Reuters Money
Medicare will cut Social Security’s “raise” in 2012
After two years without an inflation adjustment, the Social Security Administration is expected to announce a 2012 cost-of-living adjustment (COLA) of more than 3 percent next week. That would be a sizable raise in this economy, and very welcome news to seniors hit hard by rising costs, slumping home equity and very low returns on fixed-income investments.
But the good COLA news will come with a nasty kicker. Many seniors will see a substantial part of the COLA consumed by a higher premium for Medicare Part B (doctor visits and outpatient services), which usually is deducted from Social Security payments. The situation sheds light on the complex interaction of Social Security COLAs and Medicare premiums — and it underscores the critical importance of the Super Committee deficit deliberations on possible cuts to future COLAs.
The annual Social Security COLA is determined by a formula that averages inflation for the third quarter, as reflected by the Consumer Price Index for Urban Wage Earners and Clerical Workers (CPI-W). No COLA was awarded in 2010 or 2011 due to a quirky spike in the third quarter of 2008, which resulted in a whopping 5.8 percent COLA for 2009. By law subsequent Social Security payments couldn’t rise until the CPI-W exceeded the 2008 level.
This year, the third quarter CPI-W has been running high as a result of higher energy costs. September inflation numbers will be released on October 19th, and most analysts forecast a resulting 2012 COLA greater than 3 percent. Indeed, some expect a number close to 3.5 percent or more.
That’s the good news. Unfortunately, most seniors would see that COLA reduced substantially, due to the way that Social Security benefits and Medicare Part B premiums interact.
The Part B premium usually rises at a rate greater than general inflation — a reflection of medical inflation. However, by law, the premiums cannot rise in any given year by a greater amount than the Social Security COLA – a “hold harmless” provision aimed at preventing Social Security payments from ever falling.
About 75 percent of beneficiaries were exempted in this way from Part B premium increases in 2010 and 2011. Rate hikes were paid only by two groups of seniors: low-income beneficiaries whose premiums are paid by Medicaid (so-called “dual eligibles”) and high-income seniors who pay income-related surcharges.
5 ways to make a bond ladder work for you
The mention of bond laddering often makes one think of retirees sitting on the sidelines of the market, buying individual bonds with staggered maturities to goose up their yields, but lately it’s not such a doddering strategy.
With bond yields low, savings account interest rates microscopic and stock volatility scary, younger investors and even college savers are starting to embrace the time-honored laddering strategy. If can work for people who don’t want to lock up all of their money in long-term investments but want more yield than they can typically get in short-term savings vehicles.
Bond laddering also adds an element of predictability to a portfolio, since each bond produces a set amount of income and returns principal at a specific date.
Stan Richelson, a financial advisor in Blue Bell, Pennsylvania, recently constructed a ladder for a couple whose child was starting college in six years. The first of the four investment-grade municipal bonds, which matures freshman year, has a tax-free yield of 1.5 percent. The last, which matures in 2020, yields 2.35 percent. That translates into taxable equivalent yields of 2.24 percent and 3.5 percent, respectively, for investors in the 33 percent federal tax bracket.
“That may not sound like all that much,” he says. “But you’re still getting a decent return and you know the money will be there when you need it.”
Bond ladders have some limitations, though.
But buying individual corporate and municipal bonds usually requires a total investment of at least $50,000 to $100,000 to get adequate diversification and avoid high markups on small transactions, says Kathy Jones, a fixed income strategist with Charles Schwab. Smaller investors can get around that by laddering Treasury securities or certificates of deposit, since investment minimums are so low.
Hedging can end your retirement panic now
Even with the most recent market agita, there’s no reason for you to worry long-term about your retirement funds.
Is my head in the clouds? As darkly volatile as this moment in personal investing may seem, it’s actually a golden age for portfolio insurance. Retirement worries as we know it can come to an end — if you know how to hedge properly. There are plenty of retail tools available to that end.
Part of my optimism is based on the availability of off-the-shelf portfolio insurance for everyone. If you hedge your holdings the way the big institutions do, big dips will do no harm and you can even make money when the market’s down.
The three most powerful hedging devices come in the form of exchange-traded funds (ETF), which are pooled portfolios based on securities and indexes traded on stock exchanges. You can buy them from any deep-discount broker and leave them in place.
