Should Stock Investors Sell Now?

Should stock investors sell now? It’s been a good year for stocks — for the year-to-date period ending September 30, 2016, the Standard & Poors 500 has returned 7.84% despite the year’s rocky start in January and early February. But has performance been too good?

fixed-income-investment-strategies-1_1-800X800Seven-and-a-half years into the bull market, valuations are high and there may be little upside in stocks between now and year-end. Volatility has started to increase modestly in recent weeks after a summer period that saw unusually low volatility in the equity markets. So, we may be due for a pullback.

Add to that, October has sometimes been a month characterized by high volatility, especially during an important Presidential election. These factors beg the question: should you sell now? Certainly taking some profits or rebalancing portfolios according to your regular plan is prudent. But in this commentary I lay out reasons why making more dramatic changes in your investment allocation may not be the best move.

Are Stocks Too Expensive?
 Some investors think stocks are expensive. In fact, the LPL Financial Research department explained in a research note last month that the S&P 500 price-to-earnings ratio (PE) using the median calculation is more than 50% above its long-term average. Traditional market cap weighted valuations are also high — the current PE of 18 (trailing four quarters) is above the average of 15.2 going back to 1950, and even above the higher post-1980 average of 16.4.

But are high valuations a reason to sell? Not necessarily! Valuations have not been good predictors of stock market performance over the subsequent year, according to the LPL Financial research note. Other credible investment research has reached similar conclusions.

The correlation between the S&P 500’s PE and the index’s return over the following year, at -0.31, is relatively low (based on 45 years of data). Stocks can stay overvalued longer than we might think they should, so I instead recommend focusing more on macroeconomic fundamentals, and technical factors, not valuations, for indications of an impending market correction or bear market.

Valuations were a reason to sell during the tech bubble, but it was hard to tell when. The one-year return for the S&P 500 from March 31, 2000, at a PE of 28.2, was -21.7%. But valuations were high well before that, suggesting that even at extremes, predicting market direction using valuations is an inexact science at best. Starting in June 1997, with the S&P 500’s PE over 20, the S&P 500 produced gains of 30.2% and 22.8% over the two subsequent 12-month periods.

The relationship between stock market performance and valuation gets much stronger when looking at longer time periods. Once again, a recent report from LPL Financial Research showed that, when plotting PE against stock returns over the subsequent 10-year period, the correlation (negative) is quite strong. 

file0001033439999LPL Research found that, as PEs rise, subsequent returns are lower; and vice versa. Eyeballing the two charts it is easy to see the difference, but we can put numbers on it. The correlation between PE and returns over the next 10 years is -0.87, a much closer relationship than PEs and one-year returns at -0.31 (-1 is perfect negative correlation and 0 equates to no correlation).

More Reasons To Hold Your Current Equity Allocation
Valuations may not be good reasons to sell, but are there, in fact, reasons to consider buying here? In spite of the solid returns so far this year, further equity market gains would not be shocking given the following factors:

Odds For Recession May Be Low
Many market experts, including  LPL Financial, JP Morgan Asset Management, and others continue to see the odds of recession over the next 12–18 months as being in the 20% range based on leading indicators and few signs of excesses in the economy that might lead to major imbalances. If a recession is more than a year away, based on data back to 1950, the odds are over 80% that the S&P 500 delivers a positive annual return.

Favorable Monetary Policy and Low Interest Rates
If the economy weakens further, the Federal Reserve (Fed) may deliver additional stimulus. The Fed could state its intentions to maintain low interest rates for longer, or potentially initiate another round of quantitative easing, i.e., more bond purchases. Investors may understandably not like the idea of primarily relying on Federal Reserve Bank policies to prop up stocks, but the fact remains that markets have responded to them. Furthermore, low bond yields (also a result of Fed policy) continue to enhance the appeal of stocks.

A Rebound in Corporate Earnings
Future earnings estimates have tended to run high historically and are almost always subject to change. However, the economic data, along with stability in oil and the U.S. dollar,  suggest an earnings rebound may be quite achievable. Current earnings growth expectations based on Thomson Reuters consensus data for the fourth quarter of 2016 and first and second quarters of 2017 are +8%, +15%, and +13%. Remember, markets tend to look about six months ahead.

