I do not intend this post to be a statement that inflation is here. But I think that challenging our traditional notions of how we measure inflation may be in order. Whether it is Core Inflation or Consumer Price Index (CPI had an increase of 1.2% over the last 12 months through November 17), it is clear that these measures are not reflective what has been going on on the commodities markets over the last several months.
Commodity Price appreciation for the recent 5 months:
Commodities Return*
Aluminum 19.20%
Barley 75.10%
Coffee 22.73%
Copper 29.83%
Corn 55.27%
Cotton 58.86%
Gold 11.85%
Lead 28.29%
Lumber 15.42%
Lean hogs 1.69%
Live cattle 4.30%
Nickel 16.87%
Orange juice 1.38%
Palladium 66.25%
Platinum 10.03%
Rice 52.44%
Silver 52.86%
Soybeans 18.70%
Sugar 47.49%
Tin 40.95%
Wheat 50.08%
Zinc 19.62%
Rare earths 60.53%
With interest rates at historic lows, it remains to be seen how investors could keep up with a significant loss of purchasing power.
Tuesday, December 14, 2010
Monday, December 6, 2010
Investment Discipline
I am sure many of us have heard that trying to “time the market” is not a good idea. Statistics have shown that missing the five best trading days of the year can significantly affect investment returns.
Well, a different statistic this year shows again why timing is not a good idea. According to a study last week by the analysts at Bespoke1 , year-to-date returns for the S&P 500 Index would have dropped from 8.3 percent to -3.8 percent if you were out of the market the first trading day of each month!
The concept of buying near the low end and selling near the high end of a trading range in an attempt to extract incre¬mental return out of a relatively flat market may be appealing. However, when large returns are spread among a few widely dispersed days, asset allocation suddenly looks more attractive than attempting to aggressively trade a range-bound market.
The message? Traditional investment markets continue to be a great place for a longer-term strategy, but jumping in and out of the market for incremental returns is playing with fire.
Source (1): “If Only There Were 20 Months a Year”, December 1, 2010, Bespoke Investment Group, www.bespokeinvest.com
Well, a different statistic this year shows again why timing is not a good idea. According to a study last week by the analysts at Bespoke1 , year-to-date returns for the S&P 500 Index would have dropped from 8.3 percent to -3.8 percent if you were out of the market the first trading day of each month!
The concept of buying near the low end and selling near the high end of a trading range in an attempt to extract incre¬mental return out of a relatively flat market may be appealing. However, when large returns are spread among a few widely dispersed days, asset allocation suddenly looks more attractive than attempting to aggressively trade a range-bound market.
The message? Traditional investment markets continue to be a great place for a longer-term strategy, but jumping in and out of the market for incremental returns is playing with fire.
Source (1): “If Only There Were 20 Months a Year”, December 1, 2010, Bespoke Investment Group, www.bespokeinvest.com
Monday, November 29, 2010
Elections, Taxes, & QE2
With the loss of Democratic control of the House of Representatives, the pendulum of American politics continued its back and forth swing. Divided government has shown much promise in the last 30 years; with the administrations under President’s Reagan and Clinton serving “the middle” very well.
The biggest challenge ahead will be how to tackle the coming tax hike on January 1. With President Obama reaching out to the Republicans, it seems clear that some compromise will pass before the new year ticks over. This, in effect, creates a new round of stimulus for the economy. My biggest concern is that there continues to be no long term plan to tackle the deficit from either side of the aisle. At some point, those in Washington DC will need to make some difficult decisions for the long term financial well-being of the country. The proposed tax deal merely pushes that date out another two years.
What the current tax rate extension will do is take some pressure off at the Federal Reserve. Their second round of Quantitative Easing (or, their current action of buying $600 billion in Treasury bonds—a way of increasing the money supply) has been under-way and is expected to continue through next June, but the tax deal probably puts an end to any more than that.
The hope is that lower tax rates for all will translate into boosted spending and encourage hiring, to battle an unemployment rate at 9.8%. Perhaps it is not a bad short-term plan, but with the deficit growing by the second, and government entitlement programs bursting at the seems, at some point, someone will need to tackle the long term.
The biggest challenge ahead will be how to tackle the coming tax hike on January 1. With President Obama reaching out to the Republicans, it seems clear that some compromise will pass before the new year ticks over. This, in effect, creates a new round of stimulus for the economy. My biggest concern is that there continues to be no long term plan to tackle the deficit from either side of the aisle. At some point, those in Washington DC will need to make some difficult decisions for the long term financial well-being of the country. The proposed tax deal merely pushes that date out another two years.
What the current tax rate extension will do is take some pressure off at the Federal Reserve. Their second round of Quantitative Easing (or, their current action of buying $600 billion in Treasury bonds—a way of increasing the money supply) has been under-way and is expected to continue through next June, but the tax deal probably puts an end to any more than that.
The hope is that lower tax rates for all will translate into boosted spending and encourage hiring, to battle an unemployment rate at 9.8%. Perhaps it is not a bad short-term plan, but with the deficit growing by the second, and government entitlement programs bursting at the seems, at some point, someone will need to tackle the long term.
Friday, October 8, 2010
Reviewing Where We’ve Been/Where We’re Going
Every so often, as the investment market indicies bounce around, I find it important to reflect on the response to the financial crisis of 2008, and how the economy has responded to the measures.
First, let’s look at 3 major factors of government response:
• An almost $1 trillion stimulus program.
• A TARP program that bailed out banks and some auto makers that after it is all said and done, is projected to cost us roughly $100´s of billions.
• The Federal Reserve has virtually lowered interest rates to zero and spent over $1 Trillion in Asset Backed Securities to pump money into the economy and keep interest rates artificially low.
Next, let’s look at the economic response (or lack of) in the current fiscal/financial condition of the US economy:
• Massive Federal Deficits (not even including unfunded entitlement programs).
• Unemployment at 9.6%.
• Foreclosures still at record highs accompanied by lower home prices.
• A stock market roughly 30% lower from its peak.
• GDP growing in the latest quarter by 1.6%.
