Seven Financial Resolutions for the New Year (2010-12-27)

by David John Marotta

Financial resolutions usually don't even last until the end of January. Making a permanent change in our behavior requires both time and a steely resolve. We can only develop financial character one action at a time. Here are seven practices to take you from pauper to prince or princess if you add one each year.

Read through the list. If you already practice the resolution, move on to the next one. Adding one behavioral change is labor enough for the next 12 months. Keep it long enough for practice to become habit, and you are on your way to developing a millionaire mindset.

Share your resolution with everyone you meet. You are 10 times more likely to act on a goal that you have articulated to someone else. Don't wait until you have everything perfect to take ownership verbally.

First, and most critical, resolve to be and stay debt free. You may have a fixed-rate fixed-year traditional mortgage on your house but nothing else. No equity line of credit on your house. No car payments. Certainly no credit card debt. You have to learn to live within your income, which sometimes means going without. Millionaires are frugal. Learn to enjoy it.

Second, automate saving enough to get the entire match that your company's 401(k) plan offers. Usually this translates to saving 5% of your salary while the company contributes a 4% match, the fastest way to get an 80% return on your money. Most Americans forgo this match, believing they need to spend 100% of their salary. But you can learn to think like a millionaire and live well on 95% of what you make.

Next, fully fund your Roth IRA ($5,000 in 2011). If you can't manage the entire amount in January, put in $416 monthly.

Automating deposits in an employer-defined contribution plan is easy. Fortunately, automating saving in a Roth IRA or a taxable savings plan is equally painless. Most brokers offer an automatic money link between your checking account and an investment account. Set your savings on autopilot.

Fourth, save an additional 5% of your salary in a taxable account. Again, set up an automated transfer. You need taxable savings for a host of financial planning opportunities as well as for a plethora of life's challenges.

By now you are saving 15% to 20% of your salary and living off the remainder. Learning to live deferring many of your wants until later is a crucial habit that millionaires have cultivated. Money makes money. And the money you need to make money is called "capital," defined in textbooks as "deferred consumption." Money spent is gone forever. Money saved and invested works for you, adding income every year.

Fifth, save an additional 10% for charitable giving. Many millionaires might suggest being generous should be number one on your list. But until you have your own financial security on track, it is difficult to help others don their own oxygen masks.

No matter where you think charity belongs in your priorities, a sensitivity to the truly needy will change your perspective about distinguishing needs and wants. Many millionaires live simply in order that others may simply live.

Save this additional 10% in your taxable account. By now you are saving 15% in a taxable account. For your charitable giving, gift the investments from the account that has appreciated the most.

No matter which worthy organizations you support, you can donate up to 20% more if you give appreciated stock instead of cash. If you sell $1,000 worth of appreciated stock, you will have to pay the capital gains tax of 20%. If most of the stock's value is appreciation, the tax owed approaches $200, leaving only $800 for charitable giving. But if you give the stock directly to the charitable organization, you can take the full $1,000 tax deduction, and the organization will not have to pay any taxes when it sells the stock.

Up until now you may have been giving cash to charities. Now that you are developing some taxable savings, run your giving through your taxable investments. For every $1,000 of appreciated investments donated, use the $1,000 in cash you would have gifted to buy additional investments. Think of this as planting the saplings you will harvest later for future gifting.

After several years, your $1,000 worth of cash should have grown to $2,000 worth of investments. Gifting a $1,000 worth of appreciated investments leaves the original $1,000 to keep increasing in value and fund future giving. This is one reason why frugal supersavers can be much more generous than those whose rich lifestyles preclude saving and investing.

Sixth, save an additional 10% in your taxable account for unknown unknowns. If your response is to ask, "Like what?" remember that you can't plan for everything. But you can save cash for the unexpected.

Families inevitably encounter cash flow problems because of unanticipated expenses. If you are living paycheck to paycheck, your budget cannot handle large unplanned outlays such as the car breaking down, the roof leaking or emergency medical bills.

When a financial crisis strikes, you will be glad to have an emergency fund. Afterward, see if you could have predicted the expense, and adjust your plan accordingly. Budget each month for the inevitable expense of buying your next car. Budget for replacing your roof. The more you can foresee these expenses, the more this category can fund discretional big purchases instead of financial emergencies.

At this point you are saving more than 35% of your salary and living on less than 65%. This is the benchmark for a millionaire mindset. As you save and invest, the appreciation on your investments can provide income that replaces your salary, bringing you closer to financial freedom. When you can replace all of your income, you are free to retire or tackle challenges that do not make you any money.

Every 25% of your salary you save replaces over 1% of your regular income in retirement. Money makes money, which then gives you the gift of financial freedom.

The seventh and final challenge is to expand this financial engine beyond 35% toward 50%. Living off half your income requires a frugal lifestyle in comparison to your income. Impossible, you say? Unless you are among the truly needy, there are families out there living comfortably on less than half of what you earn.

And if you are among the genuinely wealthy, the only obstacle standing in your way is being accustomed to an affluent lifestyle. Learn to value financial freedom over opulence. Developing an engine of wealth production takes foresight and self-restraint in addition to time and patience. But the reward is financial peace and contentment.



from http://www.emarotta.com/article.php?ID=432

The Poorhouses of  "A Christmas Carol" (2010-12-20)

by David John Marotta

There are few better stories for talking about economics than Charles Dickens's "A Christmas Carol." Perhaps the most telling discussion in the story comes early in the first chapter when "two portly gentlemen" call on Scrooge to ask him for a donation to charity.

Dickens describes them as portly to show their affluence and success, not their weight. They were probably large and heavy in a dignified and stately way. Given that few people in those days had enough to eat, today we would probably describe them as well fed or robust. Dickens describes them as pleasant to behold.

These two portly gentlemen have made a list of establishments to visit and solicit for donations. They approach their charity work like they do their businesses, with organized efficiency. They have papers and books. They come as a team. They present their credentials. They are polite. They remove their hats.

Subsequent reinterpretations of the story often try to make capitalism Scrooge's problem and government-run social programs the answer, but that was not the case in Dickens's day or in his story. The two portly gentlemen are capitalists and entrepreneurs. Their initiative extends to good works within their community.

They are passionate about their charitable work. They assume the best about Scrooge and his former partner. Their liberality is to make slight provisions for the poor and destitute who suffer during the Winter Season. They know their efforts will not end poverty for all time. They are simply trying to spread some "Christian cheer of mind and body."

The two gentlemen focus on providing some meat, drink and means of warmth. The poor have nothing but a meager allocation of bread and gruel. They would like a little more bread. Some meat would be a great kindness. Drink and warmth are a great extravagance.

Scrooge will have none of this personal philanthropy. He argues that public entitlements are the solution. "Are there no prisons?" he asks. "And the Union workhouses? Are they still in operation? The Treadmill and the Poor Law are in full vigour, then?" After hearing these are still active, he complains, "I help to support the establishments I have mentioned: they cost enough: and those who are badly off must go there."

Dickens was very critical of the New Poor Laws passed in England in 1834 by Lord Melbourne's government. They altered the locally administered structure run by local parishes into a centralized system of workhouses. These changes cost more money and provided less relief.

The New Poor Laws were influenced by the ideas of three writers of the day. The first was Thomas Robert Malthus, who advocated limiting population growth so it wouldn't increase faster than food production. Families were split up in the workhouses into three separate barracks to discourage conception.

The second writer was David Ricardo, who argued that wages naturally tend toward a subsistence level. This view, called the "Iron Law of Wages," influenced Karl Marx's dim view of the prospects of workers benefiting from capitalism.

And the third was the philosopher Jeremy Bentham, whose idea was utilitarianism, or the idea that the moral or ethical thing to do was whatever brought the greatest happiness to the greatest number of people. Similarly, laws ought to be structured to discourage what hurts society and encourage what helps society. That these principles be put into place with draconian authoritarianism is irrelevant to his view of ethics.

That each of these thinkers was wrong was unfortunate. That the government instituted their ideas was catastrophic. One of the two portly gentlemen reminds Scrooge, "Many can't go there; and many would rather die." Scrooge's reply is Malthusian and utilitarian: "If they would rather die, they had better do it, and decrease the surplus population."

Make no mistake. Scrooge is the advocate of the sufficiency of the state to involve itself in society's welfare. Ill-conceived government programs are able to inflict misery better than any private charity. They have the force of law. How effectively the government actually does the job, Scrooge argues, is none of his business. He pays his taxes, minds his business and no additional concern is required.

Charles Dickens opposed the New Poor Laws as cruel and unchristian. He wrote "Oliver Twist" in 1837 and "A Christmas Carol" five years later partly as a response to this legislation. And in 1850 he wrote the journalistic account "A Walk in the Workhouse," in which he decried the conditions he found.

Dickens's biographer Jane Smiley described his competing philosophy this way: "It is not enough to seize power or to change wherein society power lies. With power must come an inner sense of connection to others that, in Dickens's life and work comes from the model of Jesus Christ as benevolent Savior. The truth of 'A Christmas Carol' that Dickens understood perfectly and bodied forth successfully is that life is transformed by an inner shift that is then acted upon, not by a change in circumstances."

