Sunday, February 20, 2011

Who exactly is rich these days?

Who exactly is rich these days? In other words, what criteria should we use to judge that someone is rich? In recent tax cut debates there seems to be a presumption that $250,000 of income is kind of the dividing line, but I don't quite buy it.

To me, the primary criterion for judging someone as being rich should be that they can live a relatively affluent lifestyle without working. In other words being rich is not about income per se, but a question of wealth. If you have sufficient wealth that you can live your affluent lifestyle solely on investment income from your wealth, then I would say that you are rich. And that is after taxes and after inflation. And that also requires a two-to-one safety margin so that you need not worry about what the stock market is doing or the state of the economy on either a daily, weekly, monthly, quarterly or even annual basis.

Put another way, being rich means you never have to worry about money.

That is what separates the rich from the middle class -- the latter have some money (unlike the poor or lower class who don't have enough money for the essentials of daily life), but are constantly worrying about it, frequently because they have chosen to live a level of affluence beyond their means (averaged over booms and busts.)

So, given that base definition, how much money (wealth) do you need to be considered rich?

Even back in early August 2007, just before the first big crumble of the financial crisis, in Who wants to be a millionaire? I suggested that $50 million in liquid investments was the magic number. At the beginning of April 2008, as the financial crisis was starting to rumble on the backburner with increasing fury, in Are you wealthy? I reconsidered but reaffirmed that $50 million number. And today, after further reconsideration and calculation I also reaffirm that $50 million number.

I think it is reasonable to say an income of $250,000 (from your investments) is the rock-bottom low-end of being rich. Simply avoiding work is not enough, you need to afford some significant degree of affluence, so that you at least look rich (although you may make a tactical decision to "dress down" so that you do not appear to be rich even if you are.)

For purposes of discussion I will assume a very conservative investment style consistent with no worrying about how your investments are doing. To me, that means long-term Treasury bonds. You can choose other investments based on your own risk tolerance, but for the purposes of defining worry-free rich, Treasury bonds fit the bill.

If you bought 30-year Treasury bonds at the most recent auction you got a yield of 4.75%. If you bought that same bond on the open market on Friday, the yield was 4.68%. For purposes of discussion, I'll presume that you buy only at the quarterly auctions.

Ignoring taxes and inflation for the moment, if you bought those 4.75% Treasuries, you would need $5.3 million of them to give you that $250,000 annual income. Unfortunately, taxes are not zero and inflation is not zero. Assuming the most recent annual headline inflation of 1.6%, that 4.75% becomes 3.15% and now you need $8 million for that same income level. I am presuming that you want that $250,000 income to "keep pace with inflation." There is no state or local income tax on Treasuries and I calculate the federal effective tax rate to be 27.05% using the 2010 federal tax tables. You may have deductions too, but let's start by being conservative. 4.75% minus 1.6% for inflation and 27.05% taxes gives us an effective yield of 2.30%, meaning that you would need Treasures in the amount of $10.9 million to give you that magical $250,000 annual income.

But wait... didn't I say earlier that you needed $50 million and this calculation shows that $11 million will do it? The answer is a classic "Yes, but..."

It's all about assumptions.

First of all, if you really want to be conservative, you need what Warren Buffett's mentor Ben Graham called a "margin of safety." There are all sorts of crazy things that can happen in the real world, let alone the worlds of economics and finance. So, I am going to insist that a two-to-one margin of safety be used to judge someone as being rich. This is an important factor if you want to be able to sleep at night and not have to worry about money. So, that $10.9 million would really be $21.8 million. But even that is still far short of $50 million.

Inflation may currently be 1.6%, but that is historically quite low and we have seen times when it was 3% or even 4% or on occasion higher. So, to be conservative, I would say it would be better to assume a 3% inflation rate.

Treasury yields can also fluctuate significantly, so to be conservative I will knock that 4.75% yield down to 4.25%, which is what it was in the preceding auction.