Hedge inflation A rising cost of living generally hurts bond prices. Unlike most bonds, when inflation climbs, Treasury Inflation-Protected Securities gain value. One suggestion is the iShares Barclays TIPS bond fund.
Hedge your stocks Inverse ETFs such as the ProShares Short S&P 500 ETF, move in the opposite direction of the popular stock index.
Hedge your bond position You can short a broad-market bond index through the Direxion Daily Total Bond Market Bear 1X Share or similar ETFs. This is a good hedge if your portfolio is heavy in bonds and interest rates are rising.
I agree that hedging opportunistically can make sense for investors, but when it comes to hedging stocks, I think buying optimal puts on individual stocks (to hedge stock-specific risk) or on index ETFs (to hedge market risk) makes more sense than buying inverse ETFs.
One reason is that optimal puts offer more precision. Another is that they give you the ability to cap your cost at the outset. A third reason is that they can be less of a drag on your portfolio during periods when the market goes up. I elaborated on this in a post a while back: http://seekingalpha.com/article/271046-o ptimal-puts-versus-inverse-etfs-for-hedg ing
The case for financial repression: Mild inflation, low interest rates
Rick Ashburn is a chartered financial analyst and the founding Principal Chief Investment Officer of Creekside Partners, based in Lafayette, California. The opinions expressed here are his own.
As the two – or is it three? – political parties in Washington lurch toward a budget agreement, what are the longer-term implications of the situation we find ourselves in? We have a lot of public debt combined with the rather serious economic headwinds that rapid deficit reduction always entail. And at the same time that we need to reduce our debt load relative to GDP, our real GDP growth is likely to be sub-par.
There has been a lot of commentary in recent months about the possibility of reducing the nation’s debt by means of inflation. Simply put, a dollar of today’s debt can be repaid with a dollar sometime off in the future. If in the future there are twice as many dollars floating around relative to the size of the economy, the repayment of the old debt is only half as burdensome. Debt that seemed high in 2011 is only half as high after some decades of even modest inflation.
If inflation averaged merely 3.5 percent per year for 20 years, debt incurred today can be repaid at an effective 50 cents on the dollar. The compounding of that 3.5 percent inflation over 20 years results in a doubling of the price index — and a halving of debt still denominated in “old” dollars.
Modest inflation of the genuine kind, where wages rise along with prices, has certain advantages to economic growth. Primarily, it encourages capital investment and risk-taking since companies have some confidence that prices for their products will go up over time, allowing them to recoup their investment. Banks like modest inflation since it means their loan collateral will not decline in value. Consumers tend to spend money more readily, helping stores turn over inventory and keep workers on staff.
For all the benefits of mild inflation, who does not benefit? Conservative savers and holders of long-term bonds, that’s who. A bond yield of 3.5 percent results in a zero rate of return after inflation. Savers with money tucked away in low-yielding deposit accounts fall inexorably behind.
Should inflation begin to accelerate, the bond market will drive up interest rates until bond yields are comfortably higher than inflation. Should this happen in the normal course of events, the cost of servicing the public debt will increase just as fast as inflation would normally drive it down. There is no net gain in debt reduction. What we really need in order to “inflate away” our debt is combination of high inflation and low interest rates.
An interesting piece Mr. Ashburn, and well-written. However, it is one of limited purpose (investment), and assumes stasis of a number of factors that seem destined to derail the trajectories you project.
I would be curious to hear your position on the interplay of just one of those factors: peak oil. It is widely acknowledged that in 2005, world oil production peaked. (U.S. oil production peaked in 1979.) Demand, however, has not peaked. In fact, all other things being the same, demand would be expected to grow substantially as the economies of the BRIC move forward and their infrastructure improves. Of course, all things will not be the same, and if we refuse to assume, without any basis other than optimism, that a replacement energy source will be developed, then we can expect demand to be conflated by increasingly oppressive prices.
Thus, declining production of fossil fuels alone, and particularly oil, will continue to drive inflation irrespective of the CBs’ money-printing policies. Energy depletion cuts across all sectors of the economy, and most sharply against those commodities that people (“consumers”) need the most: food, shelter and transportation. At some point, even communications can be expected to be impacted.
For these reasons, I believe your opinions are attractive, but only as a snapshot of where we are today. I frankly doubt they hold much predictive value over the long term. I’d be interested in how you would respond to that.
