What "Everybody Knows"

I must apologize ahead of time for next week's issue. While it should be a good issue, it might not cover the latest financial news since I'll be making a trip to Austin, TX to see Leonard Cohen in concert on Thursday. If a financial apocalypse happens between Thursday night and Friday, I apologize now for not covering it.

In case some of our readers are too young to know of Leonard Cohen or perhaps missed out on some of his hits during the late '60s and '70s, here are a few videos of them: Suzanne; Famous Blue Raincoat; and here's a cover of his song made famous by the movie Shrek, Hallelujah. With Leonard Cohen, the appeal is mostly his lyrics. It's certainly not his voice, which Cohen himself admits is a failure. However, if you can still make it in the music world while having a bad voice, then that really says something about your quality of songwriting.

For example, here are some lines from his song Everybody Knows. Given our political and economic situation, they ring a bell today:

Everybody knows that the dice are loaded
Everybody rolls with their fingers crossed
Everybody knows that the war is over
Everybody knows the good guys lost
Everybody knows the fight was fixed
The poor stay poor, the rich get rich
That's how it goes
Everybody knows

Everybody knows that the boat is leaking
Everybody knows the captain lied
Everybody got this broken feeling
Like their father or their dog just died
Everybody talking to their pockets
Everybody wants a box of chocolates
And a long-stem rose
Everybody knows

Now you know why I'm going to the concert, but what's really important is why Leonard Cohen is giving the concert. You see, Cohen is getting on in years... he just turned 78 years old. Another world tour was likely not what he had envisioned for his golden years. In fact, until 2008, Cohen had taken a 15-year hiatus from performing.

So what brought him out of his retirement?

Poor financial decisions.

Leonard Cohen didn't make leveraged bets on mortgage-backed securities. He didn't spend freely, as many music stars do. In fact, he retreated to a Buddhist monastery for five years – talk about a way to save money for retirement. His big mistake was one people that tend to overlook even when they think their savings and investments are in order. He trusted his ex-manager and advisors a little too much by mixing friendship with business.

Here's an excerpt from Cohen Stays Calm as $5m Pension Disappears, summing up his financial troubles:

"The alleged theft came to light a year ago, when a friend of the family alerted Cohen's daughter to his perilous financial situation. The alleged theft centres on two transactions engineered by [ex-manager] Lynch and approved by Cohen. The first, in 1997, was the $5m sale of Cohen's publishing company, Stranger Music, to Sony. The second, in 2001, concerned the sale of Cohen's future royalties for $8m, also to Sony. Lynch set up a company to minimise taxes on the transaction, giving herself 99.5% ownership of the company, and Cohen the remaining 0.5%. Cohen says he was unaware of the agreement. 'Since my own work requires a fair degree of solitary attention, I was grateful to Ms. Lynch for looking after the business details,' he told the New York Times. 'In this spirit she acquired considerable command over my finances.'"

"That command apparently extended to a link being set up allowing Lynch's American Express credit card to be paid directly from Cohen's bank account. When Cohen learned of the allegations and visited his bank, he was surprised to find that he had paid a $75,000 credit card bill for his manager. The same day, he says, Lynch tried to withdraw $40,000 in cash from another of his accounts."

Leonard Cohen's mistakes were sheer negligence of his financial situation and wrongly thinking that someone can just take care of your finances for you with no oversight. As Cohen said of the situation, "It was a long, ongoing problem of a disastrous and relentless indifference to my financial situation. I didn't even know where the bank was."

Ultimately, Cohen had $9.5 million stolen from him and was left with just $150,000 at the age of 70. He mortgaged his home to pay for his legal fees. Though he eventually won his legal battle against his ex-manager, most of the missing money had already evaporated.

While allocating your investments, where to put your friends is sometimes the toughest decision of all. Often, our friends are our most likely business partners. When things are going great, there's nothing better than doing business with a friend. However, every investor should know that a friend can drive the dagger deeper than a stranger ever could. This obviously isn't something that everybody knows; clearly Cohen didn't know – otherwise he might have included a line in his song linked above.

I hate to give the financial advice that one should be more distrustful of their best friends and even family, but honestly, they are a special risk one must consider. I'd like to think that what happened to Cohen only happens once in a million cases. However, though I'm young enough to be Leonard Cohen's grandson, I have personally already seen similar things happen to people one too many times.

The main problem is that we let our guard down with friends. We let them get away with things that would never fly in a strictly professional relationship. Sure, you don't need to see the financial statements every month. Don't worry about that large withdrawal from the account. It's your buddy, right?

You don't even have to be in business with someone to understand how this happens. Have you ever had a close friend at work? When they're late on an assignment, you let it slide and tell them, "Well, all right, man. It's OK." If it were anyone else, you'd be fuming with anger and ready to complain to the boss.

I know what you're thinking: But my money manager has been my best friend for a zillion years. He wouldn't cheat me! Let me share another quote from Leonard Cohen on his ex-manager who was at his side for seventeen years:

"She was a friend of many years, and she was accomplished at presenting herself as a trusted friend… Her mother worked in the office, and her father did my bookkeeping. Our families were close."