So, assuming you want $250,000 per year, Treasury bonds yield 4.25%, inflation at 3%, and taxes at 27.05%, my calculation comes up with an effective yield of 0.91%, which translates into needed wealth of $27.4 million. Add in that two-to-one safety margin and you get $54.8 million, modestly more than my $50 million suggestion, but, lets just call it $50 million since we have been quite conservative in its assumptions.

Another assumption I made was that you need to live on income only, not liquidation of principal. Better to plan on leaving the $50 million as inheritance to family or charity rather that put the vagaries of fate in the financial markets into play and risk the potential for introducing worry into the lifestyle of the supposed "rich."

So where does that leave you if you don't have $50 million in liquid wealth (which includes me, by the way)? If you still need to work to earn your $250,000 a year or are only a mere millionaire, you are definitely well-off and upper-middle class, but I wouldn't call you rich or wealthy.

AFAICT, "the rich" is mostly a term of partisan political disparagement and a tool for class warfare than an attempt at economic accuracy. Somehow, some liberal politicians have decreed that an income level of $250,000 defines "rich." It would be interesting to know who precisely started the "meme" of $250,000 of income meaning someone is "rich."

In any case, my number for "rich" is $50 million in liquid investments with an after-tax, after-inflation yield of 0.91%. Anything less than that and you are just pretending to be rich.

-- Jack Krupansky

Monday, February 14, 2011

Made my 14th payment to pay down the public debt of the U.S. government

I just made my 14th monthly payment to pay down the public debt of the U.S. government. It wasn't a large payment, just another $25, but it is a matter of principle, albeit mostly symbolic. It may take me another 47 billion years to pay it all down all by myself at this rate (and assuming the deficit went to zero immediately), but, as I said, it is a matter of principle and a sense of personal responsibility. It is our debt, not somebody else's.

According to the U.S. Treasury web site, the total public debt outstanding was $14,082,712,722,334.93, as of February 11, 2011, an increase of about $29 billion over 23 days, about $1.3 billion a day or $464 billion per year (annualized daily deficit.) As bad as that is, it is actually better than the $1.88 trillion deficit I reported last month. My hunch is that estimated tax payments were up sharply on January 15th due in part to big end-of-year bonuses.

Here is what I wrote back in January 2010 when I made my first donation/gift/contribution/payment:

Everybody is whining and complaining about the ballooning debt of the U.S. government, but who is actually doing anything about it? Well, for starters, ME! Yes, that's right, I, Jack Krupansky, just did something to reduce the U.S. government debt. Really. No kidding. I actually paid down a small slice of this debt. Granted, it was a rather small slice, but a slice nonetheless. Okay, sure, it was only $20, but the point is that at least I am one of the very few people willing to stand up and DO something about the problem, rather than be one of the whiners and complainers who refuse to acknowledge that it is their debt and their problem, not just the fault of mindless politicians in Washington, D.C. After all, every politician ultimately answers to voters and most of the so-called wasteful spending of the U.S. government is simply politicians responding to the demands of their consistituents (voters.) Maybe my one small contribution to paying down the debt won't really make any difference to any of those whiners and complainers, but for me it is a matter of principle. I consciously choose action rather than the inaction and lack of responsibility of the whiners and complainers.

If you have any sense of principle, you too can pay down a slice of the U.S. government debt yourself at You can pay via credit card or debit transfer from a bank account.

So do the right thing and show all those whiners and complainers (including so-called "tax protesters") how mindless and spineless they really are. PAY DOWN THE DEBT! And that has to start at the grass roots with us individuals before politicians will ever pick up the lead.

For the record, the only real way out of the deficit is not to merely cut expenditures or raise taxes or some combination of the two, but through economic growth, which includes a healthy amount of immigration in addition to unemployed workers going back to work and young people entering the work force. Sure, we need to manage the federal budget more carefully as well and make difficult choices about the size of government and tax rates, but the big focus has to be on achieving sustainable economic growth. In truth, nobody, including all of the Nobel laureate economists, knows what that sustainable rate really is or how to get there. We'll stumble our way in that general direction. That's the way we do things in America.

