The world’s debt and equity markets are hitting a rough patch due to slowing growth in certain parts. Fear of what might happen when the world’s central banks stop their loose money policies and “profit taking” is beginning to grow.
One of the first questions we get asked when we meet is, "what is 'fee only' and how does it differ from commission based wealth planning?" Envision Wealth Planning President & Founder, Bob Bolen, explains here the differences between the two, and how those differences impact the client.
I trust you had a wonderful Thanksgiving holiday, that you didn’t get trampled on Black Friday and that you worked on your cyber stocking on Cyber Monday. We enjoyed Thanksgiving Day with our nuclear family, including our daughter in from college, Saturday with my extended family and Sunday with my wife’s extended family. Time with family and the fellowship were awesome. At the office, we’ve bought some new furniture and wall art to give us a new look. We bought everything online, saving money and time. Isn’t technology great? Please come by and check out our new look when you get a chance.
As we round the corner towards the end of this “fiscal cliff” year, I wanted to remind you of the numerous tax planning opportunities available to you. The most obvious is contributing to your company retirement plan such as a 401k or 403b. Employee contributions limits of $17,000 (or $22,500 for those over age 50) are tax deductible so, depending on your tax bracket, upwards of 25% of every $1 contributed is a gift from Uncle Sam. Company matches make the deal all the sweeter. If you are self employed, a SEP or SIMPLE IRA works the same way. Contribution limits on a SEP are limited to 20% of adjusted gross income and $11,500 with a SIMPLE ($17,000 if over 50.) There are customizable retirement plans available to those willing and able to save more. Let us help you set something up and get the savings started.
Retirement plans are the best tax reduction tool available for the longer term and it will also set you up for a great retirement lifestyle. Regular contributions (dollar cost averaging) into a diversified portfolio of stock, bond and “alternative” funds, regardless of the current economic sentiment coupled with the miracle of compound interest, is the best way to grow the funds necessary to pay for the retirement of your dreams.
If you don’t have a company retirement plan or even if you do within certain income limits, contributions to a traditional IRA are tax deductible as well. You can contribute up to $5,000 ($6,000 if over age 50) and have until April 15, 2013 to make your 2012 contribution. Even if the IRA contribution is not tax deductible, growth in the account is tax deferred so is a great tool to grow your retirement nest egg. And if the IRA is not tax deductible, contribute to a ROTH IRA and the account will grow tax free forever. There are qualifications rules around ROTH contributions so give us a call if you are interested in getting this going.
For high income earners that don’t qualify to contribute to a Roth IRA, you can still contribute to a traditional IRA and then immediately convert it to a Roth and benefit from tax free growth. Even if your budget doesn’t allow for an IRA contribution this year, but you have savings from years past, you can contribute to your IRA out of savings. It doesn’t have to come from earnings directly.
Charitable gifts are another way to help in both reducing income taxes and possibly estate taxes. Within reason, gifts to charitable organizations are tax deductible against earned income. Gifts of property are deductible at stated value, but appraised value is recommended for gifts above $10,000.
By now, if you have a TV you are well aware of the looming “fiscal cliff”, the tax increases and government spending cuts set to go into effect on January 1. What is not being covered by the popular press is the strong growth that is likely to result from the fiscal restraint and smaller deficits. While these changes would indeed likely push the economy into a shallow recession next year, the independent Congressional Budget Office projects accelerating growth in 2014 and beyond along with dramatically reduced deficits. This is not the draconian situation the press has been peddling. Rather, it is a recipe for better days ahead.
If Congress fails to act, the federal estate tax exclusion is set to revert back to $1.0 million per person from the current $5.0 million. I do think Congress will ultimately come to an agreement, but who knows with all of the crazy year-end posturing going on. The lifetime gift exclusion this year is also $5 million, but on January 1 goes back to $1.0 million. So if you are in a position to make a sizable gift to loved ones, to charity or a trust and want to improve your taxable estate situation, time is of the essence. Annual gifts of $13,000 per individual or $26,000 for a married couple are an excellent tool to help out your loved ones and move money out of your estate.
