Most investors wish that they could be on a merry-go-round, not a roller coaster. Of course we know that it is not possible, but consider three different portfolios that are invested over an eight-year period.
Path #1 Path #2 Path #3
YR 1 10% 38% (22%)
YR 2 10% 23% (12%)
YR 3 10% 33% (9%)
YR 4 10% 29% 21%
YR 5 10% 21% 29%
YR 6 10% (9%) 33%
YR 7 10% (12%) 23%
YR 8 10% (22%) 38%
It’s hard to believe, but the compound annual return of each portfolio is exactly the same --- 10% for all three portfolios! Obviously Path #1 would be nice, but again, just not going to happen. Yet people consistently set themselves up for disappointment by expecting the historic “10% return” to occur year after year, only to discover that most years it’s not 10% on the nose.
Considering that we all have to endure variability of returns, which is better, Path #2 or #3? You may think that Path #2 isn’t so bad, but if you have retired at the end of year 6, it’s pretty darned painful, and it is similarly difficult to begin retirement with three nasty, down years. The one nice thing is that if you are still saving for retirement, the three down years allow you to invest in your retirement account at lower levels.
But what would happen if you were already retired in all three paths? In that case, most people would be withdrawing money from their accounts. So if the portfolio in each path is worth $1,000,000 and you are planning to withdraw an inflation-adjusted $50,000 each year, you may be surprised to see what would happen over the course of the eight years. In Path #1, after eight years, the $1million portfolio would be worth $1.6 million, in Path #2, it would be worth $1.8 million and in Path #3 it would total $1.2 million. A $600,000 differential is pretty major!
The reason that I bring this up is that when you are about to retire, rarely do results move in a straight line. Your job is to ensure that regardless of market performance, you are taking into account the various outcomes that would impact your life.
Thursday, November 15, 2007
Wednesday, November 14, 2007
The Job of Advisor
I am attending an industry meeting this week and while sometimes these things can be a bore, this group is special: everyone in the room is a Registered Investment Advisor (RIA), which means that each of us has a fiduciary responsibility to our clients and has to register with the Securities and Exchange Commission. The group gathers twice a year to talk about what we believe our clients need from us and exchange information that helps us discover new ways to serve those clients.
Individuals choose to work with registered investment advisors for lots of different reasons. Some are too busy to manage their own financial lives, while others lack the expertise to do so and then there are those who have time and smarts, but just can’t stand the emotional ups and downs of the investment world. Regardless of which category the client falls in, the answer to what they usually want is abundantly clear: “I want to make sure that I am going to be OK!”
I know that this may sound simple, but indeed, this is exactly my experience with the folks that I see in my office and talk to on the radio, regardless of whether they have $200,000 or $2,000,000 to invest. Oh sure, the point of entry may begin with a concrete question, like “Am I using the right assets in my retirement account?”, “Which 529 plan should I use for my daughter’s college funds?”, “Do I need a revocable trust?” and of course, “Can you help me reduce my tax bill?” But any advisor worth his/her salt will use these questions as a jumping off point to gain a greater understanding of the overall needs of the person asking the questions. And the real questions underlying the first round usually are: can we retire comfortably? How much do we need to sock away to be able to retire sooner? How much can we spend during our retirement years?
The ultimate goal of a fiduciary advisor is to provide not just simple answers, but a more meaningful response. Despite how much money anyone has, he wants to feel confident that he will not run out of money and he will not need to endure too much market risk to reach his goals. In the end, most people want to gain peace of mind that the advisor who is assisting them in wealth management is going to help them get to a specific destination with a reduced level of anxiety. In the end, what the people in my industry meeting seemed to share was an acknowledgment that our job is not to “beat the market”, but to help our clients relax and help them navigate their larger financial issues. It’s a pretty good job!
Individuals choose to work with registered investment advisors for lots of different reasons. Some are too busy to manage their own financial lives, while others lack the expertise to do so and then there are those who have time and smarts, but just can’t stand the emotional ups and downs of the investment world. Regardless of which category the client falls in, the answer to what they usually want is abundantly clear: “I want to make sure that I am going to be OK!”
