Bill Gross' Big Idea

Bill Gross, the "Warren Buffett of Bonds", is in the news this week. He has a radical idea to help "Main Street" and boost the economy.

In short, the tremendously successful billionaire, who runs what is the largest and, arguably, the best mutual fund in the country, wants Fannie Mae and Freddie Mac to lower the interest rates on all mortgages they hold now. Significantly. Like 6% loans would go down to 4%.

This would massively reduce the monthly payment obligations of the borrowers while still requiring they pay-back all of what they borrowed.

This would not require lenders to write-down the value of assets, either. They'd have to suck it up and plan on 1/3 less income, though.

Let me know what you think.

Retirement Account Contribution Priorities

You have a job. You can pay all of your necessary bills each month. Now you want to save for retirement. Good. You should!

But how? So many different accounts, so many ways to save.

Well, I'm here to help. And today let's forget about the investments. Let's just focus on where to put the money.

Here are the usual retirement savings choices:
1) employer-sponsored retirement plans (like 401k, 403b, TSP, 457b, and pensions)
2) individual retirement accounts (IRA, Roth IRA)
3) taxable brokerage accounts

All of these accounts allow you to hold cash or invest. Investment options vary, but typically you can at least use mutual funds.

Options 1 and 2 offer tax-deferred investment growth, and you may also be able to deduct your contribution amount from your taxable income each year.

Option 1 sometimes offers additional contributions from your employer--a very nice fringe benefit!

So, how to do all this?

First, take the "free money". If your employer offers "matching" or "profit sharing", contribute enough to earn the maximum offered. That's a no-brainer, but I'm saying it anyway!

Second, if you are eligible to contribute to a Roth IRA, do it. Any investment growth is free of capital gains taxes, AND the money comes out of the account tax-free in your retirement years. You can put in up to $5000 per year ($6k if you're 50+ yrs old). If you can't use a Roth IRA, then go to the next step.

Third, go back to the plan at work and top it off. You can contribute up to $16,500 per year. If you make $100k and get a "match" on the first 6% of your salary contributed, then you put in $6k right away. Then you put in $5k to the Roth. So, here now you can put in another $10,500 into the plan at work.

Fourth, if you can't use a Roth and have more than $16,500 to save each year, now is when you should fill-up your traditional IRA. $5k max per year, $6k if you're 50+.

Fifth... it gets complicated, and most folks do not get this far. But try!

If you can afford to save into the 401(k) and the IRA--a total of $21,500 per year--congrats! You are among the few and the proud.

If you make less than $200k per year and you are saving over $20k per year while still in your 30s, you are definitely on the right track.

If you're one of the so-called "rich" earning more than $250k per year, though, you may still need to save more. Think in terms of at least 10%, preferably 15%, and if you're getting a late start, 20% of your income should go into your retirement accounts.

Call me and we'll run a retirement projection so ballpark whether or not you're on track.

Tax Cuts: Do They Pay For Themselves?

Maybe, maybe not. This is a tough question to answer definitively, and the subject almost always gets political, and I prefer to keep this blog about sound ideas and facts instead of political stances.

Okay, with the American business sector acting as if it's on "hold" until government policy changes (taxes, regulation, etc.) are clear or in effect, we wait and debate. One huge debate is whether Congress should allow the "Bush Tax Cuts" of 2001 and 2003 to expire as scheduled, or if we should raise some rates and not the others or maintain status quo.

It is widely held, by those who believe cuts in marginal income tax rates will stimulate the economy and thus actually increase tax revenues, that there's a lag-effect for the stimulative results to appear. Some of the most ferocious debating and punditry right now is whether such tax cuts really do lead to higher, not lower, federal revenues.

With that in mind, here is some data right from the CBO and OMB:

US Budget Receipts (just from individual income taxes)
2000 was $1,004 billion
2001 was $994 billion, down 1.0%
2002 was $858 billion, down 13.7%
2003 was $794 billion, down 7.5%
2004 was $809 billion, up 1.9%
2005 was $927 billion, up 14.6%
2006 was $1,043 billion, up 12.5%
2007 was $1,163 billion, up 11.5%
2008 was $1,219 billion, up 4.8%

Tax cuts were approved in '01 and '03, so their effects likely started being felt in '02 and '04.

Federal receipts from income taxes grew a lot each year starting in 2004, while the economy did not grow at the same rate. Way too many variables would factor in here for the results to be conclusive, but the income tax cuts do correspond to increased revenue to the government.

(Here's the US GDP data for the same time-frame)
2000 was $9.76 trillion
2001 was $10.1 trillion, up 3.5%
2002 was $10.4 trillion, up 3.0%
2003 was $10.9 trillion, up 4.8%
2004 was $11.6 trillion, up 6.4%
2005 was $12.4 trillion, up 6.8%
2006 was $13.1 trillion, up 5.6%
2007 was $13.7 trillion, up 4.5%
2008 was $14.6 trillion, up 6.6%

Financial Priorities to Keep You On Track

Here is how I think folks should prioritize their financial matters:

1) Term life insurance. If you have anyone depending on you as their financial provider and you do not already have a big enough nest egg to provide for them after you're gone, you need to create a nest egg that will fund those needs.