The so-called Bush era tax cuts are set to expire at year end, raising marginal income tax rates across the board, increasing long term capital gains to 20% from 15%, eliminating favorable tax treatment of qualified dividends. As well, a host of other tax increases are pending including an increase in the Alternative Minimum Tax calculation and a 3.8% Medicare surtax on income above $250,000 to help fund so-called Obama Care. For perspective however, the top marginal tax bracket would rise from 35% to 39.6%, which still compares very favorably to the 50% top marginal tax rate in the early ‘80’s, 70% in the ‘70’s and fully 90% during the 1950’s.
If you have the ability to accelerate income into 2012 or defer business expenses into 2013, that might make sense at the margin. Or if you expect to sell some assets in 2013 to fund purchases, it can make sense to sell the holdings this year to lock in the 15% capital gains rate and avoid the 3.8% surtax. I’m not a fan of selling out of fear of taxes rising. The market does a remarkable job of discounting the full set of possible outlooks and it is hard to beat Mr. Market at its own game. But, if you expect to sell in 2013, then selling early should definitely be a consideration.
Last, but not least is taking any short and long term losses against gains, thus lowering the tax bite. We’ve had a good year in the market so losses are minimal, but we’ll review your portfolio, see what we can do and do what we can. Importantly, if we don’t have your 2011 tax return, please send it to us. If you have tax-loss carryovers on the books, those will inform our year end gain and loss harvesting strategies.
Dear Clients, Friends and Associates,
People are living longer. In less than 100 years, life expectancy has gone from barely 50 years old to over 80. Not only are we living longer, we are literally dying more slowly. People used to pass on in days or months, from heart attacks, strokes, fast acting cancers and what not. These days, through medical advances, it often takes years of declining health before we meet our makers. In addition, the cost of healthcare seems to inexorably march higher. This combination of forces increases the need to analyze your potential need for long term care and how you might pay for it.
The need for long term care arises when an individual is not fully able to care for him or herself. That is, they are unable to perform the basic “Activities of Daily Living” without assistance.
In addition there are Instrumental Activities of Daily Living. These are not necessary for fundamental functioning, but they let an individual live independently within a community. They speak to quality of life. They include the ability to do housework, take medications as prescribed, manage money, shop for groceries or clothing, use of telephone or other form of communication, using technology (as applicable), and being able to drive within the community.
As we age many of us will be faced with the need for help with this kind of care; possibly for an extended period of time. In fact, Statistics show that around 70% of people over age 65 require some type of long-term care services during their lifetime. The average length of stay for those that go into an assisted living or nursing home is 2-3 years.
What does long term care cost? Unfortunately, this is not a cheap adventure. The average daily cost of a private room in a nursing home in Nashville is more than $200 per day. For those keepings score, that’s over $73,000 per year. Even in-home assisted living can run upwards of $100-$150 per day, depending on one’s needs. As you can imagine, this can quickly deplete the nest egg you’ve worked so hard to build, or at the least put a big dent in anything you might have otherwise left to the children.
What are your options? Fortunately, there are ways to prepare for the costs of long term care. For younger individuals, it could be wise to set aside a few extra dollars each pay period. Older, wealthier clients may find that they have sufficient assets to cover the costs without significantly harming the amount of money to be left to their heirs. For individuals without sufficient assets to pay for care and not enough time to save, a long term care insurance policy may be the best solution. Paying premiums can be a headache, but sleeping better at night knowing your nest egg is protected may be well worth it. Even if you can afford to self insure that may not be the best course of action if you are insurable. Would it irritate you more to pay a few thousand dollars each year for insurance that you may not use or upwards of $75,000-$100,000 per year for long term care that you may?
We do not sell insurance, but we absolutely can help you estimate the cost of acquiring LTC insurance and discuss the different policy options available. Many of the bells and whistles add to costs and are not necessary, but some, such as the inflation rider, are absolutely essential. The best time to begin discussions about acquiring LTC insurance is in your mid 50’s. Premiums go up sharply after age 60 and can get quite expensive as you approach 70. Most people don’t need help until into their 80’s so expect to pay premiums for 15 or 20 years before needing the insurance. But it only takes one year of care to pay for all those years of premiums.
Our vision is that people live inspired lives, free from worry about their money matters. If you are concerned about the effects of long term care on your wealth and standard of living, please give us a call and we’ll help you think through your options.
Dear Clients, Friends and Associates,
The market has really taken it on the chin this past month, giving back most of the hard won gains seen in the first quarter of the year.
