February 15, 2011

Myth of the Wealthy Millionaire

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 1:21 AM by Robert Barone

The last decade (2000-2010) has been one of the most tumultuous periods in the history of financial markets.  We had the technology bust, followed by the housing bust, followed by the stock market bust, followed by the commodities bust.  Many investors lost a significant portion of their savings in one or more of these debacles.

As our politicians debate measures to shrink our budget deficits, the rich usually become a bone of contention.  Folks on the right side of the political spectrum usually push for tax cuts, while those on the left typically call for higher taxes on the wealthy.   But what is wealthy?  Are the rich living lavish lifestyles while the poor suffer?

One common definition of wealth is the term millionaire.  The term is often tossed around when money is discussed.  Further, game shows abound with titles like “Who Wants to be a Millionaire”, “The Million Dollar Money Drop” and top selling books have titles like “The Millionaire Next Door”.   Clearly, amassing a million dollars is a common measure of success.  Let’s take a look at the income a millionaire would have at her/his disposal under various asset allocations.

To keep things simple, we have chosen a simple 50/50 stock/bond split, using low cost Vanguard mutual funds (VHGEX and VBTIX) as the most basic allocation.  We have also used recommended allocations/mutual funds from Morningstar.

The approximate current yield of each allocation is as follows:

Allocation Yield Income/Million$ Income after 1% Advisor fee Income after 2% Advisor fee
Vanguard 50/50 2.65% $26,500 $16,500 $6,500
Morningstar Conservative 2.85% $28,500 $18,500 $8,500
Morningstar Income & Growth 2.58% $25,800 $15,800 $5,800
Morningstar Moderate Growth 2.21% $22,100 $12,100 $2,100
Morningstar Growth 1.87% $18,700 $8,700 -$1,300
Morningstar Aggressive Growth 1.45% $14,500 $4,500 -$5,500

The math is easy from here.  On a million dollar, conservative portfolio, an investor would receive a pre-tax income of roughly $28,500.  An “aggressive” investor would receive a measly $14,500 in income.  After taxes, a millionaire living off of the income of her/his portfolio, is receiving poverty levels of income.  And this doesn’t take into account advisor fees, which may actually leave the investor with negative income as shown in the last two columns.

Now, a couple of caveats.  First, it is said that an investor can often count on capital gains to add “income” to a portfolio.  This may have been true in certain periods in the past, and it may be true again in the future, but it wasn’t true over the past decade.  Whether you use 12/31/1999 to 12/31/2009, or 12/31/2000 to 12/31/2010, S&P 500 returns were negative (-16.1% for the former, and -7.7% for the latter).  So, an investor cannot count on capital gains.  In fact, to protect the principal, lower risk assets must be chosen, and this almost always means relatively low yields.  Secondly, a millionaire can consume principal to supplement the income from dividends and interest.  This is almost certainly the case today, as negligible rates, held down by the Fed, penalize those living on accumulated assets to the benefit of the financial sector.  So, in a sense, these “millionaires” are already being taxed to subsidize Wall Street.  Of course, any principal consumed has a large, negative impact on future income.  Using the 2.85% annual yield as a base, the table below shows how many years before the money runs out at various levels of consumption both with and without an advisory fee.

Allocation Yield Income/Million$ Income after 1% Advisor fee Income after 2% Advisor fee
Vanguard 50/50 2.65% $26,500 $16,500 $6,500
Morningstar Conservative 2.85% $28,500 $18,500 $8,500
Morningstar Income & Growth 2.58% $25,800 $15,800 $5,800
Morningstar Moderate Growth 2.21% $22,100 $12,100 $2,100
Morningstar Growth 1.87% $18,700 $8,700 -$1,300
Morningstar Aggressive Growth 1.45% $14,500 $4,500 -$5,500

For someone aged 65, just retiring with $1 million in assets and with a life expectancy of 83 years, the table shows that, because 50% of these folks are expected to live beyond 83 years, more than half will run out of money if they take as much as $75,000 per year.  And, a significant percentage would run out before the end of their lives at $60,000. As is evident, most of these so called “wealthy” are clearly depending on social security and this places such folks solidly in the middle of America’s dwindling middle class, not at the upper end.  Thirdly, this assumes that we don’t suffer yet another burst bubble where even high quality assets get decimated.  In this case, the number of years to a $0 balance is even shorter.

