Interest Rates and the Fed

Due to the financial crisis that began in 2008, interest rates are at extremely low levels. The Federal Reserve has currently set the fed funds rate at between 0 -.25% and this level is expected to be maintained for “an extended period.”

This low-level of interest rates, along with current and future levels of government expenditures, has led many investors to question or consider the impact this will have on future inflation rates.

A member of the Federal Reserve Board of Governors, Kevin Warsh, wrote an Opinion column that was published in the Wall Street Journal on September 25, 2009. He stated that long-term inflation expectations are stable and an economic conditions are likely to warrant exceptionally low level of interest rates for an extended period of time.

He then focused on the future. He stated that “we are at a critical transition period,” of an unknown duration and that “we must prepare diligently for an uneven road race ahead.” What he was beginning to address was how the Federal Reserve would increase interest rates in the future, to avoid inflation rates to rise to levels higher than desired.

In the past, when the Federal Reserve would increase interest rates, it has at times done this in .25% increments every few months. His comments indicate that once the Federal Reserve anticipates that it is the appropriate time for such an increase in interest rates, this may not be the pattern that they implement. He stated “that prudent risk management indicates that policy likely will need to begin normalization before it is obvious it is necessary, possibly with greater force than is customary…”

While the raising of interest rates may not occur for a while, we view these comments as positive. As the Federal Reserve had to act creatively during the inception of this crisis, the implication of these comments is that they will attempt to be proactive and take action to avoid much higher than normal levels of inflation in future years.

We cannot anticipate or predict future interest rates. In the structuring our fixed income portfolios, we purchase what is referred to as a laddered portfolio, which means that we will buy securities over a somewhat even period of time, rather than placing a significant bet as to how and when interest rates will change. Further, as appropriate to a specific client, we have been investing for a number of years in both TIPS (Treasury Inflation Protected Securities) and commodity mutual funds, both of which provide hedges against significant rises in inflation. We have been investing in both of these asset classes for a number of years and feel that they should be included in most investors portfolios.

Social Security: No 2010 Increase?

Preliminary estimates indicate that Social Security recipients may not receive an annual increase, when payment figures are released for 2010.

Social Security payment increases are based on annual inflation. Currently, the federal formula for inflation reflects negative inflation for 2009, so there would not be an increase when the government decides on the 2010 change. It is possible that the government may evaluate this situation and make a change in the rules, as many of the real costs that recipients incur have increased. The major reason that the 2009 inflation factor is negative is the significant decline in the price of oil from 2008 to 2009.

This is a further update to a June, 2009 post, which predicted the same trend.

Good Decision. Good News.

The reappointment today of Federal Reserve Chairman Bernanke by President Obama is clearly good news, for the country and the worldwide financial markets.

While some of his decisions can be criticized, Bernanke has shown decisiveness and creative thinking in trying to deal with the unprecedented financial challenges of the past 2 years. His background and studying of the Great Depression has proved to be fortunate for the country, as this valuable learning of prior historical lessons has been the foundation for his policy making.

A change in Fed leadership at this time would have clearly been detrimental to the financial markets, at least in short run. Bernanke has well earned the continuity of a second term and it provides for stability in the leadership of the financial markets, which is of utmost importance.

Here Comes the Judge…Against the Wrong Fund?

The Supreme Court will soon be hearing a case involving Harris Associates, Inc. (advisory firm of the well respected Oakmark family of mutual funds), due to shareholder litigation over the mutual fund expenses charged by these funds.

This is an important topic, as many mutual funds charge fees that we think are way too high. For example, for US stock mutual funds that we generally use, the expense ratios are .10% – .40%, depending on the type of fund. Industry averages for comparable funds are usually between 1.00-1.50%. Thus, our clients may be paying 1% less in mutual fund fees than an industry average fund, not including our advisory fee.

This case going to the Supreme Court may be good, from the standpoint that it may raise awareness of how expensive so many mutual funds are (which most investors are not even aware of). However, it is unfortunate that the case is being brought against the Oakmark family of funds, as their expense ratios are at the lower end of the range, near 1.10%. There are many fund families that charge much higher fees, in addition to front or back end loads (sales charges).

