Certificates of Deposit

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With short-term interest rates above their lows, the popularity of highly liquid, insured accounts has returned.  Bank savings accounts are an option.  An earlier post focused on these and their like.  Because banks and other financial institutions pay a higher rate the more money you are willing to commit and the longer you are willing to leave it, certificates of deposit, (CDs) present an attractive alternative.

CDs commit you to leave a set amount, for a set time, with the financial institution for an agreed interest rate.  Because the financial institution can better plan what to do with the money than with a savings account (where the institution cannot anticipate how much and when you may withdraw), it is willing to pay a higher interest rate.  Financial institutions sell CDs in amounts of $1,000, $5,000, $10,000, up to $100,000, and sometimes more.  Like bank accounts, the FDIC insures these up to $250,000.  Some brokers also offer CDs.  These are not FDIC insured, but often the issuers make insurance arrangements with a private insurance company.

If you decide to buy a CD, make sure you can leave the money for the entire term, because there’s usually a penalty for early withdrawal. Some banks offer “liquid CDs”  –– these allow the withdrawal of funds without penalty before the stipulated term, but they usually pay lower rates than conventional CDs.  If you buy your CD through a broker, you may have the option to sell it back before its term expires, but this almost always lowers the interest rate.  (That broker will then resell the CD on what is called the “secondary market.”)

Some CDs offer flexible rates that rise if market interest rates increase. Typically, these guarantee that the rate originally quoted to you will not be lowered. Some banks will also let you set the terms of your CD.  These so-called “designer CDs” can be useful for savings aimed at college tuition, for instance, or other expenses where you know the approximate date you will need the funds.  These, too, often pay a slightly lower rate than conventional CDs, though typically not as low as liquid CDs.   Note that these flexible and liquid CDs have become less common in recent years.

Shop around.  CDs vary considerably from one institution to another, and rates can differ by as much as a full percentage point. The Internet offers the saver a great tool for making such comparisons.  All bank websites have information on all their services, including the rates on CDs and the associated conditions on term, early withdrawal, and the like.  Be careful: marketing often make things look more attractive than they really are.  Here are a few points to consider:

  • The tease: Some CDs offer a relatively high interest rate up front but after time pay a much lower rate.  Know how long the higher “teaser” rate will last.
  • How the bank/broker treats maturity: Will you receive timely notice when your CD is about to reach term and can you then roll it over automatically into another, similar CD, or can you stop the process?  Be sure you understand the rate offered by such a “rollover.”
  • Calculation of interest: Know whether the interest rate quoted is simple or compounded.  The best you can do with a simple rate is what is quoted up front.  A compounded rate, However, will calculate the interest periodically and post the interest to your account.  Because each interest calculation will include the interest previously paid, you will effectively earn interest on the interest, as described in several earlier posts –– a far more attractive arrangement than receiving simple interest alone.  For instance, a one year a CD that compounds daily will pay you 0.15 percentage points more for each 1 percent of quoted interest.  When compounded that way, a one-year CD quoting, say, 1 percent would effectively pay 1.15 percent.  A CD quoting 2 percent would effectively pay you 2.31 percent.  Though it might not seem like a lot, a $50,000 CD quoting 2 percent interest, would earn an extra $155, enough to justify making sure you’re getting the compounded rate.


Pensions (Part Two)

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The last post describe the two basic sorts of pension plans, defined benefit (DB) and defined contribution (DC).  This second part digs down a bit into the DC area and the many different structures available there.  We start with the most widely used –– the 401(k) plan.

401(k) Plans

 Named for the 1980s law that established them, these plans take, for the purposes of investment, contributions from both employer and employee.  The law determines how  much can be put aside in this way.  Within limits, these plans also allow employees to add to them.  Some employers, in addition to their basic contribution, will match a portion of the additional savings that an employee elects to add.

One big appeal of these plans is their significant tax advantages.  The monies going into the plan on behalf of each employee do not count as taxable income.  What is more, the invested funds collect dividends, earn interest, and enjoy capital gains also free of tax.  When participants draw on the funds they will have to pay income tax on the withdrawals, but if they are already retired, the chances are they’ll have a lower tax rate then than when they were working.  These plans have a further tax advantage.  Normally, when a person sells a long-term holding, it has gained in price, creating a capital gains tax liability on the amount of that gain.  (For more on this subject, see this post.) But the monies in 401(k) plans are excused this tax when their contributors begin to liquidate their investments.

When employers set up such plans, they almost always do so with established investment firms where plan participants can choose from an array of investment products.  It is up to each participant to direct the investment of the funds, though many employers offer assistance in making these choices, as does this site. All plans give participants periodic opportunities to change their investment choices.

For all their advantages, 401(k) plans face a number of constraints. Participants must begin to draw down on the funds and pay taxes on those withdrawals no later than age 70½. Because they are meant for retirement, they impose a 10 percent tax penalty if the participant draws on the funds before age 59½.  There are, however, hardship exceptions to this rule.  The government will waive the 10 percent penalty if:

  • You have suffered a disability that makes it impossible for you to work;
  • You have significant medical expenses;
  • You face a court order to give the money to an ex-spouse or a dependent;
  • You take early retirement, but only after age 55;
  • You die and your beneficiaries collect the money.

Some plans will let you borrow against the value of what you have invested, but there are restrictions.  You can get help with specific questions from the 401(k) Help Center at www.401khelpcenter.com.

Individual Retirement Accounts (IRAs)

 If you are not in an employer-based retirement plan, you have the option of setting up a tax-advantaged individual retirement account for yourself.  (Actually, the law makes allowances for IRA contributions — though on a sliding scale –– even if you or your spouse participates in another pension plan.)  If you are married, you and your spouse can contribute to the same pool of investable money.  The law sets the maximum amount you and your spouse can put into the account.  These have the same benefits and restrictions as a 401(k) plan:

  • Every dollar put into the IRA reduces your taxable income.
  • You pay the taxes only when you begin to draw down on the funds in retirement, when, presumably, you will face a lower tax rate.
  • You pay no capital gains tax on your investments when you sell them.
  • You will pay a 10 percent tax penalty if you withdraw funds before age 59½ except under hardship conditions, as described earlier.
  • You must begin to draw down on the funds and pay taxes after age 70½.