• Historically low mortgage and interest rates.
• Huge inflows to bonds and out of equities.
Now, it’s not all bad news. Recent growth in equity markets gives me reason for some optimism in 3 timed outlooks:
• Short-term: 3rd quarter earnings might actually be better than expected.
• Intermediate-term: The mid-term elections could provide investors and business with some clarity on taxes.
• Long-term: Equities are very cheap relative to bonds.
Where I see some significant risk for the domestic economy is in the value of the US dollar as compared to other currencies. With interest rates at very low levels, central banks have turned to currencies as the next lever to pull to stimulate their economies. We are in “beggar thy neighbor” world, where each country wants a cheap currency to make their country’s goods competitive in the global market place. In our current super-low interest rate environment, cur¬rency movements can overwhelm valuation and have a significant impact on asset class returns.
The bottom line is that the Fed will need to continue use all of the tools available to it to keep the economy fixed on the road to recovery.
First, let’s look at 3 major factors of government response:
• An almost $1 trillion stimulus program.
• A TARP program that bailed out banks and some auto makers that after it is all said and done, is projected to cost us roughly $100´s of billions.
• The Federal Reserve has virtually lowered interest rates to zero and spent over $1 Trillion in Asset Backed Securities to pump money into the economy and keep interest rates artificially low.
Next, let’s look at the economic response (or lack of) in the current fiscal/financial condition of the US economy:
• Massive Federal Deficits (not even including unfunded entitlement programs).
• Unemployment at 9.6%.
• Foreclosures still at record highs accompanied by lower home prices.
• A stock market roughly 30% lower from its peak.
• GDP growing in the latest quarter by 1.6%.
• Historically low mortgage and interest rates.
• Huge inflows to bonds and out of equities.
Now, it’s not all bad news. Recent growth in equity markets gives me reason for some optimism in 3 timed outlooks:
• Short-term: 3rd quarter earnings might actually be better than expected.
• Intermediate-term: The mid-term elections could provide investors and business with some clarity on taxes.
• Long-term: Equities are very cheap relative to bonds.
Where I see some significant risk for the domestic economy is in the value of the US dollar as compared to other currencies. With interest rates at very low levels, central banks have turned to currencies as the next lever to pull to stimulate their economies. We are in “beggar thy neighbor” world, where each country wants a cheap currency to make their country’s goods competitive in the global market place. In our current super-low interest rate environment, cur¬rency movements can overwhelm valuation and have a significant impact on asset class returns.
The bottom line is that the Fed will need to continue use all of the tools available to it to keep the economy fixed on the road to recovery.
Wednesday, September 15, 2010
10 Potential Changes to the Tax Code – Plan NOW
If Congress does not act soon, January 1st, 2011 will see one of the largest increases in taxation ever. There are no fewer than 10 adjustments to the tax code that affect 3 different areas of financial planning, and probably require all of us to revisit some of the assumptions in our longer term wealth management. Here is a quick review of things to come:
Income Tax Rate Increases
1. Top Federal Rate rises from 35% to 39.6%
2. 33% Federal Rate rises to 36%
3. 28% Federal Rate rises to 31%
4. 25% Federal Rate rises to 28%
5. 10% expires and reverts to 15%
6. Standard deduction for married couples no longer double that of unmarried filers
True, over half of these 10 changes come from Federal Income Tax increases, but the significance of rising income tax for all of us is huge given the fragile state of the economic recovery. There is an obvious affect on expendable income, as well as small business’ ability to grow. At the same time, there is a need to balance that want for economic growth with growing government debt.
Taxes on Investment
7. Maximum Long-Term Capital Gains tax rises from 15% to 20%
8. Tax rate for qualified dividends rises from 15% to Ordinary Income rates (as high as 39.6%)
It is important to note that an increase in long-term capital gains from 15 to 20% is not a 5% increase… it is a 33% increase! These two potential changes will be very significant to our thoughts on after-tax investments. What I call Asset Location (meaning the choice of investment vehicle & use of registration) will become even more important, as tax efficiency and transparency of holdings becomes paramount. It may become tempting for investors to run to federally tax-free muni bonds, but more than likely these will not be the best option. Tax-free investments tend to benefit investors in the highest tax brackets the most.
Estate Taxes
9. Estate tax redemption will decrease from $3.5 million (2009) to $1 million
10. Top Estate and Gift tax rates rise from 45% (2009) to 55%
Estate planning has been a moving target since the “sun-set” provision was written into legislation earlier in the decade. 2010 saw most wealth transfers pass untaxed. With these two changes poised to set estate planning assumptions back 10 years, now is a good time to review your documents to make sure they still accomplish the goals for which they were originally designed.
Because of these significant changes, the team at our office is hosting a workshop and open house on this topic in October to kick off our tax planning season. Please be sure to attend!
Income Tax Rate Increases
1. Top Federal Rate rises from 35% to 39.6%
2. 33% Federal Rate rises to 36%
3. 28% Federal Rate rises to 31%
4. 25% Federal Rate rises to 28%
5. 10% expires and reverts to 15%
6. Standard deduction for married couples no longer double that of unmarried filers
True, over half of these 10 changes come from Federal Income Tax increases, but the significance of rising income tax for all of us is huge given the fragile state of the economic recovery. There is an obvious affect on expendable income, as well as small business’ ability to grow. At the same time, there is a need to balance that want for economic growth with growing government debt.
Taxes on Investment
7. Maximum Long-Term Capital Gains tax rises from 15% to 20%
8. Tax rate for qualified dividends rises from 15% to Ordinary Income rates (as high as 39.6%)
It is important to note that an increase in long-term capital gains from 15 to 20% is not a 5% increase… it is a 33% increase! These two potential changes will be very significant to our thoughts on after-tax investments. What I call Asset Location (meaning the choice of investment vehicle & use of registration) will become even more important, as tax efficiency and transparency of holdings becomes paramount. It may become tempting for investors to run to federally tax-free muni bonds, but more than likely these will not be the best option. Tax-free investments tend to benefit investors in the highest tax brackets the most.