Fourth Quarter Rally?
The S&P 500 has historically performed well during the fourth quarter with an average gain of over 4% (versus a 2.1% average for all quarters), with gains 79% of the time going back to 1950. Fourth quarters of election years are no better than an average quarter, but excluding 2008, the average fourth quarter gain during an election year is 3.6% and the S&P 500 is higher 87% of those quarters. We continue to believe that markets should welcome greater clarity on the potential election outcome when it arrives.

Conclusion
Valuations and seasonality do not appear to be good reasons to sell stocks right now. In fact, a number of factors I have discussed here suggest stocks do offer the potential for growth between now and year end. Although it is also possible that future gains may be limited, don’t be surprised to greater volatility and consider using temporary equity weakness to buy at lower prices.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.

Because of its narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies. All investing involves risk including loss of principal.

Correlation ranges between -1 and +1. Perfect positive correlation (a correlation co-efficient of +1) implies that as one security moves, either up or down, the other security will move in lockstep, in the same direction. Alternatively, perfect negative correlation means that if one security moves in either direction the securitythat is perfectly negatively correlated will move in the opposite direction. If the correlation is 0, the movements of the securities are said to have no correlation;they are completely random.

The PE ratio (price-to-earnings ratio) is a measure of the price paid for a share relative to the annual net income or profit earned by the firm per share. It is a financial ratio used for valuation: a higher PE ratio means that investors are paying more for each unit of net income, so the stock is more expensive compared to one with lower PE ratio

INDEX DESCRIPTIONS
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

 This research material has been prepared by LPL Financial LLC.

 

Spring Has Sprung: Will the Equity Market “Spring” Continue?

Spring has arrived here in the Bay Area and across most of the nation. Just as we have seen declining rainfall after the wintery “El Nino” conditions, the new season has recently brought a break from the significant volatility we experienced in the first two months of the year.

park practice 052 (1)However, although there is increased clarity on several issues that cast a cloud (was it the El Nino effect?) of uncertainty over financial markets in January and February, it would be unwise to forget that heightened volatility is likely not gone for good.

The first quarter of the year was historic. After being down more than 10% at its lows, the S&P 500 bounced back in March and finished the quarter positive. The S&P 500 hasn’t erased a 10% quarterly loss to finish positive since the Great Depression.

Experiencing market volatility like this is not easy; yet witnessing this kind of reversal reminds us of the importance of maintaining a long-term perspective. So, what changed between January and February and today to help calm markets?

The mid-winter market malaise largely revolved around the Federal Reserve (Fed), China, oil, corporate profits, and the U.S. dollar. Investors were likely concerned that the four 25 basis point (0.25%) rate hikes the Fed projected for 2016 would lead to a recession and exacerbate the imbalances emerging in the global economy.

These imbalances stemmed from a series of missteps by Chinese policymakers, the oversupply of oil, weak corporate profits, and unprecedented strength in the U.S. dollar. In the past couple of months, many of these issues have started to resolve.

2000px-US-FederalReserveSystem-Seal.svgAt its March policy meeting, the Fed changed its tune slightly from the December 2015 meeting and reduced its forecast for rate hikes this year from four to just two, citing concerns around global imbalances and economic growth. This more market-friendly projection helped to push the dollar lower and oil higher, alleviating some stress in global financial markets.

Meanwhile, China, which said or did all the wrong things managing its currency, economy, and financial markets during the second half of 2015 and again in early 2016, has mostly turned that around recently. The weaker dollar, soothing words from China, and the rebound in oil prices helped to renew a slightly more positive corporate profit outlook and sparked an impressive market rebound.

After the market dips, reversals, and dramatic shifts in investor sentiment, what can we expect as we look ahead? In my opinion, the second quarter of 2016-and the rest of the year-may look a lot like the first quarter, as many of the areas of concern we faced (such as Fed rate hikes, oil prices, earnings declines) remain in the background.

