Author: tomatpwa

Starting Salaries

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A lot goes into figuring out what you want to be when you grow up. Money is far from everything, but it’s definitely a factor, especially if you know you’re going to be graduating with a substantial amount of student debt and need an income that will allow you to pay it back. For all the parents out there reading this, payscale.com ranks college majors by median starting salary and gives an indication of median mid-career salary as well (list included below for your reference). No surprise in that engineering, math, and science dominate the top of the list. Also on their site, you can find the Best Schools By Major, Best Schools By Region, advice on choosing a major, and a copious amount of other information. Check it out as just one more resource to help coach college bound seniors and younger children to make important choices that may determine their career, earning potential, and happiness in adulthood.

RANK MAJOR STARTING SALARY MID-CAREER SALARY
1 Petroleum Engineering $103,000 $160,000
2 Actuarial Mathematics $58,700 $120,000
3 Nuclear Engineering $67,600 $117,000
4 Chemical Engineering $68,200 $115,000
5 Aerospace Engineering $62,800 $109,000
6 – tie Electrical Engineering (EE) $64,300 $106,000
6 – tie Computer Engineering (CE) $65,300 $106,000
8 Computer Science (CS) $59,800 $102,000
9 Physics $53,100 $101,000
10 Mechanical Engineering (ME) $60,900 $99,700
11 Materials Science & Engineering $62,700 $99,500
12 Software Engineering $60,500 $99,300
13 Statistics $52,500 $98,900
14 Government $43,200 $97,100
15 Economics $50,100 $96,700
16 Applied Mathematics $52,800 $96,200
17 Industrial Engineering (IE) $61,100 $94,400
18 Management Information Systems (MIS) $53,800 $92,200
19 Biomedical Engineering (BME) $59,000 $91,700
20 Civil Engineering (CE) $54,300 $91,100
21 Environmental Engineering $49,400 $89,800
22 – tie Construction Management $51,500 $88,800
22 – tie Mathematics $49,400 $88,800
24 Electrical Engineering Technology (EET) $57,900 $87,600
25 Computer Information Systems (CIS) $50,800 $87,400
26 Information Systems (IS) $51,900 $87,200
27 Finance $49,200 $87,100
28 International Relations $41,700 $85,700
29 Geology $46,100 $85,300
30 – tie Chemistry $44,100 $84,100
30 – tie Information Technology (IT) $49,900 $84,100
32 – tie Biotechnology $48,700 $84,000
32 – tie Mechanical Engineering Technology (MET) $54,100 $84,000
34 – tie Supply Chain Management $52,800 $83,700
34 – tie International Business $43,800 $83,700
36 Industrial Design (ID) $44,800 $82,200
37 Industrial Technology (IT) $50,800 $81,500
38 Telecommunications $43,100 $81,200
39 Food Science $45,200 $80,500
40 Occupational Health and Safety $50,500 $80,300
41 – tie Biochemistry (BCH) $42,900 $80,200
41 – tie Marketing Management $42,100 $80,200
43 Civil Engineering Technology (CET) $49,200 $79,700
44 Advertising $40,000 $79,400
45 Philosophy $39,700 $78,300
46 Marketing & Communications $40,200 $77,600
47 Fashion Design $39,400 $77,100
48 Political Science (PolySci) $41,700 $77,000
49 Linguistics $39,700 $76,800
50 Molecular Biology $40,400 $76,400
51 Architecture $41,900 $75,800
52 Accounting $45,300 $74,900
53 Agriculture $38,500 $73,600
54 Microbiology $40,800 $73,400
55 Global & International Studies $39,600 $73,200
56 Urban Planning $41,100 $72,200
57 Nursing $55,400 $71,700
58 Environmental Science $41,300 $71,500
59 English Literature $40,800 $71,400
60 – tie Business Administration $43,500 $71,000
60 – tie History $39,700 $71,000
62 Film Production $38,200 $70,900
63 Biology $40,200 $70,800
64 Health Sciences $38,400 $70,500
65 Hotel Management $40,600 $69,800
66 Communication $40,000 $69,600
67 Forestry $40,000 $69,400
68 American Studies $41,400 $69,000
69 Broadcast Journalism $32,700 $68,800
70 Landscape Architecture $41,200 $68,700
71 Speech Communication $39,400 $68,100
72 Journalism $38,100 $67,700
73 Zoology $37,400 $67,600
74 Geography $40,800 $67,200
75 Public Administration $40,600 $66,900
76 French Language $40,900 $66,700
77 English Language $38,700 $65,200
78 German Language $41,400 $65,000
79 Human Resources (HR) $38,800 $63,900
80 Public Relations (PR) $37,400 $63,300
81 Hospitality & Tourism $35,700 $62,600
82 Humanities $37,900 $61,800
83 Anthropology $36,200 $61,400
84 Multimedia & Web Design $41,600 $61,300
85 Psychology $36,300 $60,700
86 – tie Medical Technology $48,900 $60,500
86 – tie Liberal Arts $36,600 $60,500
88 – tie Kinesiology $35,600 $60,400
88 – tie Visual Communications $37,300 $60,400
90 Organizational Management $41,900 $60,300
91 Interior Design $36,000 $59,300
92 – tie Nutrition $41,300 $59,100
92 – tie Fashion Merchandising $39,100 $59,100
94 Art History $36,900 $59,000
95 Sociology $37,400 $58,800
96 – tie Health Care Administration $39,300 $58,600
96 – tie Theater $36,200 $58,600
98 Criminal Justice $35,300 $58,400
99 Radio & Television $37,900 $58,300
100 Fine Arts $37,400 $58,200
101 Religious Studies $34,900 $57,900
102 Sports Medicine $39,300 $57,400
103 Art $36,100 $57,100
104 Classics $38,700 $57,000
105 Dietetics $44,200 $56,600
106 Public Health (PH) $35,900 $56,500
107 – tie Physical Education Teaching $34,900 $56,300
107 – tie Drama $35,600 $56,300
109 Graphic Design $37,000 $56,000
110 Photography $36,200 $55,500
111 Sports Management $37,000 $55,400
112 – tie Education $37,400 $55,200
112 – tie Animal Science $33,600 $55,200
114 Social Science $37,300 $54,800
115 Interdisciplinary Studies (IS) $37,600 $53,400
116 Paralegal Studies $35,000 $53,000
117 Theology $34,000 $52,200
118 Recreation & Leisure Studies $35,000 $51,900
119 Music $35,700 $51,400
120 Culinary Arts $34,800 $51,100
121 Exercise Science $32,600 $51,000
122 Horticulture $35,200 $50,900
123 Biblical Studies $35,400 $50,800
124 Special Education $33,800 $49,600
125 Human Development $35,900 $48,000
126 Athletic Training $34,800 $46,900
127 Social Work (SW) $33,000 $46,600
128 Elementary Education $32,200 $45,300
129 Child & Family Studies $30,300 $37,200