Check with your accountant before setting up an IRA to find out exactly what restrictions apply to your particular circumstances.  The Internal Revenue Service offers help on its website, www.irs.gov.

You can open an IRA with any bank, broker, mutual fund company and many insurance firms.  The paperwork is simple and you have until April 15 (let’s say of 2020) to make the contribution for the previous year (that is, for 2019) –– although the IRA itself must be set up by Dec. 31 (of 2019).  Your investment choices are as wide as those offered to anyone doing business with the financial firm you choose.  If you were in a 401(k) plan at work and you lose your job or change employers, you can convert those 401(k) investments into an IRA, called an IRA rollover.  You set these up in the same way as a new IRA.

There is an alternative to these conventional IRA arrangements.  In 1997, Senator William Roth sponsored legislation establishing the Roth IRA.  Unlike a conventional IRA, a Roth offers no tax deduction for the funds you contribute.  To compensate, the Roth excuses tax on any monies you withdraw, including all investment income, interest, dividends, and capital gains.  As with a conventional IRA, there are limits on the amount you can set aside, but there is no 10 percent penalty if you withdraw funds early nor do you have to withdraw money after age 70½.  On the contrary, the law allows you to contribute to a Roth IRA forever and leave it there for your beneficiaries.

You can convert your conventional IRA to a Roth.  The firm handling your IRA can provide you with the necessary materials.  When you convert, you must pay tax on all the tax-deductible contributions you had previously made to the conventional IRA.  The same applies to IRA rollovers.  This tax liability can grow to significant size, especially if you have contributed to your conventional IRA for a long time.  See your accountant for how heavy this tax burden might be.

Simplified Employees Pension (SEP) Plans, Simple IRAs, and Keogh Plans

 There are three other options for tax-advantaged pension plans.  All are similar to 401(k)s and IRAs, but they are meant for the self-employed, for small firms, and for partnerships that otherwise might be unable to use a 401(k).  They are also much simpler to administer.

SEP arrangements are available to any self-employed person with a business that employs 25 people or less.  Unlike other plans, you can set up a SEP without setting up a corporation or LLC or any other corporate structure. If you qualify, you can contribute up to one-quarter of your salary, up to a stipulated amount, though the IRS might change these requirements from time to time.  These plans are similar to 401(k)s but have much lighter administration and reporting requirements.

The Simple IRA aims at firms with 100 employees or less.  Participants must earn a certain minimum salary, a figure that the IRS changes occasionally.  They can set aside a certain portion of their pay, which the IRS also reassesses these amounts from time to time.  This money is excused from taxable income.  Employers have two choices when setting up a simple IRA: (1) They can match the contributions made by participating employees up to 3 percent of their compensation, or (2) they can contribute for each employee, whether they agree to participate or not, up 2 percent of their compensation.  Otherwise, the rules are much like conventional 401(k) arrangements, except the penalty for early withdrawal is more onerous and presently stands at 25 percent.

Keogh arrangements aim at the self-employed and their business partners, whether part time or full time.  Even if you have a 401(k) for a salaried position elsewhere, you can establish a Keogh for that portion of your income that comes from self-employment.  A Keogh allows you to put aside up to a quarter of your income each year, up to a maximum that the IRS adjusts from time to time.  Generally, a Keogh allows larger contributions than either a conventional 401(k), an IRA, a simple IRA, or a SEP.  Otherwise, the rules are much like those of a conventional 401(k).

Financial institutions that work with conventional 401(k)s can make arrangements for any of these other plans.  The employer and the participants benefit if the employer sponsoring the Keogh pays the fees involved separately from the plan.  That way the plan avoids the burden and the cost counts as a tax-deductible business expense to the employer.

The 529 Funds for Education

 Though not strictly a pension, the 529 shares similar characteristics with other plans discussed here.  Named for the section of the tax code that covers the matter, the 529 allows for a tax-advantaged saving/investment plan for educational expenses.

529s are governed by each state, so rules and benefits may vary quite a bit. In general, you can set up a 529 with any financial firm, probably a mutual fund.  It will have custody of the funds and administer them together with the investments when the money is put to work.  Unlike most retirement schemes, the money put into 529s is not tax deductible when it comes to federal taxes, because the IRS treats the proceeds from a 529 as a gift.  Some states, however, allow a deduction of contributions on their (state) income taxes. However, investment earnings and capital gains are excused from all federal and state taxes.

To secure these advantages, the funds must be used for what the IRS calls “qualified” educational expenses.  These include tuition, room and board, books, fees, supplies, computer software and hardware.  Though established under state auspices, few states, if any, have strictures against using the funds for out-of-state schools.  Nor do they make distinctions between public and private institutions.  You should compare all plans available to you because their differences may suit one person more than another.  Make sure that the school chosen qualifies as a recipient of these funds.

If you start a 529 for your child at birth, invest mostly, or entirely, in stocks. The 18 or so years until the child will draw on the money is ample time for the assets to recover from the inevitable, though temporary, setbacks that stocks suffer.  As your child approaches within five years of college age, your investment focus should change.  Because short time spans constrain the period for stock values to recover from a setback, shift the fund’s investments to bonds and more stable stocks.  (See this post for more detail.)


Pension Plans

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Pension plans offer investors great advantages.  The plans collect funds, invest them, and administer the payments to participants when they retire.  They almost always possess tax advantages.  Pension funds fall into two distinct types: defined benefit (DB) arrangements, those that promise participants specific benefits in retirement, and  defined contribution (DC) arrangements, those that make no such promise but allow participants advantageous ways to accumulate funds and invest them for retirement.  Within these two basic structures, funds can vary greatly.

Because there is much to say, I will use this post and the next to examine the topic.  In this post I take up DB plans and the generalities of DC plans.  The next post will go through the complexities of DC plans, which will include 401(k) plans and IRAs.

Defined Benefit Plans

 DB plans are what most people think of as pensions.  Social Security is a DB plan.  In a DB, an employer or government entity promises to pay retirees a certain amount until they die.  Plans might include cost-of-living escalators, and they might also include medical and death benefits and/or provisions for continued payments to a surviving spouse or partner. Provisions vary from plan to plan.