Resurgent concerns about the so called “European debt crisis” and the
resulting ramifications to the rest of the world’s economies has caused
renewed fear and a “flight to quality.” More specifically, investors are
concerned about whether or not Greece would stay in the Euro zone and what impact this might have on other, weaker countries such as Spain, Portugual and Italy. Then, on Friday, the U.S. employment report was weaker than expected with employment growth of 69,000, well below expectations of 150,000. The results was quick 2%+ decline in market averages.
The questions that come to my mind are what can we infer from this new information and what might we expect next. A question on many investor’s minds is can they improve their situation by participating in the desirable market advances while avoiding these unfortunate market down drafts by “timing the market”?
Clearly the EU Central Bank and European governments are working hard at keeping Greece in the Eurozone Monetary Union and limiting the chaos that might ensue of they do exit. After a May election when the leading parties failed to form a coalition government, Greece is facing a vote on June 17th whereby all 300 Parliament members are up for election. This is widely considered a do or die referendum on whether or not Greece will remain in the Eurozone. I believe there is at least a 60%-70% probability Greece exits. This in itself is not a major issue, given that Greece is only 3% of the Eurozone’s Gross Domestic Product. The concern lies more with “contagion” and whether or not this would cause other weak countries begin to fail and/or leave the Eurozone as well. Of course no one knows for sure what will happen, but many leaders are working hard to prevent
The important thing to understand is that everyone is talking about and analyzing the possibilities ad nauseum. As such, market prices fully and completely discount at any given moment the most likely outcomes. For example, Friday’s decline on the news of less than expected employment growth is the markets best guess of what prices should be given this new information. To achieve “abnormal” returns one must correctly discern if the economy is going to worsen beyond what the market already thinks it will. Things may get worse and prices fall further, or they may get better and rise. The point is, the market is always priced to rise by its average annual risk premium rate of return. That is the only way to incentivize investors to buy at current prices. Remember, for every seller on Friday there was a buyer.
One can observe that markets always recover. That is because the cause of the downturn dissipates and economies eventually heal. As long as capital can flow to where it is treated well and markets are allowed to heal, markets will recover.
To make money by selling on advances and buying on pullbacks requires being right twice, once when selling and again when buying. As well, one must do this consistently while overcoming the burden of transaction costs, fees and taxes. While this is an appealing concept and one talked about endlessly by the talking head shows, there is no evidence indicating it is possible beyond the occasional stroke of luck. None. The closest one can come is rebalancing portfolios back to a strategic allocation, which forces a buy low, sell high discipline. This is a tool we use to our and your advantage.
Of course, as a client of the firm, you have plenty of cash to meet your short term needs and enough funds allocated to fixed income to cover an additional 4-7 years of net spending needs. The only funds you have allocated to equities are funds you won’t need for a minimum of 5 years on out to 20, 30 or even 40 years. So please don’t get too excited about a short term move in the market. This the price that is paid to get well above average returns over time.
Dear Clients, Friends and Associates,
A few weeks ago I summarized the first part of a particularly useful section in Warren Buffett’s recently released annual letter to shareholders entitled “The Basic Choices for Investors and the One We Strongly Prefer.” The bottom line of that email is to properly define your risks when investing and the biggest risk to investors is loss of purchasing power over the anticipated time horizon of the investment. Short term volatility is not necessarily risky if your time frame is expressed in years or even decades.
Buffett goes on to describe three major categories of investments: 1) Investments denominated in a given currency, such as money markets, CDs, bonds, etc; 2) Non-producing investments, such as precious metals; and 3) investments in productive assets such as businesses, farms or real estate.
Investments denominated in a given currency, such as money markets, CDs or bonds are often thought of as “safe” because they are not very volatile, but Buffett warns us that “In truth they are among the most dangerous of assets.” He is notably concerned with negative impact of inflation on purchasing power over time. He notes that it “takes no less than $7 today to buy what $1 did in 1965.” For tax-paying investors, U.S. Treasury bills produced an average of 5.7% annually. Subtracting an average 25% tax burden leaves a 4.3% after-tax return, which according to Mr. Buffett, was evaporated by inflation over that time frame. So although investors still have their account balances in tact, they had no real return to show for 47 years of effort. At current interest rate levels, “real” returns (after inflation) are in some cases negative. This is a tax on savers as real as any tax. Buffett quotes Shelby Davis as saying “Bonds promoted as offering risk-free returns are now priced to deliver return-free risk.” Given that bonds are offering yields at 30 year lows, this is serious food for thought. Clearly, there is a place for fixed income investments for shorter term goals. The point is though, to be sensitive to other forms of risk besides volatility and understand what your real return expectations are over time.
