastating. My heart goes out to these people and I pray that the people affected will be ok. Much like this tsunami has had a crushing and devestating impact on people’s lives in Samoa, the financial tsunami now known as the great recession is currently upon us all. The factors that caused this recession were like the earthquake that caused the tsunami. Once the earthquake happens, that wave is coming at you no matter what. And there is nothing anyone can do to stop it.
This is the last of a 3-part series in discussing the factors that have contributed to this great recession we are in. You can view Part 2 Here. and you can view Part 1 Here.
When doing personal financial planning, you have to take steps to prepare yourself for these types of economic situations. They are sure to happen again in the future, and you can start preparing yourself now for it. I would welcome any comments you may have about this topic.
Today I will discuss the last 3 factors that I feel have contributed to this current recession, which are: Credit default swaps, unemployment, and the stock market.
Credit Default Swaps
This is something that most of you had probably never heard prior to this mess. In my 15 years of personal financial planning, I had never heard of them until a few years ago. A credit default swap is similar to an insurance policy that is supposed to protect the buyer from losing money. A credit default swap (CDS) is a swap contract in which the buyer of the CDS makes a series of payments to the seller and, in exchange, receives a payoff if a credit instrument (typically a swap or loan) goes into swap (fails to pay). Less commonly, the credit event that triggers the payoff can be a company undergoing restructuring, bankruptcy, or even just having its credit rating downgraded.
There are some differences between a CDS and real insurance though. With insurance, the buyer of the policy typically has some insurable interest such as owning the debt that he is insuring. With a CDS, the buyer doesn’t even have to own the security. Sellers of CDS’s do not need to be regulated entities, and do not have to keep reserves to pay off buyers. However, major CDS sellers are subject to bank capital requirements.
One of the largest sellers of CDS’s was AIG, and they were selling a lot of them that were designed to insure against losses in mortgage securities. When the mortgages started to blow up, everyone was coming to AIG to get paid, and they couldn’t pay them. They didn’t have enough money to pay everyone they had sold them to. You all know how the government stepped in to bail them out and cover their losses with tax payer dollars.
Unemployment
This is always a part of a recession, as businesses struggle and close up shop, people lose jobs. As they lose jobs, they have less money to spend. Since most of our economy stands on the back of consumer spending, more businesses start to struggle. Then more businesses start to make cutbacks, and more jobs are lost. It’s a downward spiral that won’t stop until things finally hit bottom and equalize. In August 2009, the unemployment rate rose to 9.7% with 14.9 million people being unemployed. Since this recession started in December 2007, the number of people who are unemployed has risen by 7.4 million and the unemployment rate has risen 4.8%. So this is obviously affecting a lot of people, and you can see why there is so much less money being spent by consumers.
Stock Market
Some people may think that the stock market crashing causes recessions to start, and that recoveries make them end. While there is definitely a correlation to the performance of the stock market and the economic cycles, the market doesn’t really cause recessions to start or end. I would say that instead, the stock market is a good indicator of where we are at in an economic boom or recession. There is certainly a relationship between the two. The stock market peaked in November 2007. When markets near high points, you might be surprised to know that those are the times that more people are adding new money into the market. Stock mutual fund in-flows usually peak at about the same time that the market is peaking. And when the market bottoms out, that’s when most people are taking money out of the market. That’s just the time that you should be putting money back in. But psycologically, it’s very difficult for someone to sell their stocks when they’re hitting highs, or buy them when they’re hitting lows.
This peaking out of the stock market in late 2007 was just another sign that a big correction was coming. And there was nothing that anyone could do to stop it.
People ask me all the time, “Mark, why is it that when I buy something it goes down, and when I sell it, it goes back up?” It’s really very strange how this happens to almost all individual investors. This is one major benefit to hiring a professional money manager to help you manage your investments. That person can take a lot of the emotion out of the investment process which helps them to do the opposite of what your gut tells you to do. As the market hits highs, your advisor can take profits and rebalance your portfolio to protect money that you have made. Then, when the stocks decrease in value, he or she can add more money to them at the the time when you should be buying more.
Tags: Bankruptcy, Civilization, Credit Default Swap, Credit Default Swaps, Credit Instrument, Credit Rating, Earthquake, Economic Situations, Heart, Insurance Policy, Lt, Medicare, People, Perfect Storm, personal financial planning, Real Insurance, Recession, Restructuring, Samoa, Stock Market, Swap Cds, Swap Contract, Target Blank, Tsunami, Turning Point, Unemployment |
Comments (1)
Comments (1) Sep
28
2009
This is part 2 of a 3 part series on a discussion the contributing factors to this major recession that we are currently in. Personal financial planning is all about understanding the risks that you face, and then taking steps to avoid or protecting yourself against those risks. You can read Part 1 Here.
