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Credit Card Debt: America’s Looming Crisis

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Almost a decade later, the 2008 financial crisis may seem like a distant memory to some. However, current trends in national credit card debt suggest that the next crash may just be on the horizon.

The Federal Reserve has reported that consumer credit card debt has reached a staggering $952 billion in the first quarter of this year. Comparing this to 2008, the year of the global financial crisis, the United States reached a record-breaking $1.02 trillion in outstanding credit balances.

Analysts are suggesting that if the total debt continues to rise at its current rate, the country is getting perilously close to another recession.

Credit Card Debt Has Been Steadily Increasing

The chart below outlays the revolving debt American’s have since 2010

credit card debt america

 

Over the last year alone, the total amount of consumer debt has risen by over $70 billion:

(Source: federalreserve.gov)

(Source: nerdwallet.com)

The reason behind this growth is contested amongst experts, but a prominent theory suggests that American consumers are simply becoming more willing to carry larger amounts of debt, increasingly so as the last financial crisis fades into memory.

Americans Aren’t Paying Off Their Debt

Over one third of American households remain in debt from a month-to-month basis, with the average level of household debt currently resting at over $15,000. In addition, the amount of interest being generated by these outstanding accounts is making it even harder for those in debt to work their way out of it.

American households that don’t carry a credit balance are more of a rarity than anything. Only 35% of credit card holders manage to fall into this category, using them to generate reward points rather than to borrow money they don’t have (time.com).

It is not uncommon for borrowers to ultimately wind up paying multiple times the original amount lent through interest (thedailycoin.org).

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Americans Are Saving Less Than They Used To

The last financial crisis caused a large portion of Americans to be much more frugal in their spending habits. In 2008, personal savings was roughly 4% of total income for the average American, which skyrocketed to 11% by 2012 (fortune.com).

Now that the current rate of savings has gone back down to 5.4%, it suggests that Americans are becoming increasingly comfortable with looser spending habits, relying more heavily on borrowed money for large transactions.

Average Cost Of Living Is Increasing Faster Than Income Growth

The average income of the American household has increased significantly over the last decade, but it hasn’t necessarily increased average savings per family. The cost of medical care has inflated by over 50%, and groceries are 37% more expensive than they were in 2003 (nerdwallet.com).

cost of goods vs income

Barack Obama’s plan for universal medical care promised to ease the average family’s medical expenses by as much as $2500. Since his election in 2008, however, premiums have increased by an average of $4800 per household (infowars.com).

(Source: mybudget360.com)

An Increasing Reliance On Subprime Borrowers

Over 10 million new credit cards were given to subprime consumers in the last year alone, representing a 25% increase from the end of 2014. This is the highest level it has ever been since 2007, right before the financial crisis.

On the other hand, banks that fall into this trend are making some efforts to keep history from repeating itself. One of the main strategies being employed requires the borrower to make an initial deposit that will represent the spending limit of that card (hotair.com). In the same way an auto loan is secured to the lender through the actual vehicle, having a required deposit may be an effective strategy to cover potential losses on credit loans.

Lucrative Returns For Credit Card Loans

There is actually a lot of variance in profit levels between banks when it comes to credit card loans. The industry average falls at around 12.4 cents per dollar on outstanding balances, but among the top-earning banks the average sits closer to 28.4 cents (creditcards.com).

Analysts suggest that consumer habits have a lot to do with some of the steep rates these banks are charging. Many borrowers can be reluctant to research what other kinds of deals are available to them and will pounce on the first seemingly reasonable opportunity they happen upon. In addition, credit lenders will often advertise rewards and discounts for their cards in order to distract buyers from high interest rates and hidden fees.

Read more: If you want to lower your student loan payment, click here

Banks Pushing Incentives For Credit Cards

Hundreds of reward-based credit card options are available for consumers, saturating the market with options. This variance in potential reward avenues give further incentive for the average consumer to own more than one credit card and add to the average household debt.

A recent study ranked the most valuable reward cards in terms of the monetary value of their rewards over a two-year period. The top 5 issuers were:

  • Barclaycard – $1,529 (Arrival Plus)
  • Capital One – $1,482 (Venture Rewards)
  • Chase – $1,338 (Sapphire Preferred)
  • US Bank – $1,151 (FlexPerks Travel Rewards)
  • Citi – $1,141 (Double Cash Card)

Comparing 2016 to 2008: Is The Threat Real?

