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WINTER 2000 Newsletter

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For years, we’ve heard that our personal savings rate is dismally low. But that knowledge has not led to an increase in our savings rate. Instead, personal savings as a percentage of disposable income have continued to decline and actually turned negative in 1999 (Source: Bureau of Economic Analysis, 1999). How concerned should we be by this trend?


First, we need to understand why savings are important to the country. At first glance, it appears that savings hurt the economy. If consumers save rather than spend their income, current sales for stores, service establishments, and manufacturers will decline, putting a damper on jobs and income. However, this is only a short-term effect.

Over the long term, these savings are used to make investments, which finance modernized equipment, new construction of homes and factories, and research and development of new products. These investments, in turn, create more jobs and more income.

However, savings in our country come from three sources — individuals, businesses, and the government. While the savings rate of individuals has been declining, the savings rates of the government and businesses have risen. Much smaller expenditures for defense and the recent federal surpluses have resulted in significant increases in government saving. In addition, foreign investment has increased substantially. Thus, business investment has not been hampered by the decline in personal savings.


There is some debate over how much significance should be placed on the decline in the personal savings rate, since it measures what percentage of disposable income individuals are saving each year. It does not factor in changes in wealth attributable to gains in investments and real estate. Many believe that the significant increases in the stock market may have led people to reduce savings.

Yet, even when accumulated assets are considered, most studies conclude that the baby boomers do not have enough saved for retirement. For instance, a 1998 study by the National Bureau of Economic Research found that the majority of older households do not have enough assets to maintain their current level of consumption during retirement. Another study found that many retirees were forced to cut spending sharply because they did not have sufficient assets for retirement (Source: National Bureau of Economic Research, 1998).

A 1999 study by the American Association of Retired Persons reviewed the current savings of the baby boomer generation. Assuming that 60% to 80% of pre-retirement income would be needed during retirement, the study concluded that one-third of the baby boomers were doing very well, one-third had barely adequate savings, and one-third were doing very poorly.

These findings contradict the life-cycle model of saving, a model used to explain the savings patterns of individuals. According to this model, young consumers often spend more than they earn as they set up households. Middle-age consumers are generally the biggest savers in the economy. With their debts largely paid off and retirement looming, they have the most free income along with a strong incentive to save. After retirement, these individuals become net spenders again. Thus, it was believed that once the baby boomer generation hit middle age, savings rates would increase significantly. Instead, the opposite has happened.

This is alarming when you consider that the baby boomer generation is the first generation that will have to finance a significant portion of its own retirement. The baby boomers’ grandfathers did not typically retire — most men worked until they died. The baby boomers’ parents started the retirement trend, but they retired on other people’s generosity. Generous pension benefits and Social Security benefits indexed for inflation allowed them to retire to a comfortable lifestyle, without saving much on their own.

Now the baby boom generation is facing a time when Social Security benefits and company pension benefits are not assured. To make matters more difficult, this generation will live much longer than previous generations.

While the debate over the significance of the declining personal savings rate will continue, on an individual level, it should serve as a wake up call to assess how much progress we are making toward our retirement goals. If you’d like help making this assessment, please call us at (800) 878-4036.


It is generally recognized that stocks are more volatile than bonds. To compensate for the increased risk, investors expect a higher return from stocks than from bonds. This excess return is called the equity risk premium. Although there are many complicated methods to calculate this premium, a simplified approach merely looks at the difference between total returns for large company stocks and long-term government bonds. For the period from 1926 to 1998, that difference was 5.9%.*

When designing an investment program, your expected rate of return is a critical element in determining how much to invest to meet a future goal. Since no one can predict future performance, this return is typically estimated based on an analysis of the past performance of various investment classes. Thus, in setting a targeted return, it is important to assess whether 5-9% is a reasonable estimate of the equity risk premium.

It is important to realize that the equity risk premium does not stay constant over time. Like actual rates of return, which vary annually, the equity risk premium also varies. In addition, investors can develop a preference for one asset class over another, which can drastically change the premium. For instance, many investors abandoned international investments in 1998 and invested in government bonds, causing global equity risk premiums to increase dramatically.

