Financial Abundance Guide (available free at www.finabguide.com) identifies many areas of personal finance that can be controlled.  I also developed the Seven Steps to Financial Abundance to help people reach their financial goals.  With so much fear of the financial future, following the seven steps can help increase our power to control our financial future.

“Spend less than you earn,” is the required first step.  Over a 40 year career (age 25 to age 65), assume that your average income is $80,000 (in 2011 dollars) and the annualized investment real rate of return is 5%.  Saving 10% of income ($8K) each year will produce savings of over $1 million (in 2011) dollars at age 65.

By “maximizing your financial resources” (step 2) , savings can be increased with no negative impact on spending.  If a company offers a 4% of salary match with their 401(k) plan, by contributing at least 4% of salary, this amount is matched by the company. Using the previous example, annual savings are increased from $8,000 to $11,200, increasing the savings available at age 65 to almost $1.5 million.

“Minimizing your taxes” (step 3), also provides additional savings with no impact on spending.   Financial Abundance Guide provides many tax savings techniques available to people of all income levels.  One example is a spousal IRA, allowing a non working spouse to contribute $5,000 per year to an IRA.  For a couple paying 25% in federal taxes and a 5% state income tax, a $5,000 IRA contribution would yield $1,500 in annual tax savings.  Continuing with our example, the additional $1,500 in annual tax savings would  provide almost $1.7 million in 2001 dollars by age 65.

“Managing your investments” (step 4), can significantly increase investment returns.  This may require the help of an investment professional.  If so, carefully choose an investment advisor and be wary of anyone providing “free” advice.  A “free” advisor must be compensated through commissions on the investment products they sell.  Fee only advisors are compensated by the fees they charge to manage investments.  Continuing the above example, if the real rate of investment return is increase by only 0.5%, the couple would have almost $1.9 million at age 65.

Using the simplistic assumption that a couple, at age 65, can withdraw at least 4% of their investments each year and never run out of money, $76K (in 2011 dollars) can be withdrawn each year throughout retirement.  Since their previous annual expenses were $72K, with $8K per year in savings, even with no Social Security or other retirement benefits, our couple can more than maintain their lifestyle throughout retirement.

Fear of the unknown often produces a sense of financial scarcity.  “Protecting your financial resources” (step 5), through appropriate, lower cost insurance products can help keep this fear at bay.   An insurance product that is often overlooked is a $1 – $2 million umbrella liability policy.   In our litigious society, one may be sued because someone was hurt on their property or by a car driven by a family member.  For very little money, peace of mind can be secured by adding an umbrella liability policy to your auto or home insurance policy.

Financial planning helps “control your personal finances” (step 6). There are many available resources to help you produce you own financial plan.  If you have neither the time nor interest in financial planning, engage a fee only Certified Financial Planner (CFP^®)  who will listen to your concerns and provide a comprehensive plan that enumerates the options available to meet your financial goals.  A financial plan helps increase control over personal finances.  Planning will reduce the fear of scarcity, providing more financial security on the path toward financial abundance.

“Have faith in continued abundance” is the seventh step. Implementing the first six steps addresses what you can control in your personal finances.   Faith that financial abundance will continue helps eliminate the doubts and fears of the unknown often caused by events over which you have no control.

Financial abundance is a lifetime pursuit.  There will always be ups and downs in the economy and markets.  By applying the seven steps and seeking appropriate outside support as required, you will be on the pathway toward financial abundance.

I often hear people say that gold is an inflation hedge.  However, when one looks at the price of gold (on an inflation adjusted basis) there is little correlation between the price of gold and the annual inflation rate.  In my opinion, a much better prospective on gold is that of a currency hedge.

In the past ten years, gold has increased in nominal value by 400% against the US dollar.   Over that same time period, gold has increased 250% against the Euro, 190% against the Swiss Franc and “only” 150% against the Japanese yen.  This demonstrates that, while gold has indeed appreciated over the past 10 years, the larger story may be the dramatic decline in the value of the US dollar over this time period.