IRS Updates Key Tax Numbers For 2014

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The IRS released its 2014 inflation adjustments yesterday. Some key takeaways:

· All tax brackets increased by ~1.7%, meaning that you’ll pay slightly less tax given the same amount of taxable income in 2014.

· The maximum allowed employee contribution to a 401k remains the same at $17,500 (+$5500 if over age 50)

· The total contribution to a 401k plan (employee + employer combined) increases from $51k to $52k.

· The maximum income allowed to be considered for defined contributions plan matches, profit sharing, etc. increased from $250k to $260k.

· The Standard Deduction amounts increased slightly to $6200 single (S), $12,400 married filing jointly (MFJ)

· The Personal Exemption increased to $3950 per family member from $3900.

· The Social Security Wage Base increased to $117,000 (this is the amount of your income that is subject to the 6.2% employer and employee social security tax).

· The Annual Gift Tax limit stayed the same at $14,000.

· The Lifetime Gift/Estate Tax Exemption increased to $5,340,000.

· The maximum allowed contribution to a Health Savings Account (HSA) increased to $3300 for single coverage, $6550 for more than one covered person.

· The Traditional IRA / Roth IRA contribution limits remained the same at $5500 (+$1000 additional if over age 50)

· The Roth IRA contribution income limits increased. The $5500 contribution begins to phase out at $114k and is eliminated completely at $129k of AGI for singles. It’s $181k and 191k for joint filers. Note, there still are no income limits on converting to a Roth IRA from a Traditional IRA.