The second major category of investments produces nothing. It is purchased in the buyer’s hope that someone else will pay more for them in the future. We are talking about precious metals, most notably gold. Gold neither has much use nor is it procreative. It relies on ever increasing demand by the ranks of the fearful. Buffett notes that “if you own one ounce of gold for an eternity, you will still own one ounce at its end.” While the self fulfilling nature of rising prices creating its own demand works for a while, it eventually succumbs to reality. Note the Internet and housings bubbles. According to Buffett, the market must absorb around $160 billion in annual production just to maintain equilibrium at present prices. Buffett suggests strongly that rather than buying gold, investors purchase a productive asset, such as businesses or farm land. Businesses and farm land throw off handsome cash flow, or wheat, corn, cotton or other crops year after year. Yet gold owners will still just own their ounce of gold. Buffett’s thoughts really put the current raging bull market for gold in perspective.
The first two investment categories enjoy maximum popularity at peaks of fear. Buffett’s own preference, widely expected, is the third category of investing in productive assets, whether businesses, farms or real estate. Buffett maintains that “Ideally, these assets should have the ability in inflationary times to deliver output that will retain its purchasing-power value while requiring a minimum of new capital investment.” He points to farms, real estate and businesses such as Coca-Cola, IBM and See’s Candy as meeting that double-barreled test. Utilities require capital investment to grow earnings, but even so, “these investments are superior to nonproductive or currency-based assets.” The value of businesses, farms or real estate will be determined but by the medium of exchange, but rather by their capacity to deliver goods and services demanded by the masses. Buffett maintains appropriately that over any extended period of time, this category of investing will prove to be the runaway winner among the three alternatives he’s examined and more importantly, it will be by far the safest.
Thank you, Mr. Buffett for your insightful commentary. Well said.
Warren Buffett’s annual letter to Berkshire Hathaway’s shareholders is well known for its pithy and often poignant commentary and this year’s letter is no exception. Tucked between detailed commentary of his many businesses and important information for attendees of the upcoming May 5 annual meeting in Omaha are three pages of analysis that all investors would find beneficial. The title of this section is “The Basic Choices for Investors and the One We Strongly Prefer.”
Mr. Buffett starts this section with the generally accepted definition of investing as the process of laying out money now in the expectation of receiving more money in the future. At Berkshire, they take a more demanding approach, defining investing as “forgoing consumption now in order to have the ability to consume more at a later date, net of taxes and inflation.” Notice the emphasis on consumption is in terms of purchasing power rather than money per se, because inflation is important element in the equation.
He goes on to state the “riskiness of an investment in not measured by market volatility (beta), but by the reasoned probability of an investment causing its owner a loss of purchasing-power over the contemplated holding period.” His point is that assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period.
This emphasis on expected holding period is a key to investing well and is the basis of Bolen Dodson & Associates “Goals-based Investing” approach. You need cash for spending. Fixed income is best used for spending over the next few years. Bonds are not very volatile, but they do not produce returns net of taxes much if at all in excess of inflation either.
Equities are meant for longer term goals of 5-7+ years and beyond. Equity investments are volatile over the shorter term, but are quite predictable over the longer term. Knowing when you plan on using the funds is an important element to successfully investing in equities. Being afraid of short term volatility is a recipe for failure.
In a subsequent blog, I’ll summarize Buffett’s investment choices and his preference. One guess on what he prefers.
Last week’s market action was downright ugly. I’ve reviewed my basic impressions of market fundamentals and technicals and observe the following:
- Economic and corporate indicators continue to point to modest economic growth. Leading economic indicators rose again in August. Prices are undervalued.
- Markets discount a Greece default on its debt obligations. Concern of “contagion” is a major cause of U.S. equity declines. However, Greece appears dedicated to not letting this happen. If it does, markets will be chaotic for a spell and likely create a further buying opportunity.
- Consumer sentiment is very poor. While this could induce the first ever confidence led recession, odds are it is setting the stage for capitulation and a rebound.