To get more perspective on the value of gold as a surrogate for the decline of the US dollar, we compared the (inflation adjusted) value of gold over the past 40 years against the value of the Swiss Franc over that same time frame.  We priced both “currencies” in US dollars.  The Swiss Franc was chosen because it is (arguably) one of the most stable currencies and countries in the world.

When these two “currencies” were compared against the US dollar over the past 40 years, an interesting correlation arose.  From 1971 to 1980, the dollar declined 59% against the Swiss Franc.  During this same time frame, the dollar decreased 86% against the price of an ounce of gold.  In the 1980s and 1990s, the value of the dollar to the Swiss Franc was reasonably stable, while the price of gold fell from its (inflation adjusted) high of $2358 to approximately $350 in 2000.

The 2000s have seen a repeat of the same easy money policy that plagued the seventies.  From 2000 through 2010, the value of the dollar has declined 38% against the value of the Swiss franc and the value of the dollar has declined 73% against the price of an ounce of gold.  Thus, the question for a potential gold investor is what policies are being implemented that will strengthen the dollar and cause a decline in gold prices as occurred in the 1980s.

Only time will tell if the dollar will stabilize, as it did in the 1980s, or if it will continue its decade long decline.  Until concrete policies are implemented by the Fed and the Treasury to strengthen the US dollar, a small gold position might be a reasonable hedge against the possibility of the US dollar’s continued decline.

To understand this apparent dichotomy, let’s take a look at how the Consumer Price Index (CPI) is calculated.

The CPI is calculated by examining monthly price changes in eight different categories of consumer expenditures.  Each category is assigned a “weight” based on the government’s estimate of what the “average” consumer spends in each category.  The following table provides each category of expenditures as well as the percentage weighting, assigned by the Bureau of Labor Statistics.  The right hand column provides an alternative weighting for a “hypothetical consumer” with lower housing costs.  This could be a consumer that has paid off their mortgage or remained in the same house for many years.

Expenditure                                     CPI-U                  Hypothetical

Category                                       Average                 Consumer

———————————————————————————-

Total (all items)                               100.0%                      100%

Food and beverages                        15.7%                        25%

Housing                                            40.9%                        10%

Apparel                                              4.4%                          5%

Transportation                                  17.1%                       20%

Medical care                                       5.8%                        25%

Recreation                                          6.0%                         4%

Education and communication            5.8%                         3%

Other goods and services                   4.3%                         8%

———————————————————————————-

Total, all items                                  100.0%                  100.0%

If you are interested in exploring the CPI in more detail, this information can be found at   http://www.bls.gov/news.release/cpi.t01.htm

The CPI data supplied by the Bureau of Labor Statistics accurately shows that, with the current governmental category weightings, the CPI increase over the past twelve months is only 1.1%.  However, looking at the increases by expenditure category shows that transportation costs rose 4.6% and health care costs are up 3.4% over this time frame.

The large increases in transportation and medical care costs are offset by housing costs, which are given a weight of 41% of the total CPI basket.  The CPI data shows that housing costs decreased by 0.3% over the past year.  However, unless a home was refinanced or one moved into a smaller residence, most people’s housing costs have increased over the past year due to higher energy prices, property taxes etc.

Since recent costs increases appear to be accelerating, we examined CPI change data that is also available for the past three months.  Using the government provided CPI average weighting and annualizing the data by expenditure category over the last three months, we calculate the current three month “run rate” for the CPI increase as 2.7%, instead of the past year’s 1.1%.

To further test the CPI data, using the published annual CPI increases by expenditure category, we calculated the annual CPI change with the category weightings of the “hypothetical” consumer.  When the “hypothetical” consumer expenditure weightings are used, the inflation rate over the past twelve months doubles to 2.2%.