Another note: A significant part of the deficit is businesses writing off losses from the financial crisis and recession as tax deductions. That may continue for awhile longer, but will gradually wind down and tax receipts from businesses will begin to pick up in the coming years.

-- Jack Krupansky

The federal budget deficit: The answer is...

I never dreamed that the day would come when I got excited with the release of the federal budget, but today was the day. I have a lot of other (real) work to do, but I just downloaded the zip file for the full set of budget documents. My initial question was simply what the fine people in the White House were forecasting as the budget deficit for fiscal year 2012 after their "painful" budget cuts. And the number is...

  • Deficit for the current fiscal year (FY2011, before the "painful" cuts): $1.645 trillion. That's well above the $1.5T that people were talking about.
  • Deficit for FY2012 (the one with all the "painful" budget cuts): $1.101 trillion. Roughly in the range of what I expected.

The deficit for FY2010 was 1.293T. The lowest forecast for the next ten years is $607 billion in FY2015, with a forecast deficit of $774 billion in FY2021.

The single most important takeaway from this budget is that at no year in the next TEN years does it forecast a zero deficit and balanced budget let alone the kind of surplus needed to start paying down the debt.

Look, I understand and accept and agree with the fact that we should run a big deficit to recover from the financial crisis and recession, but only for a few years, maybe another year or two tops. But there is zero excuse for the leader of this country not to propose a balanced budget within the next five years. No excuse whatsoever. Yeah, I know, I know... the president has to play to his "base" and show that he wields a scalpel (to protect "investments") rather than a battle axe (to hack away all the fat and pork.)

What we need is a plan to balance the budget within five years and start a significant pay-down of the debt within ten years. What's so hard to understand about that?

In any case, now it is up to the Republicans in Congress to give us their counter-proposal.

-- Jack Krupansky

Sunday, February 13, 2011

The budget is coming, the federal budget is coming!

Usually I don't get very excited when the federal budget is issue, but this year is different as a result of the dramatic ballooning of the budget deficit and the accumulated debt. This could well be a watershed year, when we turn the corner in one of two directions: either to start getting the deficit under control (that's good) or whether it becomes clear that we are never going to get it under control (that's very bad.) I lean towards expecting the former. In any case, tomorrow is the day.

Here is the official announcement for the U.S. government budget for fiscal year 2012:

GPO will provide public access to the Budget at no cost at beginning at 10:30 a.m. Monday, February 14, 2011.

(Yeah, I know... Happy Valentine's Day from your favorite government.)

Oh, and I do believe that that is east-coast time.

Actually, this won't be the final budget, just the opening salvo from the White House. Congress and vast legions of analysts, journalists, and pundits are eagerly awaiting its arrival and stand ready to pick it to pieces like so many vultures.

The most juicy awaited tidbit is the initial projection of the deficit for 2012.

The initial projection for revenues in 2012 is also a key concern. There is no way to know what government receipts will really be until businesses and individuals pay taxes on their own revenues and incomes throughout the year. How many businesses still have tax losses (deductions) from the recession? No idea. What will business sales be in 2012? No idea. How many of the eight million people who lost jobs in the recession will be back at work and paying taxes? No idea -- until FY 2012 is over. All we will have tomorrow is a seat of the pants guesstimate from the White House. But as they used to say when I was a kid, "Close enough for government work."

The Republican-controlled House of Representatives will then propose its return opening salvo of cuts to reduce the deficit even further.

Then there will be a lot of posturing on both sides, a lot of back and forth, and eventually the White House and Republican leaders will sit down and negotiate the real budget for FY 2012 which starts on October 1, 2011.

The "battle" over raising the national debt ceiling will be a mere side show to the actual budget negotiations.

-- Jack Krupansky