Estate Taxes
9. Estate tax redemption will decrease from $3.5 million (2009) to $1 million
10. Top Estate and Gift tax rates rise from 45% (2009) to 55%
Estate planning has been a moving target since the “sun-set” provision was written into legislation earlier in the decade. 2010 saw most wealth transfers pass untaxed. With these two changes poised to set estate planning assumptions back 10 years, now is a good time to review your documents to make sure they still accomplish the goals for which they were originally designed.
Because of these significant changes, the team at our office is hosting a workshop and open house on this topic in October to kick off our tax planning season. Please be sure to attend!
Monday, August 9, 2010
Thoughts on Fixing Social Security
"We need to look at the American people and explain to them that we're broke," Boehner (US Senator, John Boehner) was quoted as saying recently in The Pittsburgh Tribune-Review. "If you have substantial non-Social Security income while you're retired, why are we paying you at a time when we're broke? We just need to be honest with people."
I think that quote is about as clear an indication as we will get from a politician about Social Security. The system is quickly charging toward insolvency unless significant changes are made. A stark fact that has almost gone unnoticed by the general public is that social security (tax) revenues fell below benefit costs this year with the economic crisis, as more people retired early and fewer workers were paying in benefits. Something needs to be done quickly.
Here are some of the thoughts that have been proposed, and my two cents on each:
Increase the normal retirement Age to 70--This one is sort of a no-brainer. It has been the typical response so far out of Washington. Clearly, as life expectancy increases and the ratio of workers to SS beneficiaries decreases, the age to claim retirement benefits will need to increase.
Increase Early Retirement Age--People can and do claim a reduced retirement benefit at age 62. If there is a need to raise the normal retirement age, then clearly there is a need to raise the age to claim early retirement benefits. Given that current projections are for SSA to exhaust payouts by 2041, this seems a likely change in tandem to the increase in the normal retirement age.
Tie Cost-of-Living Increases to Wages--Consumer price index is a traditional measure of inflation (tracking the price fluctuations of a basket of non-durable consumer goods). Actual wages have grown at a much slower rate over time, and this could effectively slow down the amount of benefits paid out of the trust.
Working Longer-–Currently, full Social Security benefits are attained through working 40 quarters; with a quarter being defined as $1,120 of earnings. I could conceivably see two potential ways to change this: one in increasing the number of quarters, or two in changing the dollar amount that qualifies for a quarter.
Raising the taxable wage base--$106,800; that’s where current taxes for social security revenue purposes stop. Meaning anyone who earns a dollar over that amount, that dollar is not taxed for social security purposes. This seems like another no-brainer, given the dire state that the Social Security trust is in.
I am unsure what it will take to make a significant step toward fixing the system. More than likely it will take a bold move by Congress, and mix and match of these and other suggested changes. With an impending insolvency and an economy that is not forecasted to grow at break-neck speed, clearly something must be done.
I think that quote is about as clear an indication as we will get from a politician about Social Security. The system is quickly charging toward insolvency unless significant changes are made. A stark fact that has almost gone unnoticed by the general public is that social security (tax) revenues fell below benefit costs this year with the economic crisis, as more people retired early and fewer workers were paying in benefits. Something needs to be done quickly.
Here are some of the thoughts that have been proposed, and my two cents on each:
Increase the normal retirement Age to 70--This one is sort of a no-brainer. It has been the typical response so far out of Washington. Clearly, as life expectancy increases and the ratio of workers to SS beneficiaries decreases, the age to claim retirement benefits will need to increase.
Increase Early Retirement Age--People can and do claim a reduced retirement benefit at age 62. If there is a need to raise the normal retirement age, then clearly there is a need to raise the age to claim early retirement benefits. Given that current projections are for SSA to exhaust payouts by 2041, this seems a likely change in tandem to the increase in the normal retirement age.
Tie Cost-of-Living Increases to Wages--Consumer price index is a traditional measure of inflation (tracking the price fluctuations of a basket of non-durable consumer goods). Actual wages have grown at a much slower rate over time, and this could effectively slow down the amount of benefits paid out of the trust.
Working Longer-–Currently, full Social Security benefits are attained through working 40 quarters; with a quarter being defined as $1,120 of earnings. I could conceivably see two potential ways to change this: one in increasing the number of quarters, or two in changing the dollar amount that qualifies for a quarter.
Raising the taxable wage base--$106,800; that’s where current taxes for social security revenue purposes stop. Meaning anyone who earns a dollar over that amount, that dollar is not taxed for social security purposes. This seems like another no-brainer, given the dire state that the Social Security trust is in.
I am unsure what it will take to make a significant step toward fixing the system. More than likely it will take a bold move by Congress, and mix and match of these and other suggested changes. With an impending insolvency and an economy that is not forecasted to grow at break-neck speed, clearly something must be done.
Monday, June 21, 2010
24 Hour News Television & the Creation of Crisis
Mini-corrections are normal for investment markets. It can be difficult to remember that coming out of this recent financial crisis and recession, but after prolonged bull-market periods it is quite normal to see a bit of a pull-back. Since 1927, the average correction within a bull market has been a decline of 13.3%, which we are still short of. It is normal for our relationship with risk and fear to be skewed after the systemic collapse in 2008, but the “creation of crisis” found on the television airwaves does not help our behavioral relationship with our finances.
Fox Business continues to ask on a daily basis “Is the World Broke?” “BREAKING NEWS” flashes across the screen on CNBC the moment an executive takes a labored breath at a domestic large-cap firm. Isn’t every news piece they are running “breaking news”? The question is whether the delivery needs to be in such a way as to disturb an internal crisis in the viewer.
Additionally, nearly every other commercial on business news stations is for investments in gold bars—a traditional crisis inflationary hedge instrument. While a tilt to commodity holdings for some investors may be appropriate as a good hedge against inflation, it is unconscionable to solicit the viewer to move all of their money to gold bars or coins because we are in a prolonged recession. At this point, that could be the equivalent of buying Yahoo stock at the height of the NASDAQ in 2000.