Finally, we calculated the “hypothetical” consumer expenditure weightings combined with the current “run rate” of inflation.  When the hypothetical consumer weightings are applied to the government supplied CPI data over the past three months, the annualized rate of inflation for our “hypothetical” (but realistic) consumer was a startling 4.0%.

Quantitative Easing Two, due to be announced at the November Fed meeting, will add vast amounts of cash to our economy.  The justification for this program is that our inflation rate is so low that the government needs to increase our rate of inflation.  Would that reasoning be acceptable if the current inflation rate is 4%?

The next time you are paying for groceries, your utility bill or your health insurance, you might discover that you are more like our “hypothetical” consumer whose inflation rate is running at several times the government provided CPI rate.  We can only hope that the Fed changes directions before our inflation rates match those last experienced in 1981.

With so much of this product being sold, it is likely that someone will soon offer you this product with “no downside risk.”  Let’s explore whether this annuity product has any downsides.

All annuity products are sold by insurance companies through licensed insurance agents.  With equity indexed annuities, you are often provided a 10% “signing bonus” and the guarantee that your purchase price (including the bonus amount) will never go down, provided you hold the annuity throughout the surrender period.

Each contract year, you are allowed to pick a specific stock (or sometimes bond) index in which you can participate.  If the chosen index appreciates, your annuity will go up, subject to a predefined “cap” (maximum amount) that is set annually by the insurance company.   If the index goes down, your annuity amount remains the same as in the previous year.

Currently, index caps are between 5% and 8%.  If the market goes up dramatically, as it did in 2009, your upside is limited by the cap.  Most equity indexed annuity products also allow you to choose a guaranteed income option for the year.  With this option, your deferred annuity increases by a set amount for the year.  Currently, income rates are typically between 2% – 4%.

Are their any downsides to guaranteed downside protection?  Consider the following:

1)    Since caps and interest rates are set annually, insurance companies may lower the cap or the guaranteed interest rates each year.  This will likely occur if interest rates remain low.

2)    Surrender charges, as high as 12% of the annuity purchase price, are applied if you need your money before the end of the surrender period.  Until recently, most deferred annuities had surrender periods of 6 to 8 years.  Most equity indexed annuities have surrender periods of 10 to 14 years.  While each year you may withdraw up to 10% of the account value with no penalty, can anyone be certain that they will not need the invested funds for 14 years?

3)    In inflation skyrockets, will the annuities guaranteed interest rates and/or caps exceed the CPI.  If not, equity indexed annuity owners will receive a negative real rate of return, even as the markets may be prospering.

4)    All annuity gains are taxed at ordinary income tax rates when withdrawn.  With investments in stocks and other capital assets, gains are taxed at capital gains tax rates, which usually are significantly lower than ordinary income tax rates.

A conservatively managed portfolio of stock funds/ETFs, bond funds and alternative investments, can usually outperform “safe” deferred annuity products over a period of 10 to 14 years.  Recently we analyzed the performance of two equity indexed annuities, using the S&P 500 as the linked index.  With the current cap rates of 6.25% (for a 10 year surrender period annuity) and 7.65% (for a 14 year surrender period annuity) the equity indexed annuities provided  annualized returns of 3.89% and 4.49% respectively from 2000 until 2010,.

Next, we analyzed the performance of a conservative balance portfolio, consisting of 25% stocks (represented by an S&P 500 ETF), 10% alternatives investments (represented by a gold ETF) and 65% bonds (represented by a Barclays Aggregate Bond Index ETF).  The portfolio, rebalanced yearly, provided an annualized return of 6.49% (2% more annually than the 14 year surrender period deferred annuity) from 2000 until 2010.

For a $100,000 investment, the balanced portfolio provided $35,000 more than the 10 year surrender period annuity and over $27,000 more than the 14 year surrender period annuity.

To quote columnist Jason Zweig in a recent Wall Street Journal article concerning equity indexed annuities,  “If you want only some of the gains from a bull market in stocks and none of the losses from a bear market, I would advise rolling your own.”

