All too often when listening to a group of people casually discussing the topic of taxation, I’m reminded of the old saying, “All the world’s insane but thee and me, and sometimes I’m not so sure about thee.”

That’s because those who follow a statist agenda tell me that to soak the rich, we must cut their taxes.

Now I consider myself a rather open-minded, rational guy but when I’m confronted by an ideology that differs from my own, I want to see evidence.  Show me the proof that back up your claims. 

MAJOR PROBLEM:  In the case of taxing productivity, there isn’t any proof.  I’m done extensive research and there is nothing that shows me that the benefits of increasing taxes on the wealthy outweigh the costs. 

No surprise there since in today’s world most people blindly follow a traditional socialist model:  our progressive tax system. 

200 years ago early Americans would have overthrown their government had they been forced to pay a tax on their production.  The only federal taxes forced on them were on tobacco, liquor, and imports. 

Present day Americans are simply lifetime tax servants to an ever-growing Master in Washington, D.C. and they love it. 

So here’s a modern history reality check:

• In the 1920s when President Calvin Coolidge cut taxes, the US economy grew faster than Nebraska corn.
• When JFK cut taxes in the 1960s, America went from having one car on every block to having one car in every garage. 
• Ronald Reagan’s tax cuts in the 80s helped move us from a demand-management, consumption-oriented society to one that stimulated capital savings, investment, and production.

Translation:  Tax cuts result in healthy wealth creation for all citizens. 

One of the most inspiring individuals I studied early in my career was free market thinker Ludwig von Mises.  If you have any interest in fiscal policies that big government thugs prefer you not understand, I recommend reading anything written by him. 

In his book, PLANNING FOR FREEDOM, von Mises writes:

If the present tax rates had been in effect from the beginning of [the 20th] century, many who are millionaires today would live under more modest circumstances.  But all those new branches of industry which supply the masses with articles unheard of before would operate, if at all, on a much smaller scale, and their products would be beyond the reach of the common man.

Fast forward to 2007.  Looking back on the tax cuts of 2003 we learn that even though the tax rates of higher income individuals were reduced by 50 percent, the amount of taxes collected on the wealthiest Americans has almost doubled. 

And one more thing, the budget deficit has fallen.

It’s precisely what history teaches us - cut taxes on the wealthy and revenues to the Treasury soar.  That’s good fiscal policy. 

So what does this all mean for investors?

Depends.  Most will continue their “government will save us” thinking and hope for the best.  You and me are better off taking an anti-statist, self-educated approach to managing our financial lives and informing as many people as we can along the way. 

For most people, contributing for a company 401k plan or other pre-tax retirement account should be Step 1 when planning a financial future.  Yet it’s amazing to me the number of folks who mismanage their pretax investment options and waste a wonderful opportunity to potentially add hundreds of thousands of dollars to their wealth.

So here are 10 tips on how to be a successful 401k investor:

1.  ENROLL & PARTICIPATE.  This is probably the most important step.  If you don’t start putting a slice of your paycheck in your plan, you will never be given the benefit it offers.  Think about it.  Outside a 401k or other pre-tax equivalent, most people have to earn at least $1.25 to invest $1.00.  For each dollar you invest in your 401k, your take home pay is reduced by only $0.75 (assuming a 25% tax bracket.)

2.  BE AN OWNER, NOT A LENDER.  The mutual funds in your 401k will likely invest in ownership positions (stocks, real estate, precious metals, etc.) or lending positions (bonds, money market accounts).  Conventional wisdom says that you have a mixture of both - a strategy I find absurd.  When you invest in lending positions you are guaranteed to lose buying power.  You will either lose it very slowly through inflation or possibly overnight if the dollar ever becomes worthless.  I recommend keeping your 401k assets fully invested in ownership positions which are not tied to the value of the dollar.  The volatility you will experience is a small price to pay for the long-term returns and the real world financial safety. 

3.  DIVERSIFY YOUR OWNERSHIP.  A diversified ownership portfolio will allow you to own shares of large, mid, and small company stocks.  Domestic and international stocks too.  As a hedge against inflation and geopolitical risk, I’d also keep a small chunk allocated to gold-related investments.  Your 401k may not offer all these asset classes so diversify as well as you can with the asset classes your are provided.