· Itemized Deductions and Personal Exemptions begin to be limited if AGI exceeds $254,200 for singles and $305,050 for joint filers. Personal exemptions are reduced by 2% for every $2500 of AGI over that threshold. Itemized deductions are reduced by 3% of the amount that AGI is over that threshold.

· The income limits for being able to deduct up to $2500 of student loan interest start at $65k S and $130k MFJ. The deduction is completely phased out at $80k S and $160k MFJ.

· 2014 IRS Mileage Rate updates have not yet been released.

As always, you can find all tax brackets and key tax numbers listed on the Resources section of the PWA Website.

New Rule For Healthcare Flexible Spending Accounts

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The IRS announced yesterday that it is relaxing the rules around the use-it-or-lose-it “feature” of healthcare flexible spending accounts (FSAs). Plan sponsors will now be able to all plan members to rollover up to $500 of unspent FSA dollars into the following year’s FSA. Currently, any money not used during the plan year would be forfeited, though most plans do have a grace period that allows until 3/15 of the following year to zero out balances before forfeiture. Starting with the 2013 calendar year, plan sponsors can now choose whether to:

  1. Implement the new $500 rollover rule OR
  2. Maintain the grace period rule that extends the deadline for using a year’s FSA funds until 3/15 of the following year OR
  3. Neither

It is up to the employer (plan sponsor) to set the rules for the given plan. Since 2013 is almost over and most plans already allow the grace period rule, I suspect few plans will be changed for the 2013 plan year to allow the new rule. It is possible that plans may be updated to the new $500 rollover rule for 2014. If you’re going through your Annual Benefits Enrollment, plan to use a healthcare FSA, and have not received any direction form your employer as to whether or not they plan to implement the new rule, please contact your HR representative and ask.

Full text for the rule change can be found in Notice 2013 -71 on the IRS Website.

DC Crisis Averted

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I don’t usually like to call the result of a game before it’s over.  But in this case I’m confident saying that the deal reached in the Senate today, which does nothing other than re-open the government through 1/15/14 and extend the debt limit to around 2/7/14, is a done deal.  The Senate is expected to vote around 6pm tonight (80+ will vote yes) and the House will vote a few hours later (I’d guess at least 65% will vote yes).  The President will likely sign the bill tonight, reopening the government by morning.

The crisis that never really was a crisis has been averted, miraculously (HA!), one day from the reported deadline.  Fear-mongering, yet again, served no purpose other than ratings and scaring people into making terrible financial decisions.  As I’ve been saying all along, there was a 0% chance of default or any permanent damage to the economy that would result from it.  Minor, temporary damage has been done though shaking the confidence of businesses and consumers, but we’ll recover from that.  However, nothing has been done to pass a budget and make the country’s long-term fiscal situation sustainable.  Over the next 3 months, which will include time off for holidays, Congress has to make some progress, or we’ll be right back in the same situation again with another “crisis” to start 2014.  We’ll see what they come up with.

For now, back to business as usual with the hopes that the last few days don’t become the new business as usual.

***Update, 11pm eastern time***

Senate passed bill 81-19 (I predicted 80+).  House passed bill 285-144 (66.4% vs. my 65%+ prediction).  Obama to sign momentarily.  Government will be open in the morning.  Debt limit extended to 2/7.  25 hours to spare from their 10/17 deadline.  Congress is getting better at this!

Quick Update On Debt Ceiling

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For those not following via Twitter, here’s what I posted today:

4pm: The storm before the calm is building in DC. Gotta take the country to the brink so they can be heroes in bringing it back.

4pm: I’d say we’re two plans away from having a plan to pass a bill that sets guidelines for developing a plan before the next deadline #cankick

7pm: Another failed plan in the House. I think we’re one away from real deal now (with little substance but will avert the “crisis”)

Still confident a deal will come right before it has to (and that’s not 10/17 as is being reported), and the US will not default on its debts.  As I’ve been saying, the result would be so catastrophic, that no one in Congress will let it go that far and the President / Treasury will use all possible measures to make sure it doesn’t happen.  Fitch ratings agency put the US on credit watch negative meaning there’s risk that they would downgrade the US Debt in the future.  Immediately after, the orchestrated response was released by Treasury explaining how Fitch’s actions demonstrate the gravity of the situation.  Everyone knows this will get resolved, but the fear-mongering will continue in the press for the next few days.