We see that transformation in Scrooge when the nameless and faceless poor over which he has little power and means to save are replaced by his own clerk's crippled son Tiny Tim. Whereas the nameless masses might be undeserving and able bodied, Tiny Tim is both a child and disabled.

"Oh no, kind Spirit! Say he will be spared," Scrooge laments, only to hear the Ghost respond, "If he be like to die, he had better do it and decrease the surplus population." Scrooge lowers his head in shame at hearing his own words and is overcome with penitence and grief.

Mercy embodies the idea that God puts the responsibility of alleviating some of the suffering in the world on you. God doesn't charge you with all of it. And God doesn't expect you to solve the problem completely. But He does expect you to be open to being the person He chooses to use to help. This openness does not solve the problem of trying to determine where God wants you to put your resources to work. Starting a viable business and hiring people can be an act of the highest charity. So can giving to charitable causes. The principle is summarized in apostle Paul's letter to the Philippians 2:3: "Do nothing from selfishness or empty conceit, but with humility of mind regard one another as more important than yourselves."

Dickens believed in the power of a changed heart. In "The Life of Our Lord" he wrote, "people who have been wicked . . . and who are truly sorry for it, however late in their lives, and pray God to forgive them will be forgiven and will go to Heaven too."

The moment of Scrooge's redemption occurs when struggling with the final Spirit, he holds "up his hands in one last prayer to have his fate reversed." At this prayer the Phantom shrinks and dwindles down into a bedpost.

We see Scrooge's changed heart on Christmas Day. He sends the prize turkey to the Cratchit family. He raises Bob Cratchit's salary. But perhaps most convincingly for men of business is his generous giving to the two portly gentlemen including a great many back payments.

A changed heart freed from past sins is a powerful force of authentic spirituality in life. If you believe all of your time, talent and wealth belong to God, you won't make any distinction between the charitable work you do for God and the rest of your life. And you won't have any fear about doing what a benevolent God sets in your path to do.

 

from http://www.emarotta.com/article.php?ID=430

The Two Portly Gentlemen Are Entrepreneurial Philanthropists (2010-12-13)

by David John Marotta

As I do every December, I have been enjoying rereading "A Christmas Carol" by Charles Dickens. This year I've been thinking about Scrooge's interaction with the two portly gentlemen who stop by to collect for the poor. These entrepreneurs represent one of my favorite financial personalities.

In his book "Why Smart People Do Stupid Things with Money," Bert Whitehead describes different financial personalities. He depicts an "entrepreneur" as someone who tends toward greed rather than fear but is balanced between a propensity to save or spend.

Whitehead maps financial personality on two different scales. The first measures people's tendency toward greed or fear. As entrepreneurs, the two portly gentlemen are motivated by greed (high risk acceptance). Ebenezer Scrooge shares this same inclination. The two men see opportunities and the risk excites them. Even soliciting funds for the poor is an integral part of their entrepreneurial spirit.

When the two portly gentlemen stop by Scrooge's office soliciting charitable donations, they discover his partner Marley has been dead for seven years. One comments, "We have no doubt that Marley's liberality is well represented by his surviving partner." The narrative continues, "It certainly was; for they had been two kindred spirits."

Liberality toward others cannot come from someone motivated by fear. Distrust drives out emotions like kindness and compassion. Later in the story, Scrooge confirms this condition in Marley as he looks through his ghostly form and remembers ironically that it was said of Marley he had no bowels. Marley had no empathy for others because he was overly anxious for himself.

When fearful misers like Marley move from savings to spending, they move first to a bon vivant and then to a shopaholic personality. Their fear motivates them to spend more but only on themselves.

Scrooge, in contrast, is more of a risk taker. Thus as he shifts toward spending some of the wealth he has accumulated, he moves squarely into the entrepreneurial financial personality shared by the two portly gentlemen.

Whitehead's second scale measures an individual's tendency to save or spend. Here the two portly gentlemen are balanced between thrift and spendthrift, whereas Scrooge is a practiced saver. A risk taker who is also profligate would be considered a gambler personality. These two gentlemen are balanced between these two extremes.

Many of our clients are small business owners. They are fascinating and passionate people to work with. They are willing to take the risks required to cultivate a business, and they devote their time and effort into doing what it takes to make it succeed. Their family and friendships grow out of running their business. They employ their children.

Interestingly, their sense of mission about their companies extends to combining corporate and charitable intent. According to a 2010 Ernst and Young study, <a href="http://www.charitablegift.org/about-us/news/11-12-2010.shtml"> Entrepreneurs and Philanthropy</a>, nine of ten entrepreneurs extend their personal giving practices to the corporations they run. The motivations they cited as most important were to give back to their local communities and to incorporate their personal philosophy into their corporate culture. In addition to starting their own businesses, 43% have started their own charities.

Most entrepreneurs surveyed have a quiet or passive giving style. Although their involvement may be known, they prefer not to be overtly recognized. Most have made charitable giving an essential part of their personal financial planning. They are as intentional about the causes they champion as they are about their companies.

You might think entrepreneurs possess the perfect financial personality, but they do have their weaknesses. First, they have a tendency to overwork. Perhaps this is how the two portly gentlemen acquired their girth by sitting behind their desks too long. Nesters spend less money and more time at home; travelers spend more money enjoying diverse experiences. In this regard the philanthropy of entrepreneurs is a healthy diversification of their business interests to "making mankind their business."

The second weakness is a tendency to run out of liquid assets. Entrepreneurs often sink all of their treasure as well as their time in their work. They are also much more tolerant of risk and wild swings of fortune. When times in their businesses get tough, they need to have liquid assets to survive a negative cash flow. Having a diversified base of liquid investments and lines of credit established during the good years can mean the difference between survival and bankruptcy.

Most entrepreneurs have complex finances but don't have the time to handle all the moving parts. But with great complexity comes great opportunity. Fiduciary advisors are invaluable to an entrepreneurial family. They can free them from some of the details and allow them to focus on their core business. They can also be proactive in suggesting aspects of comprehensive wealth management where small changes can have an enormous impact.

Delegating and accepting advice is the other impediment to entrepreneurs working with a financial advisor. They are accustomed to being the smartest people in the room, and a traditional commission-based agent or broker has little of value to offer. They need an expert, a savvy and reliable advisor to whom they can delegate key aspects of their financial well-being. They need a fiduciary who sits on their side of the table and has a legal obligation to act in their best interests.

The National Association of Personal Financial Advisors is the best organization I know to find such an advisor in your area. Visit <a href="http://www.napfa.org/"> www.napfa.org</a> to find a fiduciary advisor worth trusting.

 

from http://www.emarotta.com/article.php?ID=429

You Deserve a Fiduciary Standard of Care (2010-12-06)

by David John Marotta

Most investors are not aware of a critical division of professionals in the world of financial services. This distinction lies between fee-only fiduciaries who are free to act in your best interests and commission-based agents and brokers who are required to act in the best interest of the companies that employ them. Even when people have some inkling about the differences, several important misconceptions continue about both the nature of the problem and an adequate solution.

Fiduciaries are bound by a code of ethics. They take oaths and their conduct is based on applying ethical principles. The Certified Financial Planner (CFP) Board of Standards has a published code of ethics that includes seven principles including integrity and fairness. It states, "Integrity demands honesty and candor which must not be subordinated to personal gain and advantage." And "Fairness is treating others in the same fashion that you would want to be treated."

The National Association of Personal Financial Advisors (NAPFA) offers a similar guideline in their fiduciary oath. Advisors promise to "exercise his/her best efforts to act in good faith and in the best interests of the client." These ethical guidelines imply standards of conduct far above what may be legal. They demand what is right. They require the highest obligation of care, good faith, trust and candor.

In contrast, the nonfiduciary world is based on rules rather than on principles and ethics. If an agent has followed the correct procedures, has the paperwork in order and has client signatures on the correct disclaimer forms, no rules have been broken. The behavior can be called unethical, but it is not illegal. Thus additional rules do not necessarily translate into exemplary conduct.

This is one reason why investment advisors objected to a proposal to give the Financial Industry Regulatory Authority (FINRA) oversight of fiduciary advisors. FINRA governs nonfiduciaries such as agents and brokers by means of rule-based conduct. Such an approach is diametrically opposed to being a fiduciary.

NAPFA strongly advocates a fiduciary standard. As part of the oath that NAPFA advisors sign, they pledge they will "not receive a fee or other compensation from another party based on the referral of a client or the client's business."

NAPFA also promoted the idea of a "fee-only" advisor. Their ad campaigns were largely successful at raising public awareness about the difference between advisors who are fee only and those whose compensation is based on commissions. But as if purposefully to confuse consumers, many agents and brokers introduced and started using the category "fee based," which means charging a fee as well as continuing to collect commissions.

The distinction should be easy to understand. You would object strongly if you had to ask your doctor to act in your best interests. You would never think physicians would hesitate to sign the Hippocratic Oath. Neither would you consult a pharmaceutical salesperson instead of your doctor. But the rules-based world of most financial services is like relying on a printout of a drug's potential side effects instead of on a medical degree and the responsibility to treat patients ethically.

Fee-only fiduciaries act as agents for investors. They have permission to manage your investments and make decisions in your best interests. They are held to the highest standard of fiduciary care.