Recently, an economist explained this apparent paradox in a manner that I could actually understand.  From his perspective, while most of our everyday costs continue to increase, a significant amount of deflation has already occurred through our most valuable asset, our homes.

As most homeowners know, the price for which we can sell our home is less than it was in 2006.   To make matters worse, our financial institutions, including the Fed, still have trillions of dollars of “toxic mortgages” on their balance sheets.  These mortgages are carried on their balance sheets at their original values.  As mortgages are ultimately forced into foreclosure, more downward pressure will be placed on the value of our homes.

For many of us, our most valuable single asset is the equity in our home.  As the value of our home declines, we experience financial deflation, even though our consumption costs (food, energy, health care, etc) continue to rise.

If financial institutions are allowed to continue to carry toxic mortgages on their books, at values above their market value, we will likely suffer the same economic malaise as Japan has experienced over the past twenty years.  Over time, this economic malaise will depress the value of other financial assets, including the stock market, and could lead to economy wide deflation.  If this occurs, the only mechanism available to the Fed and US Treasury to “salvage” our economy from deflation would be to drastically devalue the dollar.  If those measures are taken, they could produce runaway inflation.

Since there seems to be no political will to address the core cause of our nation’s financial and economic malaise, let’s look at some ways that you can protect yourself regardless of whether we experience inflation or deflation.

In a recent Wall Street Journal article, Jason Zweig used the term “Meflation.”   He defines meflation  as the direct, personal impact of the changing cost of living on your investments, your budget and your labor income.

Meflation requires that you first determine whether inflation or deflation is a greater personal financial threat.  A younger person, with good future employment prospects, a stock portfolio and a home with a fixed rate mortgage, faces much greater financial damage from deflation than inflation.  However, a retired person, living on a fixed income, could actually benefit from deflation, as prices would fall while their pension and or social security benefits would remain constant.

Meflation suggests investing to protect against whichever future cost of living direction (inflation or deflation) creates your greater financial risk.  While it may appear counterintuitive, the best investment strategy for a younger person, who will prosper more with inflation than deflation, is to invest in assets that do better in deflationary times.

Japan has experienced deflation since having a similar financial crisis in 1990.   Over this 20 year period, stocks have had an average annual real rate of return of -6%, while long term bonds have increased by an average of 5.3% annually.  The accepted investment “wisdom” is for a younger person to put a large percentage of their investment portfolio into stocks.  However, since a younger person will often prosper in inflationary times, they can better protect their assets by holding more bond funds, which may perform better than stocks in deflationary times.

Conversely, a retired (or soon to be retired) individual or couple, for whom inflation poses the larger financial risk, should invest in Treasury  Inflation Protected Bond funds (TIPS) as well as a well diversified portfolio of financially sound, dividend paying stocks.  A small amount of the portfolio should also be in gold and/or Real Estate Investment Trusts (REITS) which often perform well in an inflationary environment.

No one knows whether the future will hold inflation, deflation or both.   A “meflation” approach, in which your investment strategy provides protection against the more financially harmful scenario, can help you weather the financial storm, regardless of its direction.

Long Term Care insurance typically pays a maximum daily amount for either in home care or nursing home care, after an elimination (waiting) period of either 90 or 180 days.  LTC insurance policies are a popular method of protecting against catastrophic long term care expenses.  However, depending upon the age at which you initiate the LTC insurance, policies will often have premium costs between $2,000 – $6,000 annually.  Like any insurance policy, these payments could be very worthwhile if LTC is required, but are lost if LTC is never needed.

Beginning in 2010, the 2006 Pension Protection Act provides new methods in which LTC insurance can be funded.  Some “hybrid” whole life insurance policies are combined with LTC coverage.  With these policies, a portion of the death benefit can be paid out before death, to cover the insured’s LTC expenses.  “Hybrid” deferred fixed annuities can also be packaged with LTC benefits.  Starting this year, any LTC benefits that are received from either of these “hybrid” products are tax free, providing considerably higher after tax benefits for most recipients.

