Your’s and Mine for Ours.

Headline: Data Minefield

Date: 12/10/2021

Body:  OK, this one is a little far afield, but, there were several people who expressed interest in this so, here it goes.  Data mining is something that interests a bunch of people.  The FTC wrote a great paper on it.   Basically, it is a way that companies try to get as much personal data on you as possible.   The intent is to eventually figure out how to sell you more goods and services in the future, and they do this by taking large amounts of personal data, and write advertisements that are sniper-bullet targeted to your interests and fears.    (They often claim that it is simply so that they serve up only ads that are relevant to you.  Yeah, sort of.)  Then, they can sell this aggregated data to other vendors who also might want to target you, and people like you.  As people so often say, “If you are unsure of what the product is, it’s probably you.”

So, what makes “data mining” possible?

I have seen repeated references to the advancements in data storage and developing algorithms for this rise in data mining.   All of this is true: These changes are vital to the developing infrastructure of data mining.   But I would argue that a much more interesting development is group psychology.  In a quick phrase, we are giving our permission for this to happen.    Just think of buying stuff for your household.   When I need something, I go to Amazon and buy it.  What happens then?    Before I checkout, Amazon “helpfully” suggests some other things to buy that often are purchased together.   (I bought 500 envelopes and Amazon suggested buying stamps, thru them, of course.)   After the sale, I get repeated e-mails reminding me that people who have purchased envelopes in the past often have to purchase new toner cartridges.   You get the flavor.  But, societally, we really appreciate the speed and convenience of a retailer like Amazon, so we happily give them just a little control over our habits.  This trend becomes even more pernicious when it comes to social media.   TikTok’s algorithm knows well, that I like videos that show dogs.  So, is it a surprise that it also have a penchant for serving up videos that sell dog-related products and services and  dog-related not-for-profit organizations seeking donations?   No, this is not a surprise, for once again, I have demonstrated my consent by utilizing their “free” application. 

But, is this legal and kosher?   Well, not sure about the second part, but it appears to be legal.    People all over the planet have heard about the Cambridge Analytica scandal on Facebook.   The thing that caught my eye, though, is what WAS ok.   It was legal to take data from the individuals who signed up for the psychological testing offered, the only thing that was NOT legal, it seems, is the harvesting of data from the “friends” of those who had given their consent.  (Lesson from here is to read CAREFULLY the fine print within a “free” offer.)  Mr. Zuckerberg was taken to task by one Representative, who said, “Your business is built on trust, and you’re losing trust.”  It seems that Facebook and other social media might  be ripe for legislative fixes to some of these problems.

In the more financial area, there have been a series of crimes in the U.K. that fall under the Big Data and data-mining rubric.   A very sophisticated group of thieves targeted some not-for-profit organizations by sampling the voice of a major figure in their finance arm.  Then, they were able to splice together these samples together in such a way that it appeared that a valid order was being given for an “emergency disbursement” of funds into an account they had set up.

So, data-mining is BAD!!

Well, no, not always.   Take for instance, healthcare.   This is such an intricate area.   Different people with the exact same malady will respond differently to the same course of treatment, and this has become a bugbear for clinical medicine to parse.   But now, since data mining is possible, even though 2 patients might have the same disease (and even look VERY similar in many respects) patterns seen in thousands of treatments can suggest markedly different  therapeutic procedures for each of these patients.   And, this is good, as it speeds up healing and can lead to far better clinical outcomes.     In a similar manner, if there are many bad outcomes following administration of a single drug or use of a medical device, news of this commonality is quickly seized upon, and new victims are spared.

So… what ARE you saying?

Sometimes power… just is power.     Sometimes it is neither good nor bad, but the people wielding it make it so.   For example, if a robber has a gun, they can do great  harm with it.    But, give that gun to a police officer, and  they might use it to deter crime or possibly re-unite a child  with a frantic parent.  So, I guess what we are left with is the requirement to be eternally vigilant.

What can organizations do?

  1.   Understand the types of data that your organization has and the risks that stem from this.   Keep up with the expanding research on how to safeguard this type of data.
  2.   Separation of duties is now super-critical.      In accounting, a different person should be involved in 3 atttributes of each asset, Authorization, recordkeeping and custody.   If disbursing funds, the management official should be authorizing it, the accountant should be keeping records and the Treasurer should be doing the actual disbursing.   This separation has always been important and is even more important now.
  3. Do setup a policy of random audits of your data.  Under what circumstances have they been used?   Are these uses in agreement with stated policy?   If not, there should be consequences for the people involved.
  4. Encourage your employees through frequent training, to not click on any e-mail traffic when they are unsure of the source.    This very simple technique of social engineering can be a powerful source of introducing malware into an otherwise virtuous organization.

What can ordinary people do?

  1.  Sign up with the National “Do Not Call Registry.”
  2. Do not open any e-mail that you are not sure of the source.
  3. Carefully check your Privacy settings on Facebook, and understand exactly what you are allowing them to do with your data.
  4. Cut-off 3rd party apps.  (These permissions are buried in the Settings area.)
  5. Use outside blocking tools.   Safari will automatically block some code from spying on you.   If you use Firefox, there is an extension called “container” which seems to server a similar purpose.
  6. Keep your physical location secret.   To do this, consider using  a Virtual Private Network (VPN) which assigns a new IP address to your system each time you go online.

The Verdict

Some people have tried to learn from the Facebook debacle with Cambridge Analytica and other entities.    As a result, many people are deciding to leave Facebook.   In my estimation, this is of dubious value.  If we have proven anything over the past decades, somebody somewhere is going to design and distribute a newer, shinier, cooler app, used to keep in touch with people.  Just as surely as night follows day, somebody else WILL come up with a scheme to make use of this new app to make money or create value for themselves based upon your data.  So, once again, it appears that our parents might’ve been right when they warned us, “Don’t talk  to strangers.”

REFERENCES

https://www.forbes.com/sites/cognitiveworld/2019/09/09/the-unexpected-consequences-of-big-data/?sh=7a56552d370f

https://www.consumerreports.org/privacy/easy-opt-outs-to-protect-your-privacy-a7017744648/

https://www.cnet.com/news/facebook-cambridge-analytica-data-mining-and-trump-what-you-need-to-know/

https://www.cnet.com/tech/services-and-software/5-tips-on-how-to-keep-your-data-safe-from-facebook/

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Shy of Retiring?

Headline:  Shy AND retiring?   Don’t think so..

Date: 12/9/2020

Body: I was at my full-time job working at the IRS, and I came across an article on a pilot study they are doing concerning Phased Retirement.  ( I regret that I cannot  insert a link to the source material, but I legally cannot.)  I thought this concept was important enough that it should be addressed in a post.

What is Phased Retirement?

A phased retirement is simply a way to ease into retirement.   This might include a decrease in work hours, working only certain days in the work week, or seasonal work only. (It is important to note that this type of “program” can be either formal or informal.)   It is a help to the retiree because they derive satisfaction from the work and benefit from the social interaction.   The cash doesn’t hurt either.   But, the employer also benefits because there is not that sudden “brain drain” that so many employers have to cope with.   Often, a portion of this arrangement is a “knowledge transfer” mechanism where the senior will coach junior employees. Per the IRS, there are some income limits before Social Security is affected (just over $18,000), but changes in Social Security have made it easier for many Americans to work after reaching full retirement age.

