The financial world today – adjusting expectations and planning rules

Has investing changed in the last few years? A recent Morningstar post began with this statement:

BlackRock’s Larry Fink says be 100% in equities. PIMCO’s Bill Gross claims equities are dead. Vanguard’s Jack Bogle preaches stay the course with a balanced portfolio. To read the headlines, it seems that three of the best and most trusted names in finance are decidedly at odds with one another. In truth, their forecasts are far more similar than dissimilar. [from Should I Stay or Should I Go? – Don Phillips, 10/11/2012]

His point is that neither extreme, 100% stocks or 100% bonds, is rational. Instead, we have to realize that returns will be less for now and yet still invest well.

**Expect less: ** Interest rates are at all-time lows, making fixed income returns meager, and equity investments may depend directly or indirectly on renewed growth and employment, which is not rebounding significantly any time soon regardless of who our next President is.
**Diversify more:** The correlation among asset classes is closer than before, making diversification more challenging. As Feifei Li said in a recent Morningstar post, it is not a question of having all your eggs in one basket but of having too many eggs. This would mean adding market-neutral, commodities, and real estate, to a portfolio of just stocks, bonds and cash. Among other ideas, writing calls could even be a good strategy to create income so that you have a positive return in an otherwise flat market.
**Cut back withdrawals:** Where we used to say, as a rough rule, a 4% rate of distribution would allow the portfolio to grow to face future inflation, while any higher withdrawal rate would eat into principal quickly. Today, the rule may be a 3% rate, or we may need to use other ways to analyze the proper rate of withdrawal, such as the Withdrawal Efficiency Rate from a recent Morningstar post [see below]
**Tax planning: ** As we indicated in a recent post, taxes will have more impact so tax planning to achieve even a 3% rate of return is essential. With the changes coming in 2013, good planning could add to your returns over time. **See** [[|Year-end-tax-planning-2012-vs-2013-tax-strategies-requiring-action-now]]

**Should I Stay or Should I Go?** – Don Phillips, 10/11/2012
It seems that three of the best and most trusted names in finance are decidedly at odds with one another. In truth, their forecasts are far more similar than dissimilar.Eggs Are Not Enough: The Truth About Diversification – By Feifei Li | Posted: 10-22-12
**Eggs Are Not Enough:** The Truth About Diversification – By Feifei Li | Posted: 10-22-12
Diversification means not putting all your eggs in one basket. But do you own too many eggs?
**Retirement-Withdrawal Strategies Quantified** – David Blanchett, CFA, 10/19/2012
According to a new Morningstar metric, the best approach incorporates portfolio value and life expectancy.

2012 year-end tax planning – 2012 vs. 2013 tax strategies requiring action now

The goal for tax planning, as always, is to minimize the total that you pay for 2012 and 2013. However, this year is tricky. Here is why:
First, if your 2013 income is expected to be over $250,000 ($200,000 for singles), you cannot just accelerate write-offs from 2013 into 2012 and defer income to 2013 because your taxes will be higher in 2013. There is a new 3.8% tax that works like this, for example: recognizing a capital gain in 2012 avoids that tax in 2013 and also reduces your 2013 adjusted gross income, which may keep it below the threshold for imposing that tax next year. (See below for more details on the new tax.)
Second, regardless of who becomes President, Congress is likely to reduce the amount or value of itemized deductions. Thus, you may want to accelerate what you can into 2012.
Third, as always, combine your tax planning with your investment strategies, such as tax loss harvesting and rebalancing (see explanations at the end).
Last, there are other issues to review for 2012, including converting your Roth IRA; gifting to children and grandchildren for estate planning purposes (to use the $5 million unified credit); and funding college for children or grandchildren.
However, if you will owe the alternative minimum tax (AMT), you may have to revise your strategy. Many write-offs must be added back when you calculate the AMT liability, including sales taxes, state income taxes, property taxes, some medical and most miscellaneous deductions. Large gains can also trigger the tax if they cost you some of your AMT exemption.
The best tool for planning is to do a projection for both 2012 and 2013, then see what items you can affect to reduce the total tax for both years.
Assuming you will not have an AMT problem in either year, then in 2012 you could:
• Take a bonus this year to save the 0.9% for a high-income earner;
• Sell investment assets to save the 3.8% tax next year so the gain or income is in 2012 (e.g., sales of appreciated property or business interests, Roth IRA conversions, potential acceleration of bonuses or wages);
• Defer some itemized deductions to 2013 (but, be wary of the possibility that these will be capped in 2013 and can affect your AMT for either year);
• Accelerate income from your business or partnership, depending on whether it is an active or passive business; and
• Convert Roth IRAs in 2012 as noted above.
Then in 2013 and future years, you could:
• Purchase tax-exempt bonds;
• Review your asset allocation to see if you can increase your exposure to growth assets, or add to tax-exempt investments, rather than income producing assets. Also, place equities with high dividends and taxable bonds with high interest rates into retirement accounts;
• Bunch discretionary income into the same year whenever possible so that some years the MAGI stays under the threshold;
• While we do not recommend tax-deferred annuities, they can help save tax now to pay taxes in the future when the payments are withdrawn. (These are not recommended due to high fees, illiquidity and often poor performance);
• Add real estate investments where the income is sheltered by depreciation;
• Convert IRA assets to a Roth. Even though the future distributions from both traditional and Roth IRAs are not treated as net investment income, the Roth will not increase the threshold income; and
• Reduce AGI by “above-the-line” deductions, such as deductible contributions to IRAs and qualified plans, and health savings accounts and the possible return of the teach supplies deduction.
Note, however, Congress has not finalized the 2012 rules. Some expected steps are:
• An increase in the AMT exemption to $78,750 ($50,600 for singles), raising it from 2012 rather than dropping back to 2001 rates;
• Teacher $250 supplies deduction on page 1 of 1040, as mentioned above; and
• IRA $100,000 tax free gifts to charities.
Here are the details on the 2013 tax increases, enacted to help fund health care:
• A new 3.8% Medicare tax on the “net investment income,” including dividends, interest, and capital gains, of individuals with income above the thresholds ($250,000 if married and $200,000 if single);
• 0.9% increase (from 1.45% to 2.35%) in the employee portion of the Hospital Insurance Tax on wages above the same thresholds;
• Increase in the top two ordinary income tax rates (33% to 36% and 35% to 39.6%);
• Increase in the capital gains rate (15% to 20%);
• Increase in the tax rate on qualified dividends (15% to a top marginal rate of 39.6%).
• Reinstatement of personal exemption phase-outs and limits on itemized deductions for high-income taxpayers (effectively increasing tax rates by 1.2%).
• Reinstatement of higher federal estate and gift tax rates and lower exemption amounts.
If these changes take effect, the maximum individual tax rates in 2013 could be as high as follows:
2012 vs. 2013
Wages: 36.45 vs. 43.15%
Capital gains: 15 vs. 20%
Qualified dividends: 15 vs. 46.6%
Other passive income: 35 vs. 46.6%
Estate taxes: 35 vs. 55%
*Includes 1.45% employee portion of existing Hospital Insurance Tax.
**Estate and gift tax exemption also drops from $5.12 million to $1 million, if Congress does not act soon.
Tax-loss harvesting:
>Review your investments to find stocks, mutual funds or bonds that have gone down so that selling now will create a loss. This loss shelters realized gains and up to $3,000 of other income.
N.B. – If you replace the stock, mutual fund or bond, wait 30 days or use similar, but not identical, item. Otherwise, the “wash sale” rules eliminate realization of the loss.
>review your asset allocation to see if any portion is over or under-weighted. Then sell and buy to bring the allocation back in line. However, if you sell and re-buy now, before a dividend is declared, you will receive a 1099 for a taxable dividend in the new fund for investment returns in which you did not participate.