As the previous evidence suggests, consumer debt is currently at the same place it was before the recession hit in 2008. While credit card debt certainly was a factor in the market crash, much of it was due to subprime housing loans. In 2016, the bubble is now being inflated by loans to foreign governments.

The Japanese government’s debt is now twice that of its national GDP, takes a quarter of its entire tax revenue just to pay the interest, and yet the U.S. government is willing to pay Japan to borrow money at negative interest rates. This trend has accumulated over $7 trillion dollars of debt, adding to the $19 trillion owed by the government in total (sovereignman.com).

Compare this to the $9.5 trillion owed in 2008, and you can see why a lot of experts are getting worried.

Conclusion

It is rare that events in history play out exactly the same in every respect, particularly in the realm of finance. However, the amount of similarities between pre-recession America and now are certainly raising questions as to how far away the next financial crisis really is.

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Federal Reserve Leaves Rates Untouched

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Federal Reserve Leaves Rates Untouched

The Federal Reserve has yet again failed to change interest rates.

Interest rates have remained frozen since last December.

Rates remain the same

Janet Yellen, Chair of the Federal Reserve, announced on June 15th that yet again interest rates would remain the same, despite slow signs of growth in some regions of the economy.

Interest rates rose for the first time since the financial crisis in December 2015, and the Federal Reserve have not raised the interest rate since.

j16.1

Why do rates remain frozen?

The Federal Reserve is currently reluctant to increase interest rates for some reasons, these include:

  • The rate of employment has slowed down
  • Fixed investments in business have been cautious
  • Market measures of inflation have fallen
  • The upcoming UK referendum regarding the EU
  • The German 10-year bund remains small

The key focuses for keep interest rates unchanged, however, have been the decline in the job market and the EU referendum in the UK (Brexit).

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Slow Jobs Market

The slowdown in the jobs market has concerned the Federal Reserve.

Work vacancy production plummeted in May 2016, the Federal Reserve are planning to review the figures in July to see if there are signs of improvement in the jobs market this month.

The vacancy production in the US fell to the lowest levels in six years in May 2016.

While the figures for job production are disappointing, Loretta Mester, Federal Reserve President in Cleveland, has reportedly stated that we should not focus on one number too much.

She believes there are many factors to take into consideration such as seasonal demands.

Job production has been falling since February when the rate of job production was 233k.

The rate fell to 186k in March and 123k in April.

The last recorded figure was in May when job production dropped to 38k.

j16.2

Brexit

Yellen has said that the upcoming Brexit has influenced the Federal Reserve’s decision to keep interest rates unchanged.

Opinion polls for the upcoming referendum show that results are still close.

j16.3

Yellen has warned of the possible financial consequences that the results of the referendum could have on global markets.

The Bank of England has recently stated that the UK leaving the EU would cause a global financial crisis.

Signs of growth in the markets

Although it may not appear so, there is evidence of growth in the US economy.

The Federal Reserve predicts that unemployment will remain below 5% for the next three years.

Earlier this month there were reports that the manufacturing industry experienced an unexpected boost.

Manufacturing companies have welcomed the news, but they have remained cautious.

They have called the increase a move in the right direction.

The journey to economic recovery

There have been signs of a US recovery for years.

With this in mind, lack of change in interest rates have surprised and frustrated many.

The US economy started to show signs of growth back in the second half of 2009.

Current production of services and goods have risen 10% higher than its pre-recession figures, and is 15% higher than the lowest point during the recession.

The slowdown in growth, however, predates back before the recession.

The decline of growth is due to some different factors:

The US economy has had a slow journey to recovery, and there is still a long way to go.

The Federal Reserve’s interest rate policy has played its part.

Only so much will protect the US from the potential global economic breakdown.

Summing it up

The current state of the US interest rates has frustrated many people;  Janet Yellen and the Federal Reserve have been determined to keep interest rates at a steady level for six years.

There has only been one increase in six years, and the next growth is uncertain.

There are many reasons for the Federal Reserve’s reluctance to increase interest rates, mainly the current lack of job production and the upcoming UK referendum.

The fall of job production in May has had many people alarmed.

However, Loretta Mester has stressed that we cannot focus on one figure.

The upcoming UK referendum has the potential to cause an economic catastrophe.

The UK public remains evenly divided with opinion polls showing an almost 50-50 split.

The US has come a long way in its journey to recovery, but there is still a long way to go.