Why Social Security COLA cuts will whip up a fight
If you want to tick off a senior, just mention Social Security’s cost-of-living adjustment (COLA). The COLA has been on auto-pilot since 1975, when the first automatically-adjusted benefit adjustment was made, using a formula tied to the Consumer Price Index. A COLA was awarded every year from that time until 2008, but since then — nada.
Uncle Sam’s stinginess resulted from a quirky spike in the CPI-W — the index now used to determine the COLA — in the third quarter of 2008. Just before the economy crashed, the CPI-W spiked temporarily due to a big increase in energy prices. The result was a whopping 5.8 percent COLA for 2009. Social Security payments can’t rise until the CPI-W exceeds the 2008 level — and they can’t fall under federal law — so benefits were held level in 2010 and 2011.
A 1.1 percent COLA is forecast for 2012 by the Congressional Budget Office (CBO). But debate is heating up in Washington about further changes that could enrage seniors anew.
Several of the key federal deficit reduction plans that have been advanced in Washington recommend shifting to a measure of inflation called the “chained CPI.” A chained index reflects changes that consumers make in their purchasing across dissimilar items in response to price changes; the theory is that a spike in gasoline prices will prompt consumers to spend less on fuel, perhaps more on food. And so on.
The chained CPI could be applied to federal benefit programs and to the income tax code — although it stands to generate far more benefit cuts than revenue gains.
On the benefit side, a chained CPI would impact Social Security, civilian and military pensions and veterans’ benefits and Supplemental Security Income. On the revenue side, a chained CPI might be applied to inflation adjustments for tax brackets in the personal income tax code, effectively serving as a stealth tax hike by reducing tax bracket adjustments and subjecting more of individuals’ earnings to higher tax rates over time.
According to the CBO, benefit adjustments could yield $217 billion over 10 years, with 52 percent of that — $112 billion — coming from reduced Social Security COLAs; income tax bracket creep would generate $72 billion.
The chained CPI is really the Alpo Index. It will move retirees from NY Strip to canned dog food, while telling them nothing has changed. They will end up on a Bangladeshi diet. Remember the frog in the water pot, not jumping out as the heat is gradually turned up until he is eventually cooked to death.
Why not increase the earnings of the trust fund by allowing the trustees to invest in U.S. government guaranteed debt. No increase in in risk, but a slight increase in return. Then allow the trustees to invest their funds in U.S. treasuries anywhere on the yield curve.
Retirees are already subsidizing the younger generation by getting lousy CD rates that allow the kids to get cheap mortgages.
It wasn’t retirees who caused the mortgage mess, yet Ben Bernake through 0% interest rates is forcing retirees to suffer for the kids. That is enough.
Investing: A little inflation isn’t such a bad thing
We’re in a three-headed hydra economy now. There’s the threat of burgeoning inflation, joblessness and a rotten housing market.
Yet the idea that rampant inflation will trigger an investment debacle is perhaps overblown. A touch of inflation can be a good thing and it depends on how you invest.
I’m not discounting the possibility of a bond bubble bursting, so be sure to shorten your maturities on high-quality bonds because they will get hardest hit by any interest-rate increases. Beyond that, the news may not be all that bad based on historical results for stocks.
Consumer inflation is running at a nearly four percent clip, according to the latest government report, which shows the annual rate at its highest since June, 2008. The bulk of the increase was in energy (fuel prices — up 21 percent) and food.
A little inflation isn’t that toxic to stock returns. According to research from the Leuthold Group, stocks often gain in periods of mild inflation. The last time inflation was climbing at least three percent, stocks did just fine. Leuthold found that in September, 2000; September, 1996; and June, 1995, the subsequent one-year performance of stocks was 13 percent, 20 percent and 26 percent, respectively.
Although there are exceptions to these trends — December, 2002 had a one-year trailing decline of 22 percent (recession-induced) — the overall conclusion is that “in those periods of mild inflation 45 of 53 periods (going back to 1926) had positive [stock] returns.”
What happens if inflation creeps substantially over the three percent threshold? Only four of those periods in the Leuthold study showed gains. One thing is fairly certain: Stocks generally don’t do well during high-inflation times. In the 1970s, when inflation averaged 7.4 percent — it was double that toward the end of the decade — stocks only rose about five percent, according to Ibbotson Associates. That compares to an 18 percent average stock performance for the 1990s, a decade in which inflation averaged less than three percent.