In the previous post I discussed Globalization, Low Savings, Cheap Money, and Deregulation. In this post I will cover Derivatives, National Debt, Declining Dollar, and Bank Leverage.
Derivatives
A derivative is a financial instrument that is derived from some other asset, index, event, value or condition (known as the underlying asset). Rather than trade or exchange the underlying asset itself, derivative traders enter into an agreement to exchange cash or assets over time based on the underlying asset. A simple example is a futures contract: an agreement to exchange the underlying asset at a future date.
Derivatives are often leveraged, such that a small movement in the underlying value can cause a large difference in the value of the derivative.
Wall Street geniuses came up with a way to use derivatives to trade almost anything. They came up with derivatives for all these mortgages that were flooding the market, and people started trading them like crazy. The investment banks who were creating these instruments were making money hand over fist, and so were the investors who were buying them. At least for a time. One problem was that most people didn’t really understand how they worked, and how risky they really were.
National Debt
Under President Reagan our National debt reached the $1 Trillion mark, which seemed pretty scary at the time. Today it’s just over $11 Trillion. Most people can’t even comprehend how big a Trillion dollars is. Just to put it in perspective: $1 billion dollars is a thousand millions. $1 trillion is a thousand billions. It really is hard to put your mind around how big that really is. Our country produces enough goods and services that our national debt is not unaffordable. But we can afford it right now because interest rates are so low. China currently owns about 20% of that debt (in the form of T-Bills and other U.S. Treasuries) and Japan owns another 20%. 46% of it is owned by Americans. So it’s not really the size of the debt that concerns me, becase relative to our income as a country, we can currently afford it. But if interest rates were to jump up, the interest alone on that debt could crush us financially. The interest alone on our national debt currently makes up about 20% of our country’s budget. If interest rates went back up to 6%, our interest payments would double! This is like an individual having an adjustable rate mortgage on their house, and they are at the mercy of current market rates, and they can’t really refinance! Now think about this, if you own stock in a company and you see that the company is starting to amass a lot of excess debt, what will you likely think? You will become concerned that they may not be able to pay back all that debt, and you may consider getting rid of that stock. Right now, China and Japan are looking at our situation and saying, “I wonder if they are goign to be able to pay back all that debt? Do we really want to hold onto this debt?” And what happens when everyone starts selling or trying to get rid of something? That’s right, the value of it goes down. And when the value of a bond goes down, the interest rate goes up. So our level of national debt has us in a very precarious position.
Declining Dollar
A weak dollar does have some positive things that can help stimulate an economy. When the US dollar is weak, it costs less to buy things here in the US. This can stimulate the purchase of US goods, foreign tourists coming here, and people coming here to go to college. But there are downsides too. Oil is traded in US dollars, so having a weak dollar is likely to make the price of oil go up as other countries buy up the oil with their more valuable currencies. It also makes businesses here vulnerable to hostile takeovers by foreign buyers. But the biggest risk ties back in to our interest rates. A weak dollar and low interest rates go together. If the dollar stays weak, eventually foreigners are not going to want to buy our debt at such low interest rates. This will mean that interest rates will have to go up so that they will buy our debt.
Bank Leverage
With all the money being made by the banks writing all those mortgages, they got greedy. They started to over extend themselves by writing more mortgages than they should have written, and even lending out their reserves. As we already discussed, many of these loans were NINJA loans (No Income, No Job or Assets). Real estate appraisers got in on the NINJA loan action by appraising houses for more than they were really worth so that even people with bad credit could get 100% financing to buy houses. Some banks would pressure the appraisers to appraise a house at a certain value or else they wouldn’t send them any more business. When things started to turn south in the real estate markets, speculators just walked away from properties. They owed the bank more than the property was worth, so they would just leave the keys on the counter and walk away. Many banks have already gone under. As of today, 94 banks have failed in 2009 and been taken over by FDIC, with many more on the way. Commercial real estate loans haven’t even hit the fan yet. Credit card defaults are still growing. And car loan defaults will be the last thing to bring up the rear.
Come back soon to see the last part of this 3-part series!
Tags: 1 Billion Dollars, Cheap Money, Declining Dollar, Deregulation, Derivative, Derivatives, Exchange Cash, Financial Instrument, Futures Contract, Geniuses, Hand Over Fist, Investment Banks, Money Hand, National Debt, Perfect Storm, personal financial planning, President Reagan, Taking Steps, Time One, Time Today |
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25
2009
Planning for retirement remains a top concern for many Americans, but that hasn’t resulted in a greater reliance on financial planners.
This year’s National Consumer Survey on Personal Finance by the CFP Board of Standards suggests the nation’s advisors have a big void to fill when it comes to the way the public is preparing for retirement.