In contrast, an agent or broker is an employee. They work for the mutual fund company or the life insurance company or the brokerage firm and are empowered to act only on behalf of the company they represent. So they are not allowed to make decisions without your consent. They can suggest services and products for you to purchase, but they must have your explicit permission to complete the sale. They are held to a lower standard called "suitability." They are permitted to sell you any product that is generally suitable for your class of investors.

According to FINRA, suitability means the agent or broker only must have "reasonable grounds for believing that the recommendation is suitable for such customer upon the basis of the facts, if any, disclosed by such customer." The more superficial the agent or broker's knowledge of the client, the better this works. The only items mentioned in FINRA's rules are the customer's financial status, tax status and investment objectives.

I've never seen a case of unsuitability or know what an unsuitable investment would look like. Selling 30-year bonds to a 90-year-old might be unsuitable. But age is not part of the information an agent or broker is supposed to elicit from a client.

The claim in any dispute will be that the salesperson explained everything and the client chose to purchase the product. All the disclosures are stated in the sales document you sign, so you have no excuse. You should have read the document. It's your mistake.

Salespeople are trained to get acquainted with their clients to make sales. They ask questions that begin, "Would you be willing to buy if . . ." and "Which of these choices would you prefer . . ." They are supposed to stop asking questions after the customer has agreed. Their lack of familiarity with a client's needs often results in substandard care.

The differences between these two worlds are seen most clearly in the decision-making process. Fiduciaries can't simply put your money into good investments. First they must understand as much as they can about you and your goals. They are required to have an undivided loyalty to help you meet those goals. Taking the time to understand your goals is simply part of their ethos.

Next, they have to strategize how to best meet those goals. They must be analytical and purposeful. They need to clearly articulate an investment strategy, which should include writing a customized investment policy statement for each client before investing. It means practicing comprehensive wealth management. It means striving to be proactive in areas of wealth management for which there will never be products and commissions.

One of the many questions we pose to potential clients is if they have made any investment mistakes in the past. A sad but common response is that they believed a friend, family member or fellow parishioner had their best interests at heart. One way of explaining the difference between a fiduciary and an agent or broker is that you do not have a legal right to trust that an agent or broker is acting in your best interests. They have no such legal responsibility. It really is your mistake.

Here are three questions you should ask any prospective financial advisor: Do you have a legal obligation to act in my best interests? Do you receive any compensation other than the fee I pay you? Do you offer comprehensive wealth management?

Don't accept anything less than a fiduciary standard of care. Your family's finances and welfare may depend on the real differences between what is in your best interests and what is just potentially suitable. You deserve better than satisfactory compliance to the rules. You deserve a firm that offers proactive comprehensive wealth management.

Don Trone, founder and executive director of the Foundation for Fiduciary Studies, describes the difference this way: "A fiduciary relationship requires a consultative, rather than sales, approach to working with the client. The question moves from, 'Is this a good investment?' to 'Is this a good investment for me (the client)?' Such a relationship, by necessity, has to be based on a much deeper understanding of the goals and objectives of the client."

Heed this important distinction between advisers who earn their living from the commissions of products and services they sell and those whose only payment comes from the client. One owes loyalty solely to serving the client. The other's interests are divided at best. NAPFA has promoted this distinction with their slogan "Truly Comprehensive, Strictly Fee-Only" and the "Fee Only" logo. Visit <a href="http://www.napfa.org"> www.napfa.org</a> to find an advisor in your area.

 

from http://www.emarotta.com/article.php?ID=428

Cyber Monday 2010 (2010-11-29)

by David John Marotta

The retail industry has tagged today "Cyber Monday." Like the term "Black Friday," which describes the Friday after Thanksgiving, Cyber Monday refers to the Monday three days later. Just as Black Friday is considered the biggest traditional shopping day, Cyber Monday is supposed to see a significant spike in online sales.

The description "Black Friday" has been around a long time and was named to mark the day that retailers become profitable, moving on their balance sheets from the red into the black.

The National Retail Federation's Shop.org division made up the idea of Cyber Monday to generate media coverage for their online retailers. The scheme worked. The mainstream media picked up the story and reported Cyber Monday as if the name had been around for years. Retailers are often trying to create the next big thing by generating media hype and exaggerating existing trends.

Not that the trend wasn't there. The first year it was claimed that traffic was up 35% on retail websites. Since then, sales on Cyber Monday appear to be diminishing. According to comScore, a marketing research company, in 2006 online spending jumped 25%. But in 2007 it was up 21%, 2008 up 15% and last year only up 5%.

Mondays historically have been the best shopping day of the week for Internet retailers. Originally many Americans only had access to a high-speed Internet connection at work, so the Monday shopping frenzy was a wave of pent-up demand from the weekend. Now that we can shop on our smartphones waiting for our friends Thursday evening at the coffee shop, Mondays have lost their importance.

On the calendar, Cyber Monday isn't even in the top-ten online shopping days. Those occur between December 5 and 15. This year December 13 marks the start of the last week when procrastinators can still make their purchases and leave enough time for online retailers to ship the items. Shoppers keep pushing the day back as they have grown more confident their packages will arrive before Christmas. So, at least for a few more days, you can hit the snooze button on your Christmas shopping.

Cyber Monday was a brilliant idea to promote online shopping and jump-start the online shopping season by a few weeks from its actual peak. Having found that a longer holiday season translates into bigger profits, retailers like to extend every holiday season. The holiday season is now a four-month blast of marketing genius. Thanksgivoween and Hanukwansmas extend clear through the entire month of Septoctnocember.

Online sales and services will continue to compete with brick-and-mortar companies. The best firms offer both, leveraging what they have physically and multiplying it manifold through their online presence. Some sales and services can't be accomplished effectively online, but many can. A business in Charlottesville, Virginia, has lower overhead and expenses than its online competition in California or New York. And sometimes a small city like Charlottesville can only support certain businesses if they can sell to the world.

Toys and video games show the most increase in online sales during the holiday season, followed by consumer electronics, computer hardware and software, jewelry, gourmet food, furniture and home decor.

According to Experian Hitwise, an online competitive intelligence service, the top-ten retail websites are Amazon.com, Wal-Mart, Target, JC Penney, QVC.com, Sears, Macy's, BestBuy, Overstock.com and Toys 'R' Us. Amazon's share was by far the largest with 14% of the sales traffic.

You might think these Internet retailers would be great investment opportunities, and you would be right. Collectively they have been averaging 4.90% over the S&P 500 for the year ending October 31, 2010. Half have underperformed the market with the other half overperforming. But two of them have wildly overperformed, pulling the average up. Amazon.com appreciated 39.1% and Macy's appreciated 36.1% since last year. The worst performers were Overstock.com, down 13.8% and JC Penney down 12.7%.

Take advantage of their low prices, and moderate your spending this holiday season. Stay on track with your savings. Don't let the hype of the retail holiday season jeopardize the progress you've made toward reaching your financial goals.



from http://www.emarotta.com/article.php?ID=427

<h1>Should You 'Sell in May and Stay Away'? Revisited</h1>
(2010-11-22) <i>by David John Marotta</i>

<p>Last May I wrote a column asking if you should "sell in May and stay away." I suggested it would be better simply to "rebalance in May and call it a day." Looking backward it wasn't bad advice. Looking forward, I suggest saving and investing significantly between now and next May.

<p>The original saying began in Britain as "Sell in May and go away, stay away till St. Leger Day." The final horse race of the British equivalent of the Triple Crown takes place on St. Leger Day, in the second week of September. In the United States, September and October historically are considered dangerous months to invest. In addition, St. Leger Day is unknown here. So the date of reentering the markets has been pushed to the end of October, causing the rule to also be known as the "Halloween indicator."

<p>Since 1950, September has been the only month averaging a negative return, due to severe losses in 1974 and 2002. This year September was the best month for the S&P 500, which appreciated 8.92%.

<p>October, contrary to popular opinion, is a typical month with an average return of +0.82%, despite the 21.5% loss in 1987 (Black Friday) and the 16.8% loss in 2008. This year October had a nice gain of 3.8% for the S&P 500.

<p>The traditional wisdom suggests selling on May 1. But since 1950, May has performed well with an average return of 0.80%. This year May was terrible, dropping 7.98% on the S&P 500. Selling on May 1 would have avoided the worst month for the year.

<p>My own study shows that since 1950, May through October has contributed a 3.16% return; November through April has contributed 8.44% for an annual return of 11.60%. If you sell in May, you have to be able to get a six-month Treasury return better than 3.16%. Considering trading costs and capital gains taxes, that's difficult.

<p>This year the S&P 500 only appreciated 0.74% in May through October, underperforming the historical averages. You could not have done better in Treasury bills or money market. You would only have earned 0.06%.

<p>Although the S&P 500 did not do very well over the summer months, other indexes performed better. After dropping 11.37% in May, the MSCI EAFE Foreign Index regained all that and more, ending the period up 5.97%. Despite the meltdown of the euro in May, foreign investments have still outperformed U.S. stocks. Emerging markets have performed even better. Between May and October they were up 10.15%.

