Glassman Wealth Services LLC

Jessica Ness, Client Advisor and Director of Financial Planning for Glassman Wealth Services recently shared her retirement planning tips with Mark Miller, retirement columnist for Reuters.

“Rebalancing puts an automatic buy-low and sell-high methodology to work because you trim asset classes that have grown in size and you contribute to asset classes that have shrunk.”

Click HERE to read the entire story.

I had a conversation recently with John Waggoner, the personal finance columnist for USA Today where we talked about the assumptions that many people still make about retirement, such as retirees will spend less money in retirement (they don’t), they can safely withdraw 4%-5% each year for living expenses (it depends), and the need to diversify investments and save more (always a good idea.)  To read the entire article, click HERE.

Last week, the International Energy Agency (IEA) released its 2011 world energy outlook. The IEA painted a dire picture for the global energy outlook, showing an increasingly stressed oil market where production is simply unable to match growing demand from emerging economies.

Among the key findings, the IEA projected that global energy demand will increase by one-third between 2010 and 2035, with oil demand, in particular, rising from 87 million barrels per day (mb/d) to 99 mb/d during that timeframe. Unsurprisingly, the two biggest drivers of demand growth will be China and India, which the IEA expects will account for 50% of demand growth.

Demand growth is generally a good thing, as it means goods and services are in need. In the case of crude oil, however, production is struggling to keep pace. Crude oil supply is expected to grow marginally in the next 25 years before beginning a steady decline. Even more problematic, production capacity of 47 mb/d is needed during that time to offset reduced production in existing fields.

Without an alternative to crude oil, nations around the globe run the risk of becoming ever more dependent on volatile regions such as the Middle East and North Africa.

Not only is oil becoming scarcer, but the cost of production is set to rise quickly in regions like Latin America, where extraction techniques are becoming more intricate. All of these factors will influence oil prices and consumer behavior in the coming decades.

Yet, humans are nothing if not innovative in their time of greatest need. In recent years, an abundance of natural gas has been located in various regions of the world, including right here in the US. This led the IEA to go as far as dubbing this the “Golden Age of Gas.”

The shift to a world of natural gas will not be easy. In order for natural gas to fulfill its potential, the IEA estimates that $9.5 trillion of infrastructure investment will be necessary over the next 25 years. That is a staggering sum in any environment, much less one where global governments are implementing harsh austerity measures and slashing spending. 

Lost in all the discussion about sovereign crises in Europe and “super committees” in the US is the simple fact that emerging economies continue to expand rapidly. A burgeoning middle class in emerging economies is demanding modern amenities and lifestyles that offer distinct challenges to what are everyday staples in developed countries. Crude oil demand is a perfect example and one that requires serious policy actions if we are to avoid another crisis in the not so distant future.

Yesterday, the global markets experienced a dynamic sell-off and you should know why.  This time it’s Italy.

To explain what’s going on, let’s relate this whole situation to your home loan.  Most commonly, mortgage rates are either fixed for a period of time, or adjust based on prevailing interest rates. 

Now, the way government bonds work, they are issued in various maturities – from 30-days to 30 years – at auction.  In other words, when issued, government bonds pay whatever the public, including institutions and other governments, are willing to pay.  This may be a lower rate when similar investments pay low rates, or when other more volatile options like stocks seem too risky. Unlike your home loan, the borrowing isn’t done with one loan at one fixed rate.  There is a constantly maturing stream of bonds that must be reissued.  So, unless a country has profits (surplus) to just pay off maturing debt, it must refinance when the bonds come due.

The problem that we see in Greece, and now Italy is that confidence in these governments has fallen so much that the world is demanding much higher interest rates because of this uncertainty.  This can be financially catastrophic for a country.  It’s like a loan shark increasing your daily interest if you fall on hard times. As of yesterday, Greece’s 10-year bonds are yielding 25% annually as most investors don’t believe they will get all of their principal back. 