A current whole life insurance policy or deferred annuity may also be utilized when purchasing a new “hybrid” policy, through a nontaxable exchange under IRC Section 1035.  If the “hybrid” product insurer provides for a 1035 exchange, you may “convert” a current life insurance or annuity policy to a “hybrid” policy.  The “hybrid” policy will allow for  insurance proceeds, used to pay for long term care, to be received on a tax free basis.

Another way to pay for long term care is to “self insure.”  Insurance products are best when used to protect against financially catastrophic events.  If you have adequate financial resources, you may wish “self insure” for long term care requirements.  Let’s see how self insurance works.

Jane is a single 85 year old, with $300K in retirement funds and other investments.  She also owns a mortgage free home valued at $300K.  To meet her current annual expenses of $45K, she withdraws $25K per year from her investment portfolio.

At the end of 2010, Jane, no longer able to care for herself, enters a nursing home, at a cost of $80K/year. Upon entering nursing home care, Jane’s other annual expenses decrease to $5K.  In 2011, Jane’s annual expenses will be $85K, requiring her to withdraw $65K per year from her investment funds.

Assuming no investment growth, Jane’s funds would be depleted in 2015, when Jane is age 90.  However, Jane (or possibly her children) can use a reverse mortgage or an outright sale of her home to provide more funding for her Long Term Care.  In this scenario, Jane will likely never outlive her financial resources.

When considering “self insurance”, remember that the cost of nursing home care is offset by a significant reduction in current expenses.  It is also important to consider the value of a home and other non-liquid, but salable assets in determining if self insurance is right for you.

Long Term Care requirements will affect many baby boomers.  If you are a member of this generation, now is the time to determine what financial strategies meet your LTC requirements.

If a significant amount of your family’s net worth is the value of the company that you own or stocks and stock options in a public company for whom you work, it is important to include these values in the equity portion of your investment portfolios asset allocation.  Often, business owners and corporate executives do not remember that the value of their ownership in the company for whom they work is also an equity investment.

As we have often stated, portfolio asset allocation, in which you determine the percentage of total assets to be allocated between stocks, bonds, alternatives, and cash is a critical activity required to maximize your investment returns.  To properly allocate one’s assets, the value of your ownership in the company for whom you work must also be included with the equity portion of your portfolio allocation.

As an example, let’s assume that you are a fairly aggressive investor with a desired portfolio allocation of eighty percent equities and twenty percent fixed-income and cash investments.  Let’s further assume that your current net worth is one million dollars with $500,000 being in the value in your business and $500,000 in an investment portfolio.  In this example, you should have no more than $300,000 of your investable portfolio in equity investments, since you already have $500,000 of your portfolio invested in the equity (stock) value of your small business.

If you are a more “conservative” investor, and wish to have a sixty percent equities and forty percent in fixed-income and cash positions, only $100,000 of your $500,000 investable portfolio should be put into stocks.  While this is only 20% of your investment portfolio, when combined with your company ownership, your total equity investment is 60%.

It is also important to consider size and the market space of the company for whom you work.  A well diversified portfolio has equities in Small Cap, Mid Cap, and Large Cap companies.  If you own a small company, the equity purchases in your investment portfolio should be in Large Caps and Mid Cap firms.  However, if you work for a large corporation and have a significant amount of your net worth in that company’s stock and/or stock options, your investible portfolio should have a larger percentage of equity holdings in Small Cap and Mid Cap firms.

If your company ownership is in the high-tech industry, focus your investment portfolio on stocks of companies that are in other industries.  This approach helps maintain a well-diversified portfolio, one that is not overly dominated by any industry.   Having exposure to multiple industries helps to minimize the risk that all of your stocks will decline together, since companies in the same industry often have declining stock prices at the same time.