2) Disability insurance. If you need to work for a living, presumably you'd still have those bills to pay even if you are hurt and can't work. Long-term disability coverage is very important, but also look at short-term and "gap"/"supplemental" coverage.

3) Emergency Reserves. Everyone who needs to work for a living should have at least three-months, and preferably more, of necessary living expenses in savings. You can also "invest" the money, but be sure to use very conservative investments that are readily accessible without penalty.

4) Pay-down "bad" debts. Credit card, personal loans, and loans or in-use credit lines against the equity in your home are on the agenda here. If you have them, you're probably spending more than you should for normal living expenses (so fix your budget if you can, and these are debts that usually charge high rates. A fixed-rate mortgage you can afford, a reasonable car payment, and student loans that are being paid back on schedule, are definitely debts, but they can be treated like living expenses rather than unnecessary burdens.

5) Retirement savings. Now we start investing. Start with contributing the minimum necessary to your retirement plan at work to earn the maximum "company match", if offered (no sense leaving "free money" on the table). Then max-out a Roth IRA ($5k), if you're eligible. Then top-off the plan at work, up to the $16,500 federally-mandated maximum tax-deductible contribution. If you earn enough to put away more than that $21,500, great! Call me and I'll show you what you can do...

6) Other high priorities. Saving for your children's education, contributing to charities, retiring early, buying a second home or a fancy car or a boat... this gets personal. I won't presume to tell anyone how to prioritize in this area, but let's just say "there's no work-study or student loans for retirement." This is where you might sock-away more money in your brokerage account. You can use it to invest in speculative stocks you think have "home run potential". Or you might use a variable annuity to provide a level of safety for that chunk of your portfolio. Lots to consider here.

If you have a grip on this already and also know how to invest your portfolio effectively with the best balance of risk and reward using the best available money managers and/or mutual funds, you should be fine on your own.

If you do not possess the knowledge to prioritize your financial life and to invest your money... or if you do not have time to act on the knowledge you may possess... or you do not have the wherewithal to stay on top of it... you should hire a financial advisor.

China's Advancement

According to a scholar and an investment manager I just saw interviewed, both of whom are experts on China, 300,000,000 Chinese people will move into the urban/suburban middle-class in the next 15 years.

That's as many people as we have in the entire USA. That's almost 400,000 people per week.

China will need houses, roads, bridges, hospitals, schools, water-treatment, telecommunications, electricity, cars, computer systems...

My clients and I are and will continue investing in China, both in China-based firms and firms that do business with China.

Chasing Returns vs. Identifying Skill: Picking Good Mutual Funds

We are often advised to not "chase returns" when looking for mutual funds. Don't go for the funds that are doing great in the past year--they're ripe for a fall.

Fair enough. But that does not mean we should avoid those funds. We just need to see more info before deciding.

When I choose mutual funds for the portfolios I run for clients (and myself--I eat off of the same plate from which I serve), there are many factors and data points I consider. One is the relative performance history over numerous, not just recent, time periods.

Almost every mutual fund I use has been a top-quartile performer in its category in the 10-year, 5-year AND 3-year periods. Every fund can have a good or bad stretch, but the ones that are basically always doing better than most of their peers... those are appealing.

The process is rigorous. If you can do it yourself, great! If not, though, it is worth the money to hire someone like me to do it for you.

Top-Down Bears vs. Bottom-Up Bulls

Where will the stock market go now? There is a battle between the Bulls and the Bears. Bulls think we have good things ahead, and Bears think otherwise. This is normal. Reports are that pessimism was palpable, but not insurmountable, at the recent Morningstar Investment Conference.

Given the state of the U.S. economy, portfolio managers who take a top-down view, looking at economic conditions as the primary basis of their investment decisions, were gloomy. In short, they see that the U.S. government has become dangerously overlevered in order to bail out a number of fatally overlevered private institutions.

But some managers who take a bottom-up view, searching for good investments to make now, regardless of the bigger picture, are optimistic. Recent volatility has presented the chance to buy some high-quality stocks at good discounts to their fair value.

While bigger and more intractable, macroeconomic problems are not as imminent as the dangers of the subprime-catalyzed credit crisis that started to boil over in 2007. That means we might still have time to get in while the getting is good, as long as we are flexible and can be nimble.

This is not the time to have a static portfolio. We need to use funds and managers with flexible and global mandates. They need to be able to go to the sidelines or change their game plan as conditions require.

The Top-Down Bears are probably right that the economy is precarious and investment opportunities dubious right now. But the Bottom-Up Bulls intend to take advantage of great opportunities nonetheless.