What happens beyond the agreement is a potential issue.  Further short-term agreements, followed by a “crisis”, a shutdown, a threat of default, and then a kicking of the can again in another short-term agreement, will cause a broad loss of confidence in the US government and financial system.  If we keep managing “crisis” to “crisis”, we will eventually be faced with a CRISIS.  We’re not there yet, but it’s not that far off if this continues.

If you’re not following via Twitter, I encourage you to do so as I’ll post short bursts of relevant news or a quick thought here and there.  @TomAtPWA.

US Debt Default

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More political posturing today as President Obama and House Speaker John Boehner both had press conferences to say pretty much exactly what they’ve said for the past two weeks. They’re saying it louder and more sternly each time, giving it full grandstanding effect. Obama won’t negotiate unless Republicans pass a Continuing Resolution and raise the Debt Ceiling, which is like asking them to leave all their chips outside of the poker game. Boehner won’t allow a clean Continuing Resolution or Debt Ceiling bill to be voted on in the House, even though they would almost certainly pass, without some negotiation on spending reductions or Obamacare concessions attached to it. In other words, they have a complete standoff.

I expect more of the same for another week or so, but I don’t think the sands running out of the hourglass come with a proportional increase in the chance of a US debt default. Since there is virtually no chance that a resolution will be reached until the last minute (likely a few minutes after the last minute), the probability of non-resolution should not increase as time passes. Financial markets don’t believe there will be a debt default. Countries, companies, and individuals continue to lend money to the United States at absurdly low rates (essentially 0% for a year, 1.4% for 5 years, 2.6% for 10 years, and 3.7% for 30-years!!). The chart below shows credit default swaps (CDS) on five-year treasuries in basis points. CDS pay out in full in the event of a default. 41 basis points means that people are paying 41 cents for protection on $100 of treasuries implying a four tenths of one percent (e.g. negligible) chance of default over the next five years. While slightly elevated from a few weeks ago, 41 basis points is actually about the average over the last four years, and still substantially lower than the 65 basis points during the 2011 debt ceiling “crisis”. Today, even after the grandstanding, those same CDS actually traded down to 37 basis points.

I’m not worried about a default, just like financial markets aren’t worried about it. I’m not worried about 11:59pm on October 17th either, because that is not the exact moment that a debt default would happen if the Debt Ceiling isn’t raised (ironically, the govt. shutdown has slowed spending for the last week, so there should be a bit more wiggle room). I’m confident the debt ceiling will be raised just before it needs to be raised. I really only worry about self-fulfilling feedback loops that occur in a negative direction (like the death spiral that occurs when businesses layoff workers in mass which results in less spending in aggregate in the economy which results in lower profits which results in more layoffs). I don’t worry about those things that provide a self-regulating effect. In this case, any increase in the probability of default would lead to an increase in the probability of politicians being held directly responsible for another deep recession, which leads to the sudden ability to be rational, compromise, and save their future jobs.

The stock market will continue to be jittery as program trading, momentum trading, and day trading dominate day-to-day volume and direction of movement. I have full faith that there will be no default and no permanent damage to the economy. When that becomes certain, the economy in aggregate, the actions of the Federal Reserve, and the profitability of individual companies will once again dominate the way the market is valued. I’m not making any changes to client portfolios or asset allocation models in general as result of the debt ceiling / continuing resolution “crisis”. As the old proverb states, this too shall pass.

Obamacare Exchanges To Open 10/1

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The healthcare exchanges that were created under the Affordable Care Act (more commonly known as “Obamacare”) are due to open tomorrow, October 1st, 2013. Through these exchanges, anyone who wants to purchase health insurance, should be able to purchase it from a health insurance company, with coverage to begin on 1/1/14. To access the exchanges and a host of additional information around how the exchanges will function, go to www.healthcare.gov. That portal will contains links to the Federal exchange as well as links to the State exchanges in the case that you live in one of the states that have set up their own exchange. The 36 states that will use the Federal exchange are: Alaska, Alabama, Arkansas, Arizona, Delaware, Florida, Georgia, Iowa, Idaho, Illinois, Indiana, Kansas, Louisiana, Maine, Michigan, Missouri, Mississippi, Montana, North Carolina, North Dakota, Nebraska, New Hampshire, New Jersey, New Mexico, Ohio, Oklahoma, Pennsylvania, South Carolina, South Dakota, Tennessee, Texas, Utah, Virginia, Wisconsin, West Virginia and Wyoming. All others, including Washington, D.C. will have their own exchange. The portal will guide you to the right place.

