A New Year's Message 12/26/07 | Back

I hope this week finds you celebrating with people you love, joining in hopes that the New Year will bring health and happiness, and a certain measure of prosperity.

Every year we look forward to better times for ourselves, our loved ones, our country and our planet. It is human nature to be optimistic, and we Americans have been rewarded over the centuries for our optimism and perseverance.

Those of you who follow my columns know that I don't make forecasts, but only try to look realistically at the facts as they present themselves. The facts say this will be a critical year, not only because we will elect a new President but because we enter this year as the world's biggest debtor nation! That one fact will limit our options to demand changes in the world, and to solve problems in our own economy. And it will impact our personal finances and investments.

So before touching on investments, please indulge me in this broad, but simple, look at what America is doing to itself. There's never enough space in one column to make all the logical connections. And at the end of this letter, you'll find "Terry's To Do List" for the New Year, a quick-check on your personal finances.

The Dangers of America's Debt

As I've written in several columns over the past few years, we keep buying "stuff" made in foreign countries - China, Japan, the European Union -- and in the Middle East, where the "stuff" is oil, essential to our daily lives. We sell those countries far less than we buy. So, we keep paying for that "stuff" with our dollars, which the world has been stockpiling.

One investment newsletter that I highly recommend, The Daily Reckoning, (http://www.DailyReckoning.com) keeps track of the statistics, and posts some insightful commentaries. The statistics quoted from that site reflect our country's position a year ago.

"Foreign investors now [year-end 2006] own about USD $8 trillion of U.S. financial assets, including 13% of all U.S. stocks, 24% of corporate bonds, 43% of Treasury bonds, and 14% of government agency debt. . . .

In the 1980s, the U.S. was the world's biggest creditor nation, meaning that we had far more invested in other countries than those countries had invested here. But by 2003, foreign investors owned USD $9.4 trillion of U.S. assets, while U.S. claims on the rest of the world were only USD $7.2 trillion."

The process of foreign investors using their dollars to buy pieces of America continued unabated in 2007. And this past year we saw a clear demonstration of the implications of our status as a global debtor. In recent years, our banks securitized billions of dollars of worthless mortgages. By mid-August, the bubble burst, and now our largest financial institutions face billions of dollars in write-offs.

Buying America

At the same time, billions of the dollars we've sent overseas (to buy "stuff") are coming back in the form of investments in our banking and financial services companies, which are desperate for capital to offset their huge write-offs on mortgage losses.

Singapore's investment arm is taking a $5 Billion stake in Merrill Lynch, as well as investing $9.7 billion into UBS ("you and us" as the commercials say), a global firm with a big presence in America. An Abu Dhabi state owned investment fund took a $7.5 billion stake (4.9%) in Citigroup (on top of the multi billion dollar stake in Citigroup owned by Saudi Prince Alwaleed bin Talal, who "rescued" the bank in the early 1990s). And China Investment Corp. is buying up to 9.9% of troubled Morgan Stanley.

Well, what did we expect them to do with all those dollars we've sent over there to buy stuff? Keep investing in U. S. Treasury bills as the Fed tries to push rates down? Stick with dollars, as our Federal Reserve and other central banks try to flood the world with liquidity in an attempt to get the banks to lend again?

The world doesn't want our low-yielding dollars, especially as the Fed announces it will create more of them (inflation). And so the value of the dollar is falling (just try traveling to Europe, or even Canada, and see what your dollar will buy. Or better yet, what it won't buy!

This is serious, folks. I'm all for foreign trade that keeps a growing and balanced global economy. But just as consumers have mortgaged their futures and financed their lifestyles on their credit cards, so has our country. It's not just the trade deficit that poses problems. It's the Federal Budget deficit, too.

"MEGO Numbers!"

We've run up billions of dollars in deficits in the past few years, even in the midst of strong economic growth that brought in more revenues to the Treasury. It's the old "guns and butter" story of the 1960s-1970s - and you know what that led to: major inflation.

The Comptroller General of the United States figures we have a nearly $50 TRILLION dollar unfunded liability, when you count all the promises we've made for Social Security and Medicare. How can we tax our children to pay our boomer retirement? We're creating "generation warfare." And if you think it's tough to win a war in Iraq, imagine how tough it will be when our demands for Trillions of dollars take their toll on our children!