Although it is very possible that the heightened volatility throughout the rest of 2016 might continue, some investment management firms, including the LPL Financial Research department, think that the broad US equity market might deliver mid-single-digit returns in 2016 if the U.S. economic expansion continues. Only time will tell whether these prognostications will come true.

To help you maintain perspective and stay on track, please feel free to browse on the right my previous newsletters and a sample of the educational articles from the blog section of my website. And, as always, if you have questions or are seeking clarification about your current situation, please email me at bill.pollak@lpl.com or call me at (925) 464-7057.

‘Tis the Season To Unwrap Your Crystal Ball!

It’s that time of year again! No, I am not referring to the Holidays which brings the hustle and bustle of gift buying, parties, and hopefully special time with family and friends. Those subjects could produce material for an interesting read, but there is another annual tradition which I have been thinking about.

file9821301453431I am referring to the scores of prognostications offered by many financial, investing and economic gurus. In a ritual as widely practiced as Holiday gatherings and New Year celebrations, we are hearing (or will soon hear) predictions about what 2016 “will” bring in the world of finance, including the direction and pace of economic growth, the path of interest rates, the outlook for oil prices (a hot topic!), and more!

Some of these pronouncements may sound convincing and could even be very well-reasoned. They will sometimes even come along with advice about the moves you can make to profit from those opinions or how to avoid losses. But I would caution anybody reading these missives to avoid making bold moves, no matter how compelling the prediction.

That’s because I have learned over the years to take these forecasts with a gigantic grain of salt. The business of making reliable forecasts about the sometimes arbitrary movements of the economy and financial markets is a very tough endeavor. As the late, great baseball icon and “philosopher” Yogi Berra once said, “Making predictions is difficult, especially about the future”!

That idea was recently underscored by research I have read from two prominent researchers at the International Monetary Fund (IMF), the well-known international financial organization. In a study published in May, 2014, Prakash Loungani and Hites Ahir, two IMF researchers, studied forecasters’ ability to predict recessions.

This paper, along with previous research compiled by Loungani and other economists, showed that forecasters possess a “record of failure to predict recessions” which “is virtually unblemished.” Ouch!

IMG_1312Does this mean you should ignore all prognostications? Not necessarily! I do read commentaries from many economists and investment experts. Understanding different perspectives about the financial world, especially when there are differing views, can be helpful. They can provide a measure of context and awareness.

But it is important to remember they may not be useful as an infallible investment or financial manual for the next 12 months. The workings of the economy and financial markets are extremely complicated and dynamic, making it extraordinarily difficult to forecast their movements, especially over a relatively short timeframe like one year.

In fact, if a forecaster says they know exactly what’s going to happen next, you might want to view such opinions, based on the aforementioned research, with skepticism. Alternatively, forecasts which acknowledge the possibilities of different outcomes might actually help inform you about unexpected developments.

Regardless of the quality of the forecast and research, I think most individuals and families may likely be much better off by placing their primary focus on having a long-term financial plan and following a disciplined process in making financial and investment decisions.

This approach might actually offer more long-term promise than placing too much emphasis on short-term forecasts which appear to be unreliable, no matter how credible the source.

To help provide context and perspective, this month’s blogs provide information about the recent interest rate hike by the Federal Reserve Bank as well as guidance about potential year-end tax moves:

Federal Reserve Bank Rate Hike: What Does It Mean?

Should You Worry About a Federal Reserve Interest Rate Hike?

2015 Year end Tax Planning Basics

As always, if you have any questions about your situation, I encourage you to email me at bill.pollak@lpl.com or at (925) 464-7057.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.

Federal Reserve Rate Hike: What Does it Mean?