- A recession is priced into the equity markets yet the odds of a renewed recession are only 25%-30%. This is bullish.
- Market trends are decidedly down, but selling during a market decline has not proven to be a winning strategy. Markets always eventually rebound and they can turn very fast, often when things look bleakest.
- The best course of action is to maintain liquidity for spending purposes and rebalance portfolios, buying equities to take advantage of the market pullback.
While the media was fixated on the looming debt ceiling/default date of August 2, several not-so-well covered news releases painted a glum economic picture. So even though Congress and the President came through with a last minute deal (as expected), investors immediately turned their attention to economic activity and didn’t like what they were seeing and knocked another several percent off the market averages.
On July 29th, the Bureau of Economic Analysis released its initial estimate for the 2nd quarter “real” GDP growth (Gross Domestic Product) of a weak 1.3%. More notably, the BEA revised downward 1st quarter growth from an already weak 1.9% to a paltry 0.4%. What this means is the economy is growing very slowly and not enough to create jobs in any meaningful way. The BEA also revised downward GDP growth data from 2003, which of course included the “great recession” of 2008-2009. The 4th quarter, 2008 contraction was changed from -6.8% to -8.9% and the 1st quarter, 2009 was lowered from -4.9% to -6.7%. The cumulative decline from the 4th quarter 2007 peak to the 2nd quarter 2009 trough in real GDP was revised downward almost 50 basis points (0.5%) to -5.1%. These are huge negative revisions and indicative of how severe this recession was, and how far we have to climb to get back to where we were.
Then on August 1, the Institute of Supply Management released its July manufacturing report, which showed growth in manufacturing, but at a slower pace then June and below expectations. The question in my mind is how much of this slowdown was caused by Congressional inaction on the debt ceiling debate. When consumers are uncertain about the future, they hold on to their cash and quit spending.
As well, the drum beat of potential further European Union credit defaults continues. The European Central Bank is in talks with Italy, Spain and others in efforts to contain the potential for Greece like defaults. While this could clearly get messier, systemic failure of the banking system seems highly unlikely.
Global economic activity throughout most of the first decade of the 21st century was helped in no small measure by easy credit and overuse of leverage, by both the consumer and world governments. This is now unwinding. Asset bubbles have burst and easy credit is gone. This process will not be rushed. We cannot push on a string.
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and formerly chief economist at the IMF has written an excellent article that reframes the issues of the day. He suggests that rather than having come through a Great Recession, we are going through the second Great Contraction. This makes complete sense to me. See the article here: http://www.project-syndicate.org/commentary/rogoff83/English.
The consumer is now retrenching. Savings and debt reduction is in vogue more so than over spending. We hope this continues as it is very bullish for the economy longer term. For its part, the Federal Government is now talking about actual deficit reductions. The debt deal earlier this week is hardly a down payment on what must be more substantive talks on our Government, and its people, living within its means.
The market is a discounting mechanism so responds to changes in expectations. You are seeing this up close and personal this week. Adjustments happen quickly to reflect the new information. The best guess of the “appropriate” market levels that reflect all the positives and negatives of the day, are the current prices. That is today, tomorrow and every day hence. Regardless of the current dislocations in the economy and in the markets, investors are well served by adhering to their strategic asset allocations while maintaining cash for this year’s spending needs. We will rebalance portfolios when appropriate to buy the underweighted asset class and sell the over-weighted asset class. Without fail, markets always resolve corrections to the upside….sometimes quickly….sometimes slowly….but always. Today’s employment release was a fundamental step in the right direction, but the market is not quite ready to agree…yet.
We are cognizant of human behavior and recognize that people get concerned when their nest eggs are rattled. But markets regularly correct and then once again move higher. I’m sure we are all suffering from some PTSD from the 2008-2009 “Great Contraction”. However, there is nothing remotely similar to the current situation and that series of events.
While currently the market is focused on the slow down in the economy and the potential for European contageon, there are several reasons to be optimistic. Corporate earnings are strong; oil is down 10% from its recent high; there are no major dislocations in credit markets; inflation is benign; interest rates are low; consumers are saving (allowing for future investment); Congress is serious about reducing our deficits; equity valuations are quite compelling; fear is running high (a contrary indicator); and the market is already down 11% since July 22.
We are available for questions, to provide additional commentary or to hear your concerns.