These are MEGO numbers. That stands for: My Eyes Glaze Over! But you CAN do something about them this election year. Go to http://www.truthin2008.org - a non-partisan group of experts trying to get these financial issues on center stage in this election contest, no matter which candidates become the nominees.

The Facts - and Your Investments

Meanwhile, what do these facts mean for your own, personal financial situation? What should you consider as you make your investment decisions for 2008?

First, I would like to point you to a chart that is included in both The Savage Truth (82) and The Savage Number (p.98). It shows that, going back to 1926, there has never been a 20-year period when you would have lost money in a diversified portfolio of large company stocks, with dividends reinvested - even adjusted for inflation.

So if you are a younger reader, with many years to invest until retirement, and many years to live during retirement, you'll want to keep a significant portion of your assets invested in a diversified stock market portfolio. Over the long run, and even including some very scary times, the stock market has always proved to be a good investment.

But the facts, as we see them, have some important implications for your investments. As philosopher George Santayana said in 1905: "Those who cannot remember the past are condemned to repeat it."

If our Fed tries to forestall a recession by creating excess credit, we will have inflation down the road. The Fed certainly realizes the dangers, and is walking a tightrope - trying to create just enough credit to keep our financial institutions from imploding in recession, while avoiding excess credit creation which results in inflation.

If Inflation Comes

If inflation does return, it will have an impact on your savings and investments. After all, what good does it do if you reach your "Savage Number" and find that the buying power of those dollars will sustain you for far fewer years. At even 5 percent inflation, the value of your dollar will be cut in half in only 14 years!

When global markets sense that the dollar will be worth less, traders sell dollars and convert to other currencies or hard assets. In case you missed the late 1970s and early 1980s, the American populace is at least as smart as the global currency traders. Once people figure out that the dollar won't be worth as much in the future (inflation), they demand higher interest rates to compensate for the loss of value when they lend money.

Since America is such a huge borrower - selling billions of Treasury bills, notes and bonds every month - a higher interest cost will only expand our Federal budget deficits.

If rates rise, you don't want to own bonds. If your money is locked up in bonds for years, at low interest rates, the value of your bonds will fall. You'll take a loss if you should want to sell them before maturity. And if you hold on to the bonds, you'll be getting less interest than you deserve. Bonds - all types of bonds - carry both "credit risk" and "interest rate risk." Even top rated bonds, such as U.S. Treasuries will decline in value as interest rates rise. The longer the term, or "maturity" of the bonds, the larger the price decline.

As an offset to potential inflation, you'd want to own some gold or natural resources mutual funds. Yes, these funds have had a huge percentage increase since I first wrote about them several years ago. But if inflation returns, you'd see even more gains as investors rush to get out of dollars.

Similarly, I've written several columns about diversifying OUT of the dollar - either using FDIC-insured foreign currency CDs available at http://www.EverBank.com, or though the Merk Hard Currency mutual fund. The dollar has already fallen dramatically, and traders always wait for rebounds to take a position.

More conservative investors could consider the purchase of mutual funds that buy Treasury Inflation Protected bonds, whose yields are based on adjustments for rising inflation. (American Century Funds has a no-load TIPS fund.)

[Note: It is likely that I have positions in all the funds I write about, positions taken after I write my columns, and many that have been held for the very long term.]

On the Other Hand . . .

There is always the possibility that the economy will sink into recession - an economic slowdown that could bring lower interest rates as the demand for money dwindles, and lower energy prices as industry slows.

That's why you don't want to go to any extremes in purchasing inflation hedges. They are just an "insurance policy" against global inflation. Another, but temporary, hedge is "chicken money" - money held in liquid short-term money market accounts, Treasury bills maturing in less than one year, and insured short-term bank CDs. You won't get rich with those investments, but you will have flexibility to move into other investments when you're more certain of the direction of the economy.

It's entirely possible that we could have a return of "stagflation" - inflation combined with slow economic growth. We suffered through that in the 1970s.