<p>Although the return of the S&P 500 has been disappointing, a more broadly diversified portfolio fared better. Year to date through the end of October, the S&P 500 is up 7.84%, the MSCI EAFE Foreign Index is up 5.12% and the MSCI Emerging Markets Index is up 14.24%. A diversified portfolio of half U.S. stock, a third foreign and a sixth emerging markets averaged 8.00% for the year on a buy-and-hold strategy. But rebalancing once at the end of May boosted your return to a whopping 13.94%. The reason is that these three indexes have not moved in sync this year. The S&P 500 did the best for the first four months, appreciating 7.05%. Even in May the S&P 500 did not drop as much as foreign investments. Rebalancings at the end of May meant selling out of the U.S. stock, which was only down 1.50%, and buying into the EAFE Index, which was down 12.08%, and the Emerging Market Index, which was down 5.36%. These foreign indexes rebounded heartily. Asset allocation means always having something to complain about. This past summer it was the S&P 500. Meanwhile your rebalanced portfolio allocated more to foreign stocks.

<p>When the markets are volatile, the bonus on account of rebalancing is greater. Rebalancing every month does not produce the greatest bonus. Rather the greatest bonus is produced by rebalancing just after large movements, such as the foreign meltdown in May. And then the bonus is only gained by diehard contrarians eager to buy what everyone else is selling.

<p>Rebalancing is not a magic bullet. Rebalancing at the beginning of May was 0.45% worse than the 8.00% buy-and-hold strategy, but rebalancing at the end of May was 5.94% better. On average, rebalancing boosts returns by about 1.6% annually.

<p>If a seasonal ebb and flow to market returns really exists, it may be as simple as observing when cash is tight and not flowing into the markets. In February bills from the holidays arrive, and many people are gathering cash to pay their taxes. Summer vacations strap many families, resulting in high expenses in September. Only after bills are paid can money flow back into the markets.

<p>In contrast, December sees large profit-sharing bonuses put into the markets, and pension funds are often invested in January. In the early spring, people are funding their retirement accounts.

<p>Whatever the reasoning, this is the season to be invested. Returns from November through April are historically more than twice those of May through October.

<p>The lessons are clear. Save. Invest. And rebalance regularly.

<p>

from <a href="http://www.emarotta.com/article.php?ID=426">http://www.emarotta.com/article.php?ID=426</a>

Coping with College Expenses (2010-11-15)

by Matthew Illian & David John Marotta

An old axiom states that nothing is certain except death and taxes. But now we have to add the skyrocketing costs of a college education.

According to the most recent College Board Annual Survey of Colleges, the sticker price of a college education keeps rising, faster than the price of groceries, health care and almost everything else in the basket of goods used to determine the Consumer Price Index (CPI). In the last 10 years, in-state tuition and fees at public four-year colleges increased 5.6% annually on top of a CPI growth of 2%. The average estimated total expenses for a current public in-state four-year student are an astounding $81,356.

If you were blessed with the birth of a child recently, you will need to save $430 monthly to pay for in-state college tuition, fees, room and board. Double this rate to cover the full costs at the average private institution. And this doesn't even include money for a cell phone, pizza, room decor or other stuff that college students deem "necessities."

Most students don't pay full price for college. In 2009-10, undergraduate students received an average of $12,894 in financial aid, split almost equally between loans and grants. Grants are the most attractive because students are not saddled with a repayment plan after college. Federal grants make up 26% of total aid. Institutional college grants account for 17%, state grants for 6% and private and employer grants (scholarships) for 4%.

Students are graduating with larger debt loads than they were 10 years ago. Public four-year college borrowers graduate with an average of $19,800 in debt; their nonprofit private college counterparts graduate owing $26,100. This private college debt is 17% more than it was 10 years earlier, even after accounting for inflation. In addition, a growing percentage of all college debt is unsubsidized and begins accruing interest immediately.

Our experience suggests not all college degrees are created equal. In May, the New York Times profiled a recent graduate of New York University who majored in women's and religious studies. With more than $100,000 in debt, she is struggling to repay her loans, meet her living expenses and regretting her selection of an expensive private school.

Students will have to make more astute education choices. Today's global marketplace places more value on hard skills such as engineering, computer technology, teaching and finance. Technical degrees and certificate programs will become commonplace. A liberal arts education will likely diminish in popularity and become more focused at the elite institutions. More students are likely to begin their education at lower cost community colleges and complete a four-year degree at schools that specialize in their concentration.

Parents may feel overwhelmed about the amount they need to save for college. But college education is one of the two lifetime investments for which we approve borrowing money (the other is a home mortgage). Students should plan to graduate with a debt load no higher than half of what they can reasonably expect from their first year's salary. For example, those with a starting salary of $40,000 should keep their debt at or below $20,000. Thus graduates can dedicate 10% of their annual salary to school debt and pay it off in five years.

New parents should immediately begin saving $430 a month for college. Alternatively, a onetime $50,000 investment should cover tuition, fees, room and board at an in-state college 18 years from now.

Giving a child the gift of a college education and a debt-free start to adulthood is one choice. Other parents believe their children should participate in financing their college education and can apply the 50/50 savings approach. Parents commit to saving half of the money needed, and their children commit to the other half. Students participate by working hard in high school, applying for scholarships, taking summer jobs, seeking out work study opportunities and accepting reasonable loan levels.

The support of grandparents can help tremendously. The vast majority of the college accounts that we manage are owned and funded by grandparents. Instead of buying the latest gadgets for their grandchildren, they make annual contributions to a college savings account. If the grandparents own the account, it has the added advantage of not being included as a resource on the student's financial aid forms.

The 529 plans are still the most cost-efficient way to save for college expenses. If the grandparents are Virginia residents, they are entitled to a $4,000 state tax deduction, which saves them $230 each year per account. Or they could each open one account for their grandchild and double the savings. This money grows tax deferred and is tax free when withdrawn, akin to a Roth IRA. The 529 plans have the additional benefit of an upfront state tax deduction.

Virginia has the largest 529 plan in the country, perennially ranked in the top five across the country. VEST, the Virginia Education Savings Trust, is marketed directly to the public. Another plan, CollegeAmerica, is offered through financial advisors. It has different share classes, some of which have loads that make them unattractive. But no-load shares are available through fee-only financial advisors. CollegeAmerica allows advisors to create their own asset allocation mix from a few dozen different funds.

We do not recommend prepaid college tuition plans. At best, they match college inflation, and if used at an out-of-state institution, returns are based on money market rates, which are abysmally low right now.

The plethora of decisions can be intimidating. The nonprofit NAPFA Consumer Education Foundation is offering a helpful presentation titled "Advantages of College 529 Plans for You and Your Grandchildren" at the Charlottesville Senior Center at 1180 Pepsi Place on Thursday, November 18, from 5:30 to 6:30 p.m. with a question-and-answer session to follow. The talk is free and open to the public. Bring your questions!

 

from http://www.emarotta.com/article.php?ID=424

When Donating a Dollar Only Costs Five Cents (2010-11-08)

by Beth Nedelisky & David John Marotta

According to a poll published last month by Fidelity Investments, Americans are likely to give the same amount or less to charity in 2010. But Virginians are fortunate to have a reason to donate 23 times more to charity this year.

Virginia offers tax credits in exchange for donations to nonprofit organizations serving the truly needy. More than 200 charities have been designated Neighborhood Assistance Programs (NAPs).

Donors to these approved charities are eligible to receive a Virginia tax credit for 40% of the value of their total contribution. Thus a gift of $1,000 to a NAP qualifies for a $400 Virginia tax credit. For some taxpayers, a donation to a NAP may yield total federal and state tax savings worth nearly 96 cents for every dollar they give away.

NAPs provide health care, education, housing, job training and food to the poorest people in our communities. Included in the list are large organizations such as the Virginia chapters of Habitat for Humanity, Boys & Girls Clubs, and The Salvation Army, as well as smaller ones like the Soho Center for Arts and Education.

To be eligible for the 40% Virginia credit, individuals must contribute a minimum of $500. A $500 gift to a NAP is eligible for a $200 Virginia tax credit. Donors may give cash or marketable securities. Gifts of merchandise, services or real estate are not eligible.

Remember that a tax credit is far more valuable than a deduction because it reduces your total tax bill dollar for dollar.

Businesses are also encouraged to donate. They can receive tax credits for professional services donated to an eligible charity as well as for real estate, materials, cash and stock donations. Businesses must donate $1,000 or more to be eligible for the 40% credit. They cannot receive more than $175,000 in tax credits per year.

The beauty of the Neighborhood Assistance Program is that it allows Virginians to give even more generously to help their communities. Virginians in the top federal tax bracket can donate $1,000 to a NAP and receive the equivalent of $957.50 in total federal and state tax savings. With such significant tax savings, people can give 10 or 20 times more than they had planned.

Let's assume Mr. Monopoly has a share of highly appreciated stock worth $1,000. Instead of selling the stock and paying the capital gains tax, he decides to give the stock directly to charity. By transferring the stock to a NAP, Mr. Monopoly avoids federal capital gains taxes of $150. He can take a deduction of $1,000 against his income, saving him $350 on his federal income taxes. Thus far his tax savings are $500, but they don't stop there. On his state return, Mr. Monopoly's gift yields savings of $57.50. Plus he received a $400 tax credit from the NAP. In all, Mr. Monopoly receives a total of $957.50 in tax savings. What began as a $1,000 stock gift actually cost him only $42.50.