We keep a close eye on these interest rates as there are certain thresholds where the rate is just too high for the country to afford to fund operations.  For Greece and Italy, the panic level is in the 7% range.  Italian 10-year bonds, which demanded a little over 4% a year ago are now trading with yields hovering around 7%.  This jump in yield is a barometer of how the world views Italy’s chances of getting through this tough time. To make matters worse, keep in mind that banks throughout Europe are very much tied to each other with Italian bonds owned by many European banks, who themselves are experiencing tough financial times. As an example, France’s two biggest banks hold over $400 billion of Italian debt.

So how does this affect you and your portfolio?  It means that with cuts from European government spending and fear of a European financial crisis, Europe is likely experiencing a recession as I write this. It seems unlikely that the euro-zone economy is growing at a time when there is so much uncertainty.  

On the other hand, we believe that the US is in relatively good shape.  Anticipating a euro-zone financial crisis, we moved more of our asset allocation to US equities from foreign for most portfolios earlier this year.  In fact, we have a greater US vs. Foreign weighting than any time in the last ten years.  We also shifted some assets in all but our more aggressive portfolios to more hedged (conservative) strategies this past summer.

Looking ahead there are three things to watch: China’s growth, Japan’s 10-year bond rate and US interest rates.

1. Growth solves everything.  China’s growth and demand for materials to fuel its growth are major factors in sustaining the global economy.  Any sort of slowdown – even temporarily – will have a huge impact on global markets.  Since China depends more on Europe than the US to buy its goods, a European recession is of great concern.
2. While Greece and Italy (and to a lesser extent so far, the US) are at debt levels that seem unsustainable, Japan is the worst of the bunch.  Japan is not in the news because as the US pays 2% to borrow money for 10 years, Japan is currently paying a little less than 1%.  A country can handle a lot of debt when there is virtually no cost.  If this rate increases – even by 1 – 2% – it could ignite a global financial crisis much greater than Italy and Greece.  Greece is not too big to fail; Italy is too big to fail; Japan is too big to save.  Even with its enormous debt, Japan can sustain itself for many years as this is a chronic issue not a crisis.  We’ll have more on this later in the month.
3. All this uncertainty keeps US interest rates low, benefitting US borrowers, but not retirees as retirement income remains at historic lows. It seems that safer yields, in Treasury Bonds and CDs, will remain low for the near-term.

This leaves us with the question we ask when analyzing our investment strategies, which is:  What are we willing to put at risk in stocks?  At this point, at least for our more conservative portfolios, the answer is “less than before.”  We believe that there are other areas where the risk / return relationship is more attractive.

In our Monthly Economic report, we take an in-depth look at the changes in our markets and the effects of economic policy nationally and globally. This broader perspective provides greater clarity in understanding the forces that affect investment performance and future expectations. Click Here for report.

Conventional wisdom would support the notion that the division of power between Congress and the White House should be healthy for the nation’s economic environment. However, the idea that our political leaders will find a place of compromise has not been borne out by events such as the recent debt ceiling debate.  For Congress, the White House and ultimately the rest of us, this political paralysis will have huge negative consequences.  Our Do Nothing Congress  infographic illustrates the dates and deadlines of significant events that will be the result if further congressional inaction persists.

[Click on image to enlarge]

Let’s take a closer look at upcoming deadlines and why they are important:

November 23, 2011:  Super Committee deadline to produce a deficit reduction bill

The Super Committee was granted broad jurisdiction by the Budget Control Act with the goal to produce a plan that trims $1.2 to $1.5 trillion from the budget over 10 years.  The committee is not restricted to just that amount, however, should they agree on less than the $1.2 trillion, automatic spending cuts would be triggered to make up the difference. They must come up with a bill by November 23 to be considered by Congress under expedited rules.

December 23, 2011:  Congress votes on deficit-reduction bill

Once the Super Committee presents their bill to Congress, they must take an “up-or-down” vote which means they cannot amend or change the bill.