4.  DEMAND THAT YOUR PLAN OFFER THE HIGHEST QUALITY INVESTMENT OPTIONS.  I see the investment options offered in many plans and too often I come away unimpressed.  If your plan doesn’t give you enough asset classes to create a diversified portfolio or if all the options come with high fees and mediocre returns, ask the trustees of the plan to change this.  It’s likely their assets are also in the plan so you’ll be given credit for helping their bottom line as well as your own.

5.  LIMIT YOUR INVESTMENT IN COMPANY STOCK.  This is an easier lesson to swallow following the days of Enron and WorldCom.  So unless you enjoy the thrill of riverboat gambling, I don’t recommend having the bulk of your money tied to the performance of any one company.

6.  NEVER BORROW AGAINST YOUR 401K.  It will defeat the benefit that your plan offers and any loan repayments must be paid back with after-tax dollars. 

7.  DON’T CASH OUT YOUR 401K IF YOU LEAVE YOUR COMPANY.  If you leave a job you will likely have a right to your 401k assets by by taking them in cash means you will be hit with a tax bill and possibly a 10 percent penalty if you are not yet age 59 1/2. 

8.  IF YOU ARE AT LEAST 59 1/2, ROLL YOUR ASSETS INTO AN IRA.  Your 401k may not offer this feature but if it does, take advantage of it while you are still working.  This way you have access to the entire world of investments and not just the options offered in your plan.

9.  REBALANCE REGULARLY.  At least once a year, take a few minutes to rebalance the assets in your plan.  Sit down and calculate the current percentages of the mutual funds you own.  Some percentages may be much higher and some much lower when compared to your initial allocation.  Many plan providers now allow your rebalancing to be done automatically on an annual, semi-annual, or quarterly basis. 

10.  COMMIT TO MAXING OUT YOUR PLAN.  I know not everybody can do this but as the very least, invest the maximum amount you can possibly afford.  Then every time your pay increases, up your contribution amount until you have hit the maximum allowed.  I promise you won’t be sorry.

When asked to state the average return of the stock market, what is your answer?

10 to 12 percent?

It’s true that this falls in the range of historical, long-term average market returns but to me, average is anything but average. 

Let’s say you and are taking a three day vacation and I tell you the average temperature is going to be 70 degrees.  What would you pack to wear?  Based on the information you know, a cotton shirt and a pair of light weight fabric pants would keep you quite comfortable. 

On this trip we start off in Omaha, NE where it is 85 degrees.  Then we head south near the equator where it is 105 degrees.  After that it’s off to the southern tip of Argentina where it is 20 degrees. 

The average temperature of these three locations is 70 degrees but how would this temperature “volatility” make you feel?  My guess is pretty uncomfortable since the actual temperatures were not in line with your expectations. 

The same holds true with stock market volatility and investor expectations.  Non-savvy investors look at the historical market returns and expect to earn 10 to 12 percent most years.  Savvy investors look at the same historical data but understand that “average” does not mean “likely.”

KEY LESSON:  Short term, the stock market is going to be volatile and the returns investors earn will vary considerably.  This will cause market timers and day traders to attempt to make speculative bets and most will lose.  It will also cause the mainstream investor to get greedy or fearful then wind up chasing performance and perceived safety thus ending up with sub par performance. 

But the most successful investors will be those who remain broadly diversified across mutual funds of common stock and maintain a long-term time horizon.  To them, market volatility is a non-issue and most will view market declines as a buying opportunity. 

In the short-term, those investments will bounce around like a handful of yo-yo’s.  But long-term, those yo-yo’s are bouncing up a flight of stairs. 

SO HERE’S YOUR REALITY:  Where does your focus lie?  On the yo-yo’s or the flight of stairs.  Your answer will tell me a lot about your long-term financial success. 

When dealing with the investment markets, there are no guarantees and any investment comes with some level of risk.  The key is to manage that risk and minimize is so that the odds of building and maintaining your wealth are on your side. 

There’s your financial goal.  Mine too!

Check out Part I of this brief tutorial from the Cato Institute’s Dan Mitchell explaining the relationship between tax rates, taxable income, and tax revenue:

For more, see Part II and Part III.

Everyone wants to be financially independent.

Everyone wants a safe investment portfolio.

But not everyone has real world financial safety.  Do you?

If I give you the choice between conventional financial safety and real world financial safety, which would you pick?  Or didn’t you know there was a difference?