The “sponsor,” who sets up the plan, pools employee contributions into a fund, and invests those monies prudently to fulfill the plan’s promises. Sometimes the sponsor makes contributions from its own resources, sometimes it collects them from participants, and sometimes it relies on contributions from both sources. The administration and investment decisions are entirely the sponsor’s — participants have no say, because it is the sponsor, not the participants who has the obligation to pay.  If the fund falls short, the sponsor must make good its obligations.  If the sponsor is a corporation, that burden then falls on the shareholders.  If the sponsor is a government entity, the burden falls on the taxpayer.

All these plans are exempt from investment taxes, though participants pay income taxes on the distributions made when they have retired.

Here are the three best-known examples of defined benefit plans:

  1. Social Securityis funded from the payroll taxes paid equally by employers and employees. Its payments include an escalator tied to the rate of inflation and benefits paid to surviving spouses, referred to as “spousal benefits.”  To some extent Social Security is interwoven with disability and Medicare, both of which are supported from the same sources that fund Social Security.  When these funds are invested, it is solely in U.S. Treasury bonds.
  2. State and Local Government Plans include a variety of retirement plans for government employees. All are funded in varying degrees by the sponsoring government entity –– that is, by taxpayers.  Some plans also rely on contributions from participants during their employment.  Many have escalators to accommodate rising living costs, and many offer medical benefits, though the specifics vary greatly.  All count on investments in stocks, bonds, and other assets to sustain the funds necessary to meet the plan’s obligations.
  3. Corporate Plans are usually offered by larger, well-established companies. All get most of their funding from the corporate sponsor –– that is, from the shareholders.  Many also rely on contributions from employee-participants. Most include cost-of-living escalators and survivor benefits. Here too, some offer medical benefits.  All invest in stocks, bonds, and other assets to sustain and grow the funds.

Defined Contribution Plans

 Though these so-called DC plans make none of the promises of DB plans, they have one great appeal over the DB variety: participants in DC plans own the assets accumulated with the contributions made in their name, and they can direct them as they see fit.  All DC plans rely on fixed contributions made by the sponsor on behalf of the participants.  The firms and government entities that establish them also make contributions on behalf of individual participants.  All also accept additional contributions from individual participants. Some firms, states, and local governments rely on defined contribution plans to supplement their defined benefit offerings.  Some only offer DC plans.

Because the DC assets belong to the individual participant, they follow the employee into the next job, into retirement, and should participants die before the participant’s assets are exhausted, to their designated beneficiaries.  In financial jargon, these assets are said to be portable. The funds available for retirement depend entirely on the contributions and their relative investment success over the years. More on these varied structures in the next post, including their tax advantages.



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As February has now rolled into March and we begin to focus on the April 15 tax deadline, it’s a good time to look into the role of taxes in investing.  Though only your accountant or lawyer can properly assess the tax consequences of your financial decisions, still, every investor should have a general understanding of how the government taxes investments and should also be aware of which investment strategies have tax advantages beyond those provided by pension funds.  Here are some basic considerations.

Income Tax

 Generally, all income generated from investments –– dividends and interest –– are taxed.  The tax rate, however, can differ considerably from what you pay on ordinary income from wages.  Here are how these rates vary and why:

Interest Payments 

You pay standard income tax rates on almost all interest received from investments, including interest on deposits at banks and other financial institutions and on interest from short-term bills bought and sold on financial markets.  Taxable as well are payments you receive from corporate bonds and from bonds issued by foreign entities (corporations and governments), including interest paid on U.S. Treasury bonds.  Interest paid on Treasury savings bonds is, however, free of state and local income tax.

Tax-Free Bonds

I posted earlier that taxes are excused on payments from municipal bonds (also called muni bonds).  But there are exceptions: income from bonds that support private, profit-making activities is taxed.  This should be clear in the bond’s prospectus and any broker/dealer should so inform you.

Because of their tax advantages, municipal bonds pay a lower yield than equivalent taxable bonds.  In recent years, about a 28 percent personal income tax rate is where the lower yield paid by the average municipal bond balances the advantages of the tax savings on the bond.  Professionals call this the break-even point.  If your income tax rate is higher, the muni bond becomes attractive, because your tax savings will be more than the bond’s lower interest yield. If your personal tax rate is lower than 28 percent, muni bonds become unattractive, because you would be giving up more in yield than what you save in taxes.

Dividend Income

Most dividend income qualifies for a reduced tax rate. This lower rate is usually the same as capital gains tax rates (of which more below).   As of this writing, the top tax rate on capital gains and qualified dividends is roughly half the top rate on ordinary income. To get this tax break, you must have held the stock for at least 60 days and the dividends must be issued from either a U.S. corporation, a company incorporated in the United States or one of its possessions, or a foreign corporation whose stock readily trades on a major U.S. exchange.  Even when dividends meet these criteria, they do not qualify when, among other things, they reflect dividend distributions connected with capital gains realized by the corporation itself, are paid on bank deposits, or are paid by tax-exempt corporations.

The reasoning behind giving dividends a reduced tax rate, as well as for the exceptions to it, is that corporations already pay a separate income tax before paying dividends.  Because that expense counts against –– that is, it’s paid before –– shareholder income, the argument goes, a tax rate on dividend income equal to the tax rate on ordinary income would effectively tax shareholders twice.  Applying a lower rate on dividends tops up the rate already paid at the corporate level to the full individual rate on ordinary income.

Capital Gains Tax

Generally, you are taxed when you realize any gains, the difference between the price you received when you sold the investment and the price you paid when you first bought it.  The tax rate on capital gains is usually lower than the rate on ordinary income. However, the lower rate only applies when you have held the asset for a year or more. Such profits are designated as long-term gains; if less than a year, the gains are considered short-term and are taxed at the rate applied to ordinary income.

Here is a useful strategy to help you minimize your capital gains taxes. Because the law allows taxpayers to write capital losses against capital gains before calculating your tax bill, review all your holdings for securities that have lost value each time you sell one for a profit.  By selling both, you can subtract the realized losses from the gains and pay tax only on the net figure.  This strategy works for both short-term and long-term gains and losses.