The exchanges will have plans grouped into the following 4 coverage tiers: Bronze, Silver, Gold, and Platinum. All plans must provide essential health coverage including prescriptions, preventive care, doctor visits, emergency services and hospitalization. The characteristics of each plan will fit the general model under one of these tiers so that those exchanges that have multiple insurers providing coverage can present apples-to-apples comparisons among those plans, but some insurers may offer additional coverage in certain areas (e.g. physical therapy). Bronze plans will generally be the lowest cost plan from a monthly premium perspective, but will be the highest cost from an out-of-pocket perspective if you need non-preventative care. Platinum plans are the opposite, with Silver and Gold fitting in between. You can expect a Bronze plan to cover about 60% of out-of-pocket costs after a deductible, Silver to cover 70% after a lower deductible, Gold to cover 80% after a still lower deductible, and Platinum to cover 90% after a low deductible.

The insurers themselves will provide a quote for the monthly cost of coverage based on some basic information that you provide. It’s important to note that pre-existing conditions are not a consideration for coverage or for the cost of coverage. There are a number of other government imposed rules, like not being able to charge older applicants an unreasonable amount more than younger applicants, that influence pricing. Of course the biggest influence, in theory, is that the insurers will be competing with each other for the business.

Once pricing for an applicant is determined, potential Federal subsidies could apply and reduce the cost of the monthly premiums. If you fall under 4x the Federal poverty level for the size of your family (~$46k for individuals + $16k per additional family member), you’ll usually qualify for a subsidy. You’ll have to estimate your income for the following year in order to receive the correct subsidy. If you estimate your income will allow you to qualify, but then your income is actually higher and you don’t qualify, this will be reconciled on your tax return and you will wind up paying back the subsidy amount. Kaiser has a calculator that can help estimate your subsidy.

On the other side of subsidies, those who opt not to purchase insurance and who are not covered by another plan (e.g. an employer-sponsored group plan), will face a penalty starting in 2014 at $95 or 1% of household income, whichever is higher. By 2016, it rises to $695 per individual or 2.5 percent of household income, whichever is greater. This is known as the “Individual Mandate”. The penalty will be paid as a tax when filing your tax return if you can’t prove that you have coverage.

In general, the exchanges will benefit those who are older, have income below the subsidy threshold, have pre-existing conditions, and/or don’t have employer-provided coverage. Most people fall into one of the following four groups as it pertains to health insurance, so I’ll divide the rest of this message accordingly. If you:

1) Have coverage through a large employer’s group plan – you are welcome to shop the exchanges for better or cheaper coverage, but are unlikely to find it. Large employer’s usually provide heavy subsidies for the cost of group insurance that makes that insurance cost less than the individual policies that you’ll find on the exchanges. Still, it doesn’t hurt to look and see what’s out there.

2) Have coverage through a small employer’s group plan or through your spouse’s or parent’s employer’s group plan – since small employers usually provide less of a subsidy for group plan, and many employers, regardless of size, provide less of a subsidy for spouses and dependents, the exchanges could provide a better option for you. Again, it doesn’t hurt to look and you might be surprised to find a better plan, especially is your income is below the subsidy threshold.

3) Have individual or family coverage that is purchased directly through an insurer (not a group plan) – you should definitely re-shop your insurance needs on the exchange. It’s similar to having a website that aggregates all auto insurance information for you so that you can compare between insurers. You’re likely to find a better deal than you’re getting today, especially if you’re over age 50 and have an income below the subsidy threshold. Note that there are no subsidies for individual or family policies that are purchased off-exchange.

4) Have no coverage – if you don’t have coverage because you have a pre-existing condition or because you can’t afford it, you’ll almost certainly benefit from the exchanges and should shop them during the open enrollment period. If you don’t have coverage because you have chosen not to have it, then you’ll need to compare the cost of the tax penalty for not having coverage with the cost of coverage you can obtain from the exchanges. While it may be cheaper to maintain no coverage and pay the tax penalty, when you consider the potentially catastrophic exposure to medical bills, I have to think you’re almost certainly better off with the insurance.