The big tax savings allow donors to give more to charity. Instead of donating a stock worth $1,000, Mr. Monopoly could consider giving stock valued at $23,529, a donation worth more than 23 times his original gift. Assuming the stock had a low cost basis, the real personal cost of such a gift would be closer to his original gift amount of $1,000.

Even if you are in a lower federal tax bracket, your tax savings may still be significant. For many middle-class Virginians, the total tax savings generated through a gift to a NAP is likely to be worth 60% of the gift amount.

To receive tax credits for your donation, first contact the charitable organization and determine if it has any remaining tax credits to allocate to your gift. If tax credits are still available, fill out the Contribution Notification Form and send it to the organization. The charity will orchestrate the transfer of the tax credits to you. After submitting the paperwork, you will receive a tax credit certificate. At tax time, attach the certificate to your return.

The Department of Social Services and the Department of Education manage the transfer of the credits. Each qualifying charity is assigned a set number of credits annually. Your donation might not receive a credit if the charity has already given away its share. But if you receive more tax credits than you need this year, you can carry them forward to future years.

If you want to make charitable donations to a NAP, don't wait until the end of the year. Applying for the tax credits does require some extra effort. Your gift and the corresponding paperwork must be complete by year-end to receive the credit for 2010.

Links to the charities that qualify as NAPs are available on our website at <a href="http://www.emarotta.com/nap"> www.emarotta.com/nap</a>. Give generously this year to help Virginians in need. The dollars you donate will only cost you pennies.

As part of the nonprofit NAPFA Consumer Education Foundation, we are offering a presentation titled "Philanthropy Isn't Just for the Rich" at the Charlottesville Northside Library at 300 Albemarle Square on Thursday, November 10, from 7:00 to 8:00 p.m. with a question-and-answer session to follow. The talk is free and open to the public.

 

from http://www.emarotta.com/article.php?ID=423

Wealth Management Is In Your Control (2010-11-01)

by David John Marotta

For many people, tomorrow's midterm elections feel like a political struggle over which they have very little control. It seems as though the outcome will determine the economics of the country for many years to come. Many feel similarly helpless to direct their own success. Nothing, however, could be further from the truth.

Even the smallest changes you make can have a significant impact on your future. Applying the principles of wealth management depends on exercising what psychologists call an "internal locus of control." In other words, through your own behavior and actions, you can take charge of your financial life.

Successful wealth management depends almost entirely on your choices, habits and hard work. It's based on the principle that very small changes can have a very large effect over either a 45-year working career or a 30-year retirement.

For example, pricey lattes have garnered a bad reputation in financial presentations. They have come to symbolize the fact that Americans should be saving and investing instead of spending mindlessly and spiraling ever deeper into debt. The budget-busting reputation of the caffeine habit is well deserved. My wife uses a cold brew Toddy coffee system. It produces a less bitter coffee concentrate that keeps fresh for a week. Mixed with milk, syrups or just plain water saves $4.75 per serving.

It may seem insignificant at first glance, but saving $4.75 is one of those small changes that have a large effect over time. If you save $4.75 early in your working career, you can invest it. Averaging an 11% return, that $4.75 will grow 100-fold to more than $475 between ages 20 and 65. In this case the effect of saving money when you are young removes the decimal and gains 100-fold.

Saving and investing the cost of a latte every day adds up to even more impressive numbers. Investing $4.75 every day between ages 20 and 65 grows to $475,000. That's a half a million dollar latte habit. Small daily efforts to save have large cumulative effects.

A slight increase in your investment return has a similarly large impact on your retirement savings.

In the financial world, a single percentage point is broken into hundredths of a percent. Each hundredth is called a "basis point." Basis points are abbreviated "bps," which is then shortened into the financial slang "bips." Some in the financial world will kill for 10 bps. That's how important they are.

For every additional 1% you earn over your working career, you can retire 7 years earlier or 50% richer. That is a huge effect for just 100 basis points. Every extra basis point of return over your working career allows you to retire 25 days earlier. The slightest rate of return can save you 142 hours of extra work.

Extra basis points can be found everywhere. The average portfolio's expense ratio can be reduced by about 80 basis points. Rebalancing your portfolio annually adds 160 basis points. Putting the right investments in the right investment vehicles is worth 100 basis points each year. Roth conversions, tax management and asset allocation are all worth hundreds of basis points.

In his book "Why Smart People Do Stupid Things with Money," financial advisor Bert Whitehead asks readers to identify factors that will have an impact on their financial future. In each case, the item under your control is the one that will have the greatest influence on your financial well-being. These variables include taxes, diversifying your investments across all asset classes, being a savvy shopper, how much you earn, the stability of your relationships, the house you purchase and the percentage of your income you allocate to permanent savings.

Small changes in each of these have exceptionally large effects on net worth. Saving for college in a 529 plan can provide half of a college education in appreciation. Foreign investments can boost your returns a few percent each year. Countries with the most economic freedom and emerging market countries can boost your returns a few more percent. The proper insurance coverage can save you from being wiped out financially. Tax Management can reduce the head wind of growth on your net worth. And estate planning can avoid the 55% estate tax on millions of dollars.

So by all means vote wisely in tomorrow's election. But learn to live wisely too so you can achieve your life goals. To find a fee-only advisor to help you define the changes you need to make in your personal finances and help support you in the process, visit the National Association of Personal Financial Advisors at <a href= "http://www.napfa.org"> www.napfa.org</a>.

 

 

from http://www.emarotta.com/article.php?ID=422

Liberals Get Basic Economics Wrong (2010-10-25)

by David John Marotta

Economics 101 is based on facts, not opinions. In a study by Zogby International, liberals and progressives would fail the class. They answered incorrectly to more than half of the basic questions. No wonder a liberal administration working with a liberal legislature has turned an economic downturn into a more permanent malaise.

The survey asked participants their opinion on eight statements. They could respond "strongly agree," "somewhat agree," "somewhat disagree," "strongly disagree" or are "not sure." But these questions were not really a matter of opinion. They were objective statements. Any college student in an economics class could have easily labeled them as either true or false.

The survey counted any statement of agreement or disagreement as correct or incorrect. Then it only used the number of incorrect responses. An answer of "not sure" was considered correct. Given how badly people did on the survey, more liberals need to move from "strongly agreeing" with the wrong answer to the humility inherent in being a little more "not sure."

As a true-or-false test in Economics 101, none of the questions would raise an eyebrow. "Minimum wage laws raise unemployment" or "Mandatory licensing of professional services increases the prices of those services" are both statements straight from a textbook. But asked as a personal opinion, many people felt remarkably free to disagree with economic fact. Our website has a link to <a href="http://www.emarotta.com/zogby-international-economic-enlightenment-questionnaire/"> all eight questions</a> and the <a href="http://marottaonmoney.com/resources/zogby_econ_enlightenment_survey.pdf"> original study</a>. You can take the test yourself or quibble with the answer key.

The average number of wrong answers was 2.98 for a score of 63%. That's a poor result, given that answering "not sure" on each question would have received a perfect score.

Participants were asked to self-identify as progressive/very liberal, liberal, moderate, conservative, very conservative or libertarian. Self-described progressives fared the worst. They missed an average 5.26 questions for a score of 34%. Liberals' economic opinions were also more wrong than right, missing 4.69 for a score of 41%. Even moderates scored worse than average, getting 3.67 wrong for a score of 54%.

About half those surveyed described themselves as progressive, liberal or moderate. The other half said they were conservative, very conservative or libertarian. These last three groups scored much better. Conservatives received a score of 78%. Very conservatives did the best with a score of 84%. Libertarians scored 83%.

The variation within these two camps was even smaller than the divide between moderates and conservatives. It reflects the polarized mood of the country. But the most interesting conclusion is that the debate is not debatable. There really is a right answer. For the economically aware, these issues are no more subject to compromise than the laws of gravity for a team of aircraft designers.

Progressives and liberals find this certainty maddening. Often they respond with invective and name calling but little content or economic dialogue. This disconnect is that what appears to be opinion for many liberals and progressives is not a matter of debate. They are simply wrong.

The authors of the Zogby study suggested their own explanation. "We think that, for many respondents, economic understanding takes a vacation when economic enlightenment conflicts with establishment political sensibilities."

A few other interesting insights can be gleaned from this study.

First, moderates are economic liberals. Moderates scored worse than average on each of the eight questions. Their scores were closer to progressive/very liberal than they were to conservatives. Liberals marvel that conservatives are actively trying to cleanse the GOP of moderates. They assume moderates are halfway between liberals and conservatives. But really they lean heavily liberal in the way they get economics wrong.

Second, a college education did not correlate either positively or negatively with correct responses. Perhaps the school of getting a job is as good a teacher as the modern university. Or perhaps the utopian environment of academia negates the positive effects of what students learn in their few classes in economics. Studying economics in college has been shown to move students in a slightly more conservative/libertarian direction.

It is interesting to see what did correlate with higher economic enlightenment. Voters for Obama and Democrats got 4.6 incorrect (43%). McCain voters missed only 1.6 (80%). African Americans (47%) scored lower than whites (63%). Asians/Pacific Islanders (68%) scored higher. Hispanics (59%) scored slightly less than the average (63%). Women (55%) scored worse than men (68%).