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High & Low Quality Value Stocks: A Battle

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High & Low Quality Value Stocks: A Battle

There is no doubt that value stocks can outperform growth stocks

When the two are compared, the evidence clearly shows that this is true. 

However, the question becomes, which will exceed the other when talking about high-quality or low-quality value stocks?

The simple answer is that high-quality value stocks rarely outperform low-quality value stocks. 

In fact, in most cases it is the lower quality value stocks that will shine when the two are compared.

The following chart shows an example of the growth of $1000 investments between 2010 – 2015. 

If you look at the graph, you can see that low-quality investments were consistently higher.

j18.4

What does Quality Refer to?

The word quality can have numerous different meanings. 

When speaking regarding high-quality value stocks and low-quality value stocks; quality has a specific definition and meaning.

When used in this context, the term quality  is specifically referring the underlying company’s growth and profitability.

There are investors out there that will only invest in stocks that have proven themselves. 

These investors look at the numbers and insist on investing in nothing but those that have the numbers to prove they have continuous growth, and those that consistently come with high profitability.

The problem arises in the fact that past performance does not necessarily indicate how the stock will perform in the future. 

Yes, profitability and growth are characteristics essential to any good investment; but the way they carried out in the past should not be the only two factors looked at when considering what investments to make.

Highly profitable companies that have high growth rates are too often assumed to continue their success by investors. 

However, just because a company is profitable in the past does not mean that the firm will be able to keep its head above water forever.

When deciding, which investments should be made; investors should always look toward the future. 

The past is in the past, but the future holds new possibilities, new promises, and new challenges for each and every business in the marketplace. 

Just because a company performed at the top of their game in the past few years does not necessarily mean they will be able to keep it up for the next few.

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High Quality or Low Quality?

Information can be found just about anywhere on the internet. 

The truth is that anyone can post anything, and if they set up their web page correctly, you can find information that may or may not be true. 

For this reason, the best source of information continues to come in the form of Scholarly articles.

Scholarly articles provide information in the field by professionals of the field. 

There have been several scholarly articles that have addressed the topic of how value stocks over perform when compared to the rest of the marketplace. 

Similar terms used to define value stocks across these articles have been: Out of favor and low prices ratios.

However, very few scholarly articles look at the quality as a factor when discussing quality value stocks.

Further Evidence on Investor Overreaction and Stock Market Seasonality, a paper written in 1987 by De Bondt and  Thaler, explains why it is that stocks having recently risen the most are consistently outperformed by stocks that have fallen the most end up. 

The authors used their reasoning and explained that it was natural for the “winners” to become “losers” and vice versa because of the reversals that take place in operating performance.

Simply put, a reversal that takes place in an operating performance is simply another way of stating that high-quality companies shift to low-quality businesses and vice versa. 

The value stocks that the authors used in their study had low price ratios simply because investors automatically, and inaccurately, assumed that performance by these companies would continue to decline. 

However, stock prices climbed when things went differently than expected.

It’s all Cyclical

The Most Important Thing is a book written by the billionaire Howard Marks. 

It was here that he stated that “everything is cyclical,” which has become a famous quote within the industry and something all investors should take to heart. 

He also wrote the following two rules when writing his book:

  • No. 1: Most things will prove to be cyclical.
  • No. 2: Some of the greatest opportunities for gain and loss come when other people forget Rule No. 1.

            Any investor, or any individual for that matter, wanting to make a profit dealing with the stock market should do the following:

  • Read the above two rules as mentioned earlier by Marks.
  • Read them again.
  • Live by this regulation.

Understanding that everything within the stock market is cyclical allows those who are planning to invest to avoid missing the best available opportunities available to spend their money. 

The truth is that low-quality value stocks typically have low price ratios as a result of their operating results being poor; while high-quality value stocks will typically have low-cost rates as a result of passing their peak within the economic cycle.

A + B = C, or something like that

            The Magic Formula Joel Greenblatt’s high stock screen, was created to allow investors a way of locating high-quality value stocks. 

What this screen does is finds stocks that are highly profitable but have cheap price ratios. 

The system takes each stock and ranks them based on two factors.  

Those factors are the earnings yield ratio and the return on capital.

Once the calculations have taken place, the stock that has the best combination of both factors is selected for the screen. 

The magic formula is a strategy that has been consistently proven to beat the S&P 500 through vigorous testing. 

The following graph shows a comparison between the magic formula and the S&P 500:

j18.5

How’s the Magic Formula Hold Up?

