AssetBuilder - Registered Investment Advisor

By Scott Burns

The protestant reformation began in October 1517. That was when Martin Luther nailed his 95 theses to the door of a church in Wittenberg, Germany. Among other things, Martin Luther was protesting the sale of “indulgences” by the Roman Catholic Church.  Pay enough and ones’ sins would be forgiven.

A similar— but entirely economic and secular— protest may have occurred with the publication of the annual report of the Federal Reserve Bank of Dallas. The report calls for the end of Too-Big-To-Fail and the breakup of our largest banks. TBTF has led the big banks and those who run them to receive gigantic indulgences (not to mention economic salvation) at taxpayer expense.

Richard Fisher, the bank’s President, has given speeches about the TBTF problem since 2009. But in this report he states the problem and his position very clearly, right under his picture:

 “The too-big-to-fail institutions that amplified and prolonged the recent financial crisis remain a hindrance to full economic recovery and to the very ideal of American capitalism. It is imperative that we end TBTF.”

No waffling or wimp talk there.

The 20 page essay that follows, “Choosing the Road to Prosperity: Why We Must End Too Big to Fail Now,” written by Senior Economist Harvey Rosenblum, lays out how the asset concentration in the top 5 banks has tripled from 17 percent in 1970 to 52 percent in 2010; the weakness of recovering and undercapitalized banks; why that has resulted in a weak economic recovery; and the likely failure of the Dodd-Frank legislation to end TBTF.

In one small text box, “TBTF: A Perversion of Capitalism,” Rosenblum summarizes the moral hazards and public damage caused by having institutions that are deemed too big to fail.

 “An unfortunate side effect of the government’s massive aid to TBTF banks has been an erosion of faith in American capitalism. Ordinary workers and consumers who might usually thank capitalism for their higher living standards have seen a perverse side of the system, where they see that normal rules of markets don’t apply to the rich, powerful and well connected.

 “Here are some ways TBTF has violated basic tenets of a capitalist system:

• “Capitalism requires the freedom to succeed and the freedom to fail. Hard work and good decisions should be rewarded. Perhaps more important, bad decisions should lead to failure— openly and publicly. Economist Allan Meltzer put it this way: ‘Capitalism without failure is like religion without sin.’
• “Capitalism requires government to enforce the rule of law. This requires maintaining a level playing field. The privatization of profits and socialization of losses is completely unacceptable. TBTF undermines equal treatment, reinforcing the perception of a system tilted in favor of the rich and powerful.
• “Capitalism requires businesses and individuals be held accountable for the consequences of their actions. Accountability is a key ingredient for maintaining public faith in the economic system. The perception—and the reality— is that virtually nobody has been punished or held accountable for their roles in the financial crisis.”

The left and the right of American politics don’t agree on much but there is one thing the Tea Party and Occupy Wall Street (not to mention the voting public) would joyously agree on—  Too Big To Fail has got to go. The idea of breaking up the big banks is adored by everyone but the bankers and the more conventional politicians the bankers so generously fund.

Are there alternatives to breaking up the big banks? Two come to mind.

One is for the boards of directors of the big banks to establish big time claw-backs on executive compensation so the top dogs can lose it all if they take excessive risks. Grant’s Interest Rate Observer editor, James Grant, advocated this idea in a recent speech at the New York Federal Reserve Bank.

Another is to adopt “limited purpose banking” in which banks are paid fees to connect borrowers and enterprises with lenders and investors, without taking risk. This is very much like what mutual fund firms do. Limited purpose banking would end the privatization of profit and the socialization of loss. This idea is advocated in “The Clash of Generations,” a new book I co-authored with economist Laurence J. Kotlikoff.

By Scott Burns

Q. My wife (75) and I (77) have approximately $800,000 in CD's. We are debt free and receive about $3,000 a month in Social Security benefits. We both work part-time earning a combined total of about $70,000 a year. Should we consider putting some of this money in the stock market? Could you advise me of the track records of the various investment companies and what percentage of the $800,000 would be prudent to invest. —D.T. by email

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By Scott Burns

Can you spell i-c-e-b-e-r-g?