Thanks to the Kiplinger’s Tax Newsletter, Sapers & Wallack and others for ideas and information.

The news may be too much, but there are financial matters to review, if you just set aside time

Many people react to the bombardment of news on the economy, the European debt issues, the presidential campaign and legislative gridlock by wanting to shut it all off! That is understandable, but not often the best solution

It is one matter to just not open investment statements; it is a wholly different matter to postpone addressing financial issues

So, while you may not want to review re-balancing of your investments to match your long-term allocation or hear about the dismal returns on bonds, there is more that you can still address

We have suggested a list at: finance health day your own financial planning focus

It is like a “mental health day” but for your personal finances.
After you look at the list, let me know what you think, what you decide to do,
and if we can help you or anyone you know accomplish what is needed now. Thank you,


Keeping perspective while the debt ceiling “crisis” continues ….

While Congress and the President continue the political battle on the “debt crisis,” here is more for proper perspective:

First, the yield on Treasuries if falling, not rising. If there were a serious issue about the US ability to repay, then US bonds would see high rates. That is, unlike Greece, which is in real trouble, or even Spain or Portugal, the US is still able to borrow at very favorable rates. So, the markets in general, up to this point, believe that the “crisis” has nothing to do with the economy or the strength of the US relative to other nations.

Second, the debt issues have come about after the extended bull market ended in 2008. That is, high stock values and prosperous markets yielded high tax revenues. With this, there were years of budget surpluses, even after tax cuts were enacted. But, post 2008, that has changed. The change in the economy and stock values, even with some markets approaching their 2008 high points, has led to much lower tax revenues.

Finally, from Floyd Norris in the New York Times, we have this summary:

“If rationality does prevail, the debt ceiling will be raised. For that matter, there is no good reason to have a debt ceiling other than to give politicians a chance to grandstand. The important decisions for Congress and the White House concern spending and taxing. Borrowing, or paying back debt as happened for a couple of years before the Bush tax cuts, is a result of the interplay of those decisions and the state of the economy.”
“There is a risk that many analysts now are making the opposite mistake. Deficits have skyrocketed in recent years for reasons that are clearly temporary, or that will be temporary if the economy recovers. In some of the debate, the short-term problems are mixed up with longer-term demographic concerns caused by the aging and retirement of the baby boomers and the rising costs of Medicare, the health insurance program for Americans over the age of 65.”

So, with fingers crossed for the prevailing of rationality soon, that is my update. Let me know if you have questions or comments

Financial impact of the budget plan and planning for tax reform

First, the on-going budget battle in Washington, or “the debt ceiling crisis,” should be kept in perspective. The battle is more a game of chicken, where one side will eventually blink and the ceiling increased. This political battle is not likely to have an impact on investments, as the markets have already accounted for the outcome, as usually happens well before the event. In fact, by way of example, this is much like 1989 when the municipal bonds of the Commonwealth of Massachusetts we downgraded to a rating just above that for Louisiana. Many investors panicked. However, the underlying economy had not changed. Therefore, the smart investment strategy at the time was to buy