Part of our investment philosophy is to control whatever costs that we can control. We cannot control the direction of the stock market, but we can control the expense ratios for our clients, by our selection of mutual funds with lower costs. Utilizing very low cost mutual funds, without sacrificing investment performance, is a win-win for our clients.

When we meet with new prospects, one of the things we do is to perform a “portfolio analysis” of their current investments, which includes reviewing the costs of their existing investments. We feel it is important for clients to understand all the fees they are paying and recognize that their current investments may have far higher annual costs, which they are not aware of. This is frequently an eye opening experience.

For the mutual fund industry, this Supreme Court case may become an eye opening experience!

Resources and Readings

Note: These titled posts (“Resources and Reading“) are intended to be informative and helpful, of items I have read or seen. I am not taking political positions, just providing the reference to something I’ve seen that I consider worthwhile, about the current affairs of our country and the world, which you may find informative or helpful.

Tom Friedman, New York Times: He has been traveling in Pakistan, Afghanistan and near Iran in recent weeks. His series of articles on these experiences have been clear, short and highly informative articles about what is going in in those parts of the world. Very valuable reading. Columns dated from around July 20th – ? (he is still in that area).

Health Care Reform: status changes daily, so I have not posted about this or the tax implications, as they would be outdated within a day of the post. However, for a timely explanation of the current status/stalemate, see Paul Krugman in NY Times (7/27/09) and Robert J. Samuelson in the Washington Post (7/27/09). Krugman is clearly a liberal and in favor of reform of some type. His article I cited is a good update on the current status of the Democratic party in-fighting.

Spotted in Sports Illustrated, 7/27/09, page 16: “In an ad on the (Detroit) Lions’ website for streaming video of old games, fans of the team, which went 0-16 last year, were exhorted to RELIVE THE 2008 SEASON.” Why??

We Are Pleased to Announce….

We are pleased to announce that Wasserman Wealth Management, LLC was named as the second largest Wealth Management firm in Michigan which is affiliated with a CPA firm and has a CPA within the wealth management firm. The rankings, based on the above criteria and assets under management as of December 31, 2008, were published in the July, 2009 issue of Accounting Today.

We thank our clients for their loyalty in helping our firm grow.

And now for the legal disclosure:

The ranking may not be representative of any one or all of Wasserman Wealth Management’s clients’ experiences because the rankings reflect only the size of the firm. Past performance is not a guarantee of future results. Investments involve risk, including the risk of loss of principal.

Gadgets and Things

I thought I would write about something different…the technology that I use and my firm uses. If you have any questions or would like more information about any of the following, let me know.

I would be the last person someone would have described as a techie a few years ago, but am now incorporating many different types of technology in many business and personal parts of my life.

Amazon Kindle: This is an electronic book reader, and more. With this device, almost any book can be instantly downloaded electronically to the reader, anywhere in the country. It eliminates carrying many books on trips and you can always have something to read with you (was a great way to read the Buffet biography, which was 1,000 pages plus). I also use this to read trade magazine articles. My office emails selected articles directly to the Kindle, so that they can be read whenever I want to. Books can be sampled, so I can read a chapter or two to learn what the general concept of what an author is saying (great to learn Tom Friedman’s latest thinking). Magazines are also available. I currently subscribe to Atlantic Monthly and Newsweek for a fraction of the print versions.

iPhone: I have to give credit to my son for encouraging me to get this phenomenal device. It is so much more than a phone and iPod. I download podcasts of many types; news and interviews, Leimberg Services (tax, financial and estate planning updates), technology updates and more.

A big hit for the iPhone are the “apps” which are available. I’m not much of a gamer. My apps include Toodledo (tasks, to do list management), iFitness (workout information, data collection, design your own exercise program), and Grocery IQ (learned about this from a recent NY Times article and it is amazing!). Amazon’s website can be accessed and my Kindle can be read from the iPhone.