The events of the past week bring one word to mind: finally. Last Wednesday, the Federal Reserve (Fed) finally raised the target for the federal funds rate by 0.25%. By raising this key overnight borrowing rate, the Fed raised interest rates for the first time in nine years—an event that has been receiving a great deal of attention recently. Surrounding the past several Fed meetings, there has been much talk of “will they” or “won’t they.” Leading up to this meeting, the Fed implied it would raise rates, and the market was expecting it.

file000821289525However, until the announcement was made today, a degree of uncertainty remained. So, what does this really mean? It means the potential for key rates to tick up, such as mortgage or credit card rates. Most bonds have “priced in the hike,” but some could still feel a slight negative impact. However, overall, we should take this as a positive sign. We have not experienced a rate hike in nine years, and, perhaps more importantly, we have not had rates above the 0–25 basis point range (0–0.25%) since late 2008.

The Fed said it would only raise rates if the economic data signaled a healthy economy. We have seen strong numbers posted over the past few months, and the Fed affirmed today it believes this trend should continue. To sum up, the Fed has raised rates because it believes the economy is strong and likely to continue to grow without the added support of near zero interest rates.

For the market, this is potentially a positive event. Yet, rate hikes also reaffirm that we are in the mid-to-late stage of the economic cycle. In this part of the cycle, we can expect additional market volatility. We especially anticipate it in the coming weeks and months, as investors become comfortable with the “new routine” for U.S. monetary policy.

Although we have just experienced the first raise, many will immediately start thinking about what’s next. The debate will continue regarding how fast the Fed will raise rates, how far it will raise them, and when it will stop. Today, the Fed’s own projections put the fed funds rate at 140 basis points (1.4%) a year from now, while the fed funds futures market puts the fed funds rate at just 80 basis points (0.80%) by year-end 2016.

arrowThis difference implies a gap between what the Fed says it will do and what the market thinks the Fed will do. How this gap is resolved will play a key role in the future direction of financial markets, particularly fixed income markets. Luckily, Fed Chair Janet Yellen is aware that markets will continue to debate what may lie ahead. Her comments during the post-meeting press conference suggest the Fed will continue to proceed cautiously, taking into consideration the impact of rising rates on consumer spending, the housing market, business capital spending, the value of the dollar, and overseas economies and financial markets.

A slow path for further increases will give the economy and markets time to adjust to the changes. It has been a long time since we last saw the Fed hike rates. It does feel unusual, but also positive, and hopefully this change is well worth the wait. It means that we are returning to a more typical economic environment, which is a welcome change from the atypical environment we have lived in since the Great Recession.

And even though this is a big change in Fed policy, what shouldn’t change is our commitment to the long-term investment plan that is ultimately our blueprint for success. As always, if you have any questions, I encourage you to email me at bill.pollak@lpl.com or at (925) 464-7057.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.

Economic forecasts set forth may not develop as predicted.

Investing in stock includes numerous specific risks including: the fluctuation of dividend, loss of principal, and potential liquidity of the investment in a falling market.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond and bond mutual fund values and yields will decline as interest rates rise and bonds are subject to availability and change in price.

This research material has been prepared by LPL Financial.

Securities offered through LPL Financial. Member FINRA/SIPC.

Tracking #1-449334 (Exp. 12/16)

Should You Worry about a Federal Reserve Interest Rate Hike?

After years of record-low interest rates, at some point this year the Federal Reserve is expected to begin raising its target federal funds interest rate (the rate at which banks lend to one another funds they’ve deposited at the Fed). Because bond prices typically fall when interest rates rise, any rate hike is likely to affect the value of bond investments.

bond-investingHowever, higher rates aren’t all bad news. For those who have been diligent about saving and/or have kept a substantial portion of their portfolios in cash alternatives, higher rates could be a boon. For example, higher rates could mean that savings accounts and CDs are likely to do better at providing income than they have in recent years.

Also, bonds don’t respond uniformly to interest rate changes. The differences, or spreads, between the yields of various types of debt can mean that some bonds may be under- or overvalued compared to others. Depending on your risk tolerance and time horizon, there are many ways to adjust a bond portfolio to help cope with rising interest rates. However, don’t forget that a bond’s total return is a combination of its yield and any changes in its price; bonds seeking to achieve higher yields typically involve a higher degree of risk.