Other correlations included not living in a large city (60%) but in the suburbs (66%). Protestants did better (70%) than those claiming no religious affiliation (50%). But evangelicals or fundamentalists scored even higher (75%). Atheist/realist/humanists did even better (76%), probably due to the wide influence of Ayn Rand, author of "Atlas Shrugged" and the founder of objectivism.

Having a family member in a union hurt (55%), but a relative in the armed forces helped (67%). Not surprisingly, being an investor (70%) helped even more than earning more than $100,000 (67%). But even better was being a NASCAR fan (70%) or a weekly shopper at Wal-Mart (72%).

Although all of these correlations are associated with self-identified political ideologies, they break many liberal biases of who understands economic principles correctly. This administration and this Congress have shown an amazing ignorance of economic principles. Much of the legislation passed by this Congress and signed by this president has been shown to do more harm than good.

For example, the Cash for Clunkers program was a complete waste of money. It moved the purchase of 360,000 cars ahead just seven months. And then it paid $3 billion to destroy perfectly good automobiles.

Extending unemployment benefits from 26 to 99 weeks also revealed a basic ignorance of economics. Paying people not to work for so long has increased and lengthened unemployment. It has kept the cost of hiring high. Many potential workers have opted to keep receiving benefits rather than take a full-time job paying slightly more than unemployment. While on the dole a mom can save money being a full-time homemaker. Or a couple could start a business and only report the income to the working spouse. To keep benefits going for nearly two years, people need only feign looking for a job.

The headwind of expiring, new and proposed taxes has created an economic environment that threatens to truncate productivity at $250,000 per year. This group earns a quarter of the reported income and pays half the federal tax. Thus changes in their marginal tax rate will have a significant effect.

The list of economic fallacies is as long as the list of liberal accomplishments. People currently in power talk about "fair share" and "spreading the wealth." But their policies impoverish everyone. Liberals simply get basic economic principles wrong. And when they legislate, they do more harm than good.

Obama declared last week that voters are turning conservative because they are scared and not thinking clearly. He claimed that facts, science and argument do not seem to be winning the day. The Zogby poll suggests exactly the opposite. Having been drunk on "hope and change," voters have now sobered up to the economic reality that socialism impoverishes us all.

Like physicians whose guiding tenet is "first do no harm," the first principle of good government should be a president of one political persuasion and a Congress of another. Thus a Democratic president and a Republican Congress will provide the best chances of creating deadlock that a libertarian can hope for next week.



from http://www.emarotta.com/article.php?ID=421

Seventy-Five Days Left for Tax Management (2010-10-18)

by David John Marotta

In just 75 more days the largest dollar-denominated tax hike in U.S. history will take effect. If you have been focusing more on the political solution on Election Day than your personal finances, you have work to do before the end of the year.

As a percentage of Gross Domestic Product (GDP), the Revenue Acts of 1941 and 1942 during wartime win the award for the biggest tax increase. Although the upcoming tax increases are not the biggest as a percentage of GDP, they will have an enormous impact on everyone.

On January 1, 2011, the 2001 and 2003 Tax Relief expires. Those across-the-board tax cuts lowered rates for investors, small business owners and people at every level of income. Undoing those tax reductions raises nearly every federal income tax bracket. The 10% bracket and 0% capital gains tax bracket will disappear. The lowest tax bracket will return to 15%, the 25% bracket to 28%, 28% to 31%, 33% to 36%, and 35% to 39.6%.

The only people who won't experience a tax hike are the 47% of households that pay no federal income tax at all.

Itemized deductions and personal exemptions will again be phased out. The math is complicated, but for higher income taxpayers it equates to increasing the top marginal rate from 39.6% to 41.6%.

Married couples and parents will get tax increases. The marriage penalty returns on the first dollar of spousal income. These narrower brackets virtually chastise people for marrying instead of just living together. The standard deduction for couples will no longer be double the single deduction. The child tax credit will be cut 50% from $1,000 per child to $500. Dependent care and adoption tax credits will be cut.

Last year the inheritance tax was capped at 45% and excluded for estates up to $3.5 million. This year it was repealed entirely. So far four billionaires have died owing nothing. Next year we will see the inheritance tax return at 55% for everything over $1 million. So a family that wants to pass on an illiquid farm or business worth $3.5 million, who would have been taxed nothing in the last two years, will be taxed $1.4 million in 2011. Forcing family farms or businesses to liquidate simply to pay inheritance tax is unfair and shortsighted.

These new policies will cast a pall on saving and investing. The tax on capital gains rises from 15% to 20% next year and to 23.8% two years later. The double taxation on dividends rises from 15% to 39.6% next year and up to 43.4% in 2013.

The Patient Protection and Affordable Care Act (Obamacare) further limits how Americans can spend their own pre-tax health-care dollars. Nonprescription over-the-counter medicine will no longer be covered using your health savings account (HSA), flexible spending account (FSA) or health reimbursement account (HRA).

After 2012, a cap of $2,500 will be imposed on health FSAs. Families with staggering medical expenses because of children with special needs will bear the brunt of this new policy. Rather than being able to pay with pretax dollars, their excessive medical spending will be subject to their top marginal rate, and they will have to use whatever is left over.

These tax rates will impact negatively on the country's success. But you do have control on how you manage your personal taxes. With legislation coming and going and rates rising or unstable, you should consider ways to shelter wealth from the government.

You can implement two essential strategies between now and the end of the year. First, accelerate income into 2010 and delay deductions until 2011. Second, structure your finances to reduce taxable interest and dividends until we see more favorable legislation.

Of the many ways to accelerate income into 2010, the largest and most effective is a Roth conversion, which I've written about extensively. But now there is a new and equally great opportunity.

Just three weeks ago, the president signed a provision of the Small Business Jobs Act that allows participants in 401(k) plans to roll over a portion or all of their account balance into a Roth 401(k) plan offered by their employers. Plans must be amended by the end of the year.

The ability to convert your 401(k) to a Roth 401(k) can have a considerable effect on retirement benefits. The new provision is especially advantageous for people at the upper income levels. This opportunity deserves its own article, but the details are still being released. It is important to start the process of amending your plan now.

There are many ways to put off deductions until 2011. Business owners could delay significant purchases or expenses until January 2011. Bonuses could be paid in January 2011 instead of December 2010. Additional hiring could be deferred too.

End-of-year charitable giving can also be postponed until next year. Giving in January 2011 instead of December 2010 makes little difference to the charities involved but may save you significantly by doubling your charitable deduction next year when rates are higher.

This method also works any year for families who don't have a home mortgage and therefore can't itemize their deductions. Normally they are only allowed their standard deduction each year because without the addition of home mortgage interest, their charitable giving is slightly less than their standard deduction. But twice their annual charitable giving could add up to more than their standard deduction.

One year they should take the standard deduction, and then the next combine two years of charitable giving, allowing them to take more than the standard deduction. One year they give in January and December. The next year they give nothing. Their average annual giving is the same, but every other year they can take more than the standard deduction.

Get your asset allocation and investment mix structured to avoid capital gains and dividends in your taxable accounts. Change your taxable account so it uses mostly exchange-traded funds (ETFs). These investment vehicles are tax efficient and won't kick off capital gains until you decide to sell them. Invest them so you won't need to make changes for several years.

Put investments paying interest or dividends in traditional or Roth accounts, respectively. These accounts can defer or avoid taxes until a more favorable administration.

A dollar saved on taxes is better than a dollar earned. If you save a dollar on taxes, you can keep all 100 pennies. But if you earn a dollar, the government will tax it at your marginal rate. Going forward, tax management will be as significant as investment management in a comprehensive wealth management plan.

As part of the nonprofit NAPFA Consumer Education Foundation, we are offering a presentation titled "Tax Management: Pay Less, Keep More" at the Charlottesville Senior Center at 1180 Pepsi Place on Thursday, October 21, from 5:30 to 6:30 p.m. The talk is free and open to the public. Bring your questions!



from http://www.emarotta.com/article.php?ID=420

Getting the Most from Your 401(k) or 403(b) (2010-10-11)

by David John Marotta

For many workers, their retirement account is their largest asset. Having so much of your nest egg in one place means you should watch carefully how it is invested and monitor it regularly. Unfortunately, the average family spends more time planning their annual vacation.

The secret of making it financially used to be joining the right company, earning big bonuses and promotions and letting the firm provide for you in retirement through its defined benefit program. Your benefit in retirement was typically defined by your earnings over the course of your career. But as we all know, those days are over.

Today's average worker will have a dozen employers and work at each job for less than four years. Your career is now your responsibility, and so is your retirement plan.

Instead of a defined benefit program, most companies have defined contribution programs such as a 401(k) or a 403(b). In these you reap what you sow and the growth is subject to the weather of the markets. Nothing is defined.

A 401(k) and a 403(b) are virtually indistinguishable, named after the sections of the IRS tax code that define them. Businesses use a 401(k); schools and nonprofits use a 403(b). Most of the principles for evaluating and managing them are identical.

Some 403(b) plans and many 401(k) plans offer an employer match. Formulas vary, but the most common is to match the first 3% of your salary that you contribute at 100% and the next 2% of your salary at 50%. So if you put 5% of your salary into the company's plan, your employer will give you an additional 4% of your salary.

