The Government Response

November 30, 2009 By Leave a Comment

The Government Response

I’ve given the CPI – the Consumer Price Index – something of a hard time lately. If you’ve been following my articles, you know I’ve been critical of some of the changes to the way the CPI is calculated. The danger is that inflation might be misstated, and I’ve pointed to articles that suggest that the official CPI number may be too low. I thought it would be a good idea to take a look at the government’s side of this.

The Bureau of Labor Statistics has a website – BLS.GOV – with questions and answers about the CPI. Here’s some selections from their FAQ about this very influential inflation indicator. “Has the BLS removed food or energy prices from its official measure of inflation? – No.” I’m okay there – I didn’t say they did. The next one is interesting. “The CPI used to include the value of a house in calculating inflation and now they use an estimate of what each house would rent for — doesn’t this switch simply lower the official inflation rate?”

Now the way they’ve phrased the question, the answer is no, but if you read a little further, they concede that there has been some change. They point out that the standard has changed to match the way the rest of the world calculates this. Everybody calculates home value that way. Now, that’s not unreasonable, but it is a change.

For me, the bigger question is this: is the Bureau of Labor Statistics faithfully doing their best to produce an unbiased result that accurately represents inflation trends? When I look at it from their perspective, I have to credit them with good faith. I believe this government office is doing what they believe is right and noble. But I also have to consider the reality of the times. The CPI is an intensely politicized piece of financial data. The financial markets eagerly await the monthly announcement of the new CPI indexes – and trillions of dollars hang in the balance. A stunning amount of government spending is pegged to the CPI. Governments rise and fall based on their ability to manage the economy, and in the U.S. we’ve seen that inflation is a force that can kill a political administration. So it seems clear to me that there is political pressure on the BLS to come up with numbers that suit the political needs of the administration it serves.

Where’s the right inflation number? BLS says negative 1%, John Williams at ShadowStats.com says it’s 6%. Most likely the truth is somewhere in the middle. We’re going to have inflation. We’re going to have it for decades to come. Are you planning your portfolio accordingly?

Filed Under: Video Tagged With: , ,

Be Thankful!

November 25, 2009 By Leave a Comment

Be Thankful

Thanksgiving is approaching quickly, and it’s appropriate to reflect on what we have to be thankful for. Our country was started only a couple of hundred years ago, and we sit on the top of the most successful society in world history. What is it that has made the United States of America great? In a word, it’s freedom.

We have the freest country in the world, both at this point in history and at any point in history. So take a moment to be thankful for the freedoms that we enjoy as Americans. Our unparalleled religious freedoms and freedoms of political expression are such an expected part of our lives that we forget how rare this is in the rest of the world. But beyond the obvious, consider our freedom to rise in financial status. There are countries where it could take a family generations to raise their standard of living, but in America you can go from nothing to stupendous wealth in the reach of your own lifetime. Don’t believe me? Ask Larry Page and Sergey Brin – the founders of Google. 15 years ago, nobody knew who they were. Today they are worth 12 billion dollars apiece! And they are both in their 30s! No society in history has had that kind of social mobility.

I’m thankful for astonishing technology available to ordinary guys like me. I’ve got a video blog at JohnPollock.tv that wasn’t possible 10 years ago. I couldn’t have afforded the camera! And there was no venue that would want to show the video, even if I could. Are you as thankful for the Internet as I am? Think of the business opportunities – consider that next year’s millionaires will be making money from products that haven’t even been considered yet, but will become completely indispensable as soon as they hit the market.

It’s tempting to be discouraged by the tumultuous world we live in – I’m sure many of you take the occasional break from fretting over your profile to fret instead over the news of the day. But there’s another chance to be thankful. World events are scary, but exciting! The people of the world are continuing to live out the ongoing drama of making our world a better place. You should be part of it! I know life can be messy, but still, this is the greatest time to be living in the greatest country on Earth.

Isn’t that a good reason to be thankful? Happy Thanksgiving!