How common is it to find a phased retirement program at a workplace?

It is becoming more common, and since the pandemic is making many people work from home, I can’t help but believe that it might become even more common.  In 2016, the TransAmerica Center for Retirement Studies completed a study of 1,800 workplaces and reported that 40% of the employers had some type of program to support the concept of phased retirement.    Given the size of the Baby Boom generation, we need to mitigate this potential loss of knowledge within the workplace.

In a personal example, my father worked for an engineering firm that didn’t have this type of program.   He developed symptoms of a degenerative disease, and spoke with management.   He devised a schedule where he worked Monday, Tuesday, Thursday and Friday, so that he would only have to work 2 days sequentially before he could take time off to rest and recuperate.   He worked an 80% schedule and received 80% of his salary, and continued this informally-organized pattern for several years

Per the Society for Human Resource Management (SHRM) the number of formal programs are small, but the number of informal programs have been increasing.  This pattern discovered by SHRM are echoed by a variety of other experts too.  “We’re finding that informal arrangements exist at almost every employer, but formal programs are rare,” says Steve Vernon, a vice president at Watson Wyatt Worldwide.  Other individual companies seem to recognize the need for this type of arrangement and make them a part of their employee retention programs. “We don’t have a specific program for phased retirement,” says Karen Fowler-Williams, vice president of employee relations and diversity at Lincoln Financial Group.. “It’s all within our regular flex program.”

One researcher suggested that employers might prefer the informal approaches because they can offer the arrangement only to the highest-value employees.   This would square with the story above as my father worked as an engineer for a defense contractor.   When he began to work for this contractor, he brought with him an education from the US Naval Academy and MIT, along with an impressive career as an officer in the submarine service.    Added to that, he was a gifted teacher, often helping out younger engineers.  Given the work that this contractor did, and his personality, his experience was perfectly suited to his assignments.    For these reasons, it made a lot of rational sense to be flexible enough to accommodate his medical needs.

Why don’t more employers offer a formalized plan?

To my reading, the reasoning turns out to be organization inertia, more than any other reasoning.   Until recently, when a person started receiving pension distributions, they were given a gold watch, a hearty handshake, and a kick out the door.  This might be a bit unfair to employers, who until recently had mainly defined-benefit pensions, and with these pensions, the regulations were extremely inflexible.  Is it any wonder that the employers themselves were also inflexible?  Now that defined contribution pensions are the norm, I believe that this situation will change, but for now, there is a large amount of inertia:

  1.  Often, corporate policies will not allow for medical benefits to be given to less than full-time employees.
  2. IRS regulations still favor the defined benefit pension programs.

Until 2005, this inertia was very real, but, the Pension Protection Act of 2006 allows workers 62 and older to receive pension distributions while still working part time.  So, there appears to be reasons to hope that a force might be applied to employers that will not allow them to “stay at rest.

So, what is an older-employee to do?

In view of how uncommon formal programs are, the employees need to be assertive and begin the conversation with their managers.  Said one expert:

“In the absence of a formal phased retirement program, then it’s up to the employee to initiate a conversation with the employer,” says Catherine Collinson, president of the Transamerica Center for Retirement Studies. “Set forth a proposal in terms of the value you are going to provide. Mentoring and training your successor can only help your case.”

If your employer uses your last few years of employment to set your pension benefits, it might be to your benefit to consider leaving the employer and becoming a consultant.  With their long experience, older workers can make a good case for themselves with new organizations.

REFERENCES

https://www.investopedia.com/terms/p/phased-retirement.asp

https://www.shrm.org/resourcesandtools/hr-topics/benefits/pages/phased-retirement-challenges.aspx

https://www.monster.com/career-advice/article/benefits-and-drawbacks-of-phased-re

https://money.usnews.com/money/retirement/second-careers/articles/2017-11-13/6-challenges-of-phased-retirement

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

“Can You Invest with All the Colors… of the Wind?”

Headline: Can adding Green to your portfolio put green in your pocket?

Date: 3/31/2021

Body:  I was reading a wonderful article on green investing in the latest issue of  Kiplinger’s Personal Finance (04/2021) entitled “Profit from Planet-Friendly Companies.”  It stimulated me to think of the question: is it possible that my investments could give me green, and my investments can be green too?   Given the precarious nature of our environmental health right now, I thought that this was a timely topic.

For many people, working with the environment doesn’t mean completely changing the way they live.  Instead, it means choosing more environmentally sustainable ways to do the things that they already do. Like combining trips to minimize miles on our cars, green investing is a powerful way for you to drive change towards a more sustainable society.  Under the rubric of socially responsible investing, green investing is the strategy of investing in environmentally conscious companies that make an effort to conserve natural resources either directly or in their business practices.  While this type of investment offers the benefit of helping a cause you believe in, it’s still important to consider all the risks and rewards associated with investing your money.

What Is Green Investing? 

Green investing is one example of socially responsible investing.   There are 2 kinds of green investing; There are “pure-play” options and other companies who are trying to be a bit more green in what they do.  Pure-play options include companies whose mission is to research and develop new technologies or processes that directly benefit the environment. Examples include companies that make wind turbine blades or solar panels.  Many people also broaden green investing to include companies whose primary goal and revenue stream is not environmentally motivated but engage in resource-efficient practices and institute eco-friendly policies.   This is tricky because, a company in a very pollution-causing industry can be considered “green” if it tries to engage in policies that are less polluting than their competitors.  For instance, a power plant can be considered “green” if it has a very effective filtering device.

So, is it possible that a business would pay lip-service to environmentalism, and still be inefficient?

What Is Greenwashing? 

Some businesses have engaged in policies and practices to look like they are trying to be good for the environment.   This sort of image-engineering is often called “greenwashing.”  There are some things to be aware of when reading a company’s documents. Be skeptical when you see vague marketing campaigns that make non-specific claims or emphasize one insignificant green initiative. Here are some specific things to look out for:

  • Unclear ecological terms in marketing materials like “eco-friendly” and “environmentally safe.”
  • Conservation-based imagery on packages. Specific images are often carefully selected for their unnoticed impact on your perception.
  • Abject lies are sometimes used. Companies will fabricate labels and awards that make them seem greener, or directly lie about their product’s impact on the environment. If the proof to any claim seems hard to find, that may be because it’s not true at all.

But, there are some kinds of investing that you can do in companies that are truly trying to be green.   Here are a few possibilities:

Hydropower

Water has been the de facto resource for renewable energy for centuries.   Along rivers, mills were set up so that the rushing waters could turn the heavy millstones that would grind grain into flour for bread.  More recently, huge dams have been put up to both provide water selectively and generate electrical power.  In point of fact, 98% of the renewable energy in the US is from hydrological power.