If, for sound investment reasons, you want to continue holding the securities sold at a loss, simply buy them back, though IRS rules dictate that you must wait 30 days before repurchasing the securities.  Keep in mind that the clock determining long- and short-term gains on those repurchased assets then resets to the new purchase date.  If these securities then gain in value and you want to sell, you would have to wait a full year for them to qualify for the long-term capital tax gains rate.  Though this strategy increases transactions costs, usually the tax savings more than justify this expense.

Note 1: Never take losses this way that are greater than the gains.  For tax purposes, wait from realizing the losses until you have gains elsewhere to counterbalance with the tax losses.

Note 2: When executing this strategy, be careful to match short-term losses against short-term gains and long-term losses against long-term gains.  To realize the tax advantages, never use short-term losses to offset long-term gains, though it sometimes pays to use long-term losses to offset short-term gains.

Recent Tax Proposals

Periodically, Washington or various state capitals float ideas about new taxes on investments and investment income.  A perennial favorite is the financial transactions tax.  Another, just introduced by Senator and presidential hopeful Elizabeth Warren of Massachusetts, is a federal wealth tax. I offer a word or two on each, taking the most recent proposal first.

The wealth tax would seem to have a dubious future.  It would burden in particular the many who hold wealth that does not produce ready income, and they especially would resist it.  It is also problematic because it would conflict with real estate taxes, which are a form of wealth tax relied on for revenue by states and particularly towns and cities.  It also poses constitutional questions.  Note that the country had to pass a constitutional amendment to enable the federal government to levy income taxes.  (It used such taxes during the emergency of the Civil War, but by the early twentieth century it became apparent that Washington would need, permanently, additional sources of income; thus the Sixteenth amendment, passed in 1913.)  But the amendment’s text speaks only in terms of income, not wealth.  If it took an amendment to enable the federal government to levy income tax, a wealth tax may well require the high hurdle of another amendment.

The idea of a financial transactions tax has arisen periodically in Washington and, obviously, in New York City–home to Wall Street.  Transaction taxes come in all flavors, but generally they are taxes investors pay whenever they buy or sell a stock or bond (usually a small percentage of the value of the transaction).

Transactions taxes have come and gone.  In the United States, the Revenue Act of 1914 imposed a 0.2 percent tax on stock trading.  Washington doubled it to 0.4 percent in 1932 during the Great Depression and kept it there until it was repealed in 1966.  At present thee are no transaction taxes in the U.S., except for a very small percentage on large futures trades. (More on these in this post.  At last count, some 40 countries have transaction taxes, including Belgium, Finland, France, Greece, India, Italy, Japan, Singapore, Sweden, Switzerland, Taiwan, and the United Kingdom.  Their rationale for these taxes — and for when such taxes are proposed in the U.S . –– includes:

  • The taxes supposedly dampen market volatility by discouraging trading.
  • They curb speculation for the same reason.
  • They offer a fairer and more equitable way to collect taxes.
  • They have little susceptibility to evasion.

Seldom mentioned but nonetheless prominent is that transactions taxes would offer a great source of revenue to government.

Attempts to re-impose the tax in the U.S, whether locally or nationally, have foundered on fears that it could prompt trading to move away from the jurisdiction imposing the tax.  The stock exchange has threatened to leave New York City, for instance, whenever the mayor or the governor in Albany has proposed such a tax.  It would take many jobs and much income with it.  Especially in an electronic age, such a move would face little difficulty.  The same argument has forestalled efforts to impose such a tax at the federal level. So much business has already gone offshore in the so-called inversions in which American firms to secure lower tax rates have incorporated in Ireland and other low-tax jurisdictionsthe politicians fear the same for securities dealing and trading. Still, the proposals return from time to time and every investor should keep informed on the issue..

















The National Debt

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Several readers have asked why the market and just about everyone in authority in government and in business seem so unperturbed by the announcement that the federal government is now some $22 trillion in debt.  One reader, who describes himself as “just another working slob with credit card debt,” adds a little humor and sarcasm to the question:

“For my entire adult life I’ve been listening to Republicans and ‘brilliant’ business mavens warning us: THE NATIONAL DEBT! THE NATIONAL DEBT!  Now they are as silent as mice behind the national wallboard.  I myself lose sleep if my Amex bill is one day late. And here’s the market, climbing to historic highs, as if the national debt was nothing more than some spilled Saltine crumbs on the floor.  What gives???!!!

Good question!   Actually, he asks two questions: one about the hypocrisy of politicians and business people who complain inconsistently about the evils of debt; the other about the size of the debt outstanding and implicitly what it might mean for the economy and its financial markets.

As to the first question, it is only fair to note that the hypocrisy goes beyond Republicans and business people.  It is all but universal.  Republicans and business people say little about the national debt when the latest additions to it come from their own policies –– in this case tax cuts.  In the past, Democrats have decried Republican-based debt, even as they have ignored their own contributions to it.  The only reason Democrats are not pointing at the red ink this time is because their agenda would likewise involve huge additions to debt.  This time, they are arguing not against debt per se but that the increase in debt is in service of the wrong cause.  Republicans and Democrats, always and ever, have sought to further their own interest –– or rather those of their constituents.  Each has used the outcry over debt to discredit the other.

Having pointed this out, it would be useful now to gain some perspective on this huge number.  Twenty-two trillion dollars would certainly make for a daunting Amex bill. It’s a sum that goes beyond what any individual could comprehend, much less deal with.  But, of course, the $22 trillion debt does not belong to any one individual.  It belongs to the entire nation, and our nation has considerable resources.  The $22 trillion differs only a little from the income the United States produces every year.  The country’s gross domestic product (GDP) in 2019 seems set to come in at a little over $21 trillion.  The federal government seems set to take in revenues this year of $3.4 trillion. Theoretically, then, the U.S. –– meaning all of us as a nation (but not the government coffers)––could just about pay off the entire $22 trillion debt in one year if we directed our entire income—the gross national product — to that one purpose.  Similarly, Washington — the U.S. Treasury — would take about 6.5 years to pay it down if it spent the money on nothing else.

Of course, neither the nation nor its government would do such a thing.  Each has other obligations.   But the size of the resources against which the $22 trillion debt stands does take some of the fear out of that otherwise immense figure.  To make it more personal, it might help to think of these relationships as a family that carries a mortgage on its home equal to 5 to 6 times the family’s annual income.  The household can’t dedicate all its income to pay down the debt quickly, much as it would like to, because it has to eat and clothe itself, among other things. But the circumstance of a mortgage of that relative size is hardly uncommon and hardly draws squeals of outrage when it becomes known.