Some question whether the equity risk premium will stay this high, since the relative volatility of stocks compared to bonds has reduced. In the 1920s, stocks were 10 times as volatile as bonds, but that ratio has been steadily decreasing, with stocks now 1.4 times as volatile as bonds (Source: Bloomberg Personal Finance, May 1999).

Increases in the price/earnings (P/E) ratio of the overall stocks market may also affect equity risk premiums. The P/E ratio for the Standard & Poor’s 500 has increased from a historical 15 times earnings to approximately 33 times earnings (Source: Journal of Financial Planning, May 1999).

Lower inflation may also put pressure on the equity risk premium. Bonds became more attractive with low inflation, since investors are not as concerned that inflation will erode the value of their investment. With low inflation, earnings growth tends to slow, putting pressure on stock prices.

No one can predict the future performance of investments. However, for the equity risk premium to remain at historical levels, it is believed that corporate profits need to grow faster than historical levels, P/E ratios must continue to rise, bond yields must fall. Whether any of these will happen or not remains to be seen. But when setting expected rates of return for investment programs, it may be prudent to temper those returns, targeting little less than historical returns might indicate. You should also evaluate your investment portfolio’s performance annually so that you can make adjustments to compensate for variations in return. Please call us at (800) 878-4036 if you’d like to discuss this concept in more detail.

* Source: Stocks, Bonds, Bills, and Inflation 1999 Yearbook. The large-company stock return is based on the Standard & Poor’s 500 an unmanaged index generally considered representative of the U.S. stock market. Investors cannot invest directly in an index. Past performance is not a guarantee of future results.


If you’re trying to increase your savings, one of the most important points to remember is that savings are directly tied to spending — the less you spend, the more you have to save. Some tips to consider to help you control your spending include:

  • Analyze your current spending practices over the course of a month. Are you surprised by how much you spend on eating out or clothing? This analysis can help you pinpoint areas where you can reduce spending to increase saving.
  • Make a spending plan and put it in writing. Budget for all major expenditure categories and resolve not to purchase items that aren’t in your budget.
  • Limit the use of your credit cards. Credit cards and other forms of short-term debt are increasingly used to purchase items that you couldn’t afford if you had to pay cash. In fact, people spend an estimated 30% more when they use credit cards rather than cash (Source: Consolidated Services, 1999). Go back to using checks for purchases or get a debit card, where your purchases are automatically deducted from your bank account. Not only should this help you reduce your spending, but it will also reduce credit card interest.
  • Wait for longer periods to purchase large items. For instance, instead of purchasing a new car every two or three years, keep your car for four or five years.
  • Only purchase as much house as you can afford. Make sure to consider the other costs involved, not just the mortgage payment. If your basic living expenses are stretching your budget, finding money for saving will be very difficult.
  • Separate shopping trips from spending trips. Compare price and value during a shopping trip, and then purchase the item on a separate spending trip. Resolve to use this approach for all items over a certain dollar amount and for impulse items. By waiting, you may find that that item you thought you couldn’t live without really isn’t essential.

Learn to control your spending and you should be able to increase your savings. Please call at (800) 878-4036 if you’d like more help in this area.


Before purchasing bonds for your portfolio, ask yourself the following questions:

HOW MUCH OF YOUR TOTAL PORTFOLIO DO YOU WANT TO ALLOCATE TO BONDS? Usually you will want to maintain a diversified portfolio, containing cash, stocks, and bonds. The percentages you allocate to each category will depend on your personal situation and financial objectives, but over time the percentage of bonds you own is likely to change. In general, the percentage of bonds you own should increase as you become more averse to putting your capital at risk.

WHEN DO YOU NEED YOUR MONEY BACK? If you are a buy-and-hold investor, you will probably want to select a maturity date that coincides with when you need your principal. Investors who trade actively may be more interested in the differences in yields among maturity dates. Before selecting a bond, review the yield curve to see if it makes sense to select a slightly longer or shorter maturity. Be aware that if you sell a bond before maturity, you receive the current market price, which may be more or less than your original price.

