by Archie M. Richards, Jr., CFP^®
October 10, 2005

Jerry writes, "The bulk of my IRAs, 401K plan, and outside investments are in a variety of Vanguard index funds, as you've suggested. But I'm retiring in 6 years and am worried about today's high deficits, high energy cost, rising interest rates, and an anticipated flat stock market in 2006. Are index funds still the right approach? Also, it's impossible to rebalance between retirement accounts and outside taxable accounts without paying extra taxes on withdrawals from the retirement accounts. Any suggestions?"

A variety of index funds remains the right approach, Jerry. We'll take your concerns one at a time:

Federal deficit: Decade after decade, Americans worry about government deficits, but they never seem to cause problems. Some people think that deficits make long-term interest rates rise. They don't. Long-term rates are set by international money markets. U.S. federal deficits are such a small part of those markets that they have no impact.

Besides, as a percentage of the entire U.S. economy, the deficits have been going down, not up. In 1943, during America's enormous effort to win World War II, the federal deficit amounted to 31 percent of the nation's Gross Domestic Product (GDP). No disaster occurred; stock prices rose.

During the Reagan Administration, the deficit amounted to 6 percent of the GDP. No disaster occurred; stock prices rose.

Japan's government deficit amounts to 8 percent of the nation's GDP. Guess what Japan's stock prices are doing. (They're rising.)

The U.S. federal currently amounts to only 4 percent of the GDP, among the lowest in the industrialized world. Are the getting the idea that deficits don't matter?

High Energy Costs: The world is flooded with energy sources. The price of oil will fall. More on this next week.

Rising Interest Rates: Interest rates are not rising - at least not the rates on long-term debt, which is what businesses usually pay when they borrow. Three years ago, the rates on 10-year U.S. Treasury bonds were 4.61 percent. Now, they're only 4.38 percent.

Oh, last spring, the rate was 4.17 percent - a lousy one-fifth of one percent lower. Big deal! Twenty-four years ago, 10-year Treasuries paid a horrendous 14 percent!

Short-term rates, on the other hand, are indeed rising. Over the last couple of years, the rates of Treasury-Bills have gone up from 1 percent to 3.5 percent. They'll probably rise more. I hope so. The increase is a big part of the Federal Reserve's effort to bring inflation to its knees, just as it's supposed to. Short-term rates don't affect stock prices anyway. As Fonzi would say, fugetaboudem!

An Anticipated Flat Market in 2006: Oh yeah? Who says? Just because some journalist stuck his finger in the air to see which way the Wall Street gasbags were blowing doesn't mean you have to follow like a lemming.

Corporate inventories are low. Companies are investing big time in capital projects for the future. Seldom has corporate cash - $2 trillion - been such a huge portion of corporate assets. Consumer income is healthy. Not counting real estate, the assets of American households are worth about $20 trillion more than their liabilities.

Yes, I know, the market's dropping now. Gosh, maybe it'll go down 5 percent for a whole month! So what? You have 6 years before you even retire - and a whole lot of livin' after that.

Stop reading and watching television about that sky-is-falling nonsense. The market isn't going down because of news we're learning about now. It's probably falling because of news we'll learn about in a few months. But when that bad news comes out, the market will be rising. The market's funny that way.

Just stay with a variety of index funds. They're particularly suitable when prices are falling.

You're right about the impossibility of rebalancing between tax-sheltered retirement programs and outside, taxable investments. Withdrawals from the retirement plans incur high ordinary income taxes. All the more reason to tell your Congressman and Senators to adopt a low-rate flat tax and ditch IRAs, 401Ks, pension plans, and other cruddy, complicated loopholes.