In one respect, the $22 trillion is even less outrageous than the family with the heavy mortgage.  Unlike the family, the government never has to pay off its debt. As individuals who have obligated themselves to pay off the mortgage approach the end of their lifespan, creditors will refuse to lend them money, and they will have to pay down the debt they already have.  But presumably, the country never dies.  As debt comes due, the government can borrow anew and use the new funds to pay off the maturing debt.  It has been doing this for decades, centuries actually.  Because the U.S. keeps growing and thereby expanding the resources available to its government, Washington can always get credit to retire old debt and even expand the amount outstanding.  The huge debts run up to fight World War II, for instance, amounted to 130 percent of the country’s GDP at the close of hostilities, relatively a lot higher than today’s figure.  It all came due in the 20 to 30 years after the war’s end.  Washington paid it off with newly borrowed funds.  It could get the funds because its lenders, mostly the American public and a few foreign governments, could envision America’s continuing economic growth generating the resources necessary to shoulder the new debt.

Problems arise when the growth of debt outstrips the perceived expansion of the resources behind it.  In this situation, creditors would become reluctant to lend, and Washington, instead of continuing to “roll the debt forward,” would then have to repay it.  This is similar to the different borrowing power and inclinations of companies that are growing fast or slowing down. Lenders eagerly line up for a company that is growing at, say, 10 percent a year or better, concluding that such growth makes it easier for management to pay off the debt.  Because the borrowing presumably enables the company to invest the borrowed funds and thus secure continued rapid growth, it makes sense for management to borrow — indeed, a reluctance to borrow would run counter to the company’s interests.  But the opposite is true for a company that is growing slowly.

This is hardly a complete picture of what is an indisputably complex matter, and it in no way suggests that debt is a good thing.  But it may help explain why the market and so many others have resisted the hysteria in the headlines.  They believe — rightly or wrongly — that the tax cuts that have added to the national debt will sustain the country’s necessary growth.



Keeping Track

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A reader asks: How to keep track of all the accounts, taxes due; how to measure progress in meeting financial objectives. I hate administrative tasks myself, so I sympathize with this correspondent’s anxieties.  Here is a walk through a typical year with my advice on what to do when, and what information to have on hand when you are obligated to undertake certain actions.  Some dates on what follows are dictated by federal, state, and local governments. Other dates are arbitrary.  For instance, I suggest calculating your net worth every January.  You could do it at any time, but do it at least once a year.


  • Calculate a personal statement of your net worth. By the third week of January you should have obtained statements from the financial institutions holding any of your savings and investment accounts.  Add the value of these to the value of your other assets, large pre-paid items such as college tuition and the value of your house and car, if you own them.  The total figure is your assets.  Do the same for your liabilities — large expected bills, the amount remaining on the house’s mortgage, and other outstanding debts, including credit card debt.  The difference between your assets and your liabilities is your “net worth.”
  • Review your financial goals. Revisit the plan described in this post.  Write down how your efforts in the previous year have advanced it and then how you will advance it further in the coming year.
  • Create folders for all the financial and tax information you will receive over the coming year so that you will have easy access to this material when you need it, especially at tax time. In particular, you will want to file receipts for business expenses to write off against your taxes. The Internal Revenue Service (IRS) website provides guidance on what expenses do and do not qualify as deductions. irs.gov.
  • Pay off as much credit card debt from the holidays as you can, starting with the card that charges the highest interest rate. You should do this even if it means delaying other purchases, and even if it means interrupting your saving schedule, because no investment offers a rate of gain equal to the interest cost on a credit card.
  • January 15 is a tax date, the last of four for estimated taxes due on income from the previous year. If your employer withholds taxes from your paycheck, you will not need to do much.  But if you run your own business or do freelance employment, you will need to make a payment to avoid an IRS penalty.  Consult an accountant on how much you must pay.
  • Take advantage of post-holiday sales to shop for next year. 


  • Contact any bank or financial institution that has failed to send you statements, because you will need them to file your taxes based on the previous year’s income.
  • Make an appointment with your accountant.  Taxes are due April 15, but having this conversation in February will avoid scrambling at the last minute for needed material.
  • If you expect a tax refund, file early and use the money to pay down credit card or other debt, or put it to work in your savings and investment accounts.
  • February 15 is a tax date. If your child works but will not earn enough to owe any tax, this is the latest date when you can file an IRS form W-4 with his or her employer token that employer from withholding taxes.


  • Finish preparing your tax return (if you did not file in February).
  • Confirm that all colleges and other schools have received your financial aid forms. The deadline for federal student aid varies from school to school, but earlier is always better.
  • Review your property tax bill. Deadlines to challenge it vary depending on where you live, but most allow appeals in early spring.  About half those who appeal win reductions –– on average some 10 percent.  The National Taxpayers Union website, ntu.org, offers guidance here.


  • April 15 is a tax date. Filing on income for the previous year is due to the IRS and to those states that impose state income taxes.
  • April 15 is also when you have to pay the first installment of your quarterly estimated taxes if you are self-employed or if your employer is not withholding at all or is not withholding enough. You should pay these estimated taxes equal to at least 90 percent of what you will eventually owe.  Your February conversation with your accountant should inform this calculation.
  • The 15th of April is also the last date on which you can take care of some previous tax-related business (of which more in an upcoming post) from the year before, for example:
    • funding your Individual Retirement Account (IRA);
    • funding your Keogh or Simplified Employee’s Pension (SEP) plan, if you have self-employment income;
    • paying your IRA fees. (Use a separate check, since this expense is tax deductible.);
    • filing for an extension. (If you and your accountant have failed to get your return in order on time, you are entitled to a six-month extension, which brings you to October 15th.  That is an extension for filing, not for the payment of tax.  You will have to pay estimated taxes together with an extension for filing your return.)
  • If you’re planning to move, try to do so in April.  Moving costs are some 50 percent higher between May and October than between November and April.  Save all receipts if the move is job related.  Many moving expenses are deductible.  For guidance, visit the IRS website, irs.gov.