Finally, some troubled economies overseas have been forced to lower interest rates on their sovereign bonds in an attempt to provide economic stimulus. Lower rates abroad have the potential to make U.S. debt, particularly Treasury securities (whose timely payment of interest and principal is backed by the full faith and credit of the U.S. Treasury), even more attractive to foreign investors. Though past performance is no guarantee of future results, that’s what happened during much of 2014. Increased demand abroad might help provide some support for bonds denominated in U.S. dollars.

Remember that bonds are subject not only to interest rate risk but also to inflation risk, market risk, and credit risk; a bond sold prior to maturity may be worth more or less than its original value. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.

March 2014 Blog: Can You Win “Investment” Gold?

It’s not often that we can gain investment insights from an 18-year-old wunderkind.

1_3a104b11a55dd074a15f7c05a91b6a17Many of us marveled at the performance of American Mikaela Shiffrin at the Sochi Winter Olympics, where she became the youngest Olympic slalom champion. What makes Shiffrin remarkable is not only her success, but also her approach to the sport. Unlike many of her peers, while training she focused more on technique and practice — the discipline of ski racing — rather than on competing.

When Shiffrin lost footing and became airborne on the course, she was able to regain her position quickly as she had practiced her recovery many times before. Throughout all of her training, she took the long-term view. It can be difficult to take the long-term view in investing, particularly when we are challenged by bumps on the slope.

February, for example, provided investors with mixed signals. Colder and snowier-than-usual weather adversely affected many economic reports, causing uncertainty over the health of the economy to linger. Several high-profile companies also cited the negative impact of weather on future earnings.

Looking at the bigger picture, however, helps us regain our sense of balance. U.S. stock prices appear to be looking past weather disruptions and have rebounded back to near record highs following a soft start to the year. We see underlying strength in most economic indicators including a continued recovery in the housing market, which is supported by easier mortgage availability, limited home inventory, and near-record housing affordability.

20120121-RoyersfordPA-WinterStormLimerickSquare__5MF_Absent a severe storm in March, we expect more clarity on the health of the overall U.S. economy in April, when March economic data are released, and we still expect economic growth, as measured by real gross domestic product (GDP), to reach 3% in 2014, based upon many of the drags of 2013 fading, including U.S. tax increases and spending cuts and the European recession, and growth accelerating from additional hiring and capital spending by businesses.

The bond market also hit some bumps, as Puerto Rico was downgraded during the month by all three major credit rating agencies as a result of its large debt burden and multi-year recession. But municipal bond market investors have been thinking longer term and appeared to take the downgrades in stride by noting Puerto Rico is not reflective of the overall market.

Just last week, the broader bond market appeared to corroborate the move in stock prices by ignoring another batch of weather-impacted data and anticipating better growth. Bond investors also refocused on a Federal Reserve that remains on schedule to reduce bond purchases and eventually raise interest rates in late 2015.

Policymakers in Washington, D.C. appear to be taking the longer view as well by focusing less on partisan differences and more on overall economic health. Congress agreed to a “clean” debt ceiling increase without links to the Affordable Care Act or the Keystone XL pipeline.

This “clean” bill acted as a positive for the stock market, which may have rallied on the perception that a more business-friendly legislative environment may be developing. We continue to expect a 10-15% gain for U.S. stocks in 2014, as measured by the S&P 500 Index. (Derived from earnings per share for S&P 500 companies growing 5 – 10% and a rise of half a point in the price-to-earnings [PE] ratio.)

As we look back at the concerns we’ve had during the past month, we realize — just as Mikaela Shiffrin did on her gold medal run — that we’ve been here before. We know we can trust the discipline and practice of sound investing and stay focused on our long-term goals. Even those of us who are industry veterans can take a lesson from the young champion.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult me prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.

The economic forecasts set forth in this letter may not develop as predicted.

This research material has been prepared by LPL Financial.

Will Interest Rates Rise This Year?

The Fed hasn’t yet raised its target interest rate from less than 0.25%, and it has promised not to do so before unemployment reaches roughly 6.5%, which it doesn’t expect to happen until next year. However, some interest rates have already begun to go up. For example, according to Freddie Mac, the average interest rate on a 30-year fixed-rate mortgage shot above 4% last June for the first time since late 2011, hitting its highest level in almost 2 years. In the same month, the yield on the 10-year Treasury bond went above 2.5% for the first time since August 2011.