December 2012:  approximate date when new debt ceiling will be reached

The new debt ceiling which was increased by $900 billion to $15.194 trillion by the Budget Control Act of 2011 will be reached.  This was the fourth increase since President Obama took office.

January 2, 2013:  Automatic spending cuts begin

The Office of Management and Budget will impose spending caps to achieve $1.2 trillion in savings over 10 years with $600 billion coming from defense and $600 billion coming from discretionary spending. That amounts to $54.7 billion annually in cuts from both parts of the budget although some program such as Social Security, Medicaid, and military pay will be exempt.

While these deadlines are important at the Federal level, many people will feel the pinch closer to home should other incentives and tax breaks expire.

December 31, 2011:  Expiration of unemployment benefits and payroll tax breaks

More than 6 million Americans are set to lose Federal Unemployment Benefits in 2012, with 1.8 million running out in January 2012 alone if Congress fails to reauthorize them. With unemployment stubbornly entrenched above 9%, the prospects of finding a job remain grim.

The current law put into place by the Obama administration as a job stimulus that reduces Social Security payroll taxes from 6.2% to 4.2% is set to also expire at the end of 2011. Those cuts were estimated to give between $800 and $1,000 per year back to the average worker.

December 31, 2012:  Bush tax cuts to expire

If the Bush tax cuts are allowed to expire, then the top tax rate will increase by 4.6% to 39.6%. Qualified dividends and long-term capital gains, currently taxed at 15% will increase to 39.6% and 20% respectively. The estate tax exemption also known as the death tax, currently at $5 million will revert back to its 2002 level of $1 million.

Here is an interesting take on latest from the Super Committee by Greg Valliere, Chief Political Strategist of the Potomac Research Group.

LOWERED EXPECTATIONS:  Just as European leaders are preparing the markets for a disappointment today (let’s meet again on Nov. 7-8 !!), congressional leaders also are beginning to scale back expectations for the deficit supercommittee.  Roll Call’s web site reports this morning that there was a “heated” closed door meeting yesterday, as panel members appear to be bogged down — as usual — on tax increases.  The mantra on Capitol Hill for the past week has been that congressional leaders will have to get involved, but it’s not helpful when Harry Reid insists on $1 trillion in new revenues; that’s not gonna happen.

SUPERCOMMITTEE WILD CARDS:  There are many; here are just three –

1.)  The Congressional Budget Office will have to score any proposed cuts, and that will take days or weeks, which means the panel may have to present its recommendations well before the Nov. 23 deadline.  Good luck with that. 

2.)  Could the supercommittee ask for an extension, perhaps stretching into spring?  (Getting “incompletes” always worked for us in college.)

3.)  Could hundreds of billions in savings be assumed from troop drawdowns from Afghanistan and Iraq?  An accounting gimmick, to be sure; how would the credit rating agencies react to that one?

If congress ever comes to a consensus on debt reduction, or even a revamp of the tax code, there are some deductions that are likely to disappear; and right after the deduction for private jets, is the mortgage deduction for second homes.

Congress left the deduction of mortgage interest unscathed back in 1986 when they eliminated deductibility of most other personal loans.  Now that both sides of the aisle are looking to increase revenue, many politicians want to retain the mortgage deduction, but believe that Congress never intended for the deduction to be used to promote second home ownership.

 As we consider the ramifications of the loss of this deduction, we must consider where, how and how much?

 Where:

In the infographic below, we used 2010 Census data to show the states with the highest percentage of second home ownership, the greatest number of second homes, and the percentage change since the 2000 census.  While we found it interesting that Maine had the highest percentage of second homes, Florida has by far the largest number of second homes, and Nevada has had the greatest percentage increase, it will be the pockets of communities within these states where most of the homes that are non-primary residences will feel the greatest impact.

[Click on image to enlarge]

Vacation resorts that are not necessarily retirement destinations should feel the most price pressure.  A community such as Ocean City, Maryland, while a fine place to visit in the summer, is not teeming with seniors or retirees.  In these communities, we could find a spike in vacation rentals as owners look to replace mortgage deducibility with rental income and other offsets like depreciation and expenses.