It is sad truth of today’s world that many Americans find it difficult just to make ends meet.  Saving significant sums of money to invest is even harder.   For those lucky few that have been able to either save or inherit a million dollars, it would seem that security has been assured.  Unfortunately, this is not the case.  Today’s low interest rates are destroying the incomes of people living off of past savings (never mind what they are doing to underfunded pension plans!).   For the small percentage lucky enough to retain a million dollars in assets, the reality is not as bright as it would seem.

Let’s hope that a tax assault doesn’t  further dismantle the American Dream.

Matt Marcewicz

Robert Barone, Ph.D.

February 10, 2010

The mention of securities, types of securities or portfolio allocations in this article should not be considered as an offer to sell or a solicitation to purchase any securities mentioned.  Please consult an Ancora West Investment Professional on how the purchase or sale of securities and portfolio allocations can be implemented to meet your particular investment objectives goals.

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778.

 

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February 5, 2011

Fool’s Gold 4: Death of the Empire

Posted in Banking, Big Banks, Bonds, Capital, community banks, crises, derivatives, Finance, Forward thinking, government, investment advisor, investment banking, investments, local banks, municipal bonds, San Francisco, Stocks, taxes, Uncategorized tagged , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , at 12:43 AM by Robert Barone

In the last two months, there has been a lot of hoopla in the media over municipal bonds.  If you have followed the Fool’s Gold series of articles that we published beginning in January, 2010, then the recent turmoil is not news to you (see www.ancorawest.wordpress.com, Fool’s Gold, 1/28/10, Fool’s Gold 2: Los Angeles, 4/22/10, Will Build America Bonds Save the States from Default, 6/4/10, and Fool’s Gold 3: The Empire Strikes Deals, 10/20/10).  On a recent 60 Minutes show, Meredith Whitney, the analyst famed for her calls on the impending implosion of the banking sector in 2008, predicted that the Municipal Bond Market could see 50 to 100 defaults amounting to more than $100 billion this year.   Needless to say, the municipal market has been reeling ever since.  In fact municipal mutual funds have seen more than $25 billion in outflows since Whitney’s TV appearance, according to the Investment Company Institute.  For her  prediction to have a chance of becoming reality, it appears to us that a large state would have to declare bankruptcy.  The most logical candidate for this would be California.

When we wrote the first Fool’s Gold article in January, 2010, California’s Long Term debt was about $59 billion.  Today, according to State Treasurer Bill Lockyer’s website, that long term debt is now $62.9 billion, about  7% higher.  But, that is only part of the story, as short term debt rose 30.5% over its 2009 level ($19.9 billion) to $25.9 billion.  Thus, total debt for California is $88.8 billion.   Furthermore, California currently faces a structural deficit of $25.4 billion, which newly elected Governor Jerry Brown proposes to close with $12.5 billion in spending cuts, and the rest ($12.9 billion) in tax increases. On January 20th, California declared another fiscal emergency, as Jerry Brown’s budget hit snags from t special interests.

With this budget process looking like a repeat of last year’s when the budget deadline was missed by more than 100 days, it looks likes California will have to issues IOUs again.  This explains the strong language from State Treasurer Bill Lockyer in a recent Wall Street Journal article.  “We’ve never defaulted, not once in our entire history, including the Great Depression,”  he wrote and then goes on to affirm that making the debt service payment on the State bonds is the Treasurer’s second-highest priority, after debt service on school bonds.