This is easily the fastest 80% return on your money. No one should pass up an employer match. If you are in the 25% tax bracket, each dollar you contribute will only cost you 75 cents. If you earn $50,000 and contribute $3,000, it will reduce your paycheck by only $2,250, and you may receive an employer match of $2,500. In other words, for $2,250 less in your paycheck, you can get $5,500 more in your retirement account.

Everyone should take advantage of matching plans and contribute at least the minimum amount required to receive a full match into the company plan. Unfortunately, many workers don't. In our example, between age 20 and age 72 at 6.5% return above inflation, the match would grow to more than a million dollars. Your first priority in saving should be to get the entire match.

The next step would be to fund your Roth account, make sure you are growing your taxable savings, and then return to contribute more to your company's retirement account. As we will see, there are good reasons not to contribute everything to your company plan.

The advantage of contributing to a Roth account is that your income (and therefore your tax rate) is probably increasing over the course of your working life. I've written extensively on the benefits of a Roth conversion this year, and that same reasoning makes funding a Roth IRA a good idea.

Many employers allow contributions to a 401(k) or 403(b) Roth. The more common pre-tax contributions are called a "traditional" 401(k) or 403(b) to distinguish them from Roth contributions. You should consider designating the portion you contribute toward a Roth. The portion your employer contributes, either matching or profit sharing, is always put into a traditional account.

If your income is significant, consider maximizing your contribution. The limit for 2010 is $16,500 a year. If you are older than 50, the limit rises to $22,000 to help you catch up on your retirement savings. In addition to your contributions and your employer match, companies sometimes pay bonuses or offer profit sharing as an additional pre-tax contribution. The total allowable contribution for 2010 is $49,000.

Given the amounts of money in retirement funds, it is important to invest them wisely. Every additional 0.01% return lets you retire nearly a month earlier. Thus fees matter, especially the expense ratio of your plan's fund choices. Most plans have funds laden with fees. Some share this revenue with plan sponsors, enticing them to pick more expensive funds to subsidize the costs of the plan or even make a profit.

But after you retire or leave that company's employment, you should almost always roll your 401(k) into an IRA for better investment choices and lower fees. Few plans have choices in every asset class and subsector.

When trying to craft an allocation when the choices are anemic, start by looking at your top-level asset allocation before selecting specific funds. For example, imagine you have decided on an asset allocation of 8% U.S. bonds, 7% foreign bonds, 34% U.S. stocks, 38% foreign stocks and 13% hard asset stocks. The next step is to look at the choices your plan offers.

You may find three U.S. bond funds and no foreign bond funds. One might be inflation protected, one might be intermediate-term treasuries and the other might be high-yield with a higher than normal expense ratio. You might combine the allocation to U.S. and foreign bonds and then split that amount between the first two bond funds, avoiding the third altogether.

There might be a dozen U.S. stock funds and only two foreign funds. The bulk of your asset allocation may fall in one or both of the foreign funds. And you may have to split the allocation to hard asset stocks between the U.S. and foreign choices. Your financial advisor can help you integrate your 401(k) selections with the rest of your portfolio. And as always, you want to evaluate each choice, looking closely at fees and expenses.

As part of the nonprofit NAPFA Consumer Education Foundation, we are offering a presentation titled "Get the Most Out of Your 401(k) or 403(b)" at the Charlottesville Northside Library at 300 Albemarle Square on Thursday, October 13, from 7:00 to 8:30 p.m. The talk is free and open to the public. We will be building ideal allocations and distributing sample portfolios for the University of Virginia's 403(b) options. Bring your plan's options and your questions!



from http://www.emarotta.com/article.php?ID=419

Umbrella Insurance Is Always the Right Answer (2010-10-04)

by David John Marotta

If you have a personal umbrella insurance policy, congratulations. If you don't, you must not have a lot to lose. This important insurance can extend your liability coverage beyond your home and auto insurance by millions of dollars.

We live in a litigious society. Anyone can sue you for any reason. Those with money are targets simply because suing someone without assets is pointless.

Car and home insurance are required, but even $300,000 liability coverage won't protect you in the event of a catastrophe. Your teenage driver is at fault and young people in both cars are seriously injured. Your dog bites a child. You chaperon a class trip and are judged negligent when one of the students tragically dies. You cause an accident on the freeway and a truck filled with expensive cargo is involved. A neighbor slips on your steps and sues you. You write something reckless and unwarranted on the Internet about a certain financial columnist, and he sues you for slander and libel.

The good news is that these events are relatively unlikely. The bad news is that any one of them could result in a judgment well in excess of your liability limits. Your insurance company will just pay their $300,000 share and leave you to defend yourself in court for the remainder. If the judgment doesn't ruin your finances, the legal fees will.

If you receive a judgment for more than your net worth, you could lose everything. Your taxable investments and savings may be subject to the claim. The equity in your house may be at risk. A large judgment can also garnish 2.5% of your wages for the next 10 years and/or any current or future inheritance you receive. Any inheritance left in a generation-skipping trust offers protection against creditors and failed marriages, but many families leave an inheritance outright instead.

You don't want a single accident to wipe out your life savings. Umbrella insurance helps protect you against that possibility.

Personal umbrella insurance sits on top of your auto and homeowners insurance. To get umbrella coverage you must first increase your home and auto insurance liability coverage to where the umbrella policy begins, usually $300,000. Only then can you get additional coverage of $1 million or more. If you get sued for $1.3 million, you would first pay your $1,000 deductible. Your home or auto insurance would pay $299,000 to reach the $300,000 liability on the policy. The umbrella insurance would pay the final $1 million. You would pay nothing more than the initial $1,000.

Being sued for more than $300,000 is not a remote possibility. For example, with today's more effective air bags, surviving an auto accident even with serious injuries is much more likely. As a result, the cost of life insurance policies is decreasing while medical expenses continue to accelerate. We've made cars safer and more people survive the accident. They survive, and then they sue for damages.

Anyone with assets they don't want to lose will benefit from umbrella insurance. Many accidents are the fault of someone with no assets to lose. Unfortunately they can simply not pay or at worst declare bankruptcy and lose nothing. If you are saving and investing, you have something to lose. It isn't clear at what level of assets you should get protective umbrella coverage, but financial pundit Dave Ramsey recommends it for families who have more than $200,000. It certainly isn't just for the ultra rich.

Consider buying more than $1 million in coverage. Getting the same amount of coverage as you have assets won't protect the assets you have. For example, if you have $1 million in assets and you purchase $1 million of coverage, you will lose all of your savings in a $2 million judgment. Thus you need to have enough coverage to satisfy the worst judgment you might receive. Coverage of $2 to $4 million will suffice for most of today's lawsuits.

I am usually not an advocate of insurance products. Umbrella insurance is the exception. It is designed to cover very unlikely but very costly events, exactly what insurance is supposed to do, at a reasonable price. In review courses for the certified financial planner (CFP) exam, prospective advisors are told, "Umbrella insurance is always the right answer."

About 12% of homeowners purchase umbrella insurance. For the wealthy, that number grows to about 50%. The tragedy is that half of wealthy homeowners are betting their entire net worth against the odds of a freak accident, which unfortunately do happen.

Insurance companies will only write an umbrella policy if they also provide your home and auto insurance. They want to know if the underlying coverage gets cancelled for any reason, and they don't trust another insurance company to defend their interests.

Another excellent feature of an umbrella policy is that the insurance company is obligated to provide your legal defense, and the legal costs are paid in addition to your coverage.

The first million dollars of coverage usually costs the most. A typical annual premium might be $150. Subsequent costs are about 65% of the first million for each subsequent million. So $2 million of coverage would cost about $248, and $4 million would cost $443.

Premium costs vary and are subject to a host of issues. When you apply for an umbrella policy, your answers to a number of questions may raise your rates or even disqualify you. Own a Rottweiler or a have been recently convicted of reckless driving and you may not be able to get umbrella coverage. If you serve on a board, you may not be able to get coverage for more than the board's coverage. And if you have a driver younger than age 25 or have a very poor driving record, coverage may cost a $100 more per million. Even if you don't plan on getting umbrella insurance, you might want to apply just so you know what behaviors may limit your likelihood of being sued.

Remember, personal umbrella liability insurance covers only nonbusiness activities. Umbrella policies are also available for businesses and well worth the money. Any umbrella insurance won't cover intentional acts or punitive damages.

For the cost of a splurge on a not particularly memorable restaurant meal, you can enjoy the protection of a $1 million umbrella policy. Insurance agents don't make much commission on an umbrella policy. So you have to call them. Just do it.



from http://www.emarotta.com/article.php?ID=418

Rising Capital Gains Tax Hurts Everyone (2010-09-27)

by David John Marotta

Because of Obamacare and the failure of Congress to extend current tax rates, capital gains taxes will soon rise from 15% to 23.8%. Take note, take heed, and take action.

The tax increases will come in two stages, starting with a hike in 2011 from 15% to 20%. The 15% rate, established in the 2003 tax cuts, will expire at the end of this year. This is part of a more extensive rise in taxes taking effect January 1, 2011.

Another capital gains tax hike was part of the Democrats' health-care bill. It adds an additional 3.8% tax on long-term capital gains and dividends beginning in 2013.

Combined, these two tax increases enact a 59% increase in the capital gains tax rate. That's a huge tax increase, and taxes affect behavior.