OB-XM991_0519EN_G_20130516193008Why are interest rates rising even though the Fed’s target rate hasn’t? Because bond investors are concerned that higher interest rates in the future will hurt the value of bonds that pay today’s lower rates. Immediately after the Fed’s June announcement, investors began pulling money out of bond mutual funds in droves, reversing a multiyear trend. If there’s less demand for bonds, yields have to rise to attract investors.

Aside from bonds, why are investors concerned about a possible Fed rate hike? Bonds aren’t the only financial asset that can be affected by potential future interest rate changes. Dividend-paying stocks with hefty yields have benefitted in recent years; more competitive bond yields could start to reverse that dynamic. Shares of preferred stock typically behave much like those of bonds, since their dividend payments also are fixed; their values could be affected as well.

Also, higher mortgage rates could potentially slow the housing market recovery, though historically they remain at relatively low levels. And if a Fed rate increase were to bring on higher interest rates abroad, that could create even more problems in countries already struggling with sovereign debt–problems that have provoked global market volatility in the past.

The Fed has said any hikes in its target rate will occur only if the economy seems strong enough. If higher rates seem likely to halt the recovery, the Fed could postpone a rate hike even longer. It also will take other measures before raising rates. Even though the timing and size of any Fed action is uncertain, it’s best to be aware of its potential impact.

Graph: Interest Rates 1981-2012
This graph represents the federal funds effective interest rate (the average rate at which banks lend to one another overnight), which has generally declined to historic lows over the 30-year period represented. Investment returns, as well as interest rates on bank loans and other fixed-income instruments, could potentially be affected when this rate rises.

NIV-IntGraph1013_02

Source: Board of Governors of the Federal Reserve System (www.federalreserve.gov), July 17, 2013

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with a qualified tax advisor.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013

Looking Backward and Forward on Entitlement Programs

fiscalcliffmorphing_500Last year’s presidential election, along with the more recent fiscal cliff and debt ceiling negotiations, have put the spotlight on our nation’s tax policy, deficit, and entitlement programs.

For some, entitlement programs are necessary–a social compact for America in an era of longer life spans, the decline of employer-provided pensions and health insurance in retirement, and a widening gap between the haves and the have-nots. For others, the current level of entitlement spending is jeopardizing our country’s fiscal health and creating an “entitlement lifestyle.” No matter where you stand in the debate, do you know the basic facts on our country’s largest entitlement programs?

Where the money goes
All entitlement spending isn’t created equal. The “Big Three” of Social Security, Medicare, and Medicaid account for more than two-thirds of all federal entitlement spending. Social Security and Medicare are primarily age-based programs, whereas Medicaid is based on income level.

NGB-MedSoc0313_02According to the U.S. Bureau of Economic Analysis, in 2010, the federal government spent a total of $2.2 trillion on entitlement programs, with the Big Three accounting for $1.6 trillion of this total. The largest expenditure was for Social Security ($690 billion), followed by Medicare ($518 billion) and Medicaid ($405 billion).

A history of growth
Alexis de Tocqueville, the famous French political thinker who traveled to the United States in the early 1830s and wrote about the uniqueness of our young nation’s individual self-reliance in his famous book, Democracy in America, would likely be surprised to observe the growth in spending on entitlement programs that has occurred in the United States over the past 50 years. According to the Bureau of Economic Analysis, in 1960, U.S. government transfers to individuals totaled about $24 billion in current dollars. By 2010, that figure was $2.2 trillion, almost 100 times as much.

Current status
Let’s look at our two main entitlement programs–Social Security and Medicare.

Social Security: Created in 1935, Social Security is a “pay-as-you-go” system, meaning that payments to current retirees come primarily from payments into the system by current wage earners in the form of a 12.4% Social Security payroll tax (6.2% each from employee and employer). These payroll taxes are put into two Social Security Trust Funds, which also earn interest. According to projections by the Social Security Administration, the trust funds will continue to show net growth until 2022, after which, without increases in the payroll tax or cuts in benefits, fund assets are projected to decrease each year until they are fully depleted in 2033. At that time, it’s estimated that payroll taxes would only be able to cover approximately 75% of program obligations.