Again, www.healthcare.gov is the starting point for all of this. Expect a few technical glitches in the system over the first few days / weeks, but remember that coverage doesn’t start until 1/1/14 and open enrollment lasts until 3/31/14, and can be extended by certain life events after that date.

Here We Go Again… But Not Quite

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As you all know by now, there’s a chance that the Federal government will be shut down as of midnight tonight due to lack of authority to fund it. This lack of authority comes from the fact that there is no budget and the law that allows Congress to temporarily continue to spend without a budget (known as the Continuing Resolution) is expiring. Just to be clear, markets continue to provide the Federal government with virtually any amount of financing they want/need to run the country. Obtaining money IS NOT an issue. This shutdown would be strictly due to Congress’s inability to pass a law to permit themselves to continue to spend money. It really is silly, no matter what side of the aisle one supports, but it’s the way our country works.

I’m not as confident in this getting resolved in time as I was in the Fiscal Cliff getting resolved at the 11th hour last year. However, here we’re not talking about laws that would dramatically change without action as we were with the Fiscal Cliff. We’re talking about the Federal government’s ability to perform its non-essential tasks temporarily. They’ve already indicated that all essential tasks, including those related to public safety, will go on even without a Continuing Resolution. The government has shut down numerous times in the past with negligible impact (to the point that most people don’t even remember the prior shutdowns). As long as a Continuing Resolution is passed at some point in the next few days or even weeks, there will be little to no lasting impact beyond the clear demonstration to the world, to businesses, and to individuals that our government has become inept.

Coming up shortly after this Continuing Resolution debate will be the Debt Ceiling debate. On or around October 17th, the Treasury will hit the current legal debt limit and will be unable to borrow money to fund the operation of the government and, more importantly, to make interest payments on its outstanding debt. Again, a government shutdown probably wouldn’t have a big impact as long as it only temporarily impacts non-essential services. Missing an interest payment, however, would have serious ramifications to the economy and global financial markets. In the order of increasing impact hitting the Debt Ceiling would:

  • Threaten the full faith and credit of the United States as lenders may consider the fact that we don’t make timely payments on our debt and may hesitate to lend us money in the future or demand higher interest rates in order to lend that money. I’d say this is a fairly small issue overall, as the U.S. Dollar / U.S. Treasuries are still going to be considered the strongest and safest place to put money.
  • Indicate how dysfunctional our government has become when it comes to problem solving, perhaps threatening confidence in U.S. growth and long-term solvency, especially considering the fiscal issues that need to get resolved in the coming years (Social Security and Medicare for example). This could definitely has some impact over our ability to borrow at low rates in the future.
  • Mean a technical default on our debt. While this seems the most trivial of all, especially knowing that it would only be temporary, this is the biggest issue because of all the derivative securities like credit default swaps (CDS) that are outstanding on U.S. debt. CDS are essentially insurance contracts that state that if a particular debt instrument defaults, the CDS would pay out a fixed amount as insurance against that default. A default on US Treasuries that is caused by a missed interest payment, no matter how temporary and technical in nature, would likely trigger at least some of those contracts to pay out. CDS are a highly unregulated part of the financial markets and there’s no telling how many of these contracts have been written and who’s on the hook for making payments in the event of a default. It is highly likely that some financial institutions would have to make large enough payments that they could fail. This is virtually the same problem that occurred with the ’07-’08 financial crisis and could result in a repeat of fallout we saw from Bear Sterns, Lehman, and AIG falling apart at that time.

Because of the severity of the impact of hitting the debt ceiling, it’s obviously a much bigger issue than the government shutdown that may begin tomorrow. Markets have started to react. They are pricing in the fair probability but relatively small effect of a government shutdown. They’re also starting to price in the very low (but not zero) possibility of hitting the Debt Ceiling in a few weeks (if we can’t solve the simple issue of the Continuing Resolution, it must mean that there’s an increased chance of not being able to solve something more complicated like the debt limit… that’s how the markets look at this). Regardless of what happens tonight, tomorrow, and in the coming days around keeping the government running, I’m very confident that the debt ceiling issue will be resolved in some manner without a default. Market will be volatile (down and up) over the next few weeks. A game of chicken in Congress will develop. Nothing will get resolved until it absolutely has too. Those are virtual certainties. What’s also certain, despite what the media will present over the next several hours, is that life will go on tomorrow with or without non-essential services from the Federal government.