The survey of 1,742 consumers found that 51% of respondents listed building a retirement fund as one of their most important financial concerns. Forty percent cited managing retirement income.
Yet 64% of respondents said they did not have a financial plan, and only 17% said they have a financial plan that they update regularly.
“These results tell us that Americans of every type of background and income level think carefully about their assets and how to improve their financial state,” said Eleanor Blayney, consumer advocate for the CFP Board. “We also see that many lack an understanding that everyone can benefit from having a financial plan, regardless of one’s wealth or social status.”
Among the reasons cited for not having a financial plan were the expense of hiring an advisor, the feeling by some that their financial situation wasn’t complicated enough to merit professional involvement and confusion over the qualifications of financial intermediaries. Forty percent said they were not aware of any credentials for financial professionals.
Tags: Big Void, Blayney, Cfp Board Of Standards, Consumer Advocate, Credentials, Eleanor, Financial Concerns, Financial Intermediaries, Financial Planners, Financial Professionals, Financial Situation, Managing Retirement, National Consumer Survey, Personal Finance, personal financial planning, Preparing For Retirement, Professional Involvement, Respondents, Retirement Fund, Retirement Income |
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24
2009
Many families have been asking their personal financial planning advisor what factors contributed to the great recession that we are currently experiencing. This is a very good question because there are a lot of contributing factors, many of which have been brewing for years. This three part series will discuss the major factors.
Globalization
The North America Free Trade Agreement (NAFTA) went into effect on Jan 1, 1994. This was an agreement between the United States, Canada & Mexico that was meant to open up trade between these countries. The idea of this globalization was that if we bought products from Mexico we would raise their standard of living, and eventually they would all start buying more products from us. While this agreement did increase trade between the countries, the long term effects have been somewhat damaging to us. Currently we buy as a country about $1 Trillion in goods per year from other countries, and we sell about $200 Billion of our good to them. That’s a trade deficit of about $800 Billion per year. Why is this? Because we don’t really have anything to sell to them. Everything is now made in other countries like Mexico, China & India where labor costs are so much cheaper. Why would they buy things from us when they already have it, and they make it, and it’s cheap. This has made our country very dependent on other producing countries for goods that we need. It has also weakened us financially.
Low Savings
Currently the United States is the richest country in the world, but we have the lowest personal savings rate in the world. In China the personal savings rate is 30%, in Japan it’s 16%, and Germany saves about 12%. Up until 1989 our savings rate was 11%. Today we are at -1%. That’s right, people are spending ALL of their income and then some every year. Because of inflation, today’s wages are the same as they were 20 years ago. Yet our standard of living has increased dramatically. How is that possible? Today about 90% of couples under the age of 50 have both spouses working. We’ve also been using home equity, credit cards, and our savings to maintain our standard of living.
It used to be that people set up sinking funds to pay for purchases like new cars, vacations, Christmas, etc. They would set aside a little money into their separate sinking fund account each month so that when it was time to go on the vacation the money was there. Today, people just put it on the credit card or get a loan for it, and then make monthly payments on it (with interest). This lack of savings has made our country very vulnerable to financial crisis.
Cheap Money
The Federal Reserve started making it very easy to borrow money when they reduced interest rates to near zero levels. This was an effort to “prime the pump” and get money flowing, and it worked. Banks were able to borrow money from the government at 1% interest rates, and then lend it back out in the form of home mortgages at 5 – 6% rates. They were making money hand over fist, and Wall Street was getting flooded with mortgages. So many mortgages in fact, that something had to be done to deal with all of them.
Deregulation
During this same time there was much less reguation going on in the banking industry. With a lack of regulation, many banks got greedy and started giving loans to people who really shouldn’t have had them. People got really good at falsifying loan documents in order to get a loan. This is where the NINJA loans started to run wild. NINJA stands for No Income, No Job or Assets. Here’s how they worked. Lets say a person comes in looking for a loan to buy a house and they have an income of $5,000 per year. The mortgage officer might have said something like, “Well lets just put an extra zero on the end of that income and make it $50,000, since a zero isn’t worth anything anyway.” “And you don’t have a job, you just watch TV all day? Let’s put down that you’re an entertainment executive with Dish Network.” and so forth. These were the kinds of people who the banks were lending out cheap money to on a daily basis. Can you see how this was setting us up for the big crash?
Look for “The Perfect Storm – Part 2″ for more on this topic.
Tags: Amp, Canada, China, Financial Planning Advisor, Free Trade Agreement, Globalization, Good Question, India, Inflation, Nafta, North America Free Trade Agreement, Perfect Storm, personal financial planning, Personal Savings Rate, Recession, Richest Country In The World, Standard Of Living, Trade Deficit, Trillion, Wages |
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