Saving and Investing For Self Employed Entrepreneurs

A Workbook For Financial Decision Making Based On Income and Taxes

The rules of the retirement savings game are changing rapidly. As government policy slowly shifts to acknowledge that Social Security is broke in 2011 (not in two decades, which is when the promises run out:-), the U.S. pension system will likely shift to a socialized, means tested payout. Baby boomers who have seen their 401K and IRA accounts decimated by bad investment decisions will happily vote for any policy that allows them to remain on their couches for the next thirty years. Those Americans who believe in self sufficiency and planning for their own futures are faced with the toughest savings environment in modern history, as the Federal Reserve Bank, and indeed, central banks around the world, have embarked on a course of debasing their currencies in the desperate hope of avoiding short term pain. That long term pain and massive inflation are the only possible outcome doesn't bother the Fed, which is faced with an unsustainable funding challenge whatever the outcome. At some point, the Chinese, the oil rich Gulf states, and other foreign buyers of US Treasury bonds will require that money for their own use, and start selling those bonds. The demand for the dollar will crash, inflation as seen by Americans will soar to double digits, and all dollar denominated savings will be decimated. Over the last few years I've written a number of financial articles about different aspects of saving money that have draw some terrific feedback and hundreds of visitors a day. What I hope to do now is pull it all together into a coherent approach for saving in America over the coming decades. Of course, one of the best ways to save money is not to get ripped off in your financial dealings. I found out years ago that you can't trust anybody in finance, as shown by all the errors my student loan payments.

As I develop this resource, my goal is to work a number of examples at different income levels for each savings or investment approach. The total cost of investing, whether in retirement accounts or in your business, is always impacted by the tax code and how much benefit you will see in the long run. Changes in tax policy are impossible to adjust to if you put all of your trust into some PC tax program or a financial advisor whose experiences and motivations are not 100% in line with your own. That would be all financial advisors if you missed my hint. The only way you can make informed decisions for yourself is to study and understand the different scenarios that will play out based on your savings and your income. A good example of this is in my ealrier article on how much of a tax break you get for taking out a mortgage, and what that tax break means in bottom line dollars.

Traditionally, there have been plenty of places to hid from inflation, including real estate, gold, commodities, stocks, inflation adjusted instruments, and overseas investments. Yet all of these approaches are subject to timing and government policy. Starting with real estate, we are still in the midst of a real estate bubble, as the median house price in most regions of the US still isn't affordable for a family earning the median income. Unless the government wants to return to simply loaning massive amounts of money to people who have no chance of paying it back, the only solution for this problem is for house prices to fall further, or for the government to simply make up the difference with tax credits - ie, free money. Since government policy for the passed several decades has been predicated on the principle of "First, allow no suffering", the result will most likely be a real estate market that doesn't settle down to a true market based valuation for years to come. That doesn't mean there aren't any bargains for risk takers. If you want to buy questionable properties with all sorts of possible downsides (such as environmental issues) on an as-is cash basis, you'll find some real bargains. But it's not a game for the meek of heart.

Gold is mankind's oldest hedge against currency debasement, assuming the gold itself isn't debased, but there a problems with buying and holding gold for the long run. First of all, central banks hold a large chunk of the world's gold reserves, so they can force the price down by selling into the market. Such a move gives their paper currency an illusory value, since the gold must be purchased with that currency, driving demand. Secondly, gold jewelry remains a store house of wealth for families in many of the poorer countries of the world, and when the price rises enough (or when they can't get work and their crops fail), they sell their gold in massive quantities. The problem of physically taking delivery of and storing gold has been solved by modern financial engineering, it's a simple matter to buy shares on GLD in a brokerage account, and the fund managers buy and sell the actual gold to reflect the value of the holdings. But gold is near historical highs as I write this, and while it may well go higher, gold remains a short term trader's position rather than a buy-and-hold investment.