Wes Gray and Tobias Carlisle decided to test the Magic formula against just the return on capital factor and just the earnings yield factor and discuss the surprising results in a book titled the Quantitative Value

They used the period of 1974 to 2011 for part of their test. 

During this time, the found that the Magic Formula annually returned around 13.9%; compared to the nearly 10.5% returned annually by the S&P 500 during the same time.

When the study looked at the earnings yield factor; they did not filter for return on capital. 

The magic formula was shown to produce nearly a 16% return; which is 2% higher than what it is when screening for return on capital.

However, when looking at the return on capital alone; the return is right under the total return of the S&P 500. 

In fact, they are nearly equal. 

The magic number produced around 10.3% for the annual return when only looking at return on capital.

Quality Should Be Avoided

The truth is that quality should be prevented. 

However, it should not be avoided only with the intention of preventing quality itself. 

Remember that the whole point is to invest in stocks that are undervalued and have cheap price ratios.

Investors shouldn’t worry about how much quality the company has, but rather should select their stocks based on valuations. 

When investors pass over stocks that appear to have low profitability and low growth rates associated with them, they risk passing up on stocks that are on the verge of turning around.

j18.6

 

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Social Security 101: Surviving Insolvency

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Social Security 101: Surviving Insolvency

It has emerged from the battle of left and right wing parties that social security is under threat.

Speculated by many, the program may be unsustainable by the year 2034, which is 19 years from now.

How bad is the current state of social security?

William Baldwin, contributor from Forbes said:

“Social Security is doomed; it has more money going out in benefits than from what’s coming in with payroll taxes. The US Treasury is trying to cover costs by collecting income tax, printing money, and borrowing.”

Currently, $714 billion is going out in benefits and overheads, with payroll taxes only bringing in $646 billion.

This short of inflow is the predicted cash flow, taking the budget into account from 2010.

social security cash flow

Cash flow graph analysis:

This data shows the clear nosedive in funds, as it meets negative figures by 2015.

Social Security has been in the red for a year, and it’s bound to get messy for those who survive on benefits.

A trust fund was initially set up, leaving aside a $2.7 billion, but it has recently been discovered that the fund doesn’t exist.

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The consequence of social security going bust

A Social Security bust means a risk to the social security payouts, and everybody’s payouts will stop – as well as vital public services facing closure.

The short-term

Benefits won’t be axed immediately, but the insolvency does mean major overhauls will be made to the Social Security Administration – particularly in the areas of benefit eligibility and payroll taxes.

Many people have resorted to drawing benefits out early, with some as young as 62.

This is because the majority are afraid of Congress making cuts, or stopping payouts.

What happened to Social Security’s trust fund?

Unlike a standard trust fund where savings are used to finance capital assets (services, businesses, etc.), the Fed instead made investments into their bonds.

If we take an example:

A fish stall holder puts away $30 a week in savings, but when his fishermen stop catching fish, he then starts using emergency funds and replaces the value with a bit of paper which says IOU – retirement.

If you are using savings to patch up the profit loss, then it’s never good news in the long term.

Eventually, this way of thinking would ultimately blitz his business, especially if the money put aside is no longer there to help.

How about the income side of social security?

Theoretically, the bond interest and a portion of income tax collections should be creating the payouts.

The following is a graph showing the growing gap between outgoings and revenues:

P1.2-1

Also note:

There have been attempts to boost tax returns.

One example of this is the quantity of tax disclosure has gone up to 85%, from only used to being 50% in the good old days.

The population boom danger

The population boom certainly doesn’t help matters, especially with all the baby boomers now planning retirement.

The mass retirement is probably a foreseen issue as for the massive births during the baby boom years.

Let’s have a look at the population growth in the USA from 1961 – 1985:

P1.3

Graph Analysis

  • Not only is social security experiencing lower income, but also the after effects of the big baby boomer spike now all coming through to retirement.
  • There just doesn’t seem to be any hope, unless the agency undergoes drastic measures to change their methods of business, looking at the figures.
  • Future outlook:
  • If they do not do anything soon, then its predicted only 75% will receive their promised benefits and the trust will be thoroughly exhausted.
  • Ideas on ways that Congress could rebalance outflow and income:

The following would seem like a shrewd move by the government, however given the rate at which the population is growing they become absolutely imperative:

  • Make cuts to cost of living adjustment by limiting damage to those on higher income or a legislator could play around with the formula.
  • Raise payroll tax; a bigger contribution would potentially give a two-point boost on closing up revenue s
  • Put up the retirement age; now being 66, if it went up to 69 then this would cut benefits by 10%.
  • As Chris Christie proposition, if you reduce social security payments to retirement incomes above $80,000 (and completely stopping if over the $200,000 bracket), then less money would be wasted on those who don’t need it.
  • Raise income tax from 85% to 100% on the maximum fraction benefits.