However, other communities like Park City, UT or Hilton Head, SC may fare better if those who own a second home intend to retire there someday.  These transitionary second homes will eventually become their primary residences when these owners finally retire.

California, with only 2.2% of second homes, may fare better, but in those towns and counties where a significant number of properties are used as second homes, the loss of the mortgage deduction could lead to an increase in short sales as owners struggle to make two mortgage payments.  It may not be a stretch that many of the second homes in Nevada, where the number has doubled in the last ten years, have owners who are already underwater on their mortgage and unable to refinance even at today’s historic low rates.  The additional tax cost will further dampen any recovery here.

How and how much:

As we wait for a rebound in home prices, any additional costs, like the loss of the second home deduction may be enough to keep would-be buyers away.  Certainly, historically low mortgage rates help sales; and any sort of help from the government (QE3 or Operation Twist) that further lowers intermediate and long-term rates is good news for the housing market as mortgage rates continue to move to new lows.  While the loss of the deduction may not have an immediate effect, the impact will be found in the smaller line of people willing and able to buy the home.

As one looks to qualify for the mortgage on a second property, lenders will need to incorporate the new higher non-deductible cost and disqualify those who exceed acceptable standards. 

Then there is the actual increase in cost.  Based on a 4% 30-year mortgage, homeowners will find the following cost increases based on the size of their mortgage and their tax bracket:

These additional costs may not sway most to give up on their dream of owning a place in the mountains or at the shore.  But a time when we remain skeptical of a housing rebound, and with many primary residences underwater on their mortgages and lenders holding their funds ever so tightly, these additional costs add up to greater pressure on second home prices over the coming years.

My hope is that our infographic starts a conversation about second home ownership in each state, and particularly the communities in each with a larger number of second homes. Since 49 states have counties where second homes account for at least 10% of all homes, these communities, some already under the strain of foreclosures and weak sales are certain to feel the loss.

Recently, I was fortunate enough to lead a panel discussion of several prominent financial advisors at a meeting attended by 150 financial planners in the greater Washington, D.C. area.

The topic – What assumptions do we make when helping clients plan for the future and are they still valid?

The discussion was, at times both heated and lively, and while we, as financial advisors work in the same industry and with the same set of facts and economic conditions, I was struck by our differences:

• Each of the panelists applied a different approach to filter information, and these perceptions led them to very different conclusions about the economy, investing environment, and ultimately, the recommendations they make for their clients.
• At the extremes, one advisor had changed his views in 2003, and since then has recommended investments with a bias toward a shortage of global natural resources and climate change.
• At the other extreme, an advisor with decades of experience disagreed with that notion. Her view was that people are adaptable to the challenges they face and have the ability to solve any problem regardless of the latest issues or conditions. She said that nothing has changed in her philosophy or allocations in the past 15 years.

When I asked them to share what mistakes they had made and what they would do differently, I was surprised that all of them deflected the question with answers to indicate that everything was rosy. (In fairness and full disclosure, I would have probably answered the same had I been on the receiving end.)  I asked that question, not to put any of them on the spot, but so that we might all learn more as we advise our clients in these unprecedented times.

As I reflect on what I heard, I came away with a greater appreciation of the financial planning processes we use in our own practice.  Namely:

• At Glassman Wealth Services, we put in place a decision tree to test and plan for a variety of circumstances. By actively asking ourselves, “What would we do if…?” we seek to be more nimble and proactive in our financial and investment recommendations.
• In today’s world, we believe that it is very important to consider current and potential economic events, and we will continue to factor them into our financial planning decision making for our clients.

In our Monthly Economic report, we take an in-depth look at the changes in our markets and the effects of economic policy nationally and globally. This broader perspective provides greater clarity in understanding the forces that affect investment performance and future expectations. Click Here for report.