Filed Under: Video Tagged With: , ,

Tame Inflation

November 24, 2009 By Leave a Comment

Tame Inflation

Inflation is big news lately. Government spending is at a scary level. The Fed is parachuting money onto Wall Street. It’s very sensible to wonder what inflation is going to do in the near and medium term, and to wonder what you should do about it. I’m looking at an article by Jason Zweig of the Wall Street Journal, and he’s suggesting something called TIPS as an inflation hedge. What makes TIPS interesting as an investment is the fact that its performance is indexed to inflation. In other words, inflation has less of an impact on this investment type than others.

Compare it against fixed income investments, like bonds. In a worst-case scenario, you’ve got all your money in bonds that get 5% interest, but inflation is at 5% too, so the money you “earn” from your investment can only buy you the same goods that it could when you put it into the investment. TIPS helps by paying you back either the original principal value, or an inflation-adjusted value, whichever one is higher.

I like TIPS, and think that in moderate amounts, it’s a great thing to add to a portfolio. But I do have a concern. TIPS is indexed using CPI-U, the Urban Customers portion of the Consumer Price Index. And as I’ve pointed out in other articles, I think CPI may not be the most honest measurement of inflation, thanks to governmental manipulation of the formula used to measure it. Some analysts believe that the current government number of less than -1 percent is way too low, and that the correct number – the “shadow inflation” – may be as much as 6 percent. I’m not trying to be conspiratorial here, but even if we meet halfway between those numbers, we need to be thinking about the impact of inflation on our portfolios.

The bottom line is that even with access to useful inflation-hedging products like TIPS out there, the basics of portfolio management haven’t changed. A broadly-based, properly balanced, diversified portfolio is still the best hedge against inflation. TIPS can be a part of that balance, but investors would be wise not to put all their eggs in one basket.

Filed Under: Video Tagged With: , ,

Behind the Scenes Part 1

November 23, 2009 By Leave a Comment

Filed Under: Video

I Apologize

November 20, 2009 By Leave a Comment

Filed Under: Video Tagged With: , ,

House is Not Just Lumber

November 19, 2009 By Leave a Comment

A House is Not Just Lumber

Imagine you’ve invited someone over to your house. You’ve walked him through each room, pointing out the best features of lighting, furniture, technology – all the things you love about your home. Your friend listens patiently, nodding and smiling in all the right places. At the end of the tour, he looks thoughtful and says, “It’s a nice set of lumber. I can tell it has a frame that’s really very wooden.”

Huh?!?

Exactly. It would be absolutely ridiculous for someone to react that way, and for a very clear reason: a house is much more than lumber. Now, lumber is a very important part of building a house. It gives the house a shape. It gives the walls the strength to stand up against the elements outside (or the people inside). But if you look at a house as just a set of lumber, you miss what makes a house special – what makes it a home.

I meet a lot of investors who have the same odd view of investing. Recently, I had some new clients in my office who had been working with a local financial advisor. This couple had put their whole portfolio in a variable annuity with a guaranteed 5% income for the rest of his lives. But that was the be-all and end-all of their portfolio – income.

Now, income is an important part of a portfolio, just as lumber is an important part of a house. But if you stop there, there’s a lot that’s missing. Houses don’t just need lumber, but drywall, carpeting, plumbing, and lots more. Portfolios don’t just need income – income is vulnerable to inflation. Some portfolios need a way to pull out money at critical times to deal with emergencies. Lives change, financial goals change. If your portfolio focuses on one particular goal or strategy, and ignores all other concerns, you’re sitting in a very drafty house with a great frame.

Good homes have a web of systems that work together to support the goal of having a comfortable place for you and your family to live. Is your portfolio like that, or is it all lumber and no insulation?

Filed Under: Video Tagged With: , ,

Black Tape Over the Warning Light

November 18, 2009 By Leave a Comment

Black Tape Over the Warning Light

Has this happened to you? You’re traveling in your car when suddenly your eye is drawn to a warning light on your dashboard. Maybe it’s letting you know that you are out of oil, or that your engine is overheating. What do you do? Do you immediately pull into a service station? Do you just ignore it, hoping it goes away? Or worst of all, do you pull into your garage, and hide the indicator with a thick piece of electrical tape?