Want to throw another twist into the story? They were also at times lovers.

I'm not telling you to fire your best friend who is managing your money. I'm simply saying don't overlook any risks. When friends manage our money, we have a great benefit in a trusted advisor – however, that trust also opens us to an additional, different risk and can hurt us far greater than any recession. When mixing business and friendship, don't let the friendship allow things that your professional judgment never would.

We Are Under Attack

By Dennis Miller, Editor of Miller's Money Forever

Like many seniors, I'm overweight. My doctor told me that a "man of my age" should not be running, but simply watching his diet and walking regularly. I have dutifully begun doing so. When I was young, I would have carried a radio; I now prefer the quiet solitude along the way.

I live in a typical Florida subdivision where the developer buys a huge tract of land, develops some acreage, sells off lots to other builders, and then develops another "phase." In the 2008 real-estate crunch, our developer got caught up in the mess and now has a phase of perfectly developed land with numbered lots staked out, roads, water, and sewer. They're just waiting for folks to snatch them up and build a house. Over the last few years, only two homes were built in the area.

There's a huge fence at the back. On the other side is more undeveloped land, probably functioning in the same manner it has for close to a century. From the developer's perspective, it's a very expensive area for the residents to walk, run, and bike, or walk their dogs. From our perspective, it is like a giant running track at a local school and gets lots of adult use.

Normally I take my walk after reading the morning paper, when the sun is well into the sky and the day is getting quite warm. As a result, I may find myself saying hello to one or two people, but the morning joggers are long gone.

On several occasions, I've noticed when I get near the back fence that I'm greeted by two or three very large birds flying in circles well overhead. In our part of the world they're called turkey vultures, and they are doggone near the size of a turkey.

This morning they once again greeted me. I looked around to make sure I was alone, I then looked up into the air and shouted, "Hey guys, be patient – wait your turn, will ya!" They just kept circling, probably thinking that sooner as opposed to later, they were going to get me.

As I continued my walk, I was reminded of the old cartoon in an investment article with two vultures on the top of a tree. One said to the other something like: "I'm tired of being patient. I want to go down there and make a killing!" The author went on to point out that, unless you have billions and can move a market, you have to patiently wait for Mr. Market to set the conditions where you can take advantage of a huge investment opportunity.

After a few more steps, I realized that one could easily make that same cartoon with the two vultures representing governments. No longer are they satisfied to wait their turn and be patient. They want to make a killing, and they want it now.

Baby boomers are those born between 1946 and 1964; there's a population bubble moving along as the early boomers move into their retirement years. For the sake of easy math, assume they have an average life expectancy of 80 years. The government should begin to see some significant effects of them dying off during the years 2026-2044. The result will likely be some large estate taxes and reductions in Social Security and healthcare costs as the generation continues to move along the graph of life.

Much like the impatient vulture, there are several actions our government is taking to snatch up a larger portion of baby boomers' nest eggs in taxes before we all kick the bucket – some taxes are hidden, some more aggressive.

Pure magic

I first observed this during the Carter administration. Our country experienced horribly high inflation. In an effort to soothe seniors, it passed a law indexing future Social Security payments to inflation. At the time, Social Security benefits were not subject to federal income tax. Much like watching a magician, you always need to be watching the other hand. It was not long after that another law was passed taxing a portion of your Social Security benefits under certain conditions.

Moving forward about three decades, the government still honors its obligation to raise Social Security benefits yearly in line with its published increase in the Consumer Price Index (CPI). In 2013 Social security recipients are scheduled to receive a cost-of-living adjustment of 1.7%. Several articles also mention it is the lowest increase since 1975. Most every article I have read on the subject have followed that announcement with a warning that most, if not all, of that increase will be taken back out of your Social Security check by an increase in Medicare Part B premiums. While it has not been officially announced, most articles have estimated a 7% rise in Medicare Part B premiums, three times the rate of the Social Security increase. Government magic once again; watch the other hand.

With his own data on inflation, noted economist John Williams sorts though this government shell game and provides us with some interesting data at Shadow Government Statistics. On the front page of his website is a graph showing the "official," government-reported CPI as just under 2%. Then he also provides a graph showing the inflation rate using the same calculation method that was used in 1990 – using it, the inflation rate is almost 6%. So we now have a dilemma. Do we believe the "official" government statistics or what we experience every time we go to the grocery store or the gas station to fill up the car? Like most empty-nesters, my wife and I like to go out and eat an inexpensive dinner. "Inexpensive" today would have been called "expensive" a couple of years ago – prices are going up everywhere. It doesn't take an economist to figure that out. We side with John.

So what difference does it make? How does this affect baby boomers?

The "official" rate does not just affect what the government has to pay in Social Security benefits – the CPI is an important metric in many other places. If it's lagging behind the real rate of inflation, then many more people are losing out. For example, it also is factored into the retirement benefits of federal employees.

In addition, there are several other government debt obligations also tied to this Index, such as Treasury Inflation Protected Securities (TIPS). In effect, the government borrows money, and the amount of interest it has to pay is based on the CPI – and the government gets to keep score. Now, how cool is that... for them, at least?