Let me explain.

As a rookie stockbroker in the 1970s, I was instructed by my superiors to follow the conventional model of financial safety.  They said to me, “Roland, if you have a client that is 65 years old, you need to put 35 percent of their money in stocks and the remaining 65 percent in bonds and other dollar-based investments that are guaranteed and insured.”

For the mainstream this was (and today still is) considered the safest way to manage money, especially for retirees.

Here’s the conundrum - in the real world “safety” has a totally different meaning.  In the real world, financial safety is NOT the preservation of my principal.  It’s the preservation of my buying power.   

If you are old enough, you will remember the price of a new Mustang convertible when it debuted in the 1960s.  About $2,395.  In that day gold was trading at around $35 an ounce so it took about 69 ounces of gold to buy the Mustang. 

In the late 1960s, $5,000 would have bought you two new Mustangs.  If you had instead put your $5,000 in government bonds for “safe keeping” and taken the out in today, you would no longer be able to buy two brand new cars since the interest on your bonds has not kept pace with inflation and taxes. 

However, if you had invested your $5,000 in a tangible asset such as gold, your buying power would have been maintained since 69 ounces of gold will today still buy you a new car.  (Note: Gold is a terrible investment and I only recommend it as a hedge against inflation.) 

And now for a quick history lesson.

For the last 100 years or so, the financial industry has considered dollar-based investments such as bonds, bank CDs, and fixed annuities to be among the safest options available.  There was a time when this actually was true.

Over a centruy ago when the federal government issued U.S. Savings Bonds, those bonds were backed by gold and investors were certain their buying power would be preserved. 

As long as the dollar was on the gold standard, it was.

Then came 1971 and Richard Nixon removed the final link between gold and the dollar while the Fed continued creating dollars out of thin air to pay for the Vietnam War.

But what remained was the common belief that dollar-based investments were still sound, long-term assets.

Important Point For Investors: History teaches that when a currency is no longer backed by a tangible asset and its value is at the mercy of government decisions, all investments that are claims on that currency must be viewed as speculations.

Most people today have limited background in monetary and economic history.  They fail to understand that those dollar-based investments they own carry a risk level that would have scared the bejeezus out of people living when the dollar was on the gold standard.

Perhaps a nice way to summarize this article is: Real world financial safety is so simple that most investors fail to apply this little rule of wealth preservation to their financial decisions.  Then one day they wake to realize the buying power of their portfolio has been confiscated and they have no clue why. 

Sad.

My hope is this will never be your personal fate.  So long as you stay informed, I like your odds.

There was a time in our nation’s history that gold was the basis for our monetary system.  And it wasn’t just us.  Most other currencies around the world have had some link to gold at one time or another. 

As long as a currency is linked to gold, the value of people’s paper money savings is maintained since gold cannot be created on a printing press.  But that’s not how the system is set up today.  We no longer have a link to gold and the dollar is now just a piece of government paper that can be printed without limit.

Consider this:  Since 2001, the dollar exchange rate has been on a downward slide and the price of an ounce of gold has climbed from $271 to about $860.  That means seven years ago the dollar was worth 1/271st an ounce of gold whereas today it is only worth 1/860th an ounce of gold. 

How much lower can the dollar go?  I have no clue but what I do know is that when it comes to a hedge against our currency’s depreciation, there is nothing I like better than gold.

But not many people today view gold as real money.  I’m not shocked because you would have to be at least 74 years old to have lived during a time when a gold coin was commonly accepted as currency.  The rest of the public continue to view money as the paper variety that slowly loses value year after year. 

This may explain why investors often flee tangible assets during a stock market correction for the perceived safety of dollar-based investments, namely cash and U.S. Treasuries. 

To me, the idea of a dollar-based asset offer any level of long-term financial safety holds as much reliability as Hillary Clinton tomorrow announcing her allegiance to the Libertarian Party.  But I digress . . .

Other investors hedge the risk of a falling dollar by investing in the Euro.  It’s a strategy I don’t want to use with my money because then the portfolio is tied to the far-left European economy and if the dollar is on the verge of extinction, by no means do I want the safety of my wealth resting on a paper money managed by foreign politicians. 

So here’s the truth:  Gold is still the world’s defacto currency. 

