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Richard Moheban (aka Retired Aviator) earned a BBA in Finance, Investment & Banking from a national top ten (public) business school—the University of Wisconsin at Madison. He then went on to earn a BFA (with Honors) in 1992. After that, however, his one year of working in the corporate... More
My blog:
The runaway inflation theories are unsound.
My book:
Debunking the Hyperinflation of Peter Schiff and the Gold Bugs: A Guide for Investors
  • Roth IRA Distribution Tip

    The stock market selloff in fall of 2011 caused me to reassess my situation: as I've retired relatively young from regular employment to invest & trade full time, I might eventually face a serious cash flow problem. By having all my money (except for a year's living expenses) tied up in stocks, if the market did not recover timely I could eventually be forced to sell securities at a loss just to pay my bills. If the market tanked for years I could be in real trouble and watch my life savings wither. In fact, in recent years I had quit making contributions to my Roth IRA-my thinking being that if I ever did need to liquidate stocks prior to age 59½, then why suffer the early withdrawal taxes and/or penalties?

    That was a big mistake-I should have continued my annual Roth contributions. Researching IRS Pub 590 on IRA's just now has enlightened me to some very good news that I didn't know: the tax law generally allows taking early distributions (after 5 tax years) from a Roth IRA up to the amount of your accumulated contributions without tax or penalty. The tax-free status makes sense because you've already paid income tax on the amounts you've contributed to a Roth,1 but the penalty-free status came as a big surprise. The exact verbiage on taxability from IRS Pub 590, Ch. 2 under the heading "Are Distributions Taxable?" is:

    You generally do not include in your gross income qualified distributions or distributions that are a return of your regular contributions from your Roth IRA(s). You also do not include distributions from your Roth IRA that you roll over tax free into another Roth IRA. You may have to include part of other distributions in your income. See Ordering Rules for Distributions, later. [bold mine]

    Most people probably skip over the brief bit of text that I have bolded from within the lengthy Pub 509, to focus on the rather extensive rules for "qualified distributions." "Qualified distributions" from a Roth IRA that are made before reaching age 59½ involve being disabled, transfers on death, or the first time home buyer exception as shown in this nifty IRS flowchart (from Pub 590):2

    But the idea that any flowchart-rejected unqualified early distributions could be free of tax or penalty (once they've sat in the Roth for just 5 tax years) was news to me. So I did further research in IRS Pub 590 and Form 8606, on penalties and found absolutely nothing for Roths. Searches within Pub 590, Chapter 2 (Roth IRAs) revealed that the Roth chapter does not even contain the words "penalty," "penalties," "10% tax," or "additional tax." I then did a double check on the web on the subject of penalties for Roth IRAs. Yep, everything I've read corroborates that there are no penalties on early withdrawals up to your accumulated contributions amount, provided those contributions have sat in the Roth for 5 years. One Motley Fool article gives a case study example. (Scroll down in the article to Example #4 with Rick.)

    Long ago I learned that when trying to verify whether a choice I may be making has tax consequences or not, one of the quickest and surest ways is to simply work through the appropriate IRS Form that you would attach to your 1040. In this case it is Form 8606 which figures any tax on early distributions from a Roth IRA. For my readers, I've condensed the essence of Form 8606 into a quick and easy Excel spreadsheet you can download here.3 My condensed spreadsheet version of Form 8606 boils it down to just a few basic numbers that many people can simply estimate off the top of their heads and likely come up with a pretty good idea as to whether or not they'll have any tax on an unqualified distribution. As for the 10% "additional tax" [penalty] referred to in the flowchart, the verbiage in the tax code seems murky and scant. I could not find anything on the 5 tax year rule as cited in the Motley Fool article for unqualified distributions. But Form 8606 did not have me calculating any penalty for early withdrawal, so that is promising. I could not find clear language on penalties in the code, so I phoned the IRS helpline.

    If you're concerned that job loss or some other unforeseen circumstance could leave you short of cash long before 59½, and that fact is keeping you from maxing out your Roth IRA contributions, you might want to think again. If your Roth situation is more complicated than mine (due to conversions or previous early distributions, etc.) you'll certainly want to work through a Form 8606 more carefully. But if your situation is relatively straightforward, my spreadsheet will save you tons of time. You can always start with my spreadsheet and then dig deeper into the tax code only if you are unsure. I am not a tax professional, though, so if there is any doubt at all about your situation I'd consult your tax advisor, or call the IRS helpline at 1-800-829-1040 just to be sure.

    1 unlike a traditional IRA where you get a tax shelter at the time of contribution.

    2 there is also a one-time qualified distribution from any type of IRA allowed to fund a Health Savings Account (HSA) for a maximum of one year's HSA contribution limit.