So many people go for the 3rd option when managing their finances. Maybe ignorance is bliss, but let’s not kid ourselves into thinking that it’s the solution to any problem. Ignoring a low oil light is a great way to seize your car’s engine. Ignoring structural problems in your portfolio is a great way to take on needless risk that hurts your long-term gains, and jeopardizes your retirement plans.

Part of my job as a financial manager is to draw my clients’ attention to problems in their finances. I try to be the warning light on my customers’ financial dashboard. I don’t want to be a downer – it’s not my goal to make people feel bad, I’m just trying to help people help themselves financially.

Don’t ignore the warning lights! Is a little voice in the back of your head reminding you that your portfolio hasn’t been rebalanced in three years? You should treat it the same way as the realization that you haven’t had your tires rotated. Is your portfolio protected against inflation risk? You should exercise the same discipline you use when you notice your brakes aren’t working as effectively as they used to.

Covering up problems doesn’t solve them. Doing something about the shortcomings in your portfolio will make you feel more confident in your financial future. Your financial advisor can help you change the way your portfolio is serving you, and plug the holes that are letting thousands upon thousands of dollars slip through your fingers. Even a few small changes can steer you away from financial trouble, and give you years of trouble-free travel down the road to your financial goals.

Filed Under: Video Tagged With: , ,

Shadow Statistics

November 17, 2009 By Leave a Comment

Shadow Statistics

One of the most important numbers in the financial world is called the CPI – the Consumer Price Index. It’s vitally important in government, too, because lots of different kinds of government spending are hitched to the CPI. If it goes up faster, the government spends money faster. If it goes up slower, the government spends money a little less fast.

The CPI is a number that reflects how much the cost of products that you and I buy has changed over time. It’s tracking the price changes of things like bread, milk, gasoline – you know, every day stuff. The higher the number is, the faster the prices of things you and I buy are rising.

People get worried when they see that number rising – because if everything we are buying is getting more expensive, people start spending less to save their money. Governments worry when that number starts rising too – mostly because they are first to get blamed if the economy goes bad.

If you look at a chart of CPI over the nation’s history, CPI has spiked at some very high numbers, and at other times it has dropped so far that prices for goods actually declined. I’ve got a graph here in front of me that shows the history of the CPI’s values. But this particular chart has an interesting feature to it. Toward the right part of the graph, where the official CPI trend line is going down, there’s another part of the graph – a grey region, with a trend line going up. This shadowy area of the graph is trying to show where its author, John Williams, believes the CPI should, in fact, be.

What’s going on here? Well, it turns out that the government has changed the set of products that are part of the CPI calculation several times over its history. Recent changes have included the cost of steel and asphalt in the CPI. Steel and asphalt? How many of you picked up some extra steel and asphalt last time you were out running errands? Are any of you building a bridge? I didn’t think so. Now what happens when you add these things to the CPI basket? It pulls down the CPI.

Now, I’m no conspiracy theorist, and I can’t tell you if the current CPI number is right, or if the number before steel was added is right. July 2009 inflation was reported at negative 1.43 percent. But if the government had used the old way of calculating CPI, that inflation number would have been 6 percent – more than 7 points higher than the official government number. Even if we speculate that the truth is somewhere in the middle of those two numbers, that puts inflation at 2% – much higher than negative 1.43.

I’m worried about inflation. I think it’s climbing now, and with current government spending and fiscal policies, I see an inflation tsunami coming our way. Is your portfolio in a position to weather crippling inflation? If your portfolio is only going to give you 5% until the end of your life, what will you do if inflation stays at 6%? Or better yet, have you set up your portfolio to actually gain from high inflation? Talk about it with your financial advisor, or visit my blog at JohnPollock.tv.