  • Contact the IRS if by month’s end you have not received any refund due you. Use the refund to pay down credit cards or to invest.
  • Book your summer vacation. This is usually the last month to get reduced rates for early reservations.
  • Because this is otherwise a light month for financial tasks, May might be a good time to take an inventory of your household items and check your insurance coverage.Take pictures of any valuable items.


  • June 15 is a tax date.  If you are self-employed or your employer is not withholding enough, the second installment of your quarterly estimated taxes will be due.
  • June 30 is a filing date.  It marks the deadline to file with the U.S. Treasury if you have a bank or other financial account in a foreign country worth more than $10,000.
  • Meet with your financial advisor to review your investments.  Beginning investors will have little need for such meetings, but for others, this is a good time to review.
  • Have a yard sale to raise more investable cash.  Donate to charity whatever you fail to sell.  Get a receipt from the charity to use as a write-off on your taxes. Guidance on what applies is available on the IRS website, irs.gov.
  • Pay off your credit card so it has room for you to charge items on summer vacation.


  • This is a good month to sell your old car.  Seasonal pricing patterns show that now is a likely time to get a better price.
  • Enjoy a month of financial leisure.


  • Provide children and grandchildren who are going off to college with information on managing their checking account, credit cards, and budgeting.
  • Travel that combines with work may have tax-deductible elements. Keep receipts.  Check with your accountant and/or consult the IRS website, irs.gov.


  • September 15 is a tax date.  It marks the due date for the third installment of your quarterly estimated taxesif you are self-employed or if your employer is not withholding enough.
  • Calculate what your child earned on a summer job and ask your accountant whether your offspring needs to file a return. Again, you can get guidance from the IRS website, irs.gov.


  • October 15 is a filing date for your previous year’s tax return if you received an extension the previous April.
  • October 15 also is the last day to make a Keogh or SEP contribution, if you received an extension last April.
  • With little else pending, this is a good month to review your will.


  • A good month to buy a car.  Dealers have to clear their lots for next year’s models and are inclined to offer good deals.
  • If you have a flexible spending account with your employer, plan to use it now, before the end of the year, because if you don’t use it, it will revert to your employer.
  • Check your credit score and correct any irregularities. You are entitled to do so free once a year.


  • December 31 marks the last day you can set up a Keogh plan for the following year. You have until April 15 to fund it, but you must do the paperwork by Dec. 31.
  • Though you can wait until January 15 to make estimated income tax payments to state governments, you can deduct all or a portion of them from this year’s federal tax if you pay by December 31.
  • You can make cash gifts to individuals, up to $15,000 each without them having to pay a gift tax or suffer any complications on your future estate taxes.
  • Make all charitable contributions before December’s end to receive write-offs on the current year’s taxes. For gifts over $500, the IRS recommends that you receive a letter of acknowledgment from the charity.
  • Arrange, if possible, to push income and bonuses into January to keep them off the current year’s tax liability. You will eventually have to pay taxes on the income, but this way you get the earning power in your investment account for a whole year before you have to pay the tax.


Going Abroad

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So far, these posts have focused largely on American investments and institutions.  But overseas investing offers opportunities that are frequently well worth the risk, although not for everyone.

Why Go Abroad? 

At least half the world’s stocks and bonds are issued outside the U.S.  These offer different opportunities than those in the U.S., and when it comes to diversification, they have unbeatable advantages.  Three points make the case:

  1. Because foreign economies frequently show strength when the U.S. economy shows weakness, investment positions abroad offer diversification that can give your portfolio buoyancy even when U.S. business hits one of its recurring rough patches. Foreign investing, in other words, offers other baskets for your investment eggs.

Note: Though many American firms have considerable overseas exposure, they are not a substitute for holding foreign bonds and stocks.  The stocks of American firms, even those that earn more revenues abroad than at home, such as Coca-Cola, Proctor and Gamble, and Exxon Mobil, still respond mainly to conditions in the U.S.

  1. Often, overseas investments offer the only effective means to gain exposure in certain industries.  If, for instance, you wanted to buy the stock of a large, global engineering firm for your portfolio, you would have to go overseas.  There are publiclly traded engineering firms based in the United States, but only a few do much overseas business and most of those that do are privately owned.
  2. Investing in foreign instruments is sometimes the only way to capture the main competition to American firms. Boeing, for instance, has as its chief competition the European consortium, Airbus. When one of them bests the other for a big contract — say from China Airlines — the loser’s stock drops while the winner’s rises.  Having exposure to both companies eases concerns over which firm will win the next contact and focuses your investments on the far more secure prospect that the world’s airlines will both grow and upgrade their fleets.

What Are Your Options?

Investment professionals classify foreign stocks and bonds into three basic groups:

  • Developed Europe: This includes the United Kingdom, France, Germany, Scandinavia, Italy, Spain, etc.  These economies, because they do a lot of trading with each other, frequently move in concert.  Generally, European countries that have relatively recently emerged from communist rule –– Poland, Hungary, the Czech Republic, and others –– are classified as emerging markets.
  • Developed Asia: Here the classifiers face real ambiguity.  Japan, of course, counts as a developed market.  South Korea, Hong Kong, Taiwan, and Singapore have many well-established financial and economic structures, such as a developed market economy, but many analysts still view them as “emerging,” if well along the way to full development. China, too, is sometimes included in this group, as is India.  What is more, these Asian economies, fully developed or not, depend less on each other than do their European counterparts and thus move less in concert than does developed Europe.
  • Emerging Markets: These include a diverse group, ranging from just about all of Latin America to, among others, Vietnam and Indonesia in Asia; Kuwait, Abu Dhabi, and others in the Middle East; Egypt, Nigeria, and South Africa in Africa, though some consider South Africa as developed. Some analysts make distinctions within this category, referring to the better-established members as emerging and less established members as frontier markets.
  • You may think it strange that the classification system makes geographic distinctions for developed markets but not for emerging markets.  Certainly, some emerging economies have clear geographic biases.  Latin America, for instance, has a particular orientation toward the United States, while the ex-communist countries in Europe share an orientation toward Western Europe.  Some professionals make geographic distinctions on the basis of such orientations. But two critical aspects common to all emerging markets override such geographic distinctions:

1. They are all at an early stage of development, giving each of them the potential for more rapid growth than developed markets.