Sample-Medicare-CardMedicare: Created in 1965, Medicare is a national health insurance program available to all Americans age 65 and older, regardless of income or medical history. It consists of Part A (hospital care) and Part B (outpatient care)–which together make up “traditional” Medicare; Part C (Medicare Advantage, which is private insurance partly paid by the government); and Part D (outpatient prescription drugs through private plans only).

Medicare Part A is primarily funded by a 2.9% Medicare payroll tax (1.45% each from employee and employer), which in 2013 is increased by 0.9% for employees with incomes above $200,000 (single filers) or $250,000 (married filing jointly). In addition, starting in 2013, a new 3.8% Medicare contribution tax on the net investment income of high-earning taxpayers will take effect.

Looking ahead, Medicare and Medicaid are expected to face the most serious financial challenges, due primarily to increasing enrollment. The Congressional Budget Office, in its report Budget and Economic Outlook: Fiscal Years 2012 to 2022, predicts that federal spending on Medicare will exceed $1 trillion by 2022, while federal spending on Medicaid will reach $605 billion (state spending for Medicaid is also expected to increase). According to the CBO, reining in the costs of Medicare and Medicaid over the coming years will be the central long-term challenge in setting federal fiscal policy.

Reform
There has been little national consensus by policymakers on how to deal with rising entitlement costs. At some point, though, reform is inevitable. That’s why it’s a good idea to make sure your financial plan offers enough flexibility to accommodate an uncertain future.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with a qualified tax advisor.

Is College Debt the Next Bubble?

What might a 23-year-old recent college graduate, a 45-year-old entrepreneur, and a 60-year-old pre-retiree have in common financially? They may all be hobbled by student loan debt. According to financial aid expert Mark Kantrowitz, the student loan “debt clock” reached the $1 trillion milestone last year. And even as Americans have reduced their credit card debt over the past few years, student loan debt has continued to climb–both for students and for parents borrowing on their behalf.

A perfect storm
college_debtThe last few years have stirred up the perfect storm for student loan debt: soaring college costs, stagnating incomes, declining home values, rising unemployment (particularly for young adults), and increasing exhortations about the importance of a college degree–all of which have led to an increase in borrowing to pay for college. According to the Federal Reserve Bank of New York, as of 2011, there were approximately 37 million student loan borrowers with outstanding loans. And from 2004 through 2012, the number of student loan borrowers increased by 70%.3

With total costs at four-year private colleges pushing $250,000, the maximum borrowing limit for dependent undergraduate students of $31,000 for federal Stafford Loans (the most popular type of federal student loan) hardly makes a dent, leading many families to turn to additional borrowing, most commonly: (1) private student loans, which parents typically must cosign, leaving them on the hook later if their child can’t repay; and/or (2) federal PLUS Loans, where parents with good credit histories can generally borrow the full remaining cost of their child’s undergraduate education from Uncle Sam.

The ripple effect
17620594881The implications of student loan debt are ominous–both for students and the economy as a whole. Students who borrow too much are often forced to delay life events that traditionally have marked the transition into adulthood, such as living on their own, getting married, and having children. According to the U.S. Census Bureau, there has been a marked increase in the number of young adults between the ages of 25 and 34 living at home with their parents–19% of men and 10% of women in 2011 (up from 14% and 8%, respectively, in 2005).4 This demographic group often finds themselves trapped: with a greater percentage of their salary going to student loan payments, many young adults are unable to amass a down payment for a home or even qualify for a mortgage.

And it’s not just young people who are having problems managing their student loan debt. Borrowers who extended their student loan payments beyond the traditional 10-year repayment period, postponed their loans through repeated deferments, or took out more loans to attend graduate school may discover that their student loans are now competing with the need to save for their own children’s college education. And parents who cosigned private student loans and/or took out federal PLUS Loans to help pay for their children’s education may find themselves saddled with education debt just as they reach their retirement years.