The point of my anecdote is not imply that we are some how out of the woods from a prolonged global recession, but merely to reflect that the next crisis is not occurring every minute. Behavioral finance, or balancing fear and greed with a long-term investment strategy, is something each of us struggle with, and 24-hour news television sometimes only adds one more irrational voice in our heads.
Fox Business continues to ask on a daily basis “Is the World Broke?” “BREAKING NEWS” flashes across the screen on CNBC the moment an executive takes a labored breath at a domestic large-cap firm. Isn’t every news piece they are running “breaking news”? The question is whether the delivery needs to be in such a way as to disturb an internal crisis in the viewer.
Additionally, nearly every other commercial on business news stations is for investments in gold bars—a traditional crisis inflationary hedge instrument. While a tilt to commodity holdings for some investors may be appropriate as a good hedge against inflation, it is unconscionable to solicit the viewer to move all of their money to gold bars or coins because we are in a prolonged recession. At this point, that could be the equivalent of buying Yahoo stock at the height of the NASDAQ in 2000.
The point of my anecdote is not imply that we are some how out of the woods from a prolonged global recession, but merely to reflect that the next crisis is not occurring every minute. Behavioral finance, or balancing fear and greed with a long-term investment strategy, is something each of us struggle with, and 24-hour news television sometimes only adds one more irrational voice in our heads.
Tuesday, May 11, 2010
The Return of Volatility
A confluence of events in Europe last week sent the broad market stock indicies crashing 1000 points intra-day. The Dow Jones Industrial Average fell below the 11,000 mark, and the bears decided to make a little run into this 12-month bull market.
Setting aside any potential human error on the trading side, we know that the markers generally hate uncertainty; and things had been fairly uncertain with regard to how the European Central Bank would respond to the debt crisis in Greece. Things came to a head last week, during the same time the UK elections left a hung parliament (no political party with a clear majority) for the first time since the 1970’s. Uncertainty times two for a very important political and economic region.
As the European Central Bank’s rescue package became clear by Monday morning, markets began to recover. When a coalition UK government (the conservative Tories and Liberal Democrats formed a cooperative majority in parliament) was announced, UK markets reacted dramtically; and all of a sudden the Dow is flirting with the upper 10,000’s again.
With more European debt issues likely in the future and a mid-term election later in the year in the US, you can imagine more market volatility is in the offing. Right now the economic domestic data still looks good:
• April was the 4th month in a row of positive employment growth, adding 300,000 new jobs, which was well above estimates.1
• Strong factory orders for March announced this week affirm the strength in the manufacturing sector. Excluding the volatile transportation component, orders recorded the strongest month in 5 years.2
• Becoming the standard of recent quarters, companies are beating Wall Street earnings estimates. Earnings improvements are beyond the benefits of cost cutting as 75% of companies within the S&P 500 have reported higher top-line sales from a year ago.3
• In response to the good earning reports and economic indicators, future earning estimates continue to enjoy upward revisions for all of 2010 and 2011. 4
Last week’s events continue to remind us of the interdependencies of world economies.
1 Bloomberg, May 7, 2010
2 Bloomberg, May 4, 2010
3 Zacks Investment Research, May 4, 2010
4 Standard & Poors, operating earnings estimates, May 4, 2010
Setting aside any potential human error on the trading side, we know that the markers generally hate uncertainty; and things had been fairly uncertain with regard to how the European Central Bank would respond to the debt crisis in Greece. Things came to a head last week, during the same time the UK elections left a hung parliament (no political party with a clear majority) for the first time since the 1970’s. Uncertainty times two for a very important political and economic region.
As the European Central Bank’s rescue package became clear by Monday morning, markets began to recover. When a coalition UK government (the conservative Tories and Liberal Democrats formed a cooperative majority in parliament) was announced, UK markets reacted dramtically; and all of a sudden the Dow is flirting with the upper 10,000’s again.
With more European debt issues likely in the future and a mid-term election later in the year in the US, you can imagine more market volatility is in the offing. Right now the economic domestic data still looks good:
• April was the 4th month in a row of positive employment growth, adding 300,000 new jobs, which was well above estimates.1
• Strong factory orders for March announced this week affirm the strength in the manufacturing sector. Excluding the volatile transportation component, orders recorded the strongest month in 5 years.2
• Becoming the standard of recent quarters, companies are beating Wall Street earnings estimates. Earnings improvements are beyond the benefits of cost cutting as 75% of companies within the S&P 500 have reported higher top-line sales from a year ago.3
• In response to the good earning reports and economic indicators, future earning estimates continue to enjoy upward revisions for all of 2010 and 2011. 4
Last week’s events continue to remind us of the interdependencies of world economies.
1 Bloomberg, May 7, 2010
2 Bloomberg, May 4, 2010
3 Zacks Investment Research, May 4, 2010
4 Standard & Poors, operating earnings estimates, May 4, 2010
Monday, May 3, 2010
Diagnosing Fiscal Fitness
Trying to be your own financial advisor can sometimes feel like trying to perform surgery on yourself. But, you can certainly try to diagnose your own fiscal fitness. Here are a few items to keep in mind when looking at the health of your finances:
• Emergency Fund – Usually recommended to have 3 to 6 months of nondiscretionary expenses available in very liquid holdings.
• Debt Coverage – A good measure of mortgage debt is 28% of gross income
• Savings Rates – The largest part of retirement planning is the actual savings element. Typical healthy savings rates are in the neighborhood of 10-12%.
• Net-Worth Growth – Calculated by subtracting your liabilities from your overall assets, it also helps to look at how your net worth trends over a period of time. Is there growth in your net worth?
• Asset Location – While much is often spoken of asset allocation in controlling risk tolerance, asset location is more telling of controlling exposure to the opportunity of difference financial vehicles (e.g., cash-value life insurance vs. term, liquidity of one investment vs. another, or tax-efficiency of one investment vs. another, etc.)
While these are some great elements to examine with regard to your current financial condition, making the right adjustments is key. Because of the plethora of decisions to be made in your financial life, self-diagnosis will probably only take you so far.