Well, we’ve hit one and our ship is taking on water.

Two weeks ago the Trustees for Medicare released their annual report. The report, and the warnings it contained about the uncertainty of future costs, got some attention. But not nearly enough.

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Q. I'm 46 and have been working since I was 24. I have always been a saver, so I have about $850,000 accumulated in various accounts. I'm married and have two kids in the 8th and 6th grades. My husband and I manage our money separately because we have different investment styles (So this $850,000 is entirely mine, although I understand there is no such a thing as "mine" while we live in Texas). I also have a $50,000 emergency fund in cash.

That $850,000 is in investment accounts split between Vanguard and Ameritrade. Over time these accounts have become cluttered with too many funds and stocks (some were carried over from when I worked with a Chase financial advisor).

Since my kids will be going to college in 4 to 6 years, I probably should be less aggressive, even though I always feel that I can be aggressive until I retire (probably when I turn 60). This belief stems from my earning power - I have always been working. Currently I make $92,000 a year. I used to contribute 25 percent to my company 401(k) until a month ago when I lowered it to 15 percent. I get a 3 percent match from my company.

With my kids getting into their teens and becoming difficult, I’m considering taking a year or two off to be with them. Would this change how I should invest my money? —C.T., Dallas, TX

A. You clearly have a good grasp of your situation and the decisions that need to be made, though I might add that in marriage, regardless of where you live, “ours” trumps “mine.” It’s a marital life condition that is far more important than the laws of any state.

The first thing you should do is consolidate to one firm. This does not mean consolidate all your accounts, it just means combining as many accounts as possible at the same firm. Doing so will make electronic access easier. It will also allow you see the big picture. My wife and I, for instance, have all our investment accounts housed at a single firm, as well as a checking account. It works well, particularly with getting information online.

Once the consolidation is done you'll need to do some "heavy lifting" and estimate how much of your $850,000 is needed for coming college expenses versus how much you can consider long term/retirement money. This isn't a simple task because there is a big difference between the cost of the University of Texas and the cost of, say, Stanford or Harvard or Duke. The more of your existing long-term investments you can leave in place, the better.

The college fund should be kept in safe investments even though they are likely to earn very little. The retirement money should be invested with an eye toward return and growth at an acceptable level of risk. For lots of people hoping to retire within 15 years that would be a balanced fund, 60 percent equities/40 percent fixed income. With assets in reserve for education, you might be a bit more aggressive than that.

When it comes to financial planning, talking about nominal dollars isn't very useful because inflation makes past incomes look silly. Late in the 1960s, for instance, Fortune magazine published an article titled “The Good Life Begins at $25,000 a Year.” The article showed the percentage of such households that went on overseas vacations, bought good wines, had country club memberships and owned luxury cars. Today, a Texas couple with that income would be eligible for a small monthly benefit in food stamps.

So you need a metric, a framework and a unified plan for your future. Let me explain. Your $850,000 is about 12 years of what you spend from your income ($92,000 income less $23,000 saving). In fact, the multiple is somewhat larger since you don't need to replace employment taxes when you retire and you won't be spending the money you now spend on the kids when you retire. So, relative to most people, you are well ahead of the game. In fact, if you were driving at Indianapolis, you’d be lapping the crowd. So if you want to take a year or two off, feel free, but it would have no impact on how your nest egg is invested.

You and your husband may have different investment styles but you still need to be on the same page when it comes to your long-term planning as a couple. If he is as diligent a saver as you, for instance, your savings as a multiple of your spending as a couple (excluding costs of the children) may be still higher than 12 years of income. Together, you should be looking for combined assets of 20 to 25 years of your expected retirement spending, including taxes. This multiple can be adjusted downward if you factor in the value of Social Security benefits, even if you take them at age 62.