There’s evidence that major cracks are starting to appear. According to the Federal Reserve Bank of New York, as of 2012, 17% of the 37 million student loan borrowers with outstanding balances had loans at least 90 days past due–the official definition of “delinquent.”5 Unfortunately, student loan debt is the only type of consumer debt that generally can’t be discharged in bankruptcy, and in a classic catch-22, defaulting on a student loan can ruin a borrower’s credit–and chances of landing a job.

Tools to help
The federal government has made a big push in recent years to help families research college costs and borrowers repay student loans. For example, net price calculators, which give students an estimate of how much grant aid they’ll likely be eligible for based on their individual financial and academic profiles, are now required on all college websites. The government also expanded its income-based repayment (IBR) program last year for federal student loans (called Pay As You Earn)–monthly payments are now limited to 10% of a borrower’s discretionary income, and all debt is generally forgiven after 20 years of on-time payments. (Private student loans don’t have an equivalent repayment option.)

Families are taking a much more active role, too. Increasingly, they are researching majors, job prospects, and salary ranges, as well as comparing out-of-pocket costs and job placement results at different schools to determine a college’s return on investment (ROI). For example, parents might find that, with similar majors and job placement success but widely disparate costs, State U has a better ROI than Private U. At the end of the day, it’s up to parents to make sure that their children–and they–don’t borrow too much for college. Otherwise, they may find themselves living under a big, black cloud.

Prepared by Broadridge Investor Communication Solutions, Inc. Copyright 2013

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and cannot be invested into directly. The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with a qualified tax advisor.

July 2013 Blog: Hot Weather and Hot Markets?

With temperatures in parts of the Bay Area recently moving the thermometer well north of 100 degrees, I have begun to wonder if there was any connection between the stifling weather and other unexpected and bumpy developments in the financial world!

As you might have guessed, I am referring to a recent period of heightened volatility in both the fixed income and equity markets. Some investors may have felt a different type of discomfort than what they experienced during the steamy weather, as the prices of many types of financial assets simultaneously declined in value. The unusual conditions might not have been the investment equivalent of sun spots, but they were certainly noteworthy!

I wondered whether I should commission a team of top economists and climatologists to research whether there is a connection between these seemingly disconnected events. I soon concluded, however, that such research might not result in anything useful for my clients — and besides — I most likely couldn’t afford to hire the folks I had in mind anyway!

Instead, for my July 2013 newsletter, I am opting for a more practical approach and decided to provide some useful ideas and approaches to help you take the “temperature” of some of your personal financial and investment matters:

Just How Risky Is Your Portfolio?
If you’re like most people, you probably evaluate your portfolio in terms of its return. However, the amount of risk you take in pursuing those returns is just as important, especially when you are experiencing a time of personal change, or contemplating a career shift. Learn about a nuanced approach to understanding and evaluating investment risk. Read more…

Mid-Year Planning: Accounting for New Tax Rules
As you get ready for summer, your tax situation might be the last thing on your mind! Yet, if you are not familiar with the tax provisions approved by President Obama and Congress in early January 2013, you might miss out on the chance to try to improve your year-end tax position. Read more…

Happy Healthday: HSAs Turn 10!
Health Savings Accounts (or “HSAs” as they often referred to) are a great way for individuals and families set aside money on a tax-advantaged basis to pay for health-care costs. They may also be particularly applicable to people transitioning from traditional employment to roles as either independent contractors or as sole proprietors! Read more…

The Great Investment Debate: Active versus Passive
For many years, the debate between the advocates of passive and active investing has been as hot as the weather. Learn more about of each of these approaches and why your decision about which to use is important for your long-term financial health! Read more…

I hope these thoughts may help you feel more confident and “cool”, even during times when the financial climate is heating up! As always, please do not hesitate to contact me at (925) 301-4086 or send me an email at bill.pollak@lpl.com if you have any questions about these or other financial topics!

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The tax information provided is not intended to be a substitute for specific individualized tax planning advice. We suggest that you consult with a qualified tax advisor.