Filed Under: Video Tagged With: , ,

Social Security "Cuts" Benefits

November 16, 2009 By Leave a Comment

Social Security Cuts Benefits

Social Security is one of the federal government’s largest entitlement plans, spending 680 billion dollars per year. Projections show that spending on Social Security will start increasing faster and faster, as more baby boomers retire. In seminars over the last four years, I’ve talked to investors about the ways that the government tries to manage the flow of Social Security money. The government loves endlessly fiddling with the amount of taxpayer money going to various programs, and Social Security is certainly not exempt. It’s instructive to see how the government does this.

When you think about it, the government really has only three ways to manage their expenditures on Social Security. The government manipulates the Social Security program by passing laws that influence three areas: eligibility, benefits, and taxes. Nobody in government wants to deal with the bad press that comes from trying to “balance the budget on the backs of retirees”, so any attempt to reduce spending on Social Security must be done in very subtle ways.

The government can manipulate eligibility, for example by raising the minimum age to collect benefits. They can manipulate the benefits themselves, adjusting the amount of payments that get made or the way those payments are made. And the government can change the taxes employers pay into Social Security, bringing more revenue into the program to help slow the rate at which money pours out.

Got it? Now listen to this. I just read an article: “Social Security Makes it Official: No Cost of Living Increase”. The title of the article makes it sound like Social Security hasn’t actually done anything at all, but if you think about it, the government has decided to make a subtle, but effective change to benefits. Inflation makes everything we buy more expensive – driving up prices over time. Think of the price of bread when you were growing up – or milk. The cost of eating bread and milk has continued to rise over time – the cost of living has gone up.

When the Social Security administration elects not to adjust Social Security payments to compensate for the increase in the cost of living produced by inflation, it has made an important choice. It has chosen to continue paying Social Security recipients the same amount of money as it did last year, but it is paying those recipients with dollars that are less valuable this year than they were last year.

Don’t be fooled by government trickery to camouflage a benefits cut as a reduction in the rate of increase. Does your portfolio incorporate ways to safeguard your income, and does it incorporate thoughtful tax planning strategies? If not, contact your financial advisor today.

Filed Under: Video Tagged With: , , , , ,

Crushing Profit Estimates

November 12, 2009 By Leave a Comment

Crushing Profit Estimates

Today I was on FoxNews.com, and I read a fascinating article, titled this way: “Goldman Sachs Earnings Top $3B, Crushing Profit Estimates”.

That’s right, 3 billion dollars. With a ‘B’. In one quarter. How did they make all that money? Read on:

“The company said bond, commodities and currency trading buoyed its profits for the second straight quarter. Investment banking revenue, traditionally the foundation of the company’s business, fell to $899 million in the third quarter. “

Hold on a second. They did worse in the area that they usually do well in. Where did their record profits come from? Trading. This is a deal that casinos figured out long ago, and brokerage houses have learned fast. Think about a casino. Are they really selling a product there? No – not really. If a bunch of guys are betting on a poker game, and the casino takes a percentage of each bet, does the casino really care who wins? Of course not. The same is true in brokerage houses. Brokerage managers have gotten smart, and figured out that they don’t really need to ensure that everybody they work with makes money all the time. As long as people keep trading and Goldman Sachs gets a piece of each trade, they can rack up big profits. Like 3 billion dollars in a quarter.

Who’s paying for all that profit? Investors. In other words, you are. If you make a trade, somebody takes a bite out of the value of that trade. If you’re in a mutual fund, you don’t pay the trading costs directly, but every time the fund manager makes a trade, they are paying for that transaction with money coming from the fund. That’s money you could have kept if the fund manager hadn’t decided to make that trade. So you’re still paying for the transaction costs and the fund manager’s salary out of your potential returns. Ouch.

How do you dodge trading costs? Make your own trades sparingly, and only when it benefits your portfolio to do so. Look for investments that don’t trade, or trade less frequently. If you are in mutual funds, watch them very carefully. And next time you wonder if you should care about the $10 commission you just spent on that last stock trade, consider: trading is a very, very big business.

Filed Under: Video Tagged With: , ,
« Older Posts