• Emergency Fund – Usually recommended to have 3 to 6 months of nondiscretionary expenses available in very liquid holdings.
• Debt Coverage – A good measure of mortgage debt is 28% of gross income
• Savings Rates – The largest part of retirement planning is the actual savings element. Typical healthy savings rates are in the neighborhood of 10-12%.
• Net-Worth Growth – Calculated by subtracting your liabilities from your overall assets, it also helps to look at how your net worth trends over a period of time. Is there growth in your net worth?
• Asset Location – While much is often spoken of asset allocation in controlling risk tolerance, asset location is more telling of controlling exposure to the opportunity of difference financial vehicles (e.g., cash-value life insurance vs. term, liquidity of one investment vs. another, or tax-efficiency of one investment vs. another, etc.)
While these are some great elements to examine with regard to your current financial condition, making the right adjustments is key. Because of the plethora of decisions to be made in your financial life, self-diagnosis will probably only take you so far.
Monday, April 19, 2010
Tax Planning vs. Tax Preparation: Start your 2010 strategy now.
While I took a short hiatus from blogging during the height of tax season in our office, the Dow Jones Industrial average blasted through the 11,000 mark—a significant level given the enormous drop witnessed in the fall of 2008. Time will tell if this will be a trading support level throughout 2010.
Having just come through tax preparation season in our office, though, I thought it prudent to take a moment to discuss tax planning versus preparation. Generally, the tax preparers in our office begin a meeting by asking some basic questions about financial decisions made over the past year…Did you buy a house? Did you collect unemployment? Was there an addition to your family this year? Did you purchase a car this past year? These are all reactive questions—answers provided after the fact, with little opportunity to change the tax impact.
There is a difference between tax preparation and tax planning. Tax preparation is simply completing your return: committing certain events to history and recognizing their tax consequences. Tax planning, on the other hand, is proactive in nature: you identify tax savings opportunities and create a roadmap to maximize them.
There is little doubt that with government spending and budget deficits exceeding previous records, the tax rates are going to increase. For that reason, now is the time to break the cycle of taking a reactive approach to addressing your tax exposure. This often looks at ways of reducing your taxable income, claiming potential tax credits, or, in the case of small business owners, optimizing your tax status (i.e, creation of an entity for your business to be able to use more tax deductions).
To get the true benefit of tax planning, have a strategy session with your preparer and your financial advisor. Get both on the same strategy page.
Having just come through tax preparation season in our office, though, I thought it prudent to take a moment to discuss tax planning versus preparation. Generally, the tax preparers in our office begin a meeting by asking some basic questions about financial decisions made over the past year…Did you buy a house? Did you collect unemployment? Was there an addition to your family this year? Did you purchase a car this past year? These are all reactive questions—answers provided after the fact, with little opportunity to change the tax impact.
There is a difference between tax preparation and tax planning. Tax preparation is simply completing your return: committing certain events to history and recognizing their tax consequences. Tax planning, on the other hand, is proactive in nature: you identify tax savings opportunities and create a roadmap to maximize them.
There is little doubt that with government spending and budget deficits exceeding previous records, the tax rates are going to increase. For that reason, now is the time to break the cycle of taking a reactive approach to addressing your tax exposure. This often looks at ways of reducing your taxable income, claiming potential tax credits, or, in the case of small business owners, optimizing your tax status (i.e, creation of an entity for your business to be able to use more tax deductions).
To get the true benefit of tax planning, have a strategy session with your preparer and your financial advisor. Get both on the same strategy page.
Monday, March 1, 2010
The 11 Pitfalls, Concerns, & Opportunites for Roth Conversion in 2010
When TIPRA (Tax Increase Prevention & Reconciliation Act) passed in 2005, it seemed like the opportunity for Roth IRA conversion would be a good one for some people. No one could have predicted the “perfect storm” of opportunity for Roth Conversion in 2010 that has ensued. Given record lows for the top income brackets, the sizeable government deficit that has mounted, and the Financial Crisis’ effects on account values of deferred retirement savings accounts, Roth Conversion in 2010 may be the largest tax planning opportunity some of us will ever see. Careful analysis should be taken by everyone to weigh whether or not a conversion strategy is right for you.
Given all that, I have found 11 pitfalls and considerations Californians should know about before they begin any analysis. They are:
1. Waiting Period – There is a 5 year waiting period before growth can be accessed on any Roth Conversion. Full income tax is applied if growth is touched prior to the 5 year wait. There is an additional 10% penalty if you are under 59 ½ .
2. The “Do-Over” Rule – Recharacterization can be done if you convert an account to Roth and the value is worth less around the time you are filing your taxes. If the Roth has lost value since conversion, you can recharacterize back to traditional IRA, and then reconvert at the lower value…lowering the tax burden.
3. Paying the Tax on Conversion – Generally, people should have after-tax savings in a separate account to pay for the tax on conversion. Withdrawing from a traditional IRA to pay the tax will cause a penalty for individuals under 59 ½ , and is probably not the best option for those over 59 ½ .
4. Treatment of Non-deductible IRAs – If you have been contributing after-tax dollars to a traditional IRA, the after-tax portion of the account that is converted to Roth will not be taxed (because you have already paid tax on this money). Additionally, you cannot pick and choose which portions or Ira accounts you wish to convert. You have one IRA in the eyes of the government, no matter how many accounts you have, and therefore any after-tax contributions must be converted pro-rata to the sum total of all traditional IRAs.
5. Converting Company Plans 1 – If you have an old 401k (403b or 457) from a previous employer and want to convert it to Roth, be sure to roll it over to IRA first. If you convert directly from 401k to Roth, you will not have the opportunity to recharacterize if the stock market moves against you.
6. Converting Company Plans 2 – If you want to make better use of mixed/non-deductible IRAs, convert before rolling an old 401k (403b or 457) to a traditional IRA. This will allow you to convert a larger portion of the after-tax IRA contribution.