2. All emerging markets depend for growth and profitability on the developed world’s demand for their products and its willingness to invest in them directly.  As a consequence, all emerging markets, regardless of their location, are subject, often in exaggerated ways, to the positive and negative shifts in the developed economies.

Currency Risk

This is probably the biggest single risk in foreign investing.  Because stocks and bonds bought abroad are almost always denominated in currencies other than the U.S. dollar, an American investor can lose (or gain) simply from fluctuations in currencies.  Take, for example, investments in Germany, where stocks and most bonds are denominated in euros.  Should the euro lose value against the U.S. dollar, your euro-dominated investments, even if they rose sharply, would be worth less in dollars.  Conversely, were the euro to gain against the dollar, those investments would gain dollar value even if they otherwise performed badly. The same risk and potential applies to almost all foreign investments.

For some, this risk is reason enough to avoid foreign investing, and that is understandable: Currency values can swing wildly from one month or year to the next, and they can do so in seemingly unpredictable ways.  However, before giving in to such fears consider these facts:

  1. Investors can hedge currency risk. (More on this in a coming post.)
  2. Currency moves can sometimes cut two ways. Take the earlier example of German investments. If the euro were to fall against the dollar, it is true that the dollar value of euro-dominated investments would fall with it.  But at the same time, a drop in the euro would also give German exports an advantage on global markets by reducing their price in terms of other currencies.  This boost to German business prospects might well raise German stocks sufficiently to offset much or all of the loss due to currency shifts.
  3. A purely domestic portfolio hardly avoids currency risk. To understand why, move the German example just given to the United States.  If the dollar were to rise against the world’s currencies, the holder of a purely domestic portfolio might be pleased for having avoided the currency loss implicit in foreign investments.  But that same investor might face a setback because the rising dollar means an increase in the global price of American products and so puts American producers at a competitive disadvantage. The currency move would also make foreign imports cheaper in the United States and thus put even purely domestic American producers at a competitive disadvantage.

How Much Is Enough?

 Some business school academics have said that because half the world’s assets lie outside the U.S., half your assets should, too.  This would be a mistake.  As with so much else in investing, the right answer depends on your individual circumstances and plans.  Are you investing in order to buy a home in a few years? That relatively short time horizon might preclude you from taking the risk of overseas investments.  But if you are investing for a retirement that is decades into the future, price volatility would present less of a problem compared to the investment’s long-term potential.  Your decision would also hinge on where you want to retire.  If you are thinking of Bali, or Paris, you may want more of your portfolio in those respective markets than if you plan on living your retirement years in Utica, NY.

Because most readers contemplate their future liabilities in dollars, and because of the other risks of investing abroad, few should even consider putting half their wealth overseas.  Generally, the longer time you have before you need the money, the more risk you can afford to take advantage of overseas investment opportunities, and so the more you will place abroad.  As I have said, in the end it will come down to your personal tradeoff between the risks you are willing to take, your circumstances, and your goals.  This is something you may well want to discuss with your broker or financial advisor.

How to Do It

 It is no more difficult to invest abroad than in the United States.  Full service brokers can recommend investments and also buy and sell foreign securities for you.  They will report to you with values stated in the currencies of those countries and also in dollars, using a recent exchange rate.  You can also open a brokerage account overseas.  None of this is very complex––though tax reporting can become cumbersome.  Many foreign companies also are listed on U.S. exchanges in what are called American Drawing Rights (ADRs) or Global Drawing Rights (GDRs).  These actually quote the stock in dollars and give the appearance of trading just like U.S.-based companies.  A box below lists just a few of the many foreign companies trading this way.

Note: Because these ADRs and GDRs quote prices in dollars and seem to trade just like U.S. companies, many investors mistakenly believe that such trades avoid currency risk.  But be aware that their American listing simply converts the price quoted in their currency of origin into dollars at a recent exchange rate. If the dollar’s foreign exchange value rises (or falls), the dollar quote of an ADR or GDR listing will fall (or rise) just as if you held the asset in the foreign country.

Because it is more difficult to obtain research on foreign companies and keep up with overseas events, it is usually wise to delegate the management of these investments to professionals.  Mutual funds can serve this purpose. You can buy into a number of no-load mutual funds with a focus on foreign stocks, just as with domestic investing.  Brokers will not buy you these funds, because they make no commission on the purchase, but they can buy you other mutual funds (of the load variety) and ETFs that specialize in foreign stocks.  Some mutual funds, either the load or no-load variety, tout their security-picking abilities.  As with domestic investing, make sure that you have done a complete review of these funds’ performance record to see if they’re worth their fees.  The marketplace has any number of mutual funds that make no pretense of such abilities, and for a relatively low fee, they will invest your finds in a broad index of stocks in a specific market or region.



Markets and the Shutdown

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With the government shutdown on pause, I received this interesting question last week:

“I’m a young investor, and I’ve never experienced anything like this shutdown before.  And there may be another in 3 weeks!  I see that the stock market seems not to care.  How can this be?  How should I, a thirty-something, think about it?

I can certainly understand this young person’s confusion and concern. During the shutdown and even still, everyone seems very worried about its impact.  Politicians have decried it and bureaucrats have described it as a threat to national security, to law enforcement, and to the nation’s general well being.  Some economists –– though not all –– have predicted that the economy would stall, but the February 1 job reports indicates they were wrong.  The media have run stories non-stop on who was right, who was wrong, and what evils would befall the country if it did not end soon.  But the stock market, as our young questioner points out, seemed little bothered.  The broad-based S&P 500 Stock Index did fall on the first day of trading after the shutdown started on December 22, by about 2.7 percent.  But on balance, it climbed after that.  By the end of 2018, it was up 10.7 percent from its level just before the shutdown began and held those gains right up to the time that the “pause” was announced.