The optimum rate for capital gains taxes is zero. Every economist worth his Ph.D. agrees that the correct rate for the capital gains tax is zero, zip, nada. Some have even suggested the optimum tax rate for capital gains is negative!

We should be rewarding saving and investing because it builds an enduring and robust economy. Saving is currently too low.

We need incentives to save and invest and thus create an economic environment that encourages the hard work and risk taking that pays everyone's salary. Investment is simply capital, and capital is simply deferred consumption. Why defer consumption if you are penalized for it?

Investment supports the factories, businesses and entrepreneurial ventures that actually make money. It stimulates the economy, which then creates jobs and produces real wealth.

The prospects for our Social Security system look bleak. There won't be enough money to support the number of retirees. Chances are only the worst off will receive anything significant from current funding. And now the political winds are blowing to make saving and investing for your own retirement much more difficult. It seems as though "fair" is being redefined to impoverish everyone and force them to rely on the government.

The new rate for capital gains will leave very little reason for anyone to take the risks associated with capital investments. With an average inflation rate of 4.5% and an average return of 11%, the return may not be worth the risk. Politicians are giving us no incentive to take care of ourselves. They are ensuring that government will need to save us.

For example, imagine you assume the risk and invest $100,000 in an equity venture. Let's suppose the investment pays off and appreciates 8%, or $8,000 in a year. Under the new rates, you would owe $1,904 in capital gains tax. And $4,500 of your remaining profit would simply be inflation on which you still have to pay taxes.

You would be left with only $1,596 of real return after inflation, a pitiful 1.6% gain over inflation. With such a small reward for taking risk in capital ventures, why not simply invest in municipal bonds with a guaranteed return and no taxes due?

Of course investing in municipal bonds may have its own risks. Downgrades or even defaults in muni bonds may make that category suffer its own poor returns. And if you lend money to spendthrift government entities, you may not even get your principal back.

The effect of higher capital gains taxes on investments is immediate and devastating. Capital investments make innovation and new businesses possible. Plans for such ventures include five-year return on investment projections that now have to take into account the headwind of a punitive government taxation environment.

Few will see these negative results because they are entrepreneurial plans that won't happen. People have a hard time seeing what doesn't happen. But the result will be that American-style 6.5% growth will slow to a more European-style 4% growth. Every 1% less you get on your investments over your career means you will have to work an additional seven years to attain the same lifestyle in retirement.

Big government politicians will ultimately blame all of these harmful effects on the markets themselves. They will use it as a populist excuse for higher taxes and more regulation. Their policies will have taken all the gains, and in the end they will try to take the credit for saving us.

Henry Hazlitt, in his well-known book "Economics in One Lesson," lamented, "The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups." Unfortunately, voters rarely pay attention long enough to connect the dots on the unintended consequences of economic policy.

In the meantime you should make some changes in your portfolio this year. Your retirement may depend on it.

First, if you are wealthy and haven't done Roth conversions yet, get them done before the end of the year. Pay as much tax as possible at the current tax rates and transfer your traditional IRA investments into a Roth account where the capital gains rate is zero.

Going forward, only investments in a Roth will have a tax rate that is most favorable to market risk and return.

Second, for your taxable investments, ensure your portfolio will be able to weather a long period of unfavorable capital gains taxation. If you have banked a large amount of capital losses, this may be sufficient. Otherwise you may want to cash in all your unrealized capital gains and pay the current 15% rate. Then order your portfolio so you won't have to make many significant changes over the next few years.

A well-structured portfolio may be able to avoid realizing any capital gains during the remainder of the Obama administration. Waiting for a more favorable administration is a wise strategy.

For taxable accounts, you need to be in control of when you realize capital gains. This is most easily accomplished when you are invested in exchange-traded funds (ETFs) rather than mutual funds that kick off capital gains as the fund manager makes trades in the underlying portfolio.

ETFs are very tax efficient. They seek to minimize capital gains by exchanging those stocks sold out of the index for those funds added to the index. Because buying and selling in the fund is done by means of like-kind exchanges, it is not a taxable event. Hence with ETFs no capital gains are owed until you decide to sell.

If you invest in individual stocks, there quickly comes a time when the company should be sold and your profit taken. By buying the right mix of ETFs, you will be able to hold the index indefinitely. And by structuring your portfolio across your taxable investments and your traditional and Roth accounts, you will be able to rebalance your portfolio outside of your taxable account.

A well-structured asset allocation should be able to weather a poorly run administration. And whenever voters realize they can't soak the rich without drying up the capital that drives prosperity, the capital gains rate will be lowered or, in the best case scenario, eliminated entirely.

 

from http://www.emarotta.com/article.php?ID=417

Hong Kong: An Ideal Place to Invest (2010-09-20)

by David John Marotta

According to the Heritage Foundation's 2010 Index of Economic Freedom, Hong Kong has the most economic freedom. Freedom does matter. Hong Kong is the poster child for superior investment returns following free markets. Investments there have appreciated 71% more than the S&P 500 over the past decade.

Hong Kong has an incredibly low tax rate. Individuals are taxed at the lower of a progressive tax maxing at 17% of adjusted gross income or a flat tax of 15% of gross. Just as good is Hong Kong's 16.5% top corporate tax rate.

Hong Kong's government spending is equally low. In the most recent year of the Heritage Foundation's study, tax revenue was 14.2% of gross domestic product and government spending was 14.5%. Unlike the United States, Hong Kong tries to have a balanced budget every year.

Hong Kong's constitution is completely separate from the rest of China. Corruption is minimal, and it ranks above the United States for freedom from corruption in Transparency International's Corruption Perceptions Index. Of 179 countries, Hong Kong ranks 12th; the United States only ranks 18th. In the United States, the Troubled Asset Relief Program (TARP) and other bailout programs run by the Treasury and the Federal Reserve lack public accountability or transparency.

The value of the Hong Kong Index is 60% in financials, which includes real estate properties and stock exchanges as well as traditional banks.

It is understandable why Hong Kong has so many financial institutions. Today banks can be located in any country and still do business around the world. With current technology you can take a photo of a check with your iPhone, and then send the image and deposit the money electronically in seconds. Many banks allow you to use any ATM to withdraw funds and reimburse you for the transaction fee.

So imagine you are opening a bank and have the option to locate it in either Hong Kong or the United States. You can serve clients anywhere in the world. The only difference that your choice will make is which economic environment will bring the best value to your shareholders.

If you opt for Hong Kong, oversight and regulation are light and evenly applied by the independent Hong Kong Monetary Authority. As mentioned earlier, your profits are subject to a top corporate tax rate of only 16.5%.

In contrast, if you locate in the United States you are subject to the expensive and invasive 2002 Sarbanes-Oxley Act. The government subsidizes large firms competing with you that benefited from risky investments by allocating additional credit to them at below-market rates. And after the Frank-Dodd Regulatory Act of 2010, the government can decide to dismantle your company without judicial review because it considers what your company is doing to be a threat.

In the United States your profits are subject to a tax rate of 35%, second only to Japan. And in 2011 the U.S. top corporate rate will rise to 39.5% as Japan starts to lower its tax rate from 40%.

In which country would you choose to put your headquarters?

Investments to expand banks do not do as well in the United States as they do in Hong Kong. The United States is not a bank-friendly environment. We seem to be the last country to realize that high corporate tax rates only serve to move more and more businesses overseas.

In Hong Kong, however, banks like Hang Seng live up to their name, which means "ever-growing" in Chinese. Sun Hung Kai Properties is another financial company in Hong Kong. If being located in Hong Kong is lucrative, owning real estate in Hong Kong is equally so. Sun Hung Kai controls over 43 million square feet of real estate.

Hong Kong is only 426 square miles, less than 60% of the size of Albemarle County, Virginia. But its population is more than 7 million, making it one of the most densely populated places in the world.

There is an easy and simple way to participate in Hong Kong's equivalent of the S&P 500. A single exchange-traded fund, iShares Hong Kong Index (EWH), consists of 41 of the largest publicly traded companies there. The expense ratio is a low 0.55%. It has a five-year average return of 7.61% versus the S&P 500's five-year return of -0.91%. Earning 8.5% over the S&P 500 for the past five years will boost anyone's portfolio return. The 10-year return is also good, averaging 4.46% versus the S&P 500's -1.81%.

An annual 6.27% superior return adds up over 10 years. It is the difference between a cumulative 54.7% appreciation and a cumulative 16.7% loss. That means an impressive 71.4% more in your portfolio.

Economic freedom matters. And it makes you wonder why all the capitalists are in China and all the socialists are in Washington.

Mainland China could curb economic freedoms in Hong Kong at any time, but they choose not to. They are trying to move toward more of a market economy, and Hong Kong is their model of what that might look like. When Deng Xiaoping introduced market liberalization he remarked, "Let some grow rich first."

Hong Kong provides a place for free markets to work so they can compete in the global economic environment. Even though China knows that Hong Kong is a cash cow, every now and then they long to eat beef. It would be a grave mistake, but it is still a strong temptation.

The United States has started to eat meat, and we seem to be bewildered why the milk has stopped flowing. The answers are relatively simple, but until we figure them out politically, overweight your investments in Hong Kong and underweight your investments in the United States.



from http://www.emarotta.com/article.php?ID=415