There are few pure-play stocks in the hydro business. However, there are three energy producers with notable amounts of hydropower in their portfolios. PG&E (PCG) has one of the largest hydro operations and seems to put its mouth where its money is as it offers generous credits and rebates for consumers who purchase energy efficient appliances.. Idacorp (IDA) has 17 hydro projects.  They also have a goal to only use sustainable projects by 2045, so they seem to be quite attracted to the sustainable nature of power generation.   Meanwhile, Brookfield Renewable Partners (BEP) derives 66% of its portfolio from hydropower and boasts 5,300 projects worldwide.

Wind Power

Harnessing wind power provides a clean and renewable energy source that’s growing in popularity worldwide.  (I remember that in the early 1980s, my father did some work on “windmill hill” near San Francisco.)  More recently, the Bureau of Labor Statistics estimated a 108 percent growth rate of wind turbine technicians between 2014 and 2024. Businesses that allow you to invest in wind power include both wind farms and companies that design and manufacture the turbines themselves.  More recently, many companies have been trying to get licenses to open “wind farms” offshore. 

If this renewable interests you, look for wind farms that sell wind-generated energy, or consider companies that manufacture wind turbines.  The companies holding the largest market share in the Wind Turbine Manufacturing in the US industry include General Electric Company, Vestas Wind Systems A/S and Siemens Gamesa Renewable Energy, and for those who would like to invest internationally, China seems to have a large variety of companies that make the blades for these turbines.  For those who wish to invest in the companies actually creating electrical power from wind, GE, TPIC and AMSC seem to be some of the more exciting companies.

Solar Power

Solar power currently accounts for 1.6 percent of all the energy generated in the United States. (Out in the West, there are vast arrays of solar panels that can be used to harness a good amount of solar power.)  I can only guess that these projects will increase in value and volume, as farmers come to realize benefits to both crops and livestock from the artificial shade and coolness from these installations.  If you believe in the growth of this energy source, you may want to consider investing in companies that install, manufacture, or research the technology surrounding them. Here are a few stocks and funds in this field.

Energy from the sun powers homes, buildings and a variety of other items from lights to radios. If you think the sun is just  getting hot in this industry, focus your attention on companies that make solar panels, which will benefit as homeowners and businesses increasingly adopt solar power. First Solar(FSLR) is a leading producer of solar modules and systems, and with net sales of $2.7 Billion in 2020, appears to be well-positioned for profit in the future.   JinkoSolar Holding (JKS) also makes solar modules and claims to have delivered 52 gigawatts of production capacity, and this month, won a “high achiever” award from the Renewable Energy Testing Center. Sunpower(SPWR) makes solar modules and storage solutions for homes and businesses.  Sunpower is interesting because they seem to have a very good financing arm, offering many options to prospective clients, and this seemed to help generate good results in Q4 of 2020.

Geothermal Power

Anybody who has been out to see Old Faithful geyser knows a little bit of the awesome power locked away in our Earth’s crust.   Harnessing the power of the heat of the earth, geothermal power uses steam or heated water to drive generators. Though not the most common renewable energy source, the United States produces the most geothermal energy in the world — it accounts for .4 percent of electricity generated. Here are some geothermal companies:

Geothermal energy uses heat from the earth to produce clean energy. Ormat Technologies (ORA) builds, owns and operates geothermal plants, with operations in the U.S., Guatemala, Guadeloupe, Honduras, Indonesia and Kenya.  Headquartered in Reno, NV, this company is quite small and seems to earn about 10% on its revenues, and this seems low.  Calpine is another company in this space.  Just this year, Calpine won an award from CDP for sustainability for its technology.  

Are there other ways to invest in Green technology?

There are other ways to invest in green technology, outside of electrical generation.

Sustainable Food Production

This includes organic farms and sustainable fishing practices known as aquaculture. Green food production companies aim to combat overfishing of the ocean and promote responsible farming practices. These include forgoing harmful pesticides and opting for natural animal management techniques that avoid antibiotics. Beyond Meat produces a plant-based protein that some people were introduced to by purchase of a burger at Burger King.   ADM is also interested in sustainable food productions and recently started a partnership with water.org with the goal of bringing potable water to 100,000 people.  FMC is another player in this space.   They garnered a 2020 award at the Crop Science Awards, and seem to be interested in using drones to help apply water and pesticides in a more targeted manner.

Waste and Recycling

People produce a huge amount of waste each year, and unless any preventative measures are taken, much of that ends up in landfills or our water sources. Green companies in waste and recycling aim to reuse materials like plastics and paper rather than discard them, plus promote responsible waste management.   This one is an interesting one to me because there seems to be one large company; Waste Management.  (In full disclosure, I own an immaterial amount of shares in this company.)  But, it really is an intriguing company.  In 2016 (per a company fact sheet) they were able to deliver electrical power to 2,000,000 households based upon waste.   They also seem to have some really interesting ways for consumers to become involved in conservation.

Aquaculture

Sustainable fishing is another food-related investment opportunity that is generating attention as the plight of the world’s overfished oceans impacts the human food chain.  Ingredion Inc. seems to be a major player in aquaculture.    They seem to be a very new entrant to this cognate area, but, have several innovative programs.   Interestingly, there is an ETF that focuses on aquaculture, and goes by the ticker symbol MOO.  Interestingly, based on a fact sheet, most of their larger investments seem to be focused upon tractor manufacturers.

The Verdict

A great artist cannot use only one color.   In a similar way, green investment might be an interesting portion of your portfolio, if used as a balancing item to other investments, it can be an area of robust growth for your investment account.  As most of us are not specialists in either energy production or other conservation technologies, it would seem advisable to invest in an ETF or mutual fund with a variety of companies within the specialized investing space.

REFERENCES

https://www.investopedia.com/articles/stocks/07/green-industries.asp

https://www.investopedia.com/terms/g/green-investing.asp

https://fortune.com/2021/02/24/green-investing-can-pay-off-in-spades-ceo-daily/

https://www.economist.com/leaders/2020/06/20/green-investing-has-shortcomings

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Timing might be everything…

Headline: Save Money and Your Life?

Date: 12/5/2020

Body: I was reading this wonderful article in The Penny Hoarder, and something really hit me between the eyes.   The article is linked below:

25 Ways to Save Money When You Don’t Know Where to Start (thepennyhoarder.com)

This article really gives some good food for thought (as it also gives thought to food.) and  this is part of what I wanted to explore

Everything has its Season, everything has its Time…

Be very glad that this is not a podcast, else, you would’ve heard me sing that.   All jokes aside, one of the tips from this article concerns the buying of food.  Within the article, the tip is, “Shop Seasonally and Locally.”   In the context of this article, it means that if you live in the Mid-Atlantic region, and it is either Summer or Fall, and you are looking for a vegetable, go towards any type of squash.  This is good advice because if it is near (or in) the growing season, there is likely to be a LOT of squash..   And if they are local, distribution costs are nil (almost.)  Because of these twin conditions, the prices of squash are likely to be low.

In a similar manner…

To get the best prices on merchandise, you might want to shop off-season.   For instance, if you need a new gas grill, if you look to buy in April or May, you will find MANY people looking for the same thing at the same time.   Manufacturers know this, and raise prices accordingly.   But, nobody (almost nobody) is grilling in late October, so, when you go looking for grills, you will have less company.   Manufacturers know this too, and thus offer price rollbacks to motivate people to buy the final units.