The theory behind buying commodities in inflationary times and economic downturns can be summed up by "People have to eat." The same logic says people have to drive, live in houses, fly in planes, etc. The trouble is that people have been doing way too much of all of these things in recent decades, especially eating, but the habit of gluttony can't be sustained if there's no money to pay for it. As the economy continues to contract, waistlines will contract as well, because people can eat less pricey junk, just as they can drive less, own fewer homes, and not go on vacation. Even more than gold or stocks, commodities trading is driven by up-to-date information, a game for insiders and professionals. It may make sense to dip a toe in commodities for the sake of diversification, especially a macro bet like assuming oil will eventually cost more than today if the world economy recovers, but I'd stay away from hog bellies unless you know somebody.

In late 2008, America woke up to the fact that stocks are and have always been a Ponzi scheme. Stocks are everyone's favorite Ponzi scheme, the investor base is so massive that the share values rarely fall to zero, and then only on an individual company or sector basis. But there's no denying the fine print on a stock certificate that states, "This share is redeemable at a par value of $0.001 per share", a fraction of a penny at best. Corporate bonds are senior to stock, meaning it's the bond holders who really own the company, and the bondholders are the only ones who may recover some of their investment if the company goes "Pop!" There was a time when stocks were purchased and held for their dividend payouts, but dividends have long since been replaced by speculative appreciation of the share value, driven up by greedy or corrupt executives and boards. The sole value of a share of common stock is what you can get some other sucker to pay you for it. In good times, that value rises, in bad times, that value falls. It doesn't make you smart or stupid if you win or lose, it's all about timing and finding another sucker with cash.

Due to their fixed payout, bonds have never been seen as a shelter from inflation. It doesn't really matter what the bond's payout is, if inflation really picks up, you lose money in a hurry. There's a tremendous difference between owning the actual bond, which pays you that fixed interest and returns your capital at the termination date if the issuer doesn't fail, and purchasing shares in a bond fund. The share value of a bond fund fluctuates with how much people are willing to pay to own a share in the bond fund, just like stocks. While the bond fund actually owns something with real value, bonds, so your investment shouldn't go to zero, owning a long term bond fund in an inflationary environment is begging for problems. The option is to purchase bonds directly, like tax advantaged municipal bonds or inflation protected bonds. The former have the problem of all fixed rate bonds, you lose if inflation outstrips the interest, but they can be purchased for fairly short terms, such as five years, so the damage could be limited. Inflation protected bonds are supposed to gaurantee an inflation adjusted return, so you can't lose money, at least money denominated in the issue currency of the bond. The only question is whether or not the inflation index computed by the government matches the inflation experienced by you in your life. It rarely does, and the return over inflation is normally so low that it's strictly a question of saving money, not investing for returns.

Overseas investment is an attractive alternative for sophisticates who keep up with the news and are comfortable with political risk and accounting standards in emerging markets. But in a world-wide recession, it's tough to pick the winning markets, and impossible to say what might cause a smaller market to go belly-up. The problem with investing in small markets is relatively minor changes in the flow of world capital can jerk your investment value around by double digit percentage points. In other words, you can easily lose half your investment value to a policy decision made by a third party who had a lot of money in that market. Internationally currency investing is another option. I've owned the Yen (FXY) and the Euro (FXE) through the named exchange traded funds at various times, but the relative value of currencies is heavily influenced by central bank policies. In the beggar-your-brother race to the bottom, countries all want to boost exports and minimize imports through weakening their own currencies, at the same time, devaluing the investments that foreigners have made in their countries. So far, the major loser in this game is China, who's Yuan has risen around 20% in the past couple years, yet still gets hammered by Fed to increase the float. In the meantime, China has enough economic problems that they may be tempted into rolling the printing presses, which would devalue the Yuan, increase their exports, and hammer anybody who buys their currency in the theory that it may appreciate.

The only solution to the puzzle of saving money is to build wealth through diversification, but I'm not talking about diversification of investment instruments, but diversification of real investments. The future of America may look more like the past, with a much larger proportion of the population being freeholders, running their own businesses and living on their own land. Even as the country becomes more socialistic along Western European lines, an unavoidable outcome as far as I can see, the large employers, outside of government, will continue to shed jobs, and those American who want to work will have little choice other than working on their own accounts. The challenge for building wealth with have as much to do with tax management as profitability, as taxes go up and up to cover the new government centric economy. So be prepared to invest in your own business, and focus on building business equity. More soon...