If tomorrow a financial panic breaks out in the corner of the world that takes out the dollar, I am highly confident that the haven investors will flock to will be gold-related investments and other non dollar-based assets.  Investors who are broadly diversified in those areas will likely be heavily rewarded. 

The way I see it, you and I have no control over the government decisions that impact the dollar’s value so we might as well continue profiting from Washington’s blunders. 

My personal investment portfolio is quite simple.  It’s broadly diversified among ownership positions using equity mutual funds and I hedge my portfolio against the depreciation of the dollar using a link to gold.

That allocation offers me the opportunity to do well during most economic environments while keeping the portfolio safe.

But to have a portfolio designed to offer true financial safety, that portfolio must also be able to weather any economic environment that is thrown our way.

A threat that we’ve not experienced in some time is deflation.  A deflationary environment is when there is a decrease in consumer prices and an increase in the buying power of money.  Historically, deflation has often led to a depression - such as the one America went through during the 1930s.

So what if the Federal Reserve’s monetary policy triggers another deflationary environment like it did in the late 1920s?  How would my portfolio be protected then?

If deflation is on the horizon, I would add a second hedge position to my portfolio and that would be a slice of long-term U.S. Treasury bonds.

Interest rates (the cost of renting money) and bond prices are inversely proportional so as interest rates decline in a deflationary environment, the price of long-term government bonds goes up.

Why TREASURY bonds?  As long as the federal government has the ability to create money out of nothing and holds the power of taxation, the threat of credit risk is virtually nonexistent. 

Why LONG-TERM bonds?  Simply put, the greater the length to maturity, the greater the impact interest rates will have on bond prices.  Therefore, if I see the economy heading down the path that leads me to believe the threat of deflation is probable, I want to buy some Treasuries in my portfolio as far out as I can own them.

Remember 1987?

There was a threat of a deflationary collapse due to Alan Greenspan’s tightening of the money supply.  Knowing I had to protect my portfolio, I allocated 10 percent of it to long-term U.S. Treasuries. 

Then in 1994, there was a spike in interest rates which presented an opportunity to buy more - which I did, and hung on until 1998.

Throughout the year, headlines were filled with news about the Asian crises and the Long Term Capital hedge fund fiasco.  The media was touting their usual doom and gloom so the public was buying up bonds which drove up the price of the bonds I owned.   

About that time the economy was experiencing high money supply growth and one of the iron laws of economics is you cannot have deflation when new money is created at such a rapid pace.  Inflation, yes; but not deflation.

Once I believe Greenspan had created enough money to cover the major deflationary pressures, I sold the long-term Treasury bonds for a handsome profit and have not owned any since.

In summarizing, until there is a compelling reason to argue a pending deflationary collapse in the economy, my portfolio will have nothing to do with bonds. 

Until then, diversified ownership is the way to go. 

“Duh Roland,” you say.  The job of the Fed is to run the economy.”

True.  The primary function of the Federal Reserve is to oversee the economy but what exactly is “The Economy?”  Conventional dogma (and the politicians in Washington) would have you believe the economy is like a machine which can be controlled and managed. 

I share a slightly opposing viewpoint.  In my opinion, the economy is more like a living environment made up of people and their activities and behaviors.  That means every time the Fed messes around with the economy by manipulating interest rates and the money supply, their monetary policy decisions have consequences that impact you, your family, and everyone you care about.

Not many people alive today remember a time when there was no Federal Reserve.  Prior to its creation the nation got along just fine without it.  In fact, America transformed itself from a tiny colony to the wealthiest nation on the planet in just over 120 years.  

I’m not saying it was an economic utopia; there were still the usual economic concerns but most issues like recessions, inflation, and depressions where confined to regional areas and healed themselves rather efficiently.

It was during this pre-Fed era that America experienced explosive growth in wealth and prosperity unlike any the world had ever seen.  Life was so good that the average worker could get by earning $20 a month and still support a large family at home. 

So what happened?

The Fed is what happened.

From its creation in 1913 to the present, the Fed’s meddling has created more booms and busts than any time in U.S. history.  These boom/bust cycles can offer wonderful opportunities to investors who understand what is going on and are prepared.  For those that aren’t, well, things get a little dicey.

That’s why I’ve long believed any investment decision not based on the consequences of fiscal and monetary policy is likely to be extremely unsafe.