Inflation is ALWAYS a bad thing. Deflation is much better. It means our purchasing power goes up … each dollar can buy more, whether it’s food our a house. Inflation is only good for one thing: allowing the government to steal more of our money via taxes.
How to invest for long-term inflation
It’s no secret that food and energy prices are volatile and rising of late. Yet what’s missing from the latest inflation hand-wringing is what’s down the road. Some commodities are becoming scarcer and that will drive long-term inflation.
While few invest based on scarcity, it’s a prudent long-term strategy. This is not something that will turn up in the latest inflation numbers. In the most recent Consumer Price Index report, core inflation climbed at a 1.3-percent annual rate in April. Gasoline prices accounted for half the increase.
One long-term prediction that has slowly manifested itself over the past 30 years is the concept of peak oil. This theory — borne out by production figures — posits that we have passed the peak of petroleum production worldwide. New oil is not only harder to find, it’s in places that are tougher to access, such as miles below the ocean floor.
Is peak oil responsible for the recent $100/barrel-plus prices? Not entirely, since supply disruptions in the Middle East and speculation play a big part. There’s also the demand side: Developing countries like China, India and Brazil want their share of hydrocarbons for new cars, chemicals, plastics and fertilizer.
Some of the peak-oil thinking has already been integrated into urban planning in emerging economies. New public-transit systems are being built in 82 Chinese and 14 Indian cities. It’s extremely difficult to buy a car in either Shanghai or Beijing. If we’re indeed seeing the end of the carbon age, then mass transit is a positive development.
Speaking of transportation, more of it is greening due to the revolution in electric cars and batteries. Not only are cars becoming all-electric (great for short trips, which is how much people use them), they can go further on a single charge. Right now, no one can use them for long trips. With newer technology, that will change.
Long-term, greener vehicles mean lower transportation costs, which take a hefty bite of family budgets in an era of $4-plus-a-gallon gasoline and diesel.
The next great threat: 5 ways to battle inflation
As the U.S. deals with one pernicious threat, another one looms: Inflation.
Consumer prices, led by food and energy increases, are the highest they’ve been in two and a half years.
Forecasts can be distracting, so you need to avert your eyes from the headlines. Yes, I know gold hit $1,500 an ounce, silver hit $50 and the dollar was headed for the dungeon, but there’s a household impact you need to gauge first.
Depending upon whom you track, inflation is either on a huge upsurge or will be mild this year. The Leuthold Group sees consumer price hikes ranging from 3.5 percent to up to 8 percent this year. Those who savor metals and commodities see an even higher surge.
I’m not in the camp that thinks there’s going to be hyper-inflation (10 percent-plus) or even stagflation (higher prices, no economic growth). For the short term, at least, inflation may be under 3 percent. Yet even that modest rise in prices is something you should – and can – guard against.
The market sentiment on U.S. inflation is about a 2.6 percent increase in consumer prices. That’s the approximate spread between U.S. Treasury Bills and Treasury Inflation-Protected Securities (TIPS) maturing in 2021 .
Let’s get personal about inflation first: If your income, housing, medical or transportation costs are directly driven by inflation, you need to pay close attention to price increases. You don’t want to be blindsided and lose purchasing power.
Scary and scarier: rising prices and rising rates
Data expected out of Washington this week may raise anxiety levels of investors and consumers who are already worried about inflation and rising interest rates.
On April 12, the Bureau of Labor Statistics reported that U.S. import prices jumped in March. We’ll also get data on producer prices on April 14 and consumer prices on April 15. But here’s what we already know: It costs more to fill your car, and your belly. And what doesn’t run on food or fuel?
At the same time, Federal Reserve officials have gone out of their way to pooh-pooh the dangers of inflation. That just worries consumers and bond investors all the more. If niche commodity price increases start feeding through to other goods and services, or if the Fed starts throwing around too much cash, the end result could be rising long-term interest rates. And rising rates could slam bond investors, who would lose money if the prices of their bonds fell to create higher yields. That would be particularly bad for mom and pop retirement investors who have been told that bonds are “safer” than stocks.
So, what to do, what to do? Realize, first, that rising prices and rising long-term bond yields are two distinct and different situations. “Even though in theory, they should be linked together, the math shows they don’t move in lockstep,” says Tim Courtney of Burns Advisory Group in Oklahoma City. Long-term bond yields are more likely to rise ahead of consumer inflation. They’ll rise when bond fund investors start to expect future inflation.
