Monday, August 22, 2011

Are Savers Headed for the Poor House?

Even as Fed Chairman Ben Bernanke gets ready to deliver his annual speech at Jackson Hole, WY - a favored playground of the rich and famous- many seniors on fixed incomes are pondering how they'll survive the next two years. No COLAs for their Social Security to speak of (and they may even be adjusted lower), even as Medicare premiums are set to increase, and (thanks to Faithful Ben) no higher interest on any interest -bearing cash accounts to supplement Social Security income.

The Fed Chairman's recent announcement that interest rates will remain near zero for the next two years, while great news for borrowers, was horrific news for savers - especially seniors who don't wish to risk their assets in volatile markets. (Never mind the Fed's efforts to get them to do just that!)

These prolonged low interest rates have also wreaked havoc on millions of seniors' balance sheets.

For example, just five years ago, a $20,000 CD would've netted a diligent-saving senior roughly $1,000. Now he's lucky if he can reap 'bupkiss', otherwise known as chump change, The nominal rates for many CDs now (say even 5 -year) hang at about 0.5% or ten times less than five years ago. That means the senior will collect about $100 now for a year on his holdings that previous delivered $1,000.

The situation isn't any better in money market funds which currently have $2.4 trillion stashed in them, with a whopping yield for the past year of about 0.01% It's no wonder that 401k companies (i.e. who manage them for corporations) get mad when people bail out of stocks and plant money in money funds. With such a low yield they're unable to charge normal fees without sending the 401k holder's savings into negative territory!

Well, what's a safety-inclined 401 k saver to do? The answer is to hold strain, and max out your 401k especially if you can get a company match! My wife's last twenty 401k statements have shown average quarterly gains on her holdings at 0.0000%. However, if her company matches are figured in as gains, she's averaging about 15% with NO losses. My point? Look at your company match gains as real gains, indeed, as riskless gains!

Also, don't just go to bond funds which lots of financial advisors have recommended for clients as "safety places". To me, bond funds are little better than stocks. Indeed, in 2008, the average bond fund in Morningstar's ultra-short bond category lost nearly 8%. The Pimco fund lost 1.3% that year. Unlike money market funds which assure investors that they will not "break the buck" (i.e. let the magic invested amount dip below parity with $1) the bond funds make no such promises. Ten years ago, I recommended my wife get out of her company's 'Life Cycle' fund - which had two bond funds in it - because she was losing $800 a quarter and got no matches. Now, strictly in money market funds- she's doing much better thanks to her company's matches.

The environment we are in right now, with these absurdly low interest rates (conferring loads of cheap "bubble" money on Wall Street), has been called one of "financial repression" by many economists, which is just as good a name as any. One investment manager at PIMCO, has even predicted seniors will "be punished for many years to come".

This is what makes it a dangerous environment for so many seniors, because it invites a barrage of terrible advice that may actually cost them a lot of money in the end.

One of the persistent finance tropes that makes the rounds is that people will "lose" money if its kept in cash, CDs, money market funds or accounts. Even this morning, one female guru was warning that people will LOSE on account of inflation. Of course, this is recycled bollocks intended to entice people to take on more risk than they're willing to accept.

Consider - if over the next two years the most inflation prone commodities are fuel (for heating, as well as auto) and food - groceries.

Let's say I average $100 a month on the first right now and $500 a month on the 2nd. Let inflation cause the first to go up by 5%/year and the latter also by 5% each year (a kind of worst case scenario). Then after 2 years, inflation on the first eats up roughly $180 and on the second $900. That is a total of $180 + $900 = $1080 "lost". But how much is really "lost" when total financial holdings (in fixed income) are reckoned in?

First, the interest on my total fixed income holdings over the same time, assuming no changes made by any of the banks, should be about $4,000. Even if one allots 15% of that as a loss - for taxes, that leaves: $3,400.

In absolute terms, I haven't lost because the net interest earned still tops the inflation amounts. (I regard it as a true loss only if the total from inflation -hiked costs eats up all my interest!) What this shows is, contrary to the money guru's blather, the registration of loss will actually depend on the fixed income holdings. If these are small then, yes, that means there will likely be losses - whereby the interest that would have provided income is eaten up by increased food, fuel prices.

The point? A saver religiously sticking to his savings program (while keeping frivolous spending at bay) to do what he does best: SAVE- is the best solution! SAVE, SAVE and SAVE - don't accept risks that ensure losses that must be made up- and so build up your total saved holdings so the interest earned is ample to withstand moderate or even higher inflation over years!

What about medical inflation? Even here, estimating a 14% per annum increase in drug costs for my Medicare prescription drug (aciphex), this amounts to about $225 over the next two years. Again, even factoring this into the higher inflation costs doesn't portend a true loss. Even if my wife's meds' inflation are factored in ($440) that still doesn't convert to a true loss.

Now what if one's fixed income savings are not so much that any leeway is allowed, and the person is operating close to the margins? In this case, assume that $1080 in additional inflation-driven costs in food and fuel not only eliminates one's earned interest, but puts one $1,000 into the hole.

In this case, there are always adjustments (done on the basis of retrospective analysis) to one's consumption that can be made, as suggested by authors Vicki Robbins and Joe Dominguez in Your Money or Your Life. For example, the simple expedient of eliminating all (more expensive) processed foods at the grocery store. Or, dropping one or more cable stations. In energy terms, maybe check on ways to save (such as turning off the furnace gas during the summers) which are provided yearly by utility companies. If 'push comes to shove', then yes. .. cut back on charities, or better, substitute action volunteering in selected charities for monetary donations.

Even a simple change like eating out less per month can help. If you eat out twice a month, then change it to once. If you've been going to Outback, then maybe go to Applebee's instead. Or, don't eat out at all! Besides, the best food is that you can cook yourself!

Shopping patterns and prices are also up for grabs. People being squeezed in Bernanke's "financial repression" vice can thus take their shopping bags to the nearest Dollar Store, as opposed to a Big Box store or large commercial supermarket.

The point is that just because interest rates are nearly zero doesn't mean you should let yourselves be chased into risky stock markets.

It is not seniors' job (nor anyone's on a low or fixed income) to help prop up the smoke and mirrors stock market.

The sooner more finance gurus get that, the better.

As for the best advice: Retaining a rigorous discipline about spending and saving is the only genuine way to make a dent over the long term. If one is a spendthrift now, even a 10% interest rate suddenly bestowed by the Fed won't help. All that extra money will just be wasted. If one is a diligent saver, and prudent in the disposition of purchases, even a near-zero interest rate will not convert him into a pauper!

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