The same day Governor Brown, announced his budget, the Illinois legislature, in a secret closed door session, raised its state income tax to 5% from 3% to plug its budget short fall.  Four days later Standards & Poor’s announced that there could be a surge in downgrades of bonds issued by state and local governments.  “We believe that continued revenue decreases for state and local government may increase fiscal strain on budgets, and monitoring of liquidity will be especially important in 2011,” said S&P’s credit analyst Gabriel Petek.  Mr. Petek could also be referring to Congress’s decision not to renew the Build America Bond (BABs) program that traders and analysts believed would save many states and municipalities when it was first introduced.  (See Will Build America Bonds Save the States from Default, 6/2/10)

With the ending of the back door BABs bailout of the States, it’s no wonder that there have been rumblings within Congress over legislation that will allow a state to file bankruptcy.  A recent New York Times article entitled State Bankruptcy Option is Sought (January 21, 2011) states, “Policy makers are working behind the scenes to come up with a way to let states declare bankruptcy and get out from under crushing debts, including the pensions they have promised to retired public workers.”  While there is no draft legislation at the moment for fear of a constituent backlash and/or a destabilizing impact on the municipal market, in a recent meeting on Capitol Hill, Senator John Cornyn (R TX) broached the subject of the impact of such bankruptcies with Federal Reserve Chairman, Ben Bernanke.

Bankruptcy could be a the best option for a state like California, as it could permit it to alter its contractual promises to its current pensioners, and break current union contracts.  David A. Skeel, a law professor at the University of Pennsylvania, said in an article in The Weekly Standard (“Give States a Way to Go Bankrupt“), that it was possible to envision how bankruptcy for states might work by looking at the existing law for local governments.  Called Chapter 9, it gives distressed municipalities a period of debt-collection relief which they can use to restructure their obligations with the help of a bankruptcy judge. Unfunded pensions would become unsecured debts in municipal bankruptcy and may be reduced. However the biggest surprise may await the holders of a state’s general obligation bonds.  Through widely considered the strongest credit of any government, they can be treated as unsecured credits, subject to reduction, under Chapter 9.  While this is one way Congress could go, another would be modeled on the Municipal Assistance Corporation, which dealt with New York City in 1975.  That entity acted as an oversight agency in the restructuring of New York City’s debt.

In our opinion, in California’s case, there are really only two options: the state could go bankrupt, or seek a bailout from the Federal government, a move that will be resisted by House GOP members.  In bankruptcy, the losers are the bondholders, a group that has, so far in this economic crisis, escaped nearly unscathed (except in the Chrysler bailout), while a general bailout falls on all of the taxpayers and would likely be financed with yet more federal debt. While bankruptcy would allow the state to fully fund public services like education, police and firefighters, and health care, it could cost the state more in the long-run as new investors, sensitive to the fact that their preferred status had been removed, would require higher rates of return on newly issued debt.

Both of these alternatives will result in significant pain in the municipal bond market.  Bankruptcy, where bondholders take a discount, would be more disruptive to the markets than a general federal bailout, and if one state uses it, it is likely that others would follow.  But, in our view, bankruptcy would be preferable, as it establishes the fact to investors that there is risk in these investments and spells out to politicians that the ‘free lunch” of taxpayer bailouts has ended.

Robert Barone, Ph.D.

Joshua Barone

January 27, 2011

The mention of securities or types of securities in this article should not be considered as an offer to sell or a solicitation to purchase any securities mentioned.  Please consult an Ancora West Investment Professional on how the purchase or sale of securities can be implemented to meet your particular investment objectives goals.

Statistics and other information have been compiled from various sources.  Ancora West Advisors believes the facts and information to be accurate and credible but makes no guarantee to the complete accuracy of this information.

Ancora West Advisors LLC is a registered investment adviser with the Securities and Exchange Commission of the United States.  A more detailed description of the company, its management and practices are contained in its registration document, Form ADV, Part II.  A copy of this form may be received by contacting the company at: 8630 Technology Way, Suite A, Reno, NV 89511, Phone (775) 284-7778