Many baby boomers have purchased TIPS with the idea that they will be protected from the worst tax of all: inflation. But if the CPI isn't tracking inflation well, then you are slowly but surely losing ground to inflation. And the other traditional options outside TIPS aren't a much better solution to the problem. The best rate I can find for a five-year CD is 1.5%. Unless an investor would hold that CD inside an IRA or tax-sheltered account, it would be included in your taxable income, so your net yield would be even less.

Let's get out our score card and see how that adds up for the investor. To simplify the example, let's suppose the investor has a $100,000 CD inside a Roth IRA, so the interest is not taxed. At the end of the year, he would collect $1,500 in interest. Now if one prefers to believe the official rate of inflation of 2%, the principal would lose $2,000 in buying power minus the $1,500 interest he received, for a net loss of $500. If, however, one is more inclined to believe that the true inflation rate is 6%, he would lose $6,000 in buying power, minus the $1,500 in interest received, for a net loss of $4,500.

Assuming things move at the 6% rate, at the end of the five-year period our investor would receive his $100,000 back... only it would have lost $25,700 net buying power along the way. Just for fun I went to Kelly Blue Book and priced a 2013 Ford Fusion with standard options: $22,495. So the amount of buying power lost to inflation would equal that of a pretty decent vehicle and a few months of gas. Even at a modest 2% inflation rate, our investor's deposit would be worth $9,400 less after five years. That is why many economists call inflation the worst tax of all.

But inflation index problems don't stop with TIPS and Social Security. We are currently working on a November issue on annuities for Miller's Money Forever. One of the first things that jumped out to me was the fact there are nearly $2 trillion in annuities currently in force, many with variable components tied to the official, government-reported CPI. The main purpose in buying an annuity is to provide money for the rest of your life. If inflation is eating up the purchasing power of the dollar, once again many baby boomers are losing ground.

What about taxes?

In January 2012, the Congressional Budget Office issued a report. Here is part of what it stated (emphasis mine):

"Much of the projected decline in the deficit occurs because, under current law, revenues are projected to shoot up by almost $800 billion, or more than 30 percent, between 2012 and 2014 – from 16.3 percent of GDP in 2012 to 20.0 percent in 2014. That increase is mostly the result of the recent or scheduled expirations of tax provisions, such as those initially enacted in 2001, 2003, and 2009 that lower income tax rates and those that limit the number of people subject to the alternative minimum tax (AMT)."

We are hearing a lot in the political debates about extending the Bush tax cuts. It looks to me like both political parties are playing a political game of chicken to enhance their election chances. Both parties carry on about how important it is that they are extended. Really! Then why have they not done that or even brought it out of committee for a vote?

Summary

We have a government that cannot pay the bills and is in desperate need of finding tax dollars wherever it can. In addition, it owes trillions in debt that cannot be repaid. By keeping interest rates down and fiddling with the inflation statistics, it can save billions of dollars, at the expense of baby boomers, retirees, and every consumer in the United States.

The government has committed to a policy of keeping interest rates down through the next few years. While that may save the government money, it has devastated seniors and savers. No longer can we count on 6% CDs. People are being forced to put their money at risk – money that has to last them for the rest of their lives.

Baby boomers in their peak earning years are desperately trying to put money away for their retirement. Seniors and savers are trying to invest wisely so they can provide for themselves. Almost half of the population currently does not pay federal income tax. If a government needs money to pay for their irresponsible political promises, where do they go to get it? Where the money is – or it simply prints it on a printing press or electronically. The US government is doing all these things.

My point is simple. The government is acting like a vulture – and we are its prey. It's targeting an entire generation, licking its chops, and it can't wait to get its claws into our wealth – it wants it now! It's finding creative ways to extract as much wealth as it possibly can from those who have worked hard, played by the rules, lived within their means, and tried to save for their retirement years.

It's time to call it what it is: a generational war. The vultures are circling overhead. We have only two options: let them pick at us and dwindle our hard-earned savings; or we can take steps to stay one step ahead of the vultures. While maybe one day people will wake up with an outright tax revolt and send the country back on its track, in the mean time, you have to find ways to keep your standard of living from declining.

When David Galland asked me to tailor a newsletter to help folks in my generation accomplish this, I jumped at the chance. While we may be getting older, we still have the ability to think rationally; plus the benefit of experience gives us even better judgment than when we were younger. For close to 40 years, I taught adults throughout the world. The phrase "continuous education" is not an option any more. For those who are successful and want to stay that way, it is just a way of life. I know that I am preaching to the choir... most everyone reading this article is likely cut from that same cloth.

And finally, I want to make sure I am not misunderstood. The events I have covered are the result of both political parties' actions over many generations. Politicians are not going to hunker down and really solve the problems our society faces until they are absolutely forced to do so by an angry population. They much prefer to kick the can down the road. Eventually our society will say, "Enough already!," and it might not be pretty when it happens. But until then, you need to find ways to grow your assets beyond the rate of inflation – those TIPS, CDs, and inflation-indexed annuities aren't going to do it for you.