How Politics Affect Your Portfolio

Posted on September 9, 2011 at 9:47 AM PST by

The markets shuddered last week when the Bureau of Labor Statistics announced unemployment remained stalled at a dismal 9.1 percent. While this news launched a wave of rhetoric from politicians on potential solutions, for the layman the meaning and impact of such numbers can be deceiving. A deeper dive into the unemployment report, as well as other statistics, such as the inflation rate and mutual fund performance, reveals some shocking facts.

Unemployment. The U.S. government uses dishonest statistical skullduggery to calculate the “official unemployment rate.” Lying with statistics is easy. It is not how you count, it’s how you define what to count, and over the years both political parties have used this trickery.

When the government reports unemployment, it understandably excludes people that are under 16, institutionalized (in jail, hospital), are in the military, or retired. What many do not know, however, is that the government also excludes discouraged workers—people who want to work but have not been able to find a job and have given up looking after four weeks or longer. In this economic climate, there are many citizens who want to work but have taken an understandable hiatus from pounding their head against the wall of employment rejection. But by excluding all unemployed people who have not applied for a job in four short weeks, the unemployment rate is dramatically skewed downward.

A simpler way of looking at the unemployment story is through the often-overlooked employment-to-population ratio, or how many able-bodied adult Americans actually work compared to those that don’t. You may be shocked to learn that this number stands at just over 58 percent. There are many stay-at-home parents and others who are not interested in employment who should not be considered as unemployed, but to think that more than 4 out of 10 able-bodied Americans simply don’t have work is eye opening.

Inflation. What about inflation? Could it be that the governmentskews inflation number downward, too? The Consumer Price Index (CPI) is calculated monthly based on a basket of 84,000 goods. This sounds straight forward enough, but there is a twist. New methodology was introduced in the calculation of the CPI in which goods and services in the defined basket could be substituted. Some argued that if beef, for instance, goes up in price, consumers may switch to something cheaper like chicken. Therefore, items that are actually moving dramatically higher in price are switched out for “similar” items that are not inflating at the same dramatic rate.

Although there is a debate among economists on this new methodology, the renowned economist John Williams described this change as manipulative and suggested a return to the more honest and accurate fixed-basket methodology.

Why might the government prefer reporting a lower inflation rate? Could the fact that the government must make inflation adjustments to pension benefits, government entitlements such as Social Security, and even the returns on Treasury Inflation Protected Securities (TIPS) based on the CPI number? A higher number means much higher government expenditures.

Because the CPI is artificially skewed downward, it makes sense for investors to respond by adding to their TIPS allocation and other commodities such as gold and energy that help protect a portfolio from the actual rate of inflation.

Mutual fund returns. It is not just the government that may be trying to play you by the numbers. Take a closer look at your investment adviser and the mutual funds he may have sold you. When you receive your annual performance report from your adviser, note that most do not report the 1 to 1.5 percent fee taken from your portfolio annually.

Unfortunately, the story gets worse. Although mutual funds report performance after mutual fund fees, such reports do not take into consideration taxes—a kind of invisible fee. Although churning is against SEC rulings, according to Vanguard founder John Bogle, the average turnover for actively managed funds increased from 65 percent in 1975 to 90 percent in 2000. This buying and selling may help the fund report a higher return, but for the unassuming investor, the result is much lower performance.

Many of these churned stocks will create tax liabilities, some at short-term interest rates, reducing the performance of the fund significantly. When you add the invisible fee of taxes to adviser fees, it’s no wonder index funds and ETFs with low fee structures and tax efficiency are rapidly becoming the preferred investment choice for so many.

When it comes to investing, it pays to know the real numbers both in your portfolio and the economy. By having honest reporting, you can make informed decisions that protect and guide your retirement future.

 




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