I know that this may sound simple, but indeed, this is exactly my experience with the folks that I see in my office and talk to on the radio, regardless of whether they have $200,000 or $2,000,000 to invest. Oh sure, the point of entry may begin with a concrete question, like “Am I using the right assets in my retirement account?”, “Which 529 plan should I use for my daughter’s college funds?”, “Do I need a revocable trust?” and of course, “Can you help me reduce my tax bill?” But any advisor worth his/her salt will use these questions as a jumping off point to gain a greater understanding of the overall needs of the person asking the questions. And the real questions underlying the first round usually are: can we retire comfortably? How much do we need to sock away to be able to retire sooner? How much can we spend during our retirement years?
The ultimate goal of a fiduciary advisor is to provide not just simple answers, but a more meaningful response. Despite how much money anyone has, he wants to feel confident that he will not run out of money and he will not need to endure too much market risk to reach his goals. In the end, most people want to gain peace of mind that the advisor who is assisting them in wealth management is going to help them get to a specific destination with a reduced level of anxiety. In the end, what the people in my industry meeting seemed to share was an acknowledgment that our job is not to “beat the market”, but to help our clients relax and help them navigate their larger financial issues. It’s a pretty good job!
Tuesday, November 13, 2007
I got sssssssteam heat…
As the price of crude oil nears $100, my thoughts wander to…a Broadway musical! This could be a stretch, but in “The Pajama Game” there is a song called “Steam Heat,” with an almost-perfect hook: “I got sssssssteam heat…But I need your love to keep away the cold!” As the winter months near, Northeasterners should be reminded of this song.
According to the Department of Energy, Northeastern states use 76% of the nation's heating oil and almost of a third of households in the region use oil heat. Unfortunately, the price for heating oil has risen about 2.5 times faster than for gasoline in recent weeks because heating oil and related products, such as diesel oil, are in record demand here and overseas. As a result, Northeasterners are facing a projected increase of over 20% for heating oil—ouch!
The spiking costs are the continuation of a multi-year trend: from ’00-05, the average cost in New England for a winter's supply of heating oil was $900 a household. Last year, it hit a record $1,433 and this year it could reach over $2,200. Given that we are all paying more to fill up our cars each week, it’s time to pull out the old sweater from Jimmy Carter’s “Whip Inflation Now” (WIN) and find ways to reduce your home heating bill.
1. Opt for a price cap: The way that you pay for oil could save you money. Fuel companies usually let you buy oil as you need it, but many give you an option to “lock in” a price or elect a “price cap,” which guarantees a per-gallon price that will not go higher over winter. Because the risk of rising prices is more significant than if prices drop, the capped price is one of the best ways to control your costs.
2. Install a programmable thermostat: This can save about $150 a year in energy costs if your home temperature is set back 8 degrees in the winter for an 8-hour span during the day when no one is home, and 10 hours at night. Cost: Less than $50
3. Do system maintenance: Contact your oil company or the company that installed your furnace or boiler to go over the system, which should cost $100-$150 but could save that amount and more for years to come!
4. Conduct an energy audit: You can hire an expert to conduct an "energy audit", or you can do it yourself. Go to the US EPA’s Energy Star Home Advisor web site (www.energystar.gov/homeadvisor) for tips that could help you reduce your energy bills by up to 25%. Enter your ZIP code and the type of heating, cooling system and water heater you have, and you will receive a customized list of recommendations — from caulking doorways to adding more insulation to the attic.
5. File for an energy tax credit: Replacing an old furnace, boiler, or water heater with energy-efficient units can save you money on your taxes, too. Installing new storm windows and insulation can also help keep your house warmer. Look for products with the ENERGY STAR logo. The EPA says they’re designed to use 10-50% less energy and water than standard models. File Form 5695, Residential Energy Credits, with your 2007 Federal Income Tax Return.
And on top of these ideas, the tried and true methods prescribed in “The Pajama Game” are probably a little more fun.
“But I can't get warm without your hand to hold.The radiators hissin’ still I need your kissin’ to keep me from freezing each nite.I've got a hot water bottle, but nothing I've got'll take the place of you holdin’ me tight.”
According to the Department of Energy, Northeastern states use 76% of the nation's heating oil and almost of a third of households in the region use oil heat. Unfortunately, the price for heating oil has risen about 2.5 times faster than for gasoline in recent weeks because heating oil and related products, such as diesel oil, are in record demand here and overseas. As a result, Northeasterners are facing a projected increase of over 20% for heating oil—ouch!
The spiking costs are the continuation of a multi-year trend: from ’00-05, the average cost in New England for a winter's supply of heating oil was $900 a household. Last year, it hit a record $1,433 and this year it could reach over $2,200. Given that we are all paying more to fill up our cars each week, it’s time to pull out the old sweater from Jimmy Carter’s “Whip Inflation Now” (WIN) and find ways to reduce your home heating bill.
1. Opt for a price cap: The way that you pay for oil could save you money. Fuel companies usually let you buy oil as you need it, but many give you an option to “lock in” a price or elect a “price cap,” which guarantees a per-gallon price that will not go higher over winter. Because the risk of rising prices is more significant than if prices drop, the capped price is one of the best ways to control your costs.
2. Install a programmable thermostat: This can save about $150 a year in energy costs if your home temperature is set back 8 degrees in the winter for an 8-hour span during the day when no one is home, and 10 hours at night. Cost: Less than $50
3. Do system maintenance: Contact your oil company or the company that installed your furnace or boiler to go over the system, which should cost $100-$150 but could save that amount and more for years to come!
4. Conduct an energy audit: You can hire an expert to conduct an "energy audit", or you can do it yourself. Go to the US EPA’s Energy Star Home Advisor web site (www.energystar.gov/homeadvisor) for tips that could help you reduce your energy bills by up to 25%. Enter your ZIP code and the type of heating, cooling system and water heater you have, and you will receive a customized list of recommendations — from caulking doorways to adding more insulation to the attic.
5. File for an energy tax credit: Replacing an old furnace, boiler, or water heater with energy-efficient units can save you money on your taxes, too. Installing new storm windows and insulation can also help keep your house warmer. Look for products with the ENERGY STAR logo. The EPA says they’re designed to use 10-50% less energy and water than standard models. File Form 5695, Residential Energy Credits, with your 2007 Federal Income Tax Return.
And on top of these ideas, the tried and true methods prescribed in “The Pajama Game” are probably a little more fun.
“But I can't get warm without your hand to hold.The radiators hissin’ still I need your kissin’ to keep me from freezing each nite.I've got a hot water bottle, but nothing I've got'll take the place of you holdin’ me tight.”
Monday, November 12, 2007
Engineering Portfolio Returns
Engineers are a special breed of investor—at least the engineers that I have seen in my career. These detail-oriented creatures show up at the office, armed with spreadsheets of cash flow, net worth and of course, portfolio allocation --- color pie charts at no extra charge! With all of their great knowledge of numbers and their organized minds, why do engineers need investment advice?
The answer to that question was revealed to me when “John,” a civil engineer, wanted to discuss his retirement accounts. I smiled as he unpacked what looked like a suitcase full of financial projections and balance sheets. After reviewing the numbers, I concurred with John’s belief that his goal of retiring in two years was indeed attainable. “That’s what I keep telling my wife, so I’m glad to hear it.”
I then pointed out that the only way that the 55-year old couple might run into a problem is if they incurred heavy losses in their portfolios at the wrong time, “so let’s take a look at how you are invested right now.” The first graph was an asset allocation pie chart that showed a fairly significant overweight in stocks. The total portfolio was 82% stocks, 12% bonds and 6% cash. That seemed a tad bit aggressive for a couple that wanted to retire in two years, but it wasn’t the biggest problem.
When I reviewed the holdings, I saw that of the total assets invested for retirement, 75% was in-the-money stock options of one company---the company for whom John worked! Of course John knew that this dangerous, but his problem was that his engineering brain was stuck in a loop. He kept trying to figure out how he could avoid taxes when he exercised and sold the position. And in the year that he has been trying to figure it out, the stock price has been rising, so it has not hurt him to drag his feet in the process.
While I think tax reduction is important for all investors, the risk that John was assuming so near to his desired retirement age seemed enormous. He said that when he thought about paying taxes, it felt like he was losing “40% of the gains”. I reminded him that at least 15-18% of the gains absolutely belonged to the federal and state governments. The remaining taxes due would be realized depending on the timing of the sale (whether the proceeds would be taxed at long or short-term rates). “The main question to consider is how you would feel if the stock went down and instead of paying 20 cents on the dollar in taxes, you would be eating 100 cents of every dollar as the stock dropped.”
John was stymied. He wanted to find a solution that would satisfy the need to diversify and to reduce taxes. Like so many others, he really wanted rewards without risk. Unfortunately in the emotional world of investing, this is usually impossible. No matter how hard we try, there is a tradeoff. Each individual must clearly understand and weigh both the risks and rewards involved in every investment decision to determine the most reasonable action necessary. Sometimes you can’t engineer the portfolio returns that you want, even when armed with information.
The answer to that question was revealed to me when “John,” a civil engineer, wanted to discuss his retirement accounts. I smiled as he unpacked what looked like a suitcase full of financial projections and balance sheets. After reviewing the numbers, I concurred with John’s belief that his goal of retiring in two years was indeed attainable. “That’s what I keep telling my wife, so I’m glad to hear it.”
I then pointed out that the only way that the 55-year old couple might run into a problem is if they incurred heavy losses in their portfolios at the wrong time, “so let’s take a look at how you are invested right now.” The first graph was an asset allocation pie chart that showed a fairly significant overweight in stocks. The total portfolio was 82% stocks, 12% bonds and 6% cash. That seemed a tad bit aggressive for a couple that wanted to retire in two years, but it wasn’t the biggest problem.
When I reviewed the holdings, I saw that of the total assets invested for retirement, 75% was in-the-money stock options of one company---the company for whom John worked! Of course John knew that this dangerous, but his problem was that his engineering brain was stuck in a loop. He kept trying to figure out how he could avoid taxes when he exercised and sold the position. And in the year that he has been trying to figure it out, the stock price has been rising, so it has not hurt him to drag his feet in the process.
While I think tax reduction is important for all investors, the risk that John was assuming so near to his desired retirement age seemed enormous. He said that when he thought about paying taxes, it felt like he was losing “40% of the gains”. I reminded him that at least 15-18% of the gains absolutely belonged to the federal and state governments. The remaining taxes due would be realized depending on the timing of the sale (whether the proceeds would be taxed at long or short-term rates). “The main question to consider is how you would feel if the stock went down and instead of paying 20 cents on the dollar in taxes, you would be eating 100 cents of every dollar as the stock dropped.”
John was stymied. He wanted to find a solution that would satisfy the need to diversify and to reduce taxes. Like so many others, he really wanted rewards without risk. Unfortunately in the emotional world of investing, this is usually impossible. No matter how hard we try, there is a tradeoff. Each individual must clearly understand and weigh both the risks and rewards involved in every investment decision to determine the most reasonable action necessary. Sometimes you can’t engineer the portfolio returns that you want, even when armed with information.
Friday, November 9, 2007
Lisa’s Lament
“Lisa” e-mailed the radio show about a month ago, asking what she should do about a portfolio heavily weighted in financial stocks (she estimated that about 40% of her $200,000 non-retirement portfolio was concentrated in the sector). While on the air, I responded, “I would cry!” but that was obviously not the last word on the topic.
I started to e-mail with Lisa to learn more about her situation. She noted, “I must say that your response of "CRY" to my question has been my gut reaction for the past couple of months.” She had been frustrated by her advisor, who “doesn’t seem to listen to me!” Lisa’s lament was one with which I am quite familiar and I asked her to come in to the office so that I could review the portfolio and provide her with guidance.
I learned that Lisa is retired and that the money that was in this account was probably invested more aggressively than it should have been, given her overall risk tolerance and potential need for the money within the next five years. That was the first problem. Problem #2 was that the portfolio was difficult to change (she wanted her advisor to sell all of the financial stocks in the portfolio), because it was managed by a sub-advisor in a pooled account, not by her investment advisor. Finally, the last problem was the fees associated with the account were high…really high.
After identifying the three problems, it was on to the fun part: the solutions! Lisa showed me the new proposal that her advisor had presented. I pointed out that the advisor was suggesting that Lisa switch to a balanced sub-advisor to replace the more growth-oriented sub-advisor that she had. I asked her a simple question: “if that’s his answer, then why not manage the account yourself?” She looked at me as if I had suggested that she jump into the space shuttle and fly to the moon, so I elaborated on the recommendation.
If her advisor thought that Lisa should be in a balanced portfolio of stocks and bonds, she might consider purchasing a Vanguard Balanced Index Fund (VBINX) directly. Instead of paying her manager 2.25%, she would pay Vanguard .20% -- a savings of $4,100 annually! She wondered if the performance might be better over time with the sub-advisor, but it would have to be a whole heck of lot better to justify 2.05% every single year!
It seemed like a great solution to me, but Lisa said that she did not want to deal with managing her money herself and in fact, for some odd reason, despite her admission that she did not think her advisor was all that smart when it came to investments, “he does meet with me every month and help me reallocate my variable annuities.” Oi, variable annuities too? In the end, despite Lisa’s lament, I just didn’t think that she was ready to make a big change. I sent her on her way, telling her as much. She sent me an e-mail a few hours later thanking me for my time and said, “Who knows? You may not have heard the last of me yet.”
I started to e-mail with Lisa to learn more about her situation. She noted, “I must say that your response of "CRY" to my question has been my gut reaction for the past couple of months.” She had been frustrated by her advisor, who “doesn’t seem to listen to me!” Lisa’s lament was one with which I am quite familiar and I asked her to come in to the office so that I could review the portfolio and provide her with guidance.
I learned that Lisa is retired and that the money that was in this account was probably invested more aggressively than it should have been, given her overall risk tolerance and potential need for the money within the next five years. That was the first problem. Problem #2 was that the portfolio was difficult to change (she wanted her advisor to sell all of the financial stocks in the portfolio), because it was managed by a sub-advisor in a pooled account, not by her investment advisor. Finally, the last problem was the fees associated with the account were high…really high.
After identifying the three problems, it was on to the fun part: the solutions! Lisa showed me the new proposal that her advisor had presented. I pointed out that the advisor was suggesting that Lisa switch to a balanced sub-advisor to replace the more growth-oriented sub-advisor that she had. I asked her a simple question: “if that’s his answer, then why not manage the account yourself?” She looked at me as if I had suggested that she jump into the space shuttle and fly to the moon, so I elaborated on the recommendation.
If her advisor thought that Lisa should be in a balanced portfolio of stocks and bonds, she might consider purchasing a Vanguard Balanced Index Fund (VBINX) directly. Instead of paying her manager 2.25%, she would pay Vanguard .20% -- a savings of $4,100 annually! She wondered if the performance might be better over time with the sub-advisor, but it would have to be a whole heck of lot better to justify 2.05% every single year!
It seemed like a great solution to me, but Lisa said that she did not want to deal with managing her money herself and in fact, for some odd reason, despite her admission that she did not think her advisor was all that smart when it came to investments, “he does meet with me every month and help me reallocate my variable annuities.” Oi, variable annuities too? In the end, despite Lisa’s lament, I just didn’t think that she was ready to make a big change. I sent her on her way, telling her as much. She sent me an e-mail a few hours later thanking me for my time and said, “Who knows? You may not have heard the last of me yet.”
Thursday, November 8, 2007
A Chill in the Air (Don’t Worry, Chillax!)
I woke up yesterday morning and for the first time, grabbed a scarf before heading out into a crisp New England morning. There was a real chill in the air and I guessed that I would need to wrap myself in a cocoon of warmth. As the day progressed, it was clear that a cool blast was sweeping through Wall Street and by the end of the day investors would need to seek comfort in their respective scarves.
Like a new season that you know is coming, but still catches you by surprise, yesterday’s market action was painful, though not shocking. We had been feeling the cool winds over the past couple of weeks, in the form of more bad news from financial institutions about subprime losses. Although we were warned of the new weather pattern, now that it is here, investors are feeling chilled to their bones.
As banks attempt to quantify the billions of dollars of losses tied to mortgage-related securities, there were hints of more credit headaches yesterday. Stocks started the day weak, but selling accelerated around midday, and major benchmarks finished near their lows for the session. The Dow Jones Industrial Average tumbled 360.92 points to 13300.02, wiping out all the gains since the Fed's first rate cut September 18. The S&P 500 sagged 44.65 points to 1475.62, while the Nasdaq Composite Index shed 76.42 points to slide to 2748.76.
And like the weather professionals who can’t help talk about the first chill or snow storm, the analysts were coming out of the woodworks to do the play-by-play of this event. Ratings agency Moody's downgraded about $36 billion of debt securities held in structured investment vehicles (if you’re like me, you might be wondering where the ratings agencies were when we needed them—when the initial ratings were determined for these securities!) and others were guesstimating that when the dust settles from this credit crisis, there will be over $100 billion in write-downs on the illiquid, difficult-to-value holdings.
Before you get crazy about the weather (what are we, Brits?), don’t forget that you probably have a delicious scarf in your investment closet---it maybe those “boring” short-term government bonds or the classic black cashmere, also known as the money market account, or maybe the exotic and colorful commodities position. Any of these might provide some comfort as everyone else is frozen with fear. In the words of my nephew, this is not an occasion to be chilled by fear; rather diversified investors can “chillax”.
Like a new season that you know is coming, but still catches you by surprise, yesterday’s market action was painful, though not shocking. We had been feeling the cool winds over the past couple of weeks, in the form of more bad news from financial institutions about subprime losses. Although we were warned of the new weather pattern, now that it is here, investors are feeling chilled to their bones.
As banks attempt to quantify the billions of dollars of losses tied to mortgage-related securities, there were hints of more credit headaches yesterday. Stocks started the day weak, but selling accelerated around midday, and major benchmarks finished near their lows for the session. The Dow Jones Industrial Average tumbled 360.92 points to 13300.02, wiping out all the gains since the Fed's first rate cut September 18. The S&P 500 sagged 44.65 points to 1475.62, while the Nasdaq Composite Index shed 76.42 points to slide to 2748.76.
And like the weather professionals who can’t help talk about the first chill or snow storm, the analysts were coming out of the woodworks to do the play-by-play of this event. Ratings agency Moody's downgraded about $36 billion of debt securities held in structured investment vehicles (if you’re like me, you might be wondering where the ratings agencies were when we needed them—when the initial ratings were determined for these securities!) and others were guesstimating that when the dust settles from this credit crisis, there will be over $100 billion in write-downs on the illiquid, difficult-to-value holdings.
Before you get crazy about the weather (what are we, Brits?), don’t forget that you probably have a delicious scarf in your investment closet---it maybe those “boring” short-term government bonds or the classic black cashmere, also known as the money market account, or maybe the exotic and colorful commodities position. Any of these might provide some comfort as everyone else is frozen with fear. In the words of my nephew, this is not an occasion to be chilled by fear; rather diversified investors can “chillax”.
