Pages

Sunday, February 14, 2016

The Federal Reserve and Other Retirement Risks

The Federal Reserve’s growing balance sheet is a major concern for professional investors. However, it should be a growing concern for main stream investors, and it should be a concern for folks looking at retirement in the near future. Why should this be a concern for individuals attempting to accumulate wealth for retirement, and seeking to use their retirement funds to enjoy the golden years? What other concerns should individuals have while planning for retirement?

Background

The Federal Reserve’s balance sheet has grown since the Great Recession of 2008. The Federal Reserve began purchasing US Government Debt instruments via programs such as Operation Twist. When the Fed purchases Government debt (Bonds), it does not purchase them directly; it purchases them via a 3rd party dealer. This purchase, in turn, increases the money supply.  The Fed creates the cash, from a computer entry, and the purchase occurs. Due to the rules of the fractional banking system, the money supply is increased once that purchase check is deposited.

Here is an example a chart here showing the growth of the Federal Reserve’s balance sheet:












Eventually, the Federal Reserve must have an exit strategy to deal with this debt from the growing balance sheet. What is the strategy? Raising interest rates? Selling off the debt? What is it?


Inflation Concerns

Recall, for readers who frequent this blog, the definition of inflation: It is the increase of the monetary stock or base.  The monetary base is increased, as the Fed continues to purchase more US Government Debt.  Inflation impacts individuals that are on fixed incomes, which are typically retirees.  As the monetary base is debased, the ability for retirees to spend dollars on goods and services alters dramatically.  This means that retirees must have the ability to have their investment dollars outpace inflation.

Analysts love to cite the CPI as a measure of inflation; however, this is not an accurate measure of inflation. Looking at various factors, such as commodity prices, is one way of looking at inflation. Food prices should be analyzed as well, with regards to looking at inflation. While food prices, as well as commodity prices have dropped considerably since 2008, they are still higher than they were 10 years ago.

Graph of Food Prices:





Graph of Commodity Prices:







Individual Savings Rate

Currently, the individual savings rate is around 5.5%, as of December 2015. Since the 1950s, the individual savings rate has shown a downward trend. This is an interesting trend.  From an economics perspective, savings is needed to expand the economy and spur economic growth.  If the savings rate is down, this could be a harbinger for things to come.  As a retiree, one must review their stocks accordingly. Should my equities include companies that are seeking to expand? Can they expand if there is a declining savings rate? If this is the trend, how should one manage their portfolio?

A graphical display showing the trend of the individual savings rate:











Taxes 

Currently, the marginal income tax rates are the lowest in decades. With the United States Government debt load reaching its zenith, and the demand of the use of Social security, Medicare, Obamacare, and the like, politicians will seek to raise tax rates.  In fact, some of the leading presidential candidates are proposing to raise taxes on the “rich”. For example, Donald Trump says the following:
“If you look at actually raise, some very wealthy are going to be raised. Some people that are getting unfair deductions are going to be raised. But overall it’s going to be a tremendous incentive to grow the economy and we’re going to take in the same or more money. And I think we’re going to have something that’s going to be spectacular.” (Nolte, 2015)
Presidential Candidate Bernie Sanders is pushing the following:

“Mr. Sanders has proposed a headline top tax rate of 52 percent, applying only to incomes over $10 million. But that’s just the federal income tax. When you combine it with other taxes that apply to income, like existing payroll taxes and new ones Mr. Sanders would impose to pay for Social Security, single-payer health care and family leave, and then add those on top of taxes levied by state governments, it would add up to a combined tax rate of over 73 percent on the highest incomes, more than 20 points higher than today. That’s in the average state — maximum rates in high-tax jurisdictions like California and New York City would be even higher.” (Barro, 2016)

One should consider that all sorts of tax increases could occur; this is to include an increase with Estate Taxes.  No one knows for sure if this will happen, however, there needs to be a plan in place to deal with this tax risk.

Conclusion

Saving retirement in this economic climate will be a challenge. All of these aforementioned items must be considered while designing a plan for retirement. These risks are real concerns, and building an solution to protect and grow your hard earned cash should be the objective. This can be done, as there are solutions to mitigate these risks. If you are at retirement age, these things, and many other items, should concern you. Attempting to mitigate your tax liability, while at retirement, should be one of the top priorities in dealing with your economic plan. Ideally, having a Tax Free retirement should be the objective.



Works Cited

Barro, J. (2016, Febuary 9). Bernie Sanders' Plan Would Test an Economic Hypothesis. New York Times.
Nolte, J. (2015, September 28). Trump Pushes Single Payer Healthcare, Tax Increases on the Wealthy. Breitbart.



No comments: