Do you worry about debt?

The following was cross-posted. Since it was on-topic for MIFP and we had a few minutes, here is the post.

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Subject: Question: Do you worry about debt? From: snipped-for-privacy@gmail.com (James C)

The context for all of this is, I am tempted to advise my family and close friends to cash in existing risky investments (mostly mutual funds) and I am tempted to stay away from stocks and corp bonds myself.

I need someone to help me feel better. You see, I can accept that I might be overly pessimistic about the economy. Perhaps I've been wrong for months, maybe things are in much better shape than I think. The #1 thing I worry about is DEBT. I keep thinking about consumer debt, and corporate debt.

Consumer debt -- the household debt load has been steadily rising. Last year I recall total household debt was over 100% of disposable income. People have been able to borrow money for cheap to afford consumer goods, cars, whatever. A big factor is that the strength of housing (high asset value) has kept consumers afloat, letting them borrow more. I keep getting the spam emails every day -- free money if you own a house.

Corporate debt -- financing opportunities have been insane after 2001. Companies are highly leveraged, making use of borrowed money to do just about everything. The financial/credit sector specifically makes my hairs stand on end. There is more debt and less cash on the balance sheets every year. Share capital is nothing compared to the borrowed money.

Let's not enough touch the issue of government debt!

Now when I look at the situation, it makes me nervous. I say to myself, if consumers have already just about gone broke borrowing money to afford their lifestyles, how can they keep buying consumer goods? And for companies, if money becomes more difficult to borrow, how are they going to pay their executives and satisfy their debt obligations? Where will they find the cash?

So what's the other side of this, the optimistic side? Am I saying things that are misleading? Have I made poor assumptions about consequences? I'm willing to discuss this if anyone is game.

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-HW "Skip" Weldon Columbia, SC

Reply to
HW "Skip" Weldon
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There are all types of mutual funds. Why do you consider mutual funds risky?

Elizabeth Richardson

Reply to
Elizabeth Richardson

(Thanks for posting my message through by the way)

Well most of the mutual funds I have seen, and certainly those that my family relies upon, perform in tandem with either the general stock market (say S&P 500) or the domestic bond market. The correlation is less than perfect of course but the trends are related to varying degrees. So although these investment vehicles have been pitched under a variety of names, the end result is substantial exposure to stock and bond markets.

It's the exposure to those north american markets that worries me because it seems that both the markets are generally overvalued now. I personally don't think they have healthy fundamentals to keep increasing in value. That's the issue of massive debt that I first posted about.

I used to be comfortable with leaving in an investment, letting it weather "corrections". But my thinking has changed somewhat over the past 6 months or so I've spent researching markets. Now I think to myself, it would be very very stupid to leave an investment in, when my own research suggests major problems with the investment. The gains to date have been significant enough.

Reply to
james92c

Once you buy a house, this isn't very unusual is it? Or is this stat referring to just credit cards and car loans (i.e. excluding mortgages)?

Leverage is not necessarily a bad thing. The recent ease of financing in generally credited for the economic recovery we're experiencing.

Generally speaking, companies don't borrow just to pay debt and salaries. If they do, they're already in trouble. Are many companies in this situation already?

I'm not saying you're wrong, I'm just not sure that the information you've presented leads to your conclusions.

-Will

Reply to
Will Trice

I've done no research at all myself. I just put all my contributions in funds and "let it ride". But I do know this: if you leave it in for 10 years, history has shown that you're guaranteed to make a profit. Of course that's no guarantee for the future, but when you consider all of the high-inflation periods, wars, interest rate swings, market crashes, and the depression and other stuff that's happened through the years and still the smart money stayed in long-term, that's all I care to know.

YMMV

mark

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Reply to
mark (sixstringtheoryDOTcom)

--snip--

Thought I was the only one so concerned. Everyone I know that owns a house has refinanced to extract equity. Credit card debt is out of sight. What have I done . . . I am out of debt. Own house, cars, and no credit card debt. Have only 15% of our IRAs in mutual funds (TRP Cap Apprec, Dodge and Cox Stock and International, TRP Mid Growth) the rest is in CDs. Hope the pessimistic outlook is wrong - but the uneasy feeling I have just won't go away.

Bill

Reply to
WeathermanBill

The US is potentially facing a significant crisis with SS and Medicare costs being far more than we are able to pay. However, I would take the position that Bill is leaving too much money on the table. I'm currently

55% equities, 5% REIT, and 40% bonds. Defensive actions would be as follows: 1) Pay off all debt. When you pay off debt, you are investing money at the rate the debt is financed at, risk free. (Cars are another matter, since its unwise to invest in depreciating assets.) 2) Get out of mutual funds (and their high expenses) and re-invest in indexed ETFs. 3) Make sure that you are diversified. The more conservative you feel, hold a larger share of bonds. 4) In the equity side of the portfolio, be diversified between domestic equities, international value equities, and developing markets (esp. China and India.) You also might consider ETFs focused on energy and healthcare indexes. 5) On the bond side, US goverment bonds are a good place to be. Believe me, if the government defaults on its obligations, this place will be so screwed up that no amount of investment will help us. Specifically, TIPS and I series savings bonds have inflation adjustment features such that if we go into liquidity crisis (leading to high inflation) their return will be assured.

Bill, just moving out of CDs into the goverment paper (or municipal paper, if you're in a high tax bracket) could double returns without adding tangible risk. If a person wanted to be as little as 20% equities because they are risk-adverse, I wouldn't think they were off base in the slightest.

If an economic meltdown happens, the only thing that I would take for granted is that the Goverment will not default on its paper. They'll take a meat cleaver to SS and Medicare before they'll do that.

Mike

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Reply to
Michael E Craney

You have to be really careful when analyzing history to look at the big enough picture. History has also demonstrated that all markets eventually collapse and disappear. I believe the American stock market has been the longest-running such market in history. This certainly is impressive, but it's naive to think that it will exist forever.

crashes,

The smart money also pulled out its investments near market peaks, since they know there was not much more upward direction. And the smart money got in after crashes, buying up assets at bargain prices, THEN sitting on them.

The performance of the smart money, who is aware of when the market is overvalued and when it is undervalued, ALWAYS exceeds that of the dumb money (us investors) who are trained to throw our money into the markets and let it sit for decades. When you are invested during a crash, you need a several hundred % increase before you break even.

Remember that Warren Buffet, definitely smart money and an honest guy, has publicly said that he had a lot of difficulty finding attractive investments over the past couple of years. He is hinting that the markets are overvalued. A lot of experts are saying this too! George Soros points at a derivative market bubble, several trillion dollars of highly risky intangible assets, that is propping up the stock market.

Reply to
james92c

What stock markets have collapsed and disappeared? Countries collapse and disappear, and I guess that would typically take that country's market with it, but I hardly think the U.S. is going to collapse and disppear within the next 10 years or so. Even if you do worry about this, I would think international diversification would mitigate the risk.

I would hazard a guesss that there are not many investors (big or small, corporate or private) that fit this definition of "smart money." I don't know of any investor that has consistently been able to time the market.

Are these star performers "smart" a priori and continue to perform this way, or are you thinking of just the latest bear market? Even perfect timing can lead to results that are worse than "letting it sit" because of the effects of taxes and trading costs.

That would have to be quite the crash for several hundred % to be required. During the recent 2000 - 2002 debacle the market "only" dropped by ~50% (as measured by the Wilshire 5000). That requires only a double to get back to even. Daunting, but hardly "several hundred %". Still, I doubt that the 2000-2002 drop will be the worst that the U.S. market will experience going forward.

-Will

Reply to
Will Trice

If the NYSE goes down, it will be due to the US government collapsing, and the only folks who even entertain the thought of that actually happening are the left-wing wack-wacks and Kim Jong-Il. I'll take my chances.

But my statement stands - if you leave it in long-term, history has show n *every* time that you will gain. I'm talking large cap index like the S&P. No time in history has a dollar invested not made money 10 years later. Even the great depression. 10 years seems to be the magic number.

These "smart money" investors you're referring to are beyond the comprehension of the little guys. Including me.

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Reply to
mark (sixstringtheoryDOTcom)

mortgages)?

I think it includes any borrowed money. There are many articles out there; American household debt is at all time highs now. Part of this is due to the money borrowed against high valued houses. If houses significantly decline in value, many people will go broke.

financing

Some call it a economic recovery, others say there never really was a recovery and now we are in a position where cheap credit has fuelled unsustainable business practices. There are LOTS of examples where uncontrolled borrowing has landed companies in bankruptcy later on.

I'm not saying leverage is a bad thing. But I think that free money over the past few years has led to a corporate recklessness. I think most large companies lack the discipline to make the most of free money.