Wednesday, November 7, 2007
Two Economies
I was discussing the US economy with my client “Eric” yesterday. He noted that many of the Democratic presidential candidates are talking about “two economies,” but that he does not see evidence of that fact. Given that Eric is a corporate attorney who earns approximately $400,000 per year, this does not surprise me. But I talk to all kinds of people on the radio every weekend and I have heard and experienced the voices of the two different economies. Without turning this into a political column, let’s discuss some of the facts.
According to IRS data released last month, the wealthiest 1% of Americans earned 21.2% of all income in 2005, which is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks. The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000. These numbers are based on a large sample of tax returns and reflect "adjusted gross income," which is income after some deductions, such as for alimony and contributions to individual retirement accounts.
How did this happen? Economists and scholars attribute rising inequality to several factors, including technological change that favors those with more skills, but I think that it also speaks to globalization, which has forced down wages in some sectors of the US economy. Indeed, there has been a divergence between who is benefiting from globalization in the developed world. In these early stages, it appears that those who already own capital are making great strides, while only meager rewards are going to labor. In other words, the rich may be getting richer and living better, while the middle is somewhat stuck.
That’s why despite strong growth in the US economy last quarter (estimated at 3.9%), many Americans think the economy is in a recession. Remember, a recession is defined as two consecutive quarters of negative growth and we are clearly far from that level. But some people feel worse than the data indicate, despite news that the US economy is doing well and we are all living better as a result of the forces of globalization. It is obvious that the economic strength of certain sectors or the stock market does not negate the fact that if you work in the auto industry, the economy probably seems miserable. Or if you have had to pay more for your health insurance or have given up a piece of your pension because of changes in the economy, you probably had to make significant adjustments to your lifestyle and Democratic candidates are attempting to exploit those feelings every day on the campaign trail.
People like Eric may not encounter the other tier of the economy on a day-to-day basis, but I believe that it really does exist. The proof may be as simple as these numbers: the IRS data show that the median tax filer's income -- half earn less than the median, half earn more -- fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881. At the same time, the income level for the tax filer just inside the top 1% grew 3%, to $364,657. That sounds like two-tiers to me.
According to IRS data released last month, the wealthiest 1% of Americans earned 21.2% of all income in 2005, which is up sharply from 19% in 2004, and surpasses the previous high of 20.8% set in 2000, at the peak of the previous bull market in stocks. The bottom 50% earned 12.8% of all income, down from 13.4% in 2004 and a bit less than their 13% share in 2000. These numbers are based on a large sample of tax returns and reflect "adjusted gross income," which is income after some deductions, such as for alimony and contributions to individual retirement accounts.
How did this happen? Economists and scholars attribute rising inequality to several factors, including technological change that favors those with more skills, but I think that it also speaks to globalization, which has forced down wages in some sectors of the US economy. Indeed, there has been a divergence between who is benefiting from globalization in the developed world. In these early stages, it appears that those who already own capital are making great strides, while only meager rewards are going to labor. In other words, the rich may be getting richer and living better, while the middle is somewhat stuck.
That’s why despite strong growth in the US economy last quarter (estimated at 3.9%), many Americans think the economy is in a recession. Remember, a recession is defined as two consecutive quarters of negative growth and we are clearly far from that level. But some people feel worse than the data indicate, despite news that the US economy is doing well and we are all living better as a result of the forces of globalization. It is obvious that the economic strength of certain sectors or the stock market does not negate the fact that if you work in the auto industry, the economy probably seems miserable. Or if you have had to pay more for your health insurance or have given up a piece of your pension because of changes in the economy, you probably had to make significant adjustments to your lifestyle and Democratic candidates are attempting to exploit those feelings every day on the campaign trail.
People like Eric may not encounter the other tier of the economy on a day-to-day basis, but I believe that it really does exist. The proof may be as simple as these numbers: the IRS data show that the median tax filer's income -- half earn less than the median, half earn more -- fell 2% between 2000 and 2005 when adjusted for inflation, to $30,881. At the same time, the income level for the tax filer just inside the top 1% grew 3%, to $364,657. That sounds like two-tiers to me.
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