7. Utilizing Tax Losses – This could be a great time to use net operating loss carry-forwards, charitable contribution carry-forwards, non-refundable tax credits, and pass-through losses to mitigate the taxes of conversion. Work with your tax advisor to coordinate this.
8. Financial Aid Loss – When applying for college financial aid, retirement accounts are generally discounted, but income is not. Roth IRA conversion is considered income and is classified this way on all IRS tax forms.
9. Converting SIMPLE IRAs – There is a 2-year holding period requirement on initial contributions to SIMPLE IRAs. Conversion to Roth prior to the 2-year hold could trigger a 10% penalty. Be sure you time this correctly.
10. Split the State Tax not the Federal – If you have the after-tax dollars to pay the tax on conversion, and there is not a need to manage tax brackets for your conversion strategy, you may consider paying the Federal taxes now (which are scheduled to increase) and use the 2-year deferral split option for State taxes.
11. Trying to Coordinate your Tax Advisor & your Financial Advisor – In all seriousness, this is an opportunity which requires the coordination of your financial advisor and your tax advisor. Be sure to include both in a strategy session to work out whether a full, partial, or multi-year conversion plan may be right. They will be able to help you wade through these and other pitfalls.
This is not meant as a do-it-yourself guide. Roth Conversion is potentially a great opportunity, but should be evaluated on an individual basis, given all of the considerations involved.
The preceding should not be construed as tax advice. Be sure to consult your tax advisor before making any decisions.
Given all that, I have found 11 pitfalls and considerations Californians should know about before they begin any analysis. They are:
1. Waiting Period – There is a 5 year waiting period before growth can be accessed on any Roth Conversion. Full income tax is applied if growth is touched prior to the 5 year wait. There is an additional 10% penalty if you are under 59 ½ .
2. The “Do-Over” Rule – Recharacterization can be done if you convert an account to Roth and the value is worth less around the time you are filing your taxes. If the Roth has lost value since conversion, you can recharacterize back to traditional IRA, and then reconvert at the lower value…lowering the tax burden.
3. Paying the Tax on Conversion – Generally, people should have after-tax savings in a separate account to pay for the tax on conversion. Withdrawing from a traditional IRA to pay the tax will cause a penalty for individuals under 59 ½ , and is probably not the best option for those over 59 ½ .
4. Treatment of Non-deductible IRAs – If you have been contributing after-tax dollars to a traditional IRA, the after-tax portion of the account that is converted to Roth will not be taxed (because you have already paid tax on this money). Additionally, you cannot pick and choose which portions or Ira accounts you wish to convert. You have one IRA in the eyes of the government, no matter how many accounts you have, and therefore any after-tax contributions must be converted pro-rata to the sum total of all traditional IRAs.
5. Converting Company Plans 1 – If you have an old 401k (403b or 457) from a previous employer and want to convert it to Roth, be sure to roll it over to IRA first. If you convert directly from 401k to Roth, you will not have the opportunity to recharacterize if the stock market moves against you.
6. Converting Company Plans 2 – If you want to make better use of mixed/non-deductible IRAs, convert before rolling an old 401k (403b or 457) to a traditional IRA. This will allow you to convert a larger portion of the after-tax IRA contribution.
7. Utilizing Tax Losses – This could be a great time to use net operating loss carry-forwards, charitable contribution carry-forwards, non-refundable tax credits, and pass-through losses to mitigate the taxes of conversion. Work with your tax advisor to coordinate this.
8. Financial Aid Loss – When applying for college financial aid, retirement accounts are generally discounted, but income is not. Roth IRA conversion is considered income and is classified this way on all IRS tax forms.
9. Converting SIMPLE IRAs – There is a 2-year holding period requirement on initial contributions to SIMPLE IRAs. Conversion to Roth prior to the 2-year hold could trigger a 10% penalty. Be sure you time this correctly.
10. Split the State Tax not the Federal – If you have the after-tax dollars to pay the tax on conversion, and there is not a need to manage tax brackets for your conversion strategy, you may consider paying the Federal taxes now (which are scheduled to increase) and use the 2-year deferral split option for State taxes.
11. Trying to Coordinate your Tax Advisor & your Financial Advisor – In all seriousness, this is an opportunity which requires the coordination of your financial advisor and your tax advisor. Be sure to include both in a strategy session to work out whether a full, partial, or multi-year conversion plan may be right. They will be able to help you wade through these and other pitfalls.
This is not meant as a do-it-yourself guide. Roth Conversion is potentially a great opportunity, but should be evaluated on an individual basis, given all of the considerations involved.
The preceding should not be construed as tax advice. Be sure to consult your tax advisor before making any decisions.
Friday, February 19, 2010
How will your Social Security be Taxed in Retirement?
In light of a recent Wealth Management Workshop about Social Security that we hosted for our clients, I have found it helpful to review with people the potential taxation of their Social Security benefits in retirement. Many people do not realize how taxation will affect them in retirement, and consequently fail to plan for it properly.
The IRS looks at your “combined income” to determine the taxability of your Social Security benefit. Combined income is calculated by adding your Adjusted Gross Income with any non-taxable interest (such as Muni Bond interest), plus half of your Social Security Benefits. The equation looks like this:
AGI + Non-taxable Interest + ½ Social Security Benefits = Combined Income
If your “combined income” is between $25K and $34K for a single person, or $32K and $44K for a couple, 50% of your Social Security benefit will be taxable.
If your “combined income” is over 34K for a single person, or $44k for a couple, 85% of your Social Security Benefit will be taxable.
As you can see this can become quite significant and should be weighed when planning for retirement income.
The IRS looks at your “combined income” to determine the taxability of your Social Security benefit. Combined income is calculated by adding your Adjusted Gross Income with any non-taxable interest (such as Muni Bond interest), plus half of your Social Security Benefits. The equation looks like this:
AGI + Non-taxable Interest + ½ Social Security Benefits = Combined Income
If your “combined income” is between $25K and $34K for a single person, or $32K and $44K for a couple, 50% of your Social Security benefit will be taxable.
