Paul Ferraresi

I am sure you can reflect on your life and remember when warning lights were flashing. Unfortunately, Americans do not prepare for potential risks. Too often, warning signs are presented, people ignore the signs, and then, after the risk comes up they are shocked and not prepared.

Here are some facts that have been presented to people for countless years. The outcomes are obvious. It is up to you to prepare for you and your families. Enjoy!

2041 IS THE YEAR – Social Security Trustees announced in 2006 that the trust fund backing the payment of Social Security benefits would be zero in 2040. In April 2007, the annual report determined the trust fund will be gone in 2041, an addition of 1 year. On Tuesday 3/25/08, the 2008 report again stated that the trust fund worth, 2.0 trillion on 12/31/07, will be gone in 2041. A zero trust fund does not mean the payment of Social Security benefits would also go to zero, but rather would drop to 78% of their originally promised levels (source: SSA)

LONG TERM ISSUE- The estimated Social Security shortfall as of today (i.e., a present value number) between the future taxes anticipated being collected and the future benefits expected to be paid out over the next 75 years is $4.3 trillion. The entire deficit could be eliminated by either an immediate 14% increase in Social Security taxes or an immediate 12% reduction in Social Security benefits (source: SSA)

MEDICARE MESS – The problems facing Medicare are even worse than those of Social Security as benefits being paid out to the Medicare program are expected to exceed tax revenues from 2008 forward. The Medicare trust fund is projected to be depleted by 2019 or just 11 years from now. The long term (75 year) present value shortfall in the trust fund could be corrected by an immediate 51% reduction in program benefits (source: SSA)

PUBLIC ENEMY #1 – Medicare expenses are expected to be $396 billion during the current fiscal year or 14%of total government spending. Former Fed Chairman Alan Greenspan has characterized rising Medicare expenses as the #1 threat to our economy, greater than the current mortgage housing crisis. (source: White House, Fortune)

Funny, President George W. Bush tried for 2 years to wake up Americans to the looming Social Security/Medicare tragedy. He proposed as a solution, not the solution, for individuals to set up their own retirement accounts using some of the Social Security/Medicare taxes. But, the majority of Congressmen, Senators and the drive-by media trashed the idea. Why? Well, it will take control away from Congress since you would be financially independent and not be dependent on the government. Instead of “trashing” the idea why not come up with alternatives? No one came up with any ideas. Sure criticize Bush’s plan, but, why not come up with your own ideas? Instead, they will let it go bankrupt, placing millions of Americans into financial distress. The only solution they will have…..raise your taxes – duh! Remember, Congress has their own “sweet” retirement plan that is much better than our Social Security. You better prepare. I plan with all my clients not to count on Social Security.

A BUNDLE OF JOY/DOLLARS – An upper-class American family that had a baby in calendar year 2007 will spend $299,000 (i.e., a present value amount stated in 2007 dollars) to raise a child until his/her 18th birthday, not counting any college education costs. The actual dollars projected to be spent (i.e., using future dollar totals and not a present value calculation) is $393,000 (source: Department of Agriculture)

HALF THE CASH – A married couple with three children spend 48% of their total family expenditures on their kids (source: Department of Agriculture).

The summary: Again, better prepare for, (1), your own retirement income, (2), your retirement medical coverage, and (3) funding college costs for the kids. Like anything, if you start early it does not require large payments. Wait until it’s too late and the result is obvious. Ah, discipline or regret!

Study after study shows that trying to “time” the market is a waste of time. You see, it is not “timing” the market, but rather, time in the market. Research has shown that 93% of a portfolio’s rate of return is due to the Asset Allocation. Specific security selection and market timing make up the other 7%. Then, why would someone waste their “time” trying to time the market when it makes up about 3% of the return.

If you study the reports from the Investment Company Institute you will see the “small” investor still tries to time things. In retrospect, they pour money into the market and hot mutual funds at a market top. Then, they do massive selling (liquidation) at market bottoms. You see they buy high and sell low…is this you??

Smart investors set their asset allocation and make buy/sell decisions when their allocations get out of alignment. This way there is no emotion in the decision. The newspaper headlines and TV “talking heads” create “greed or panic” in an investor’s thinking.

One other error that most investors make with “timing” is trying to “guess” which group, stock or mutual fund will be hot next! They switch back and forth between “hot” funds or stocks. Have you ever been on a freeway in a traffic jam? Have you ever constantly changed lanes trying to get ahead? Did you notice after all that maneuvering you are no further ahead than the “blue truck” that was next to you at the start? This is the same action as trying to guess the next “hot” area. It is a futile effort.

To make my point I have attached a chart from Morningstar Advisors. It shows major asset classes and when they were “hot and cold.” It is random. You can not time the market or guess the next hot area. So, do what the rich or thrivers do….set your allocation and adjust it when it gets out of alignment.

View Full Image (Open in New Window) or Download PDF

My mom always said….If you want to be poor do what poor people do. If you want to be rich…do what they do. Mom was right!

You know….stick with discipline…or regret the results.

No, I am not calling you a “DRIP”. Rather, DRIPs, also known as Dividend Reinvestment Plans, have been around for a long time. It is a great way to build your wealth in a slow, methodical, systematic basis.

Anyone can open a brokerage account to buy stocks. Unfortunately, for some people the requirement to buy a round lot (100 shares) of a stock does not allow them to properly diversify. Another issue is that many people feel they should only buy “growth” stocks which pay little or no dividends. If you study the stock market over time you will see that more than 40% of a stock’s total return comes from dividends.