Are you going out of your gourd?

No, this has a point.   When choosing investments like stocks or bonds, some of the same concerns apply.     It is true, you cannot smell a stock, or pick it up and see how dense it is, but there are some similarities.

Seasonality

Just like in Nature, the financial markets have seasons.  Instead of Fall, Winter, Spring and Summer, we have Recession, Growth, Maturation, Decline.   It describes a sine wave, and acts pretty like the seasons.     In the Recession times, the anti-cyclicals do well.  (Think of these like stop-gap measures: Instead of a new car, you buy a used one.   Instead of buying a new home, you fix up your current home.)  Following this logic, the companies in these industries are likely to do well.      As things ramp up, companies need more raw materials, so the price of commodities are likely to go up.  In the maturation stage, technology stocks seem to do well (usually).   And in the falling stage, financial services stocks tend to do well.  However, the difference is that in the financial markets, investments are cheaper when they are NOT in their growing season.  When you purchase investments “out of season” they are often “on sale” to encourage consumption.

Locality

OK, this one might be an over-extended metaphor, but I think it works.   You might have a major facility of a company in your vicinity.  You can see most of the employees are happy, you can see the “Now Hiring” signs up, and you can hear the gossip in the coffee shop.   If you get a series of positive observations, it might be time to look at the numbers behind this company (which others might’ve overlooked.)  To make things more concrete, you might live in or near Louisville, KY, and you note that the UPS air facility is always busy, the people seem relatively happy, and the gossip is good.   So, you look at the numbers, and you decide that it might make a good investment, and you take a position.  Your location might’ve given you access to information that others would’ve had to invest much time and money to discover.

Related, you might be employed in an industry, and that might make you a “local” who knows that neighborhood better than most.  For instance, if you were a dog trainer, you might become aware of a new internet-based pet supply firm (e.g. Chewy) but many don’t see what the big deal is.   Many might fear this to be another Pets.com, and shy away from the investment.   But you like the way they seem to “get” owners, and pets, so you invest early.  (Then you retire early.)

The Verdict:

Both Seasonality and Locality play a role in investment, just like any type of shopping.   Buy at the right time, and in the areas that you have “local knowledge” and you are likely to get a much better price.

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Personal Representative

Headline: REPRESENT!!

Date: 3/4/2021

Body:   Nobody likes to think about death (or taxes) but they are both inevitable.  When you receive correspondence from the IRS, you always have the right to have somebody represent you.   Death is no different, in this respect.   You will want somebody  who knows your desires and your wishes, and appreciates your essence in life.  You want this person to ensure that your final wishes here on Earth are carried out as you would want them to be.   This is why you draft a Will, and you also select a personal representative.

What Is a Personal Representative?

A personal representative (a.k.a. executor or administrator) is the person who represents you in the disposition of your estate when you are deceased.  The Personal Representative has to act as a fiduciary, and act in the best interest of your beneficiaries.  They are responsible for a great many things including funeral arrangements, notifications of beneficiaries and conserving the estate property for the beneficiaries, until distribution.  They also have to file the tax returns for the Estate.  Given this rather onerous list of duties, the representative will be compensated for their services and often have to contract with professionals, on behalf of the Estate.

This person will be given a document by the Court, naming them personal representative, and use this document in conjunction with the Death Certificate to execute the objectives in the Will.  (Because of differences in State laws, your particular state might have slightly different requirements.)

What exactly do they have to do?

First, the personal representative has to appear in Court so that they can be duly appointed.   Then the fun starts.  They first have to locate your assets and ascertain their value on the date of death.  Sometimes, appraisals  are necessary.  They also have to notify your creditors of your passing, and place newspaper ads announcing your death.  They also have to pay on-going expenses and are allowed to sell some property from the Estate to help afford these expenses.

When the Will is found (or similar document) the representative has 10 days to lodge it with the Probate Court.  If there is a safe deposit box, the heir can request that a bank official open it in search of a Will and other relevant documents.  If found, they will lodge the Will with the Probate Court.   At that point, the personal representative can be officially appointed.  Once appointed, the Representative can engage in a search for the other documents needed to faithfully represent the deceased.

What can I do to make it easier for my Personal Representative to do their job?

There are a number of things that you can do:

1.Establish and maintain a listing of all of your assets and accounts.   This list will change over time, so, please treat it like the living document that it is and make updates regularly.   Make sure that your Personal Representative has access to this inventory.

2.In addition to your list of assets, be sure to have a list of your creditors too.  Include in this document plenty of contact information (e.g. telephone numbers, e-mail addresses and the like.)

3.If you keep a Will in a safe deposit box at a bank, be sure to keep 2 copies there.  The Bank will have to lodge one copy with the Court, and the Personal Representative will need the other copy.

4.If you nominate  somebody to be personal representative for you and they refuse, it would be much better if you also had 1-2 back

What if I have to act as Personal Representative for Somebody Else?

If you are Personal Representative for somebody else, there are several things you can do to make the process easier:

1.Be sure to get 2-3 certified copies of the Death Certificate.   In the vast majority of cases, a photocopy will suffice, but sometimes, you need to use a certified copy of the document.

2.File an SS-4 with the IRS to obtain an FEIN for the estate.

3.Prepare a Notice of Appointment Form to inform external parties and creditors that you are the Personal Representative.

4.Setup an accounting system to track expenses associated with the Estate.

5.Do an inventory of the Estate property within 3 months.

6.You must respond to all written claims on Estate assets.   Now, creditors fall into different classes, each with a different priority on assets.    So, please wait until the creditor window is closed before paying each class of creditor equitably from Estate assets.

7.If there is stock or other securities in the Estate, the Personal Representative must send a copy of their letter of Appointment to the transfer agent.

8.You will have to file a final tax return for the decedent, and then for the Estate itself.  (It is usually a good idea to engage the services of an attorney and an accountant to approach this.)

9.After all distributions are made, you must close the estate.   To do so informally, you can lodge an affidavit with the court.  To close the Estate formally, you would receive Court approval to proceed in the closing of the estate.

The Verdict

Being appointed a personal representative can be both a blessing and a curse.  On one hand, it is a blessing that the deceased held you in such high regard, that they put you in charge of disposition of their assets at their death.  On the other hand, the detail-oriented tasks that you are required to attend to can be tedious and time-consuming.  I suppose that it can also serve as a part of your grieving process as well.  The bottom line seems to be that if you really loved a person while here on Earth, you should probably feel a responsibility to ensure that their wishes are carried out, after they’re gone.  Even if it is, taxing.

 REFERENCES

https://www.investopedia.com/terms/p/personal-representative.asp

https://www.thebalance.com/what-does-a-personal-representative-do-3505111

https://www.usafa.af.mil/Portals/21/documents/Leadership/JudgeAdvocate/So%20Now%20You%20Are%20A%20Personal%20Representative.pdf?ver=2015-10-30-115236-263

https://www.legalzoom.com/articles/the-other-side-of-the-will-top-10-duties-of-an-executor

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

TIPS Can Help Avoid a Tipsy portfolio.