If your “combined income” is over 34K for a single person, or $44k for a couple, 85% of your Social Security Benefit will be taxable.
As you can see this can become quite significant and should be weighed when planning for retirement income.
Monday, February 8, 2010
Europe’s PIiGS vs.Emerging BRICs
As we have watched the globally economy grapple with Greece’s debt load in the last couple of weeks, it has become clear that international investing in 2010 will be characterized by a tug of war between the struggling Euro-zone and the potentially overbought Emerging Markets.
The investment world loves to use acronyms whenever possible, so let’s be clear. Dubbed the PIiGS, the struggling economies of Portugal, Ireland, Greece, Spain, and to a lesser extent Italy (the small “i”). The basic challenge for Greece is that the decline in world eco¬nomic growth has exposed the declining relative productivity of Greek business. Historically in this situation, the currency of the country would decline and interest rates would be cut. The decline in currency would improve the trade deficit because cheaper goods become more attractive to foreign markets, thus reducing any trade deficit.
Because these countries use the Euro for their currency, they have little to no control on monetary policy—specifically interest rates. The Europe¬an Central Bank remains reluc¬tant to cut rates as low as the Federal Reserve, which would help Greece. The other PIiGS are not in as bad a shape as Greece, but the entire continent has been terribly hit by this recession.
On the other side are the Emerging market BRIC countries of Brazil, Russia, India, and China—with China being the biggest of the capital letters here. To get an understanding of just how large the Chinese market is, consider that it has three of the four largest banks, the two largest insurance companies, and the second-largest stockmarket. Currency issues have been a global concern toward China, with the yuan having been “allowed” to devalue with the US dollar. Both economists and politicians have argued that the value of China’s currency should be much higher given the country’s improving economic performance.
The challenges with Greece will result in a challenge to the rest of Europe and to global liquidity. If this challenge becomes more likely, emerging markets, corpo¬rate bonds, and domestic equities may suffer. China will have the biggest questions to answer of all of the BRICs, with an exploding economy. With regard to the international sector in 2010 the balance will be between the old world and the new.
The investment world loves to use acronyms whenever possible, so let’s be clear. Dubbed the PIiGS, the struggling economies of Portugal, Ireland, Greece, Spain, and to a lesser extent Italy (the small “i”). The basic challenge for Greece is that the decline in world eco¬nomic growth has exposed the declining relative productivity of Greek business. Historically in this situation, the currency of the country would decline and interest rates would be cut. The decline in currency would improve the trade deficit because cheaper goods become more attractive to foreign markets, thus reducing any trade deficit.
Because these countries use the Euro for their currency, they have little to no control on monetary policy—specifically interest rates. The Europe¬an Central Bank remains reluc¬tant to cut rates as low as the Federal Reserve, which would help Greece. The other PIiGS are not in as bad a shape as Greece, but the entire continent has been terribly hit by this recession.
On the other side are the Emerging market BRIC countries of Brazil, Russia, India, and China—with China being the biggest of the capital letters here. To get an understanding of just how large the Chinese market is, consider that it has three of the four largest banks, the two largest insurance companies, and the second-largest stockmarket. Currency issues have been a global concern toward China, with the yuan having been “allowed” to devalue with the US dollar. Both economists and politicians have argued that the value of China’s currency should be much higher given the country’s improving economic performance.
The challenges with Greece will result in a challenge to the rest of Europe and to global liquidity. If this challenge becomes more likely, emerging markets, corpo¬rate bonds, and domestic equities may suffer. China will have the biggest questions to answer of all of the BRICs, with an exploding economy. With regard to the international sector in 2010 the balance will be between the old world and the new.
Wednesday, January 20, 2010
2010 in the Crystal Ball--Part 3
Thoughts on ...
Tax & Financial Planning
Tax & Financial Planning
- What to Expect from Retirement Benefits
• Social Security will be staying as is. While there is usually some cost of living adjustment associated with payments, 2010 will not show an increase.
• 401k contributions limits are staying as is. While the government has been building in slight increases each year, there will not be any for 2010. Limits will stay a $16,500 maximum, with a $5500 catchup provision for participants over age 50.
• 401(k) matches are returning. Statistics are showing that ofthose company plans that cut employer contributions, 27% have already become matching again. Look for this trend to continue as the economy continues to stabilize.
- Roth Conversion
• Be sure to consider whether a Roth Conversion is right for you. 2010 marks the first time that the conversion opportunity is open to EVERYONE. Be sure to avoid potential tax pitfalls of conversion.
- What about the Estate Tax?
• The current law on estate tax is that there isn't one. The tax expired at the end of2009, but Congress has until September to make a retroactive law, and you can probably bet that something will shake out of Washington between now and then.
- RMDs Return
• After the financial crisis in the fall of 2008, Congress decided to suspend required minimum distributions from retirement plans. Well, they are back in 2010, so be sure that you are set to continue withdrawing, otherwise you could be penalized.
- Tax Rates--Capital Gains Rates are Still Low ... For Now
• Capital gains rates are set to increase in 2011, as the government grapples with deficit, but for now, the highest rate is 15 percent for individuals in the 25 percent to 35% brackets. There is no capital gains for individuals in the 10 percent and 15 percent tax brackets pay no capital gains.
- Tax Rates--One of the Lowest Income Tax Rate Eras ... For Now
• The fact that we are probably in a rising income tax environment (given the fact that we are at near historic low levels for the top income tax bracket), traditional ideas for retirement planning are being rethought. Roth Conversion, Section 79 Plans, and other tax advantaged tools for retirement are becoming more important for business owners.
Thursday, January 14, 2010
2010 in the Crystal Ball--Part 2
Thoughts on ...
Your Retirement Savings
Your Retirement Savings
- Manage your Retirement Savings
• Earmark Other Savings While not selling off in last year's panic was the right move for investors, not adjusting holdings-or ignoring them-is not a good move either. Adjusting investment strategy is a good idea not only when markets adjust, but also as your life does. Retirement strategy adjustment becomes even more important as you enter what I call the redzone-about 10 years before through to 10 years into retirement. It's here the risk tolerance becomes a moving target and the sequence of returns can really weigh on your goals. Poor investment performance in the redzone can severely impact the longevity of your savings.