WHAT TYPES OF BONDS ARE YOU INTERESTED IN? Treasury securities are the safest bonds since they are guaranteed by the U.S. government for the timely payment of principal and interest if held to maturity, but also typically have the lowest yields. Municipal bonds contain more risk than Treasury securities, but less risk than corporate bonds. Corporate bonds typically offer higher returns because of the additional risk.

WHAT ARE THE TAX CONSEQUENCES OF THE BONDS YOU ARE INTERESTED IN? Interest income from Treasury securities is usually exempt from state and local income taxes, but subject to federal income taxes. Interest income from municipal bonds is typically exempt from federal income taxes and may be exempt from state and local income taxes. Interest income from corporate bonds is subject to federal and state income taxes.

HOW MUCH RISK ARE YOU WILLING TO TOLERATE WITH YOUR BOND INVESTMENTS? Bonds are typically subject to interest rate risk, reinvestment risk, inflation risk, default and credit risk, and call risk. Each bond type is affected to a varying degree by each risk type.

DO YOU UNDERSTAND THE SPECIFICS OF EACH BOND YOU ARE INTERESTED IN? Before purchasing a bond, make sure to investigate it thoroughly, reviewing the yield, tax status, call provisions, and credit rating.

DO YOU NEED HELP WITH YOUR BOND INVESTMENTS? Make sure to use carefully devised strategies for your bond decisions. Please call us at (800) 878-4036 if you’d like assistance.


It is important to keep on top of your financial situation daily, not just annually when you prepare your tax return or review your investment portfolio. Here are some ways to be aware of your finances every day:

  • Read financial newsletters you receive. When an article applies to your situation, cut it out and keep it in a file. Call your financial planner if it’s something you need to take care of right away.
  • Save money. Set a specific goal for each week. As you go through your day think, "Do I really need this?" before you make purchases.
  • Contribute to your 401(k) or IRA. If both spouses work, both should contribute.
  • Read your statements. Pay attention to what is happening in your accounts and whether your investments are meeting the goals you set for them.
  • Talk to co-workers, family, and friends about investments. Even though your friends may not be financial professionals, it is beneficial to see what other people are doing and where they are getting advice.
  • Seek help. No matter how much you read about finance, you are not an expert. Find a financial professional that you trust who can design a plan to help you reach your goals.

Planning for your financial future is an everyday job. If you take the time to be aware of your finances every day and make decisions with the future in mind, you will be on your way.


When a company implements a stock buyback program, it systematically repurchases shares of its stock in the open market and then either retires the stock or uses it for employee stock options. Repurchase programs can affect stock prices in a couple of ways:

  • A repurchase program is often viewed as a signal that the company’s management feels its stock is cheap relative to the business’s potential, which can cause increased interest by investors. Two recent studies found that stocks of companies with significant buyback programs outperformed competitor’s stock by an average of 2.8% to 4.2% annually for up to four years (Source: Money, March 1999). Stocks that received the most benefit from repurchase programs were those with lower price earnings ratios or higher yields.
  • If the shares are purchased and retired, earnings per share (EPS) will increase since the number of shares used in EPS calculation decreases. Each shareholder’s percentage of the total stock owned also increases, since there are fewer shares outstanding. From a shareholder’s perspective, this may be a better alternative than receiving dividends. A shareholder has no say in when the dividends are received and must pay ordinary income taxes on the dividends. If the stock repurchase program results in higher stock prices, the shareholder does not have to pay taxes on the capital gains until the shares are sold. At that time, capital gains tax rates, rather than ordinary income tax rates, are likely to be paid.

To have a positive impact on stock value, a repurchase program must typically involve a large number of shares, must be completed on a timely basis, and the stock must be retired, not used for employee stock options or pension distributions.

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We do not offer legal advice. All information provided on this website is for informational purposes only and is not a substitute for proper legal advice. If you have legal questions, we recommend that you seek the advice of legal professionals.

Tax Disclaimer: To ensure compliance with IRS Rules, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer under the Internal Revenue Code, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.

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Last modified: January 30, 2017