Congress needs to get its act together. However, it doesn’t need to do it tonight. That lack of urgency, despite media representations, is what very well might prevent them from getting it together tonight. High media interest in something that really isn’t a crisis is the perfect opportunity for grandstanding and that’s what it looks like we’re getting.

Market Update 6/20/13

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The Federal Reserve is eventually going to stop firing their Monetary Bazooka (“QE”, as its commonly known). We’ve always known that. Over the last month, culminating in yesterday’s post-FOMC announcement press conference, “eventually” became “soon”. Despite reiterating their promise to keep short-term interest rates near-zero into 2015, their plan to continue to QE program through mid-2014, and their resolve to support the economy through aggressive monetary policy for as long as it needs their support, the Fed has spooked the market by signaling the beginning of the end of monetary stimulus. First, let’s quantify the damage:

There are other factors at work as well including Japan’s unprecedented attempt to stimulate its economy through QE (makes ours look like child’s play) and the currency fluctuations that has caused, China attempting to pop its real estate bubble by extracting stimulus and causing domestic bank liquidity issues, recent protests in Turkey and Brazil, ongoing political instability in Syria, Egypt, and much of the rest of the middle east, inflation in India, Brazil, and some of the other emerging markets, massive unemployment and fiscal issues in southern Europe (Portugal, Italy, Greece, Spain, Cypress) while debating between austerity and trying to stimulate growth. I don’t want to minimize them, but here I want to focus on the Fed, which is really the only change in the past two days. Clearly, from the table above, there hasn’t been anywhere to hide but emerging markets have really taken the biggest beating as expected since they are typically the most volatile asset class.

In addition, mortgage rates have started to rise, following treasury rates. 30-year fixed rates have moved from 3.3% in May to an average of 3.93% last week according to Freddie Mac’s weekly survey, and likely well over 4% this week. Continued increases in mortgage rates will hurt the housing market which has been in full recovery mode for last 18-months and is the prime reason behind the economy’s strengthening.

So, should you be worried? I would be worried if any of the following are true:

1) If my financial plan was built on an expectation that I’d be able to borrow at absurdly low rates forever. I’ve been building 4.5% rates in for the near term and 6-7% rates for 2015 and beyond into all client plans. Higher rates are unfortunate, especially if you’re hoping to buy a home soon, but rates are still within the tolerances of your plan. It’s important to note also that if rates move much higher over the short-term, prices will most likely come down as buyers simply won’t be able to afford the higher monthly payment that comes along with higher rates on the same amount borrowed. In hot markets like the SF bay area, higher rates, if matched by an expected increase in supply thanks to higher prices, could stop the housing recovery in its tracks.

2) If my financial plan was built on an expectation that my investment portfolio would only go up, day-after-day, with no volatility forever. If you believe that’s possible, you haven’t been listening to anything I’ve said or written in the past. No portfolio (except maybe Bernie Madoff’s) will do that and your financial plan certain doesn’t have that expectation built in if I helped to create it. We’ve seen stocks relentlessly increasing since March 2009 and have to expect pullbacks / corrections from time to time. It’s the price you pay as an investor for the reward of higher long-term gains. As a general rule of thumb, you have to be prepared to lose 50% of the portion of your portfolio that’s in the stock market in any downturn. If you’re 50% stock / 50% bond, that means a 25% loss can be expected at some point (it’s happened twice in the last 13 years). As I’ve said before, if you’re uncomfortable with the potential for loss, then you must be more conservative and must accept lower long-term return expectations. There’s no way around this point.

3) If I was invested only in stocks and long-term bonds for my short-term goals and I needed every dollar I had invested for those goals. I coach all clients to invest conservatively for short-term goals, in some cases extremely conservatively, and to maintain cash for ultra short-term goals where you need every dollar you have. I’m not using long-term bonds in any client portfolios, favoring shorter-durations which will fare better in a slowly rising rate environment.

4) If I was investing for long-term goals primarily in stocks, but couldn’t get past short-term results, even though they don’t matter over the long-term. This one is psychological, but is key. Unless you think you have a crystal ball that can predict the short-term future of the markets, you just have to accept the short-term in favor of higher expected long-term returns. Hopefully you’re all on board. If you’re not, investing may not be for you.