 

Is Congress likely to take action?

The first five bullet points are most likely to be put into movement in a diluted combination, while overall it is unlikely that the rich will be the target.

What can you do?

Find out how much your social security benefits are worth.

There’s even an online calculator available, which will apply all the formulas you need.

It can calculate the following:

  • Your benefit streams of income.
  • Any discounted time off you take.
  • Your health and mortality.

What you should not do:

It would be a big mistake now to start claiming early, even those doing it now, could be making a big mistake by messing up their financial future.

What you can do:

Instead, focus on your career, as the benefit formula only counts 35 of your highest earning years – go 45 years and then quit at 62 (early retirement).

You do have the risk of payroll taxes going up, so that’s why it’s a good idea to start planning for early retirement.

You should consider going Roth IRA:

  • IRA stands for Individual Retirement Arrangement
  • This IRA is a type of retirement plan, subject to US law, which offers a tax deduction to savings under certain conditions.
  • It is significantly different to other plans, as the tax break comes from withdrawal rather than on the amount saved.
  • The advantages of a Roth IRA:
  • You can withdraw money which is a penalty and tax-free after five years but is subject to qualifying terms and conditions.
  • If you make the maximum $10,000 from earnings, then withdrawals can also qualify if the Roth IRA owner is using the savings to purchase the primary residence (also by the Roth IRA owner’s immediate family, descendants, and ancestors – if they haven’t brought a home in 24 months).
  • You can still make contributions to a Roth IRA, even if the holder has any other plans in place – like the 401(k) plan (do note that other retirement plans may not be tax deductible).
  • In the event of death for the retirement plan holder, then his/her spouse will inherit the Roth IRA trust, and will merge if they own a separate account.
  • They have higher limits to contribution (in comparison to standard IRAs); this is because the post-tax contribution is a larger equivalent to a bigger pre-tax contribution from any other IRA plans – the tax deduction will give you higher returns from your savings.
  • The majority of employer funds tend to be more similar to the standard IRA plans, rather than Roth. Ultimately, you’ll diversify tax risk and gain higher returns for your pension pot.
  • Large estates can also have taxes reduced.
  • However, there are some disadvantages to a Roth IRA:
  • You can’t use the funds as collateral towards any loans, financial leverage or any cash management tools used for investment.
  • Qualifying for a Roth will be determined by your income limit, whereas the standard IRAs do not have any income limits.
  • While withdrawals are subsidized in this unique plan, contributions to Roth are not subject to tax deductions – so is only beneficial for after retirement.
  • It doesn’t reduce the taxpayer’s adjusted gross income (AGI), in comparison to other retirement plans where AGI can be reduced (this can benefit for minimizing taxable income) – other perks that are missed are a disqualification for deductions and tax credits. Other lost subsidies include reducing student loans, child tax credit, and earned income credit.
  • The contribution set at the current taxpayer’s income tax rate – it’s the norm for the majority in retirement to see their income fall, which also downgrades the retiree’s tax bracket. The reduction of the bracket can certainly put some risk into your retirement investment (this may also be likely if Congress lower income tax rates before the retirement age). So the more traditional plan would otherwise benefit from providing immediate tax breaks.
  • If a taxpayer pays state income taxes, while also paying into a Roth IRA, then they’ll have to pay the state income tax towards the contributions in the same year. But if the taxpayer retires on a lower income tax rate (or on no income taxes), then the opportunity is lost to avoid paying state income taxes – an advantage offered by the traditional IRA pension plans.

Conclusion

There are always pros and cons for doing something, so whether you go the Roth IRA route or not will depend on your personal circumstance. However, forming a private pension plan and being less reliant on the state may be thanked by your future self – especially with social security facing much uncertainty.

There are many methods for taking control of your financial future, for example, downloading an online calculator like My Money Platform.

Not only can they accurately work out your retirement age and how much you can earn, but also increase saving contributions by scrutinizing your budget.

Taking control of your finances now will offer you a much brighter retirement, where you can enjoy life and spend more time with family and friends.

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