Headline: I have some hot TIPS for you…

Date: 1/25/2021

Body:  I was looking around for some good investments, and I have a contrarian recommendation.   In fact, I am going to change my policy here and give you some hot TIPS.  That’s it, right there.   See you later.

Oh, you need a bit more, OK.   TIPS stands for Treasury Inflation Protected Securities.   They are very important when inflation is very high.   So, there is currently no buzz about this in the media.   The current inflation rate is near 0, and by all indications, the Fed is not going to increase rates anytime soon, so, nobody is crowing from the rooftops, exclaiming how incredibly brilliant they are to have invested here; and that is exactly my point.    This is the exact economic position where TIPS are inappropriate, and that makes them cheap.   Hence, your opportunity.   Said one expert,

 Whether TIPS are worth it depends a lot on the economic landscape. The big factors are stock-market performance and how much inflation the bond market is pricing in, says Tony Crescenzi, chief bond market strategist for Miller, Tabak & Co. and author of The Strategic Bond Investor (McGraw-Hill, $29.95).

OK, so what are these things called TIPS  and how are they used in a portfolio?

TIPS are Treasury Inflation-Protected Securities, which means that their objective is to preserve purchasing power of one’s assets in an environment of rising prices.  Confusing?    Let me give you an example   Picture a sailboat, out at sea.  In this metaphor, the tide would represent the inflationary pressures in the economic environment; It would raise and lower our boat.   The boat itself represents the value of the principle of TIP security, as it rises and falls on the inflationary environment.  The sail provides the force that pushes the boat forward, just as interest payments  do in our metaphor.  So, even though the shape and quantity of sail does not change (interest rate) based on the principle changing, the payment will.

What do I have to think about before I invest in TIPS?

Pros

  • The principal increases with inflation meaning that at maturity, bondholders are paid the inflation-adjusted principal
  • Investors will never be paid less than their original principal when TIPS mature.   Said another way, the investor will always get back at least the principal they invested; principal amount ONLY ratchets up.
  • Interest payments increase as inflation increases since the rate is calculated based on the adjusted principal balance.  Remember, the sailboat?   The sail area remains the same, but, the boat is now higher, and catches the wind better, and goes faster.  This increase in velocity can be thought of as the increase in interest payments.

Cons

  • Interest rate offered is usually lower than most fixed-income bonds that do not have an inflation adjustment.   More particularly, the yields on corporate bonds (even the really high-quality ones) are usually significantly higher.
  • Investors might be subject to higher taxes on increased coupon payments
  • If inflation does not materialize while TIPS are held, the utility of holding TIPS decreases
  • If there is an increase in principal value, the increase is taxed each year UNLESS these are held in a non-taxable investment vehicle.

How do I go about buying TIPS?

TIPS can be purchased from TreasuryDirect.   New securities are auctioned off in a sequence of months in a competitive bidding scenario.  For instance, in January, they might auction only the 5-year and 10-year securities.  In February, they might be auctioning only 30-year TIPS.  There might also be some non-competition auctions that ensure that each investor gets something.

How do I eventually sell my TIPS?
TIPS may be held until maturity or sold at any time through a securities broker or the U.S. Treasury’s Sell Direct program. TreasuryDirect gets an agent to execute the sale and charges a commission of $34.    A confirmation of the sale is transmitted to the seller, and a roll-up of these transactions is presented in a F.1099 annually.

TIPS also qualify for the Treasury’s Separate Trading of Registered Interest and Principal of Securities (STRIPS) program.  Under this program, the principal and interest rights can be sold separately. If held for the entire term, the bond will be redeemed at the adjusted principal balance.

How are TIPS taxed?

TIPS generate revenue for the investor in 2 ways: principal and interest.   The interest payments are made semi-annually, and information on these transactions is rolled up into an annual F. 1099-INT.   Adjustments to the principal are taxed immediately, and rolled up int an annual F. 1099-OID.

There is one other cost when TIPS are involved. The Treasury imposes an annual maintenance fee of $25 on accounts of more than $100,000. This fee may be deductible, subject to the investor’s limit on miscellaneous itemized deductions.

The Verdict

TIPS are something to consider for a part of your portfolio.  They are probably not as important as stocks for growth, and probably not as good as corporate bonds for income.   But, they ARE really handy to have in some economic conditions, like rapidly increasing inflation.  As we are at 0% now, and inflationary pressures seem high (and the Fed suggested that it is unlikely they will change the interest rates any time soon), now might be just the time to add these to your investment mix.  Just understand that they should likely represent a small percentage of your investable assets.   If you are piloting a sailboat, your trip goes a lot smoother if you have a massive, stabilizing keel.

P.S. It would appear quite possible (perhaps probable) that our future could hold significant inflation. If true, then, these securities might make even more cents… er… um… I mean sense.

REFERENCES

Treasury Inflation-Protected Securities (TIPS) Definition (investopedia.com)

Treasury Inflation-Protected Securities, Explained (thebalance.com)

TIPS and CIPS (journalofaccountancy.com)

Tips for Investing in TIPS | Kiplinger

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

It’s Life Insurance, Jim…

Headline: Is Life Insurance Boring You to Death?

Date: 2/27/2021

Body:   I was just viewing the course Getting Your Legal  House in Order, and it mentioned Life Insurance.   Life insurance can be really important in many families, but the subject is not…. Well, people don’t cram the auditoriums for the seminars.  But, I would like to argue to the contrary, that Life Insurance can be Life-affirming and ZZZZZZZZZZZ.     See?  Now you know why only 54% of adult Americans have Life Insurance today.  To really approach this topic, a whole semester would be required.   I will try to approach it in 4 pages.   Wish me luck.

What is Life Insurance and Who REALLY needs it?

Life insurance is a legally binding contractual arrangement between the insurer and the insured.   At the beginning, it is important to see this insurance as a risk-mitigation technique: For this reason, life insurance will normally be much less expensive when you’re young (and the risk of death is lower) and the premiums will increase as you begin a policy later on in life.   This is because of the increasing risk of a large payout that th Life insurance has a couple of purposes.  Chief among them is to replace income for family members left behind.   It is likely that the departed family member had some significant role in financially supporting the family.   Life insurance provides a financial cushion that allows space for the family to adjust financially to a new reality.  It also pays for unpaid expenses for the deceased family member and can create an inheritance for the heirs.   Related, life insurance proceeds can be used to pay inheritance and other estate-related taxes. (This can be significant!!)

In addition to families with young children, life insurance can come in very handy in other situations as well.   If there is a member of the family who has special needs and will require expensive treatment over the long-term, Life Insurance can ensure the future possibilities for this family member.  Additionally, businesses can sometimes benefit significantly if they take out insurance policies on key employees.

The death benefit associated with a Life Insurance Policy is usually tax free.   Some wealthy individuals will have this tax-advantaged policy within a Trust arrangement, and use tis money to pay estate taxes.  Some people try to use Life Insurance as an investing tool, but, I think that there are probably better ways to go about this

Pros and Cons of Life Insurance

Like any part of life, there are Pros and Cons of purchasing Life Insurance:

Pros

Financial peace of mind for your family.