I found an interesting article (talks about GM too) from 1998

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On the supply side, companies still turn out a profit, inventory as a percentage of sales has fallen (instead of rising) so far in the cycle, debt is shrinking as a percentage of corporate assets, and the value of the dollar is stable or rising at home and abroad. On the demand side, employment is up, wages are up, consumer spending and house buying are strong, and household debt as a percentage of disposable income has plateaued.

So far, there isn't the buildup in supply, slack in demand, or financial excess that precede a recession -- anywhere on the horizon.

So where are we now... debt has been growing as a percentage of corporate assets (especially since 2001); the dollar has declined 30% against world currencies; household debt has been rapidly increasing. There are signs of the "financial excess that precede a recession", IMHO.

This article was talking about how, amazingly, GM still is afloat. Well, now we know that GM is screwed... its debt (bonds) were investment grade a short time ago, but now they're practically junk. What concerns me is that these dangerous economic conditions -- including high debt -- that these articles from a few years ago were talking about are NOW being realized, today. With the predicted consequences for (e.g. GM).

Reply to
james92c

(Deleted most of the message that I agree with.)

Not all ETFs are cheaper to own than index funds. A lot of Fidelity index funds have an expense ratio of 0.1%. SPY has a comparable expense ratio and you have to pay transaction fees every time you buy.

At this point in time, with interest rates virtually guaranteed to go up steeply, I'm not sure this is a good strategy. It might make more sense to wait until rates stabilize before getting into bonds.

Believe

I totally agree with getting into I-Bonds. I think it's the best investment that protects the purchasing power of one's money. However, one cannot buy these in a retirement account.

As far as TIPS go, I'm a bit baffled by the negative YTD return that Fidelity reports for its TIPS fund. I'd appreciate it if someone could shed some light on that...how can the total return for an inflation-protected fund be negative?

equities

I too share a lot of concerns that Bill has, probably because I'm a conservative investor as well. Thus far, my retirement accounts consist of investments in S&P500 and the MSCI EAFE, but I'm getting less comfortable with this, especially when I read the kinds of things that, for example, Warren Buffet says about the current market.

Outside of the retirement accounts, I've steered clear of stocks, corporate bonds, and even real-estate. A year ago, I was thinking of buying a house, but the size of the mortgage and monthly payments made me uncomfortable and so I decided to keep renting. In the last year, my rent has fallen 10%, while the prices of houses have appreciated 30% (I'm in the Sacramento area). Some people feel prices will keep going up in which case I'm priced out, but that was an outcome I had to be prepared for when I made my decision a year ago.

Anoop

Reply to
anoop

Well, Laurence Koltikoff (MIT Economist) is far from a left wing wack wack, and he doesn't rule out a significant stock market challenge tied up with the fiscal imbalance sitting in SS and Medicare.

In essence, you and I agree that it's unlikely, but I'd say it is not as unlikely as it was previously.

Mike

Reply to
Michael E Craney

Yes, all commentary comes with a *buyer beware. Suffice to say that indexed ETFs have the potential to be far cheaper than mutual funds, and most are. I have mostly ETFs but a couple funds where the expense/preformance ratio is justifiable and which track indexes that ETF's don't (yet.)

That's a timing issue. Regardless, you have lower downside risk on bonds than stocks at any time. The point is diversification. If you don't like bonds, use convertables or REITs or buy a condo you can rent out, but be diversified.

Sneaky politicians.......

I have no idea. I have seen a scenario where TIPS go negative if rates skyrocket and fall, but that's not the case here. I'd look at the investments held by the fund and check if they're not holding some other investments in the fund that they got burned on.

I'm not sure if Mr. Buffet is adjusting his P/E expectations of the market in light of current demand for equities. Buffet's mentor, Benjamin Graham, was adamant about not investing in securities selling at over 7 times earning. It has always seemed to me that the average market P/E, which is at 20 and change now, is tied to some ratio between the total equity shares available for purchase and the money currently invested in the market. IOW, P/E is also sensitive to supply/demand, and demand for shares is much higher than it was back in the days of Graham, where only the rich and the institutions invested, and not as heavily as today.

Having said that, I mitigate risk domestically with an ETF (PEY) that invests in high dividend equities, which is a strategy that both Mr. Buffet and Dr. Graham would look kindly on, as the fund follows Dr. Graham's firm guidance about the desireability of investing in equities with a historical record of raising dividends. Mr. Buffet would likely agree that if equities were to get pummeled in the future, the high dividend group would outperform the market (they always do anyway.)