Voice Dictation Software: In the office, I use “Dragon Naturally Speaking” to “write” letters, emails and sometimes, these posts. It is an incredible time-saver and the technology seems to be steadily improving, meaning the program is able to more accurately type what I’m saying. If you “write” a lot, you may find this very valuable.

Cash or Credit? You may be very surprised

You pull into gas station. The price is $2.45 per gallon to pay by credit card or $2.35 for paying in cash. What do you do? How do you pay?

Most of us have gotten very used to paying for gas by credit card, almost exclusively, in recent years. In the past few months, gas stations have started to charge a $.10 differential between paying by cash or credit card. I have a feeling that most people are continuing to pay by credit card, because that is what they are used to doing.

Like our approach to investing, before you pay at the pump, you should consider the evidence and make a rational decision. The additional $.10 charge to pay by credit card, at current gas prices, is a premium of 4%. So by using your credit card, it is costing you 4%.

Even if you are participating in almost any type of credit card reward program, you will probably not be able to recoup anywhere near this 4% added cost. Thus, you will save money by paying in cash and not by paying with your credit card.

This may require a change in what you are accustomed to doing. But rationally, it is the correct strategy.

For readers of this blog who are not currently clients of our firm, this is similar to an investor who has been using a traditional brokerage firm (and their “strategies”) and has not considered the academic evidence that supports our investment philosophy. They are used to what they’ve been doing and they are comfortable with it. It may not necessarily be in their best interest, but they haven’t considered an alternative strategy.

So the next time you fill up your tank, think about your choices…. and hopefully you’ll make the rational one.

Thoughts About Oil

Various thoughts and information about the price of oil and it’s impact:

  • Prices of a barrel of crude oil:
  • One year ago: $136/barrel
  • February 2009: $45-50/barrel
  • Early June, 2009: $73/barrel
  • July 8, 2009: $61/barrel
  • In another example of the unpredictability of the financial markets, the price of crude oil has dropped for 6 straight days, declining by 16% during these 6 days. That is a huge change. I don’t think that two weeks ago, anyone would or could have predicted this steep decline over such a short time period. The lesson for investors should be that you cannot predict the future accurately (and then try rely on these predictions for investment decisions).
  • The steep decline was partially a reaction to the increase in unemployment figures that were released last week. The thought was that if more people are unemployed and companies are not hiring, there will be less demand or use of oil in the future. Based on supply and demand basics, with less anticipated demand, the price would go down.
  • However, the drop in the price of a barrel also means that gas prices will go down. For our economy, this is good. Consumers will have more to spend on things other than gas. The cost that companies will incur will also be less, which is good. The downside to reduced oil prices is that reduces the movement towards more efficient vehicles and investments in alternative energy.
  • Other interesting items:
  • Saudi Arabia cut the official price for exports to the US on Sunday. The Wall Street Journal indicated that this would mean more oil being shipped from Saudi Arabia to the US.*
  • OPEC future demand estimates have declined. They predict a decline in 2030 oil usage to 105 million barrels a day, which is an 8 million barrel decrease from the same estimate a year ago (a 7% decline).*
  • OPEC’s demand forecast for 2013 also dropped by 5.7 million barrels a day. *

* Wall Street Journal, Oil’s Rational Retreat, July 8, 2009

College Financial Aid Form Simplication Coming

The U.S. Department of Education announced recently that the Free Application for Federal Student Aid (FAFSA) will be shorter in length and more user friendly. The government uses this application to determine a student’s eligibility for financial aid, as well as, most colleges use it to gauge a student’s financial needs.

The Department of Education has promised to reduce the number of questions by 25% and to reduce the online screens from 30 to 10. The changes to the form include eliminating questions that don’t apply to a specific student, providing quicker estimates and streamlining information from the IRS. Some of the changes are currently in place with the rest to follow over the next few months.

Beginning in January, students will have easier access to income information from the IRS when applying on-line (which 98% of students do) for the spring semester. The goal is for tax return information to be downloaded from the IRS to the FAFSA form, which will save time and increase accuracy.