• Many investors had a disproportionate amount of their money in equities-nearly four in 10 employees ages 56 to 65 had more than 80 percent of their 401(k)s in stock, according to the Employee Benefits Research Institute. - Increase your savings
• Earmark Other Savings Performance alone will not get you to your goals. Increase your savings rate, especially in 2010, as the market continues to recover from the recent bear market. Recent studies show that in fact the opposite is happening, and many investors have set aside less in their retirement savings accounts. - Fees
• Many people do not realize the extra fees they are paying by keeping money in former employer sponsored plans. Rolling over old company plans will probably decrease the amount of administrative fees you are paying. It will also open up freedom of choice for types of investments, allowing you to choose low cost options.
• Earmark Other Savings
• There are other investments out there specifically geared for retirement savings which help guard against longevity risk. Earmark other funds for retirement as you enter the redzone. Seek out the best investments from a tax-advantaged standpoint.
Friday, January 8, 2010
2010 in the Crystal Ball--Part 1
I wanted to share my thoughts for the year ahead. This series of blog entries focuses on the economy, retirement savings, and financial planning for 2010 and beyond.
Thoughts on ...
The Economy
- Emerging Markets will still be a major focus for 2010
• China continues to play the "will-they-or-won't-they" game when it comes to re-valuing its currency. But the figures for 2009 publish by the Economist are astonishing: "real GDP grew by 10.7% year on year in the fourth quarter. Industrial production jumped by 18.5% in the year to December, while retail sales increased by 17.5%, boosted by government subsidies and tax cuts on purchases of cars and appliances. In real terms, the rise in retail sales last year was the biggest for over two decades." You cannot ignore this sector of the global economy - Small business breaks out
• When you look at past recessions, often it has been small business that has led the way out. I do not think that this recession will be any different, however, I do think that Washington has another mine field to navigate in enticing small business back to job creation and growth. Regulation has been a hot topic recently, and the potential for new national and state regulations and taxes may have companies putting their growth plans on hold. That means no new jobs and continued jobless recovery. This is particularly true for small to medium sized businesses, which have generated about two-thirds jobs on a national scale. Uncertainty about 2010 and beyond simply has business planning in the holding pattern. New workplace rules and higher income tax are just two of the worries. - California Constitutional Convention
• A push for referendum is gaining a lot of support for calling a constitutional convention here in California. This has the potential to effect positive change in the broken political system in our state. It also has the potential to wreak havoc with the 8th largest economy in world. Just exactly who would be the delegates for such a convention has been a much argued element. This leads us to my next point ... - Will CA continue to foster areas of "economic success" (e.g. Silicon Valley; Hollywood; Agriculture)?
• With state spending increased from $56 billion in 1998 to $131 billion in 2008, and the state facing a budget deficit of $40 billion (in 2008), the temptation is for the government to tax successful businesses. The danger as that business will relocate to friendlier confines. The state cannot afford to lose those current tax revenues, and the jobs that come with having those companies in-state.
Saturday, January 2, 2010
Decade in Review--From a Financial Perspective
Looking back on the last ten years, it seems there may have been a geo-political or economic event to mark each year. From an economist’s standpoint, the decade from 2000 to 2009 is painted with a string of investment bubbles. From an advisory standpoint, I can recall with much clarity the impact that these events had on client relationships. Let’s take a quick look at each year’s main event.
- 2000--Dotcom bust…Get-rich-quick stock bubble bursts. This had a profound effect on California’s economy (particularly the Bay Area), as a large part of the workforce were sent away from jobs that would not return in the same industry sector.
- 2001--9/11…When stock markets reopened on Wall Street after the 9/11 hiatus, the Dow (DJIA) dropped 685 points. A very scary time in America, resulted in a short-term over-reaction on equity markets. Over the long-term, the 9/11 sell-off had close to zero effect on the economy.
- 2002--Accounting Scandals…As detrimental as the Enron & Arthur Anderson (& others) scandal were to the US economy, the legislative response of Sarbanes Oxley certainly has had unintended consequences. While holding executives to a higher standard is a fine idea, this piece of legislation has allowed places like London and Hong Kong to creep closer to NY as the preeminent location for global finance.
- 2003--Iraq War begins…No matter how any of us feel politically about war, the fact remains that it has been costly.
- 2004--President Bush Re-elected…Again, no matter how any of us feel politically, re-election meant staying the course for the US both internationally and domestically.
- 2005--Significant Oil Price Increases…Not sure if oil shocks in 2005 can be described as a bubble, but certainly provided a mixed year for equity markets, with the S&P 500 index creeping up only 3%. Certainly those industries dependent on oil continued to be hurt by prices.
- 2006--Dow Reaches 12,000…Big movement for equity markets in 2006 with the Dow Jones Industrial Average reaching new highs. Additionally, the Democratic Party seized control of Congress in the 2006 mid-term elections.
- 2007--Sub-prime mortgage crisis…First thought to be the only “problem area” for the mortgage business we soon quickly and painfully learned that securitization of those loans meant that no investor knew who was holding the proverbial bag (of bad debt). 2007 also marked the official start of recession.
- 2008--Global Financial Crisis…Markets bounced around quite a bit throughout 2008, but it was not until Lehman Brothers bankruptcy on September 14th that the systemic financial problems were truly revealed. AIG’s would soon follow, and before we knew it, we all became majority shareholders in the insurance giant.
- 2009--The Great Recession…It bears noting just how bad 2008 was: 8of 500 companies on the S&P 500 index posted positive returns and it was only the 5th time in history stocks and bonds had losing years simultaneously. Policymakers have walked a pretty impressive tightrope in 2009. I believe the S&P 500’s “roar-back” in 2009 came from a negative overreaction in late 2008. Real planning and strategy will begin to play a larger part in the process as we move in to 2010 and beyond.
Subscribe to:
Posts (Atom)