That means investors and consumers should be planning for both eventualities separately. Here are five ways to protect yourself from rising rates. (We’ll address rising prices in a later post.)
Be careful about TIPs. Treasury inflation-protected securities promise to protect portfolios from the ravages of inflation, through a complex pricing mechanism. Their yield is divided into two parts: a fixed yield and a yield guaranteed to rise with the Consumer Price Index. Right now, they are more expensive than regular Treasuries — an expectation of two percent annual inflation is built into their price, says Courtney. That means they will only pay off if inflation runs higher than that, but that isn’t the real risk with these bonds. The real risk is that interest rates will rise, but prices won’t. Then what happens to TIPs holders? They’ll get slammed. Their yields won’t rise and their prices could fall.
Short bonds. This is something Pimco’s bond buff, Bill Gross, has already started to do. His Total Return Fund — the world largest bond fund — began shorting Treasury debt in March. Ed Easterling, president of Crestmont Research, an investment research firm, suggests that this is one of the very few ways you could buy “proactive protection” from future inflation. If rates go up in anticipation of future inflation, and you’re shorting long bonds (in effect, borrowing bonds and selling them at today’s prices), you’ll gain when bond prices fall and you can cover your short position with cheaper bonds. That sounds complex, but you could do that by buying shares of an exchange-traded fund, such as the Proshares Ultra Short 20 Yr Treasury, that inverts and doubles the performance of long term Treasury bonds. Even more aggressive, reports Lipper, is the Direxion Daily 20+ Year Treasury Bear 3x exchange-traded fund. That inverts the Treasury 20-year bond and then triples it.
This is a really interesting and insightful article, thank you for posting it. I think the best thing for all of us to do is just make sure that we are doing all we can to manage our finances so we know what is going on! I have been using an investment analysis software called Statpro which has helped me in analysing my value-based estate, litigation support, and acquisition activities. Even more so the most helpful tool I have used is the bond pricing which have really come into use when trying to assess my mortgage.
Why market-neutral funds may come up short
Does the prospect of inflation, higher oil prices and double-dip housing recession keep you up at night? Long-short or market-neutral funds seem ideal for nervous nellies. They attempt to blunt your downside risk by “shorting” stocks while giving you a piece of the upside.
Brokers are aggressively hawking these funds — sometimes referred to as “alternative investments” — to conservative investors as a way to blunt market risk.
Yet they don’t always work the way you hope they will. While these hedge-like funds are certainly a bulwark in awful markets, you’re almost always better off in a broad-based global stock index fund like the Vanguard Total World Stock ETF in bullish times.
The mechanics of long-short funds can be tricky. They generally hedge their bets on the downside by buying put options, derivatives that protect investors against a loss by locking in a sale price for securities they own. On the upside, fund managers buy call options, which lock in a gain at a certain price to generate income.
One of the most popular long-short vehicles is the Gateway Fund, which buys options on the S&P 500 Index. The fund has one of the highest capital preservation ratings from Lipper and sports relatively low costs (0.95 percent annually) with a $2,500 minimum investment.
If you look closely at what the fund did during that wretched 2008 debacle, it makes sense — if you’re a cautious investor. The fund lost only about 14 percent in that year, compared to a 37 percent loss for the Vanguard Total Stock Market Index .
The insulation in a long-short fund, though, typically means you sacrifice gains on the upside. Say you stayed in your Vanguard broad-market index fund (above) through the recovery years of 2009 and 2010. You would have gained 29 percent and 17 percent, respectively, in each of those years. Your returns in the Gateway fund during those years? Don’t hold your breath: About six percent and five percent in each year.
I forgot to mention. My disability check is now less than it was in 2009. I am not on Medicare. I have fought through my horror with as little tax payer assistance that I could get by on. I gave my children to their father so as to keep off of welfare and give them a better chance and a better life. I moved in with my ailing mother to help her. I sold everything I had to keep my mother from stressing out. I am not perfect. My bad decisions and mistakes caused my trauma. However, because of my journey I am that much better trained and equipped with the tools to help other people avoid my path and even more so to identify the people that I can hope to be able to encourage and offer emotional support to help them find their way back. If anyone feels a connection to my posts, please contact me. As Madonna sang, “I Have A Tale to Tell”. A tale worth being heard.