Flexibility to use the funds from life.

Fixed premiums so that you know how to budget

Permanent life insurance offers the possibility of building savings through investments

Cons

For term life insurance policies, when the term is over and the death benefit is not paid, any premiums paid into the policy are forfeited back to the insurance company.

For whole life with cash values or universal life, investment options do not usually yield the highest possible returns.  If one were to invest wisely, you could likely do better.

If you do not pay the premium, your policy will be canceled and you may have to take out a new life insurance policy, subject to your current (read “older”) age and a new medical exam.  Your new premium could be significantly higher.

Are there flavors of Life Insurance, and are they suited to different situations?

There are many different varieties of life insurance, but, they mainly seem to circle around 2: Term and Whole Life.   Term insurance will pay a death benefit if and only if the death occurs within the term covered (usually 1 to 30 years.)   You might ask why this type is attractive, and it boils  down to cost-effectiveness.   (Just for a bit of context, assuming a healthy 30-year old woman,  might want a death  benefit of $500,000.  The whole-life policy might cost $3,750 per year, and a 30-year term policy, $300 per year.)  Parents who have young children are usually the ones who need to most consider life insurance.   But, when those “kids” are done with college and raising families of their own, it might not make sense to pay for the policy anymore. 

But, Wait, there’s More!!

So, due to the differing kinds of insurance products, it can be rather complicated to choose a policy.  To make things even more challenging, some policies can come with “riders.”  These are contractual provisions that can be added to the policy to add coverage for a variety of situations.   Please note that with each rider (generally) the cost of the policy increases.  Some of the more common riders include the following:

 Accidental Death Benefit Rider–>pays more for a tragic accident

Waiver of Premium Rider–> If the insured is unable to work, there is no need to pay premiums.

Accelerated Death Benefit Rider–> can be used to receive a partial death benefit that can be used to cover medical treatment.

Long-Term Care Rider–>Accelerated Death Benefits can, with this Rider, be allocated to pay for Long Term Care expenses.

There are a multitude of other Riders available, but this provides a nice sample of what is on offer.

How much Life Insurance do I REALLY need?

Just as the assigning of rates for Life Insurance is based on Risk Management, this question can also be productively approached from the same standpoint.   To get a decent estimate of your needs, take out a clean sheet of paper:

Add all of the expenses that you would want covered, if you were not there to support your family.  This might include income replacement, mortgage and college expenses for our children.   Deduct amount you currently have in savings or other life insurance policies.   Disregard retirement savings if they will be needed later.

The resulting number might be shockingly high.  But, if you are serious about getting coverage for your family, a free quote from a few reputable companies might not be a bad place to start.   If the premiums appear unapproachable, you might want to start at a lower level, but lock in the rate of a younger person.  You can very easily add more later, and this way, you can do so at your “locked in” lower rate.

What happens if my loved ones have to use the policy?

The claim will normally take between one week and one month to file and evaluate.   Unfortunately, it will fall upon your loved one to make the first moves.   First, they should obtain 3 to 5 certified copies of the Death Certificate (sometimes photocopies are adequate, sometimes not.).  Then, they need to call the insurer, and notify them of the death.  They can print and fill in a claim form and mail that in with a certified copy of the Death Certificate and any other documents required by the insurer.

REFERENCES

Life Insurance Basics | III

Life Insurance Guide to Policies & Companies (investopedia.com)

How Does Life Insurance Work? – NerdWallet

How Does Life Insurance Work? – Forbes Advisor

How to Choose a Life Insurance Policy (thebalance.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Annuities, Years, or Tears?

Headline: Annuities might Insure your savings?

Date: 2/26/2021

Body:  I was continuing with a series of videos, “Getting Your Legal House in Order” and the subject of annuities came up.    Now, the lecturer was herself an experienced elder law attorney, and I am not    That said, I thought that the basics would probably be instructive.  Before you purchase an annuity, please carefully read the contract several times, and it might be sensible to hire an attorney to look over the document

“Annuities have been around for centuries,” says Troy Bender, president and chief executive officer at Asset Retention Insurance Services in Laguna Hills, California. “In Ancient Rome, people would make a single payment in return for annual lifetime payments. Even back then, retirement planning was a concern.”

What Is an Annuity?

Put simply, an annuity is a contractual agreement sold by an insurance company or investment company.  The agreement (generally)  states that you will fund it for a while (accumulation phase) and then at some point, you will begin to receive payments from it (annuitization phase).   Each of these points can be changed and the exact type of annuity could then be changed.  For instance, you might pay a lump sum of $200,000 to buy the annuity, and then on a time schedule (written into the contract) you will begin to receive payments from this $200,000 and the earnings it has thrown off.

Are there different types of annuities?

In a word, yes, there are lots of different kinds of annuities.  There are immediate annuities where you receive payments in the same period that you fund the annuity.  In another type (deferred annuity) you fund the annuity, and then pause for a period (5-10 years or longer is not unusual) and then when the annuitization period starts, you can make much larger withdrawals.  A fixed annuity pays the same amount each period, and a variable annuity pays an amount that is changed based on market conditions.  There are many other flavors of the annuity too.

To make things even more complex, different riders can be added to the contract to add features or modify the particulars of the arrangement.  As an example, an inflation rider will increase earnings gradually, to help mitigate the effect of inflation risk.

Who likes Annuities and what makes them likeable?

  1. Traditionally, annuities are used by retirees to guarantee a dependable  stream of payments that might replace a portion of their paycheck.  The major fear addressed by the annuity is the fear that the elder might outlive their savings.
  2. The earnings on your annuity are tax deferred.  Withdrawal of your own money (if already taxed) is not a taxable event.
  3. If a retiree invests in an annuity, they might be apt to more aggressively invest their other investable assets.  This can be important to enjoying a long retirement.
  4. Per the IRS, you can convert the lesser of 25% of your annuity or $130,000 into a QLAC.   The important point here is that within the QLAC, there are no required minimum distributions until you are 85.

Why might you NOT like annuities?

  1.  Annuities are highly illiquid assets.  This means  that they can be very difficult to sell or have substantial fees associated with the sale.  There are usually surrender fees and these usually decline over time.  Still, this is something to consider carefully before investing.
  2. Please be aware that there is usually not a cost of living adjustment within an  annuity.  So, the $200 you get in month #1 will be nice, but the same $200 in month #130 will not go as far.
  3. Please note that there is market risk involved with this investment.
  4. If it is of importance, the inheritance available to other family members will be decreased as a result of this investment.

Are there things to think about?