I also mitigate with MSCI EAFE. Koltikoff also recommends international energy and healthcare ETF's and a small position in gold (there is a gold ETF.)

Well, one can't argue with real estate, generally speaking. However, one should look for lower tax jurisdictions to live in (speaking of property and school taxes, here) beccause high tax areas can eat your retirement lunch.

Mike

Reply to
Michael E Craney

--snip--

I live in Florida - the real estate market has gone berserk. During the last year the prices have increased 30% or greater yet the median income has not kept pace. Average wage earner has been priced out with 1800-2000 sq ft homes selling for $190K and up. Even toured (just to see what they looked like) some estates that are selling for

1-1.2Million (never thought I would see that day in this area). All it would take would be a slow down in military spending, closing Patrick AFB, space program hiccup and the housing market would collapse. Harris, JDSU and GE have all had significant layoffs and I fear more to come. Real Estate agents claim the customers coming from Orlando, Miami, plus the influx of new people is the cause of the inflating prices. Supply and demand is alive and well but housing and stock prices always seem to overshoot then the correction sets in - a nasty correction.

Bill

Reply to
WeathermanBill

"Michael E Craney" wrote

Doesn't Kotlikoff preface this prediction with words like "IF our government does not respond to Social Security and Medicare challenges... "? I believe the latter are his main concern. A severe stock market crash is an after effect.

Reply to
Elle

"anoop" wrote snip

I think it makes more sense to build a bond ladder. As rates rise, the bond ladder's yield will rise.

Trying to time interest rates has as much validity as trying to time the stock market, IMO.

I wouldn't buy a CD that has a maturity of more than about five years, though, unless it's an adjustable rate CD.

The total return includes both net asset value and dividend yield.

The NAVs of funds like FINP will vary with interest rate changes, like any investment grade bond fund.

Chart it at finance.yahoo.com and note the variation in NAV.

Reply to
Elle

wrote snip

What do you mean by "go broke"?

If housing values fall, the owners' net worth will decline, but that doesn't mean they'll go broke. They might go broke if they sold their house at a loss, but I think people tend not to do this when their house has lost value. They hold onto the house, saving on the cost of rent, until years in the future when it makes more sense to sell.

My sense is you would benefit greatly from reading about the theory behind diversifying one's portfolio. It is theory that is heavily supported by historical evidence, including periods of stock market dives and flat stock markets.

The fact is that the population keeps growing (worldwide and/or U.S.); demand for at least basic goods keeps rising; inflation drives up earnings further; and so stock prices tend to rise accordingly, given enough time.

You mention GM, but it's an extreme example. Companies do go bankrupt. It's part of the natural processes of the markets. If every company were a winner, then we wouldn't have a true market.

Reply to
Elle

Fidelity

I think mutual funds and ETFs will have to have comparable expenses in order to stay competitive. ETFs do make sense in some situations where the trading commissions might be offset by other charges in a mutual fund. Some of the advantages of ETFs as I see it:

- No short-term trading costs. Some mutual funds will charge a short-term trading fee to discourage frequent trading.

- No "low balance fee." Vanguard, for example will charge $10.00/year if the total investment in a fund is < $10,000.

- Some funds, like Fidelity's bond index fund requires a minimum investment of $100K! If you try to buy a Vanguard fund from a Fidelity account they charge a $75.00 transaction fee. In this case it makes sense to buy a comparable ETF since the transaction fee for that would be way lower.

- ETFs can be transferred easily between brokerage accounts, and you can continue to invest in the same ETFs by simply paying the trading commissions. With mutual funds, things can get tricky if the new brokerage doesn't offer the mutual funds you currently hold, and even if they do, they might charge a steep transaction fee (as described in the previous bullet). This issue is really important because one may be forced to sell their funds if one wants to change brokerages which could be a killer if the funds are in a taxable account. Alternatively, one would have to maintain several different brokerage accounts which might cause the investor to lose out on "premium service" offerings because they can't meet the minimum balance requirements at all the brokerages, while they could have if they had consolidated their investments in one place.

Anoop

Reply to
anoop

Not so. I don't have S&P 500 figures for period, but the Dow peaked at 384 in August of 1929 and didn't return to that level until November of 1954. That's

25 years.

Similarly, the Dow rose above 1000 for the first time in January 1966, flirted with the number several times in the later 60's, 70's, and 80's, but didn't stay above it until December of 1982. That's 16 years.

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-- Doug

Reply to
Douglas Johnson

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