If you work for a publicly traded company, it is important to remember that both the stock that you own and your paycheck are dependent upon the continuing success of your firm.   With so much at stake with one company, it is usually best to have no more than 10% of your liquid net worth invested in the stock of the company for whom you work.

Risk diversification is an important aspect of safely accumulating the resources required for an abundant retirement.  Often, small business owner’s and senior executives forget that the value of their ownership in the company for whom they work is an equity investment that should be included in their investment portfolio.  By honoring this important fact, your total portfolio will be better diversified.

For many years it has been well understood that a well diversified portfolio is critical to an investor’s long term success.  By including your ownership in the company for whom you work in your equity allocation, you will lower your long-term investment risk and help assure your pathway to an abundant retirement .

As an asset manager, I must continually consider whether I should be increasing, decreasing or maintaining my clients’ equity (stock market) allocations. My decision has been to use the market rally to lower my clients’ equity positions. While my crystal ball is no better than yours, here are a few of the factors that that I believe could negatively impact the market.

1) Valuation – Most economist are predicting that the S&P 500 will end 2009 with operating earning per share (before write-offs) of between $45 and $55. With the S&P 500 index at approximately 900, these earnings provide (pre-write off) P/E (price earnings) ratios of between 16 and 20. In a healthy, growing economy, those P/E values would signify a fully valued market. Can these P/Es be justified in our current environment?

2) Federal Debt – Many ‘bulls” argue that low interest rates justify paying a higher P/E on equities. In normal times, they would be correct. However, with the $700 billion stimulus package, a $1.8 trillion 2010 federal deficit and over $1 trillion dollars committed to federal bail outs, our federal debt will likely increase by well over $2 trillion in the next 18 months. (Remember, a trillion is 1,000 billions)

At some point, China, Japan and other “saving” countries will only buy our federal debt if it is offered at much higher interest rates. When interest rates increase, debt oriented investments become more attractive and equity investments less so. Higher interest rates will also make corporate borrowing more costly, which could easily damage our economic recovery.

3) Commercial Real Estate – The recent financial crisis, requiring $700 billion in TARP funds (not to mention TALF and PPIP), was mainly created by consumer debt. Defaults on mortgages, home equity lines and credit card debt created most of the current “toxic assets.” However, the next “shoe to fall” is commercial real estate. Large commercial real estate bankruptcies are beginning to proliferate. As these failures continue, expect to see more toxic assets appear on our bank’s balance sheets.

4) Toxic Assets – Many banks have balance sheets filled with toxic assets, with more likely to come. The Treasury has proposed the PPIP program to help banks remove these toxic assets to a “private/public partnership.” It seems unlikely that these assets are worth the value at which they are carried on the banks’ balance sheets. Assuming these toxic assets are purchased, much of any losses suffered, as reflected in the difference between their final value and the price paid under the PPIP program, will be assumed by the tax payers (you and me). These losses will increase our federal debt, putting even more pressure on interest rates.

5) International Event – Shortly after the election, our new Vice President predicted that the administration would be tested with an international crisis within its first six months. Most recent administrations have been tested during their early phases. Needless to say, there are many candidates to test our will and resolve. If such an incident occurs, the market will react negatively until the situation is resolved.

While “green shoots” may be appearing, along with signs that the recession may be slowing, our economy still faces many daunting problems. Until there are workable solutions to these problems, it will be difficult for the economy to have a significant recovery.

Considering the problems facing our economic recovery, it is hard to see significant stock market upside at current market prices. While it never pays to time the market, practicing “market intelligence” is always wise. If you are a long term investor, it may be prudent to stay at the low end of your investment policy’s equity allocation. In turbulent markets, investors should focus on asset preservation. The goal of asset preservation is to have the maximum assets available to invest when the economy truly begins to recover and grow.

Since the deferred annuity sales person will be paid a commission as high as 10% on your deferred annuity purchase, let’s take a closer look at what he/she is trying to sell you. Here are some areas that are not always well explained by the deferred annuity sales person.