That's the nature of investing.: you never know the future for sure. There are two sides to every coin - heads and tails, inflation or recession, bull or bear. And no one has the answers for certain on a consistent basis. Even famed fund managers and traders lose their touch.

The point of this essay is twofold - to encourage you to continue investing in a diversified way, and to organize your personal finances so you can be flexible and alert to changing scenarios.

My Readers are Special

The very fact that you've come to my website means you care about your money and are watching the economy. But there are millions of others, who simply float along with the trends - which means they're over their heads in debt. So as you look at this checklist, please consider sharing it with someone who's afraid to talk about money - maybe your adult children (or aging parents), or co-worker or best friend.

It may not be "polite" to talk about personal finances, but it is far less helpful to avoid the talk and watch loved ones deal with the consequences of poor planning. On that note, here's a quick check-list for the New Year.

Terry's "To Do" List for the New Year

* Detail your debts. Make a list of what you owe and the interest rate and minimum payment. (Remember, if you double the minimum monthly payment, and never charge another penny, you'll pay off your credit card in less than 3 years.)

* Check your mortgage. Plan to pay extra every month to pay it off early, and save a fortune in interest. If your rate is floating, or if you have a home equity loan, consolidate now to a fixed rate loan, if possible. Help is available at 800-CALL-FHA, if you're not behind on your payments. Contact your loan servicing company immediately if you're in danger of missing a payment.

* Get Credit Counseling. If necessary, contact Consumer Credit Counseling Services. One call to 800-388-2227 will put you in touch with the nearest local agency. You can talk over the phone to get unbiased, safe advice.

* Secure your Identity. I recommend http://www.identitysweep.com, a group I've been working with closely to encourage people to be pro-active about security - not waiting until a breach occurs.

* Evaluate Your Investments. Over the years I've mentioned numerous ways to get help in planning your investments for the future. One of the easiest - and the only way individuals can get this service free --is to go to my website and click on the blue box for a direct link to www.FinancialEngines.com. Then you can input your goals and current status, to get a secure, personalized, computerized evaluation of whether you're on track to reach financial goals such as retirement. (Many Fortune 100 companies offer this service to their employees to help advise on investing their 40lk plans.)

* Get on Track for Retirement: While many companies offer retirement investment and withdrawal planning, the one I truly recommend is offered by T. Rowe Price for a one-time charge of $250. It is a personalized service, not an online computer model, and will require some effort on your part. Contact them at 800-638-5660. Or if you just want to get oriented about where you stand, how much you should be saving, go to http://www.choosetosave.org, and click on "ballpark estimator" which is the best online calculator around. It's a product of the Employee Benefit Research Institute.

* Update your Insurance. Do you have enough life insurance? Do you think it's too expensive? How would your loved ones afford the life you provide for them, without your income? Go to http://www.Accuquote.com to check term life prices, which have fallen dramatically over the past few years.

* Update your Estate Plan. Review your documents, keeping in mind that the Estate Tax law is scheduled to change dramatically in the next few years. You may not want to pay for updates now, unless they are truly necessary, since we have no idea how the next Congress will change the laws. To find an estate planning attorney in your area, go to your state bar association. Remember, state laws apply - so if you've moved recently, be sure to find an attorney in your state.

* Double check your Beneficiaries. Make sure you have named the correct beneficiaries for your life insurance, Individual Retirement Accounts, 401(k) and 403(b) plans. Money goes directly to these beneficiaries, outside your will or living trust, and when you're gone there's nothing you can do if your ex-spouse is still the beneficiary instead of your children!

* Buy Long Term Care Insurance - for yourself, or your parents. The time to start is at age 50, but it is still affordable - and worthwhile - into your seventies. The money you spend on premiums will ensure the care of your choice, while leaving your assets to your children. Check the many articles at my website for details.

Finally, look forward to the New Year with hope and happiness in your heart. Maybe this is the year we will find Peace on Earth. Count your blessings, for they are many - and not accounted for on a financial ledger. Resolve to do something different in the New Year to make the world a better place. Tell someone you love them, call someone who is alone, and smile at a stranger.

My very best wishes to all of you for a healthy, happy, and prosperous New Year. And God Bless America, for America is US!

Terry Savage

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