The market’s shrug would seem to have at least four drivers:

  1. Most investors had confidence it would not last.  They have seen quite a few of these over the years, and for all the wringing of hands, the shutdowns all ended without much economic or financial incident.  And even as this one went on longer than the others, investors retained their common sense of the matter.
  2. The impact of the shutdown, its scale, didn’t threaten the economy as much as the media said it would. According to government estimates, some 450,000 workers were either furloughed or had to work without pay.  That is less than 0.3 percent of the country’s workforce.  The economy produced more jobs than that in the last three months of 2018.  Of course, government contractors also missed payments.  Those who depend on government workers and contractors for their business also suffered — victims of what economists call multiplier effects.  Perhaps the 800,000 workers referred to frequently in the media took all these effects into account.  That would have had an economic effect, if the shutdown had continued, but still not the disaster that common rhetoric implied.
  3. However severe or understated the problem was, investors knew that government workers would get their back pay (and contractors would have their invoices honored) when the shutdown ended. What is more, contracted work that was put on hold for the shutdown would resume. All would help the economy spring back.
  4. Investors understood that no issue of real economic or financial significance hung on the outcome. Donald Trump wanted funding for his “wall,” while Nancy Pelosi wanted to thwart Trump.  As much as the country really needs to revisit its immigration laws, that was not likely to occur, no matter how the shutdown was resolved.  Investors understood that no new significant policy would emerge.

If the sides fail to compromise and the shutdown returns, this same analysis will likely prevail again.  There is a possibility that another such event, because it would have no precedent in the memories of most investors, could make them feel that this time things would be different, but the odds do not favor such a reaction. What might change matters is if the dispute takes on more substance than a cynical battle between political heavyweights to see who can pin on the other the blame they both deserve.

And even if something more substantive develops, young people investing in stocks for the long term should have every reason to look beyond this episode and continue their bet on the U.S. economy’s basic growth and its tendency to lift stock prices over time, no matter the fear or distraction of the moment.



More Detail On REITs

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A public official responded to this recent post on real estate investment trusts (REITs) with two pertinent questions: 1) Is it better to buy a specific, open-ended, actively managed REIT or a broad-based REIT index? 2) Is it true that actively managed REIT funds do not track all that closely to the stock market and are less volatile than broad-based REIT indexes?

On the first question, the answer depends entirely on the track record of the actively managed REIT and its performance prospects going forward.  If it has a good track record, if it has consistently outperformed its benchmark index and shows evidence it will continue to do so––for instance, the stability of its staff––then it is generally a better bet than a broad-based REIT index.  But there are two other important considerations:

  1. Actively managed REITs generally charge higher management fees than broad-based index products. Make sure that the better performance more than compensates for the additional fees.
  2. Many actively managed REITs concentrate on particular regions of the country and/or on particular sorts of real estate investments –– shopping malls, for example, or office buildings. If those concentrations are not part of your strategy, then the investment is not for you, however strong it may appear.  If the focus fits, but you also want a broad diversification within real estate, then you might need to buy into several other actively managed funds. Or you could combine a particularly good actively managed REIT with holdings of a broad index product, the one for its outperformance, the other to broaden your exposure.

This second consideration brings us to the public official’s second question.  Yes, actively managed REITs tend correlate less with the stock market than do broad-based REIT index products.  This is because both the stock market and broad-based REIT investments have national exposures, and thus both reflect the health of the U.S. economy.  The same comparison applies to broad-based and narrowly based stock funds.  With a more narrowly based investment, you are implicitly betting on that narrow area over the broader economy.  There is nothing wrong with that strategy, of course, but know what you are doing when you seek to avoid correlation to the broader market in this way.

Investing with an emphasis on stability can offer less volatility even when narrowly focused.  Selecting such an approach or choosing a broad-based portfolio (similar to an index) to dampen volatility will depend on your particular objectives and preferences.  If you’re tempted to go with the narrower, actively managed alternative, be sure to compare its historic volatility record to the stock market or any other relevant comparison point.  And be sure that the calculations show lower amounts of volatility year-by-year over a long period of time, and not just over an unusually favorable period.



Mortgage-Backed Bonds

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Mortgage-backed bonds got a bad name during the 2008-09 financial crisis.  They were a large part of how bad mortgages made by banks infected the entire financial system, threatening the stability and well being of all of us.  Nevertheless, there is nothing particularly dangerous or devious about these instruments.

Essentially, these bonds are a way for investors large and small to participate in the usually superior interest rate returns available to mortgage lenders.  These bonds are created when banks and other mortgage lenders package the mortgages on their books into securities and sell them to investors in the broad bond marketMost of these bonds are divided into subgroups, called tranches.  Each tranche reflects a level of credit risk for that subset of mortgages in the bundle. Whether their underlying mortgages are risky or secure, these bonds effectively pass the payments made by the borrowers who take out the mortgages through to the holders of these mortgage-backed bonds.

You can buy mortgage-backed bonds directly through brokers or through mutual funds.  Some mutual funds specialize in these bonds, while others include them in a broader selection of offerings.  Although such bonds are similar to those described in this earlier post, they can have a special appeal for three reasons:

  1. Because mortgage borrowers usually pay higher interest rates than corporate borrowers, mortgage-backed bonds tend to pay higher yields than other bonds of comparable maturity and quality.
  2. The pass-through arrangements (mentioned above) pay out monthly, providing a more regular flow of income than conventional bonds, which usually pay semi-annually.
  3. Because mortgages pay down the principal on the loan in stages, bond owners also get part of their principal back with each payment, thus enriching the regular cash flow. (Most conventional bonds pay the principal back only when the bonds reach maturity.)  The drawback with mortgage-backed bonds is that there is no further payment of principal at maturity.

These bonds do have one unique risk.  When interest rates fall, many mortgage borrowers will take advantage and refinance.  Just as with bonds that have “call provisions.” Bondholders get paid in full, but they miss the benefit falling rates have on bond prices.  (For a discussion of call provisions and the price effects on bonds from falling interest rates, see this earlier post.)  But even recognizing this drawback, the other advantages of mortgage-backed bonds give them a distinct appeal to many investors.

If you want to hold mortgaged-backed bonds in your portfolio but remain wary because of memories of the 2008-09 financial crisis, you might consider buying Ginnie Mae bonds.  These mortgage-backed bonds are issued by the Government National Mortgage Association on behalf of the Federal Housing Authority (FHA) and the Veterans Administration (VA).  The US government backs them, making them as safe from default as possible, and they pay a slightly higher yield than Treasury bonds.  You can buy them directly from the US Treasury or through a broker in units of $25,000. Alternatively, you can buy into mutual funds that specialize in Ginnie Maes.