1) Mortality and Expenses (M&E) Charges – All deferred annuities have M&E charges to pay for the life insurance guarantee, the sales person’s commissions and the administrative expenses of the contract. M&E charges are usually between 1% and 2% of the contract value, paid every year. If your deferred annuity has a value of $100,000, up to $2,000 annually will be used for M&E expenses. Even though you will likely never see these charges, they are being taken from your investment each year.

2) Surrender Charges – Virtually all deferred annuities that are sold through commissioned sales people will carry a surrender charge. Typically, these charges begin at 7% for the first year of the contract and decrease by 1% per year. Seven years after you purchase the contract, you may still have to pay 1% of its total value if you want to cash it in. Sometimes, you are allowed to withdraw up to10% of contract value yearly. However, the surrender charges assure that the insurance company will have your money long enough to pay for the high sales commissions required.

3) Management Fees – If you buy a variable annuity, the subaccounts are very similar to mutual funds. A typical subaccount will have a 1% or higher management fee. This expense is over and above the M&E fees that were previously discussed. While these fees are somewhat consistent with the fees charged for actively managed mutual funds, they are up to 5 times as high as the fees charged for indexed mutual funds and Exchange Traded Funds (ETFs). The subaccount returns will be net of the management fees, but they will not show the M&E fees that are assessed each year.

While it is true that a deferred annuity will be tax deferred until you cash it in or annuitize it, all gains of the deferred annuity will be taxed at your ordinary income rate when you receive your returns. Since the deferred annuity is typically held for 10+ years, this tax advantage may completely disappear when you cash it out.

If you believe that a deferred annuity is right for you, before you buy the product that your sales person is offering, contact Schwab, Fidelity, Vanguard or another discount brokerage house. They will likely have a similar deferred annuity product. Compare M&E expenses, surrender charges and management fees of the non-commissioned product with the one you are being sold. You will likely find that the non-commissioned product provides a better total return than the one that you are being sold.

However, from July 2007 to July 2008, the Consumer Price Index (CPI-U) was up 5.6%, the highest in 17 years, oil is 75% higher than it was in 2007 and the dollar is down 10% against the Euro in 2008. From my perspective, the reason that the Fed is ignoring inflation is that, while maintaining a Fed funds rate of 2% and increasing the US dollar money supply, they are willing to trade the risk of high inflation against the risk of collapse of major US financial institutions. These, of course, are the same financial institutions which created the current financial crisis.

I do not have enough data, nor am I wise enough to evaluate the risk of failure of our financial services institutions. I will trust that this data and wisdom resides in the Fed and that they have made a calculated decision to create an inflationary environment in order to minimize the risk of financial institutional failure.  However, regardless of their reasons, the Fed policies are destined to increase inflationary pressures.

In today’s financial environment, there are several reasons why low interest rates are beneficial to financial institutions. Two examples include:

1. Adjustable rate mortgages are often tied to the Fed funds rate. A low Fed funds rate helps keep payments on adjustable rate mortgages low. While in ordinary times this might not be in a bank’s best interest, in today’s mortgage marketplace, maintaining the current 2% Fed funds rate may help decrease the number of mortgage defaults by keeping the adjustable mortgage payments lower

2. Lending institutions typically pay depositors interest that is based on short term interest rates, while the interest they receive on loans is often based on longer term rates. Lending institutions can maximize profits when there is a significant difference, as there is today, between short term interest rates and longer term interest rates.

Unless the Fed radically changes course, the US could repeat the hyper inflation of the 70s. At this point, there is no commitment by the Fed to address their current inflation stimuli. Until this changes, my plan is to remain “invested for inflation.” Our past experience has demonstrated that once inflation is imbedded in our financial systems, it will likely take years before it can be lowered.  Let’s hope that the Fed takes action to correct this situation, before it is too late.