  1.  You might want to think about an income rider that ensures a smooth receipt of income payments.   Before you do, carefully consider when you might need this as a source of income AND how much is being charged for the rider.  Remember, the thumb rule is that the simpler the annuity, the lower the fees will be.
  2. The variable annuity can be attractive, to both have a guaranteed stream of income AND to participate in market appreciation.   And, in some cases, they make sense.  But, in most cases, caution is warranted.   Remember, you are going to be investing in a very illiquid asset AND face a large amount of market risk.  Plus, the variable annuity involves fees that you might not think about, like mortality risk charge, administrative fees and the fees charged by the mutual fund company they are using for the market features.  Finally, there are a plethora of fraudsters who stalk the areas of the internet where people might congregate if they are considering this investment.
  3. One way to protect yourself is to immediately write down what you understand the contract to say, and then have the salesperson sign and date the statement.
  4. Be aware that the guarantee associated with the annuity is only as safe as the company offering that product.

The Verdict

Not everybody needs an annuity.  Some have pensions, or other arrangements that make the annuity (and associated fees) much less attractive.   If you decide to invest, please do so thru an investment advisor, who willingly shows you 3-5 options from different companies that offer annuities that are perfect for you.

If you do find yourself involved in an annuity contract that now appears unattractive, be aware that there is often a “free look” period of 10-30 days.  If you decide to not continue within this period, you will receive a full refund.

REFERENCES

https://www.investopedia.com/terms/a/annuity.asp

https://www.investor.gov/introduction-investing/investing-basics/investment-products/insurance-products/annuities#Kinds

https://money.usnews.com/investing/investing-101/articles/things-you-need-to-know-now-about-annuities

https://www.finra.org/investors/learn-to-invest/types-investments/annuities/fixed-annuities

https://www.wsj.com/ad/article/annuities-kerry_pechter

SPIA: Single Premium Immediate Annuity – Forbes Advisor

REFERENCES

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Banging Timeshares into Swords?

Headline: The Last Resort?

Date: 2/24/2021

Body:  I was listening to an excellent lecture on legal topics facing mostly older people. There was a surprisingly large section on timeshares.   So, I think it’s probably profitable to provide some background and context for learning.  (The particular lecture was one of The Great Courses, entitled Putting your Legal House in Order.   It is an excellent course.) 

What is a Timeshare?

A timeshare is an arrangement wherein you purchase the right to reside at a resort in a certain unit, usually for a week or 2 in a defined season.  Sometimes, depending upon the verbiage in the agreement, you can trade with a person (in a similar arrangement, who has a unit in a different location) and for an additional fee, enjoy your time in that new location.  This arrangement of having a unit you can depend upon, in one location, appeals to people who have identified their favorite vacation location, and appreciate the feeling of a home away from their permanent home.  But, the tricky thing is that to get this arrangement, there is a contract to sign, and that contract usually has enough strings to it to weave ropes  capable of tying up cruise ships.  And, these arrangements are epically difficult to sell, so, before one invests in one, one should think twice, perhaps 3-4 times.

OOPS!!  I used the wrong word.

I carelessly used the word “invest.”   This word intuitively appeals to me because the arrangement is long-term and you are likely to sink a lot of money into this arrangement.  I learned a lot in my research for this post, but the #1 thing that all of the articles agreed upon was, “A timeshare is NOT an investment.”   It will never earn you a monetary return, nor should you ever expect one.  What it will do is guarantee you a place to escape to, every year, for a very long time.

What are the potential problems with owning a timeshare?

  1.  It can be very expensive.   You have a mortgage payment to make, and there is an annual maintenance fee that can be quite robust (and will ALWAYS increase.)  Don’t forget that you also might have property tax and/or real estate tax to pay.
  2. Read your contract very carefully.   Often people don’t and get hit with gigantic “special assessments.”  Be sure to take your time and compare the contract you are considering with other similar timeshare arrangements within the area.   Be aware that there is usually some room for negotiation.
  3. Sometimes, there are complaints about the timeshare company from former tenants.   Be sure to do research with the state’s Attorney General’s office to look for any complaints against the developer or Resort.
  4. Often, the salesperson will promise you the moon and stars, but these promises are NOT within the written agreement.   If this happens, walk away.
  5. Even if the site doesn’t change and the management doesn’t change, over time you probably will.  You might add human or non-human family members, or you might injure yourself.   Each of these life changes could make your ownership of the timeshare much less desirable. 

What can you do to ensure that you do get good value?

  1.  Be sure to get plenty of contact information for all parties involved in the sale.  You want to ensure that you can contact all of them before, during and after the sale is complete.
  2. Many states have a “right of recission” period where you can terminate the contract if you get buyers’ remorse.   This period varies from state to state, and some contracts are cleverly engineered to make this very difficult.   Make sure that you have this escape hatch, easily accessible.
  3. Many people are trying desperately to get rid of their timeshares, so, there are some VERY GOOD DEALS out there to be had.   Just be sure to really take your time; Deals are for the taking, and you shouldn’t be.
  4. Timeshares are like cruises.  Half the fun SHOULD BE the getting there.   If you are not enjoying the planning process that goes into purchasing the timeshare, one would be wise to consider walking away entirely.

At some point, you will probably want to sell

If a company approaches you, be VERY wary.  You can check out the company with the Attorney General’s office and you can get all promises in writing, and this will help, some.  Once you find a legitimate buyer, these sales are every bit as technical as selling a house, with the added caveat that the resort itself might have some restrictions on transfer.  That said, there are a couple of tips.

  1.  Keep the pricing realisticà people who are looking to buy have MANY options to choose from, and if you are keeping your price high (ostensibly in an attempt to recoup some of your annual maintenance fees) your unit will NOT sell. 
  2. In a related manner, keep in mind just how “hot” that property market is.  If you are looking to sell a timeshare in Miami, you can likely get a buyer.   If you are looking to sell a timeshare in a tiny town in New Mexico, you might have more difficulty.
  3. Before you list your timeshare with an agent, gather up ALL documents related to your unit, including your deed, maintenance agreement, bills and receipts for repairs made and everything else that seems applicable.
  4. You can find an agent either online or offline.  Regardless of the source, be sure to check the BBB and State Attorney General’s office for records of complaints against them.  Be sure to understand exactly how the agent is compensated (e.g. upfront fee AND/OR commission?)  and be sure to interview several agents.
  5. Be aware that developers will sometimes have resale programs.   It might likely be a good idea to get an attorney who is really well-versed in timeshare law, if it comes to this.  Timeshares attract scam artists like a picnic attracts ants, be careful!!!

The Verdict

Often, when we take vacations, we want to travel on different time schedules to different locations, and this would seem to argue against timeshares.   But my aunt and uncle had a timeshare in Naples, FL for decades, and absolutely loved it.  At the end of the day, it can be the perfect idea for the right people (who love a location and are unlikely to want to go elsewhere for vacation) who have the resources (e.g. money, time and energy).   But, if you are unsure of either of the qualifications, it might be the wisest course to not drop your hard-earned cash here.

REFERENCES

https://www.consumer.ftc.gov/articles/0073-timeshares-and-vacation-plans

https://www.nolo.com/legal-encyclopedia/buying-timeshare-pros-cons-form-ownership.html

https://www.investopedia.com/articles/pf/08/timeshare.asp

https://www.nerdwallet.com/blog/finance/are-timeshares-worth-it/

How to Sell a Timeshare (thebalance.com)

 Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.

Throwing Shade at Shadow Banking?

Headline: Should we really throw shade at shadow banking system?