    3 earlier MS Office 2003 version here in case you don't have Office 2007 or later.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Jan 26 5:53 PM | Link | Comment!
  • The Ultimate Inflation Hedge for the Mattress

        I am not worried about runaway inflation, but I know some people who are these days. I get asked about investing in gold as an inflation hedge (at over $1300 per ounce) and I wince and try to discourage it. Invariably the next question is something like "What alternative do you recommend?"

        I am in favor of first, paying down debt (especially the high interest rate variety), second, owning one's own home (bargain mortgage rates and home prices abound these days!), and third, for any savings that won't be needed for many years, investing in stock index ETFs. 

         However, if you seek an asset you can physically possess as a pure hedge against runaway inflation, there is one completely overlooked item that has such compelling advantages, and so few disadvantages, as to trump all of the others in my opinion. That asset, believe it or not, is the lowly 'Forever' first class postage stamp. Its advantages include:


          • unlike gold and silver, its value cannot go down, as it will always mail a letter (and have letter-equivalent value in mailing packages); this advantage cannot be overemphasized!
          • unlike gold and silver, its value is guaranteed to rise in step with postage rates (inflation); (gold fell from $800/oz in 1980 to $250/oz in 2002, so gold certainly wasn't keeping up with inflation for those 22 years!)
          • it is used by everybody and therefore extremely liquid, and easily sold for the tiniest spread below whatever the current first class letter rate may be
          • it requires very little storage space, is easily hidden, and a large value in stamps is also very easily and cheaply moved or shipped (a shoebox would hold up to $50,000 worth today)
          • it can be divided into many smaller stashes
          • it is highly divisible for barter -- in fact, during the Civil War when coin was hoarded until it was quite scarce in commerce and paper money was not trusted, postage stamps became the preferred medium of exchange
          • if used for postage, it is not subject to capital gains tax -- a significant benefit if you own a business that does much mailing (but if sold, technically a gains tax would be incurred);  (keep in mind that if you sell gold for nominally twice what you paid for it, you'll owe tax on the 'phantom' gain -- if you're only breaking even after inflation, you'll be in loss territory after taxes)
          • it has no risk of loss from currency swings, being denominated in US dollars
          • though you only intended to hedge for inflation, it could actually turn out to be a money maker if letter rates rise faster than the prices of the things you typically buy (it is quite possible that postage rates rise faster than inflation since snail mail volume continues to fall from more and more use of electronic communication)


            If you really feel you need to dump your dollars for an inflation hedge that you can physically hold, 'Forever' stamps are an outstanding choice. You can rest assured that if a gallon of milk (or gasoline) costs $25, and mailing a letter costs $5, your stash won't have lost any value. Don't neglect to keep the stamps in multiple locations in fireproof safes.

            Think ahead several years from now when prices have failed to skyrocket as the gold bugs predict. Would you like to discover you own a pile of gold or silver that you probably bought too high, or rather a mess of stamps that have increased in nominal value just as sure as the U.S. Postal Service hikes its rates? 

    Disclosure: I do not have a stash of stamps -- the ultimate inflation hedge idea just struck me one day in line at the post office!
    Oct 29 1:55 PM | Link | Comment!
  • The Fed and Inflation

           A frequently voiced charge against the Federal Reserve is that it has severely debased the purchasing power of the dollar over time, through its easy and excessive creation of new money. I just read Texas Congressman Ron Paul's new book, End the Fed, in which he suggests that the Fed (alone) is responsible for gutting the value of the dollar since the time of the Fed's inception in 1913. Compared to its original 1913 purchasing power, a dollar is now worth less than a nickel after inflation (at the time of his writing in 2009). That's an over 95% drop in value of the dollar over 96 years. I read Paul's provocatively-titled book expecting some kind of argument to support his implicit assumption that whenever a business raises its prices, somehow the Fed's easy money is always behind it. Actually, in the book Paul makes no effort at all to attempt to prove that rising prices are caused wholly by an increased money supply -- he simply assumes it! I had been prepared to set to work and find his analysis to be faulty, but instead found he had no analysis at all to support his most essential point!

           I have read many times these hollow claims that the Fed causes all rising prices, but ask yourself this: have you ever heard of any instance of a business raising its prices based on its having observed an increase in the size of the national money supply? How would such a thing -- either consciously or not -- actually come about? Does more money coming into a business (i.e., more sales) really make the business view the money more 'cheaply' and thus raise prices? The answer, typically, is no. Competition does not allow that, and with booming sales a company's profits are flush without the need to raise prices. Common sense and the common experience of business owners reveal that increased costs often pave the way to higher prices, but increased sales generally do not. And when the Fed eases and the money supply thereby grows, it does not increase costs for any business.

    But "inflation is always and everywhere a monetary phenomenon," right?