Prudent investors have taken their dividends and reinvested into more shares. Over periods of times those small investments begin to blossom into many shares. Keep in mind dividends are taxable whether you receive the dividends or reinvest them. (This is known as constructive receipt in the tax code. Picture your savings account in which your interest is reinvested, but, you still must pay tax on the interest earned.)

With dividend tax rates at the lowest in history (15% presently), then, why not take advantage of these low tax rates.
You can participate in a DRIP with many companies. You simply must purchase a minimum of 1 share of that company’s stock. You elect to have dividends reinvested and, voila, it is done automatically. It does not require further investment, unless you desire, and is a fantastic wealth building tool.

May I suggest, as you teach your young children about investing, to have them start in a DRIP program. They, and you also, by only having to buy 1 share of a company’s stock could invest in 15-20 different companies with a small amount of money. Remember the kids are watching you and will mimic your money tactics.

Others may think you are a “drip” for doing this, but, it will “drip” a fortune into your lap in later years.

Here are some great websites to learn, investigate and test out the process.

www.dripcentral.com

www.drip.fool.com

www.moneypaper.com

www.sharebuilder.com

www.equiserve.com

www.buyandhold.com

Of course, you can go straight to the source. Companies that offer DRIPs post information about their program on their websites.

I hope you get wet with all the money “dripping” on you in the future.

What do investors expect the dividend tax rate to be in 2011? This will be the year after the Bush tax cuts expire.

Recent surveys show that tax rates will rise dramatically. Here is why: Democrats are likely to maintain their majority in both Houses of Congress. In addition, the Dems will probably pick up seats in the Senate. Even if the GOP wins the White House, a Republican President will probably be dealing with a Democratic Congress. On the other hand the more likely scenario is an all-Democratic government (look out for what you pray for … here it comes).

Under current law the dividend and cap gains tax rate would return from the present 15% tax rate to the old 39.6%. All the Democratic candidates have said they would repeal the Bush tax cuts immediately. In addition, Rep. Charles Rangel (D-N.Y.) chairman of the tax-writing Ways and Means Committee is vowing to repeal the AMT. He is proposing a surtax on high income individuals plus moving the top rate (including dividends and cap gains) from the present 35% to 44.2%.

[Side Bar: I have written countless times in this blog that taxes will be going up in the future. You should have restructured your contributions to the time-bombs, (i.e. 401K and IRA) and even been pulling money out of your qualified plans at the present low rates.]

Even if the GOP and Dems settle on a dividend and cap gains rate of “only” 28% that is a doubling of the present tax rate.

Conversely, a Republican President will probably be faced with a majority Democratic Congress and be forced to make major concessions to get tax legislation passed. Yup – higher taxes!

What does this mean for you?

• Investors in the stock market are always looking ahead – Have the markets been dropping lately as investors, prepare for more taxes?
• Future stock market returns will be moderate at best.
• Investment into start up businesses will halt curbing job creation due to higher cap gain taxes.
• Businesses will have to lay off people as corporate tax rates also go up in order to maintain their basic profits.
• Jobs will move overseas to a more friendly tax environment.
• Investors will place monies overseas further weakening the U.S. economy and the U.S. dollar.
• Less take home money for you with increased taxes and rising inflation.

Presently Congress is working on a stimulus package to “give back” to us some of our own money (And also give some of our tax money back to people that have NOT paid taxes – Hmmm!)

Don’t they get it? The Dems want to raise taxes, but, they are full throttle to give back money via stimulus package. Isn’t the return of our tax money the same as a tax cut? Let the people keep more of their money. Most people know how to spend their own money better than Congress does!!!

And you said you wanted change? WATCH OUT … for Happy Days are NOT here again (Where are Richie, Ralph and Fonzi  ?)

Maybe you want to borrow a small amount for paying off holiday bills, tax season money or unexpected home repairs. There are person-to -person (P2P) lending sites like Prosper (www.prosper.com) or Lending Club (www.lendingclub.com).

On the other side of the equation you may have a few dollars to invest (lend out). Your present money sitting at a local financial institution may pay you 3-4%. P2P lending allows you to put some money “on the street” with some returns as high as 17%. The return is dependent on the website’s mission, loan type and borrower’s credit history.

In this social lending program peers are the sources of funding and the sites do identity verification, credit checks, fund maintenance and even collections. The sites either charge a percentage of the loan or a flat fee. These programs are highly automatic, transparent and use Web 2.0 era methods to match borrowers and lenders.

“Prosper” has 500,000 members with more than $100 million exchanged in two years via eBay-style auctions. Prospective borrowers post a loan request and a summary of the loan needs. The site then researches credit history and other ratios. The borrower explains his need for the funds. Minimum bid to lend money can be as low as $50. With many people spreading the risk you have a method to diversify your loan portfolio.

The average American has over $5,400 in credit card debt and could pay it off sooner with a lower rate.

Affinity lending in which borrower and lender have a preexisting relationship is the focus of Virgin Money U.S.A. This site provides loan documentation, payment schedules and collections. Virgin specializes in real estate, business and other long term loans.

An automated version is Loan Back (www.loanback.com). This is a true do-it-yourself program. You can have Loan Back’s programs help create promissory notes for $15 or just download forms for $10.

Here are a few others for you to check out:

Lending Club

Zopa

Micro Place (www.microplace.com)

www.Kiva.org

All these programs have higher risk, but the returns may be worthwhile. Check it out!