To understand basic monetary policy, visualize the Federal Reserve holding a giant stick.  At one end of this stick is the price of money (interest rates); and at the other end, the quantity of money.

In the 1970s, when I first entered the investment business it was commonly assumed the only way for the Fed to control the economy was by manipulating interest rates.

During the spring of 1978, Jimmy Carter gave a speech telling the public that in an effort to help more Americans own a home, he had instructed the Treasury and the Fed to work together to make more money available at lower interest rates.

The next day, hardly a word of this was mentioned in the media but to me Carter’s new policy translated into future inflation.  So I began telling investors that the Fed had to make a change because Carter’s policy was destroying the economy and the dollar.

A change came in 1979 when Paul Volcker became Fed Chairman who then orchestrated a reversal in monetary policy where the Fed began managing the quantity of money in the long term, non-inflationary way.  The Fed began to shrink the growth of the money supply down from the huge levels seen under the Carter administration.

By early 1981, with the Dow Jones trading between 800 and 1000, it seemed logical that corporate profits would increase as the cost of capital fell so in a letter to my clients in August of 1982, I made the conservative estimate that within the next 10 years the Dow could reach 3000.  The first time the Dow Jones ever traded above 3000 occurred in the summer of 1990 so those investors who were prepared fared quite well.

And that brings me to — where are we headed today?

The mainstream media rarely says anything about this but Ben Bernanke has a far better grip on the economy than Alan Greenspan ever did.  Bernanke’s policies are moving us back in the direction of Paul Volcker’s policies.  Greenspan made the disastrous mistake of managing interest rates versus what Bernanke appears to be doing which is managing the quantity of money and allowing the free market to determine the price of money.

Using simple arithmetic, I recently made the conservative prediction on my weekly radio show that there is a better than even chance by 2020 we’ll see the Dow Jones reach 40,000.

40,000 on the Dow in 13 years?  Has Roland gone mad?

Possibly.  In 1982, many people thought so.  The fact that I was right on then does not guarantee that I’m correct again; but if I am, handsome profits will likely be made for those of us who are diversified across ownership positions.   

A book I highly recommend is THE CREATURE FROM JEKYLL ISLAND by G. Edward Griffin.  The title sounds like a Stephen King novel but it’s actually the story behind the creation of the Federal Reserve System.

You might also want to check out Ed’s lecture that he gave on the topic of his book.   

Those were the words meandering through my mental theatre after hearing the story of a new client who had been victimized by one of the most unethical sales pitches in the financial industry - the pitch for an equity index annuity.

If you are at or nearing retirement, chances are that you likely have received an invitation to an annuity sales presentation.  Sales forces offer these all the time and are usually elaborate and often include a free dinner at an upscale restaurant.

Some will even ask that you bring your brokerage account statements with you in an attempt to convince you to transfer your assets into their products. 

That is what happened to our client.

A few years ago he was sold an annuity which had an upfront sales commission of 12 percent.  That means if you had invested $100,000 into this product, $12,000 of your money would go directly into the salesperson’s product. 

Did I mention the client was 83 years old when he was sold the annuity?

The problem with that is with many annuities, you are penalized if you need immediate access to your money.  Only after owning the annuity for a period of years can most people escape what is referred to as a “surrender charge.”  Find the logic there.

But here is where the story gets worse.

In this particiular annuity he was sold, there was a provision that allowed him to withdraw 10% of his account on an annual basis without penalty.  This is precisely what this gentleman did but guess what the annuity salesperson recommended he do with the withdrawn funds?

Put it into another annuity, of course.

The salesman, marketing himself as a “Retirement Specialist,” took the proceeds of the withdrawal and plunked it down on another equity index annuity annuity, triggering another upfront 12 percent commission charge, and starting the entire process over again.  Sad.

It is episodes like these which remind me of the words of the Securities and Litigation Consulting Group which in recent years stated:  “Annuities stand out as the investment most likely to be unsuitable since in virtually every instance, the investor would have been better served by a mutual fund or a portfolio of individual stocks.”

Dateline NBC recently aired an undercover series on the hidden practices of equity index annuities.  I suggest you check it out. 

If you or someone you know has been sold one an equity index annuity or other types of annuity products and are not sure if it makes sense to have it, seek out someone who’s income is not based on selling annuities to evaluate your situation.