           The macroeconomic idea that price inflation is "always and everywhere a monetary phenomenon," as Milton Friedman has famously claimed, surely deserves a rigorous common sense vetting at the microeconomic level of businesses and individuals, since they are the ones who set prices. Yet this microeconomic sounding board of the macroeconomic concept of monetary price inflation is sorely missing from economics literature. To say in macro terms that "more money in existence amongst the same amount of goods must cause prices to rise" or that "a glut of money will reduce its value (purchasing power)" is not nearly adequate explanation. How?  My book reveals that such simplistic, overarching statements -- that boil down to a supply/demand relationship for the valuing of money -- do not make sense. For one thing, most peoples' demand for money is essentially infinite. Thus, it is exceedingly difficult for money's supply to overwhelm its demand in our economy and create a 'glut of money'. The underlying reason for this is that money is a nearly frictionless proxy for anything and everything that money can buy. People don't want the money. They want the endless variety of things for which money can be so easily traded. Money uniquely poses no storage or liquidity problems (frictions), so demand for it is as limitless as people's desire for anything and everything. Unlike the demand for a specific good or service, when considering "the demand for money," one really must equate the phrase with "the demand for all things that money can buy." This puts an entirely different perspective on the notion of "the demand for money."

           You can do a test at home of how the demand for money is unlike the demand for a good. Fill some boxes with items of some real value -- perhaps your better used clothing or household items -- and offer them on a street corner for free. See how vigorous the demand for these items is at the price of zero. Then try it with an equal value in jars full of free dollar bills or coins. Surely the first passerby will take all your jars of money and ask you whether you have any more! The aggregate demand for money is nearly insatiable. Only a quite profound sea change in the population's view of and faith in the money itself can produce a runaway 'monetary' type of price inflation in conjunction with large money supply growth. The inflation is a psychological -- not monetary -- phenomenon. A large influx of newly created money will only cause such rampant inflation if widespread public perception of the money markedly changes. This can happen at times, but I do not see the conditions necessary for this rampant inflation to be present in the U.S. economy. I expect that though the U.S. money supply is likely to grow dramatically in the coming years, price inflation will remain relatively tame.

    Cash is for Spending

           Let's go back to the supposed 95% loss of wealth for those possessing dollars over the 96 year period. The Federal Reserve Note was never intended for long term wealth storage, nor has the Federal Reserve or the government ever claimed so. It is printed with only the claim to be "Legal Tender for all debts, public and private." It is supposed to be tendered, or spent. For long term wealth storage, only a fool would not put their dollars into some kind of interest-bearing account. Currency and equivalents (demand deposits such as checking accounts) are for one's spending money and nothing more. The Fed cannot be blamed for fools being foolish, especially when they have a century to figure out their foolishness!

           The supposed 95% loss of wealth over 96 years represents average annual price inflation of about 3.2%. Therefore, an interest yield of 3.2% compounded over that period would have held steady the value of a family's savings. Actually, an average yield of 3.2% has been easily beaten in even the very safest of government-insured investments for the great majority of the last century. Longer dated U.S. Treasuries have yielded as high as over 10% (circa 1980), more than making up for lost ground during periods of low interest rates. But even during such periods, the longer-dated maturity end of the Treasury curve has typically yielded more than 3.2%. In short, anyone in 1913 wishing to safely preserve their dollar's purchasing power for a very long period could have easily done so (and in fact achieved a large purchasing power gain), by investing in only the safest U.S. Treasury bonds or FDIC-insured bank CD's.

    Who has lost 95 cents on the dollar?

           Virtually nobody. Ron Paul misleadingly suggests that if a family had stashed some cash back in 1913, by 2009 it would have in fact lost 95% of its value. However, it can be easily shown that this is not true. That is because there was only one way to lose your cash's purchasing power in such a big way over that period. That was to put the cash in a non-interest bearing account and let it sit for all those decades. As I said above, someone foolish enough to do that with interest-bearing alternatives readily available probably deserves to lose their purchasing power! Surely, extremely few families actually did this with any significant amount of cash for decades on end, as the generations came and went!

           But what of a family that was distrustful of keeping their wealth in banks or other investment management firms at all? Such fear was once quite common, especially before FDIC depositors insurance began in 1934. Many people actually did lose their deposits held at banks or other financial institutions during various 'bank panics' throughout the 19th and early 20th centuries. These fearful folks would sometimes hide cash at home. Fortunately for them, anybody stashing cash in the mattress in 1913 did not lose any purchasing power long term. On the contrary, currency and coins from the era have exploded in value. Depending on the dates, mintmarks, and conditions, much of the contemporary small change, preserved as it was in 1913, is fabulously valuable now to collectors. One hundred dollars in small change stuffed in a shoebox in 1913 is likely to be worth tens of thousands or more now. The fact that such coins in unworn condition are so valuable is testament to their great scarcity. And their great scarcity tells us that hardly anybody in those days stashed cash for long periods. This, of course, means that Ron Paul's complaint is a hollow claim on behalf of virtually nobody!

    Disclosure: No relationship with the Federal Reserve, any elected or appointed government official or agency, or any adversary of Ron Paul. 100% independent viewpoint!
    Oct 29 10:59 AM | Link | Comment!
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