Date: 2/21/2021

Body  I was listening to a wonderful article on the radio that mentioned the “shadow banking system.”  Sounded to me like a GREAT murder mystery.   To my surprise, I found an even BETTER story.   On the International Monetary Fund site, I found the following article Shadow Banks: Out of the Eyes of Regulators (imf.org)  It really does an excellent job laying out the facts that  can be even more engaging than the fiction.

What is the “shadow banking system?”

Shadow banking is a phrase made up by Paul McCulley in 2007 as he gave a speech to a gathering of the Kansas City Federal Reserve. Players in the shadow banking system are numerous and include investment banks, mortgage lenders, money market funds, insurance companies, hedge funds, private equity funds and payday lenders, all of which are a significant and growing source of credit in the economy.  Shadow banking refers to the “bank-like” institutions that engage in “maturity transformation” and the related “liquidity transformation”, to make money.    Banks will take the deposits made to them by consumers (to the Banks, these represent short-term liabilities which require very little interest to compensate them) and then lend these funds out on a longer-term basis (which requires higher interest rates coming in.)   This is how a bank makes money.  The key differences are 2:

  1. As a “last resort” Banks can borrow from the Federal Reserve.  The shadow banks cannot borrow from the Federal Reserve.

2,         Banks are insured.    The shadow banking system is not.

Further, some Banks take part in these shadow banking activities.   The best known activity is the credit-default swap.  (The buyer essentially makes payments to the seller until the maturity date, and if mortgagee goes into default, the buyer is paid a discounted fee by the seller.)

What is the origin story of these shadow banks?

In a few words, “Home Mortgages.”  For many years, institutions that are not banks have been making loans such as home mortgages.  What often happens is that a bunch of these mortgages will be bundled together and sold as a “security” to another institution, and this could happen a few times.  This trend was steady for a while, but really accelerated in 2007-2008.  For a while, this was a great business to be in, and these shadow banks took on more and more debt in order to purchase more of these mortgage securities; This debt financing is known as leverage, and can serve to increase profits (or losses.)  But, remember, these shadow banks are NOT regulated as Banks, and… remember the Great Recession?

What happened to these “finance companies?”

Many years ago, there was a ship called the Titanic, ran into an iceberg.   The going theory was that there would be a gaping hole in its hull that caused it to sink into the sea.   But, inspection with remote operated vehicles (ROV) suggest that it was instead point-damages where the rivets popped out.   This is similar to what happened to the finance companies.  Individual investors became concerned about the value of the properties and ran to pull out their money.  To produce the money, these companies had to sell their other assets at rock-bottom prices.  They quickly wound up with nothing left.  Worse yet, sometimes traditional Banks do get involved with these finance companies, so they too are affected.

How would this happen?   Banks now have to compete with these shadow players.   Let’s just think of home mortgages (but note that similar logic could apply to a variety of financial products.)  The Bank sees these shadow institutions offering mortgages for lower percentage rates of interest, and to compete, they lower interest rates.   Then, the Banks do what the can to “simplify” paperwork, which gives them less information on the mortgagor.    And, in this way, the problems of the shadow banks are now also owned by the other Banks.

What are the specific risks?

 Investor Safety–>Banks are insured by FDIC.   Money market funds offered by investment houses are not.    This shouldn’t be a problem, but, when investors panic, they quickly withdraw money and without the FDIC insurance, these institutions cannot withstand this kind of shock.   Bottom line: If investors were rational, this wouldn’t be a problem.   Investors are human, and gentle reader, we humans are not rational.

Liquidity Risk–>Related to #1, this is refers to the fact that shadow banks use nearly all of their deposits to underwrite longer-term loans, leaving VERY LITTLE to cover such “runs” on their deposits.   Please note that as there is no FDIC insurance, there is no reserve requirement on these institutions.  So, you get enough skittish investors, these institution can fail in a hurry.

Recession–>Recessions are nearly impossible to predict, so, there is no way for these institutions to proactively begin to save liquidity in preparation for a recession.

How large of a problem is this?

Transparency issues are being addressed, but since 2015, shadow banking represents 33% of banking activity in Europe, and 28% of the activity in the U.S.  The Financial Stability Board found that non-bank financial assets had risen to $92 trillion in 2015 from $89 trillion in 2014  .   In addition, peer-to-peer lending added more than $1.7 Billion  in loans in 2015 alone.   Quicken Loans (alone) has 17,000 employees and closed nearly half a billion dollars in loans between 2013 and 2018.   One expert said the following:

“It’s a wild west space,” a top credit strategist from Bank of America told the Financial Times this year. “The whole thing has exploded in size, and everyone is getting into it.”

So, shadow banking represents a large set of issues that we should get our arms around before it manifests again as a much larger problem. “Anytime you have this much money chasing loans, you are going to have accidents,” a banker told me recently.

Have we seen this movie before??

One person said, “history might not repeat itself, but it does rhyme.”    I think we might be hearing a phrasing similar to 2008.  “Anytime you have this much money chasing loans, you are going to have accidents,” a banker said recently.

Said in a different way, too much of the lending growth is driven by investors’ search for yield rather than borrowers need for new capital.    One key attribute to the defense of capitalism is that it provides the most rational allocation of scarce capital.   With investors seeking yield, some more rational projects might not be funded adequately, and some less rational ones might get funding, then fold.

Further complicating the picture, many regulators don’t understand the problems well enough to suggest rational solutions.  (Hard to blame them entirely, it is complicated)  It is difficult to understand where all of the risks are most densely packed.  Sometimes it’s difficult to see and appreciate the potentially corrosive effects of leverage.

What can be done?

Not long ago, some international banking regulators came up with an idea that might be used to avoid the 2008-type crisis.  Over-simplifying the idea, when certain economic indicators all light up green (like in 2008) banks should be required to withhold a larger amount of reserves.   This is  a pro-active response to the  demand for liquidity that might be not far off.   Currently, many of the market indicators are in agreement to be like 2008, but 4 out of 5  of the Fed’s Board of Governors decided not to place this extra restraint on Banks, right now.   The stink of it is that there might be political entanglements causing some of the Governors to vote as they did.

The Verdict

Anytime the government does anything to create an environment more friendly to business, there is always a danger that business can be made “too easy” and the effectiveness of regulation is compromised.  I guess the boil-out of all of these thoughts is, “Buyer, Beware.!!”  When you sign for a new credit card, when you sign up for a new bank account, be sure to ask questions first, especially if there is a term you don’t understand.  Usually, if there are many terms you don’t understand, this is a good reason to avoid that potential investment.    Turns out, mom was probably right when she said, “Be careful out there.”

REFERENCES

Shadow Banking System Definition (investopedia.com)

What You Need to Know About Shadow Banking System Now | Kiplinger

The shadow banks are back with another big bad credit bubble – The Washington Post

Credit Default Swap (CDS) Definition (investopedia.com)

Editor’s Note: Please note that the information contained herein is meant only for general education: This should not be construed as Tax Advice.   Personal attributes could make a material difference in the advice given, so, before taking action, please consult your tax advisor or CPA.