5) If I hadn’t communicated my goals and plans with my financial advisor, or if I didn’t have a financial plan at all. Here’s there’s room for worry if things have changed in your life, you’re a PWA-client, and you haven’t communicated those changes or kept up with your annual reviews, or if you’ve never completed or kept up with a financial plan to begin with. To quote Yogi Berra as I’ve done in past posts, “If you don’t know where you’re going, you might wind up someplace else”. A similar result can be expected if you haven’t told your financial advisor where you’d like to go!

On the flip side, instead of worrying, remember that a falling market creates opportunity as long as you continue to add to your portfolio. You’ll be much better off with some dips along the way to your goal than you would in a straight line where the market only goes up, counter-intuitive as that might seem.

With all of the above said, perhaps some of you are still worried that rates are going to soar, the market is going to plunge into an abyss, and we’re headed for the Great Depression v2.0. After all, the real danger in unstable markets is the circular feedback loop that they have on the economy and that the economy has on the market. If asset prices irrationally fall, consumer and corporate confidence tends to fall too, which can slow the economy and cause asset prices to fall. Normally, this kind of feedback loop has the potential to cause a catastrophic downward spiral where fear begets fear and markets crash. If the Fed was stepping away and saying, “we’ve done all we can”, I’d worry about that too. In this case though, the Fed hasn’t stepped away from the market. They haven’t taken the training wheels off the bike, given the child a push, and turned their back. They’ve told that precious child that they’re going to take the training wheels off when she’s mature enough and steady enough and they’re monitoring that regularly. When they do, they’ll be there running along with the bike keeping it steady until it has picked up enough speed that she can balance and pedal without falling. And, if by some chance she falls off that bike even with all the support, they may put the training wheels back on again, repair the damage, and try again later. Yep, there may be crying, there may be a sleepless night or two, there may be a scraped knee, but she’ll make it. There may be short-term dislocations in the market as selling causes margin calls which leads to more selling temporarily, but the economy and the markets will make it as well.

To summarize, don’t worry unless you don’t have a plan or you haven’t communicated your goals to your financial advisor. Market volatility is both normal, and even helpful over the long-term. Finally, realize that the Fed hasn’t spent 6 years trying to get the economy back in working order only to walk away and let it crash now.

The Value Of Volatility

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When the market falls, especially after a strong upward run (4+ years in this case), I think it’s worthwhile to remind everyone about the value of volatility. To keep it simple, let’s just think about a simple portfolio containing all US stocks and no bonds. This is what I would consider to be an extremely aggressive portfolio, one that would be hit very hard by a bear market like we had from late 2007 to 2009. Let’s look at 2 cases, with the stock index in both cases shown in the graph below:

Case 1: Reality (Volatile Market) – Using the actual performance of US Stocks from late 2007 to the end of 2012, suppose you had a $100k portfolio in September of 2007, just before stocks peaked and started heading lower. Your financial plan for retirement called for $1k per month contributions consistently (think of this as your 401k for example). The market tanks, losing almost 50 of its value by March 2009, and then slowly comes back to surpass where it started. By the end of 2012, you would have amassed a sum of $196,024.60. That’s your original $100k + $63k in contributions + over $33k in gains.

Case 2: “Ideal” (Market Never Falls) – In this case, we’ll pretend that the stock market moved in a slow straight line starting at the same value as in Case 1 and ending at the same value as in Case 1, but with no volatility. It never had a losing month and just kept slowly increasing. Let’s start with the same $100k and add the same $1k per month. This would feel much more comfortable. You could look at your statement and see constant progress… slow and steady. No sweating, no heartburn, no temptation to sell or alter your contributions. I call this the “ideal” case in quotes, but it’s actually far from ideal. In this scenario, you would have ended 2012 with $180,931.30. Again, your original $100k + $63k in contributions + ~$21k in gains. That’s only 2/3rds of the gain with the volatile portfolio, simply because you never get to add your $1k per month at lower prices.

The moral of the story here is that if you’re adding to your portfolio regularly, you really should be hoping for the market to fall from time to time, not rise, so that you can buy at lower prices. Sure, you want the market to rise right before you need to withdraw money, but until then, the lower it goes (a la March 2009), the worse it will feel, but the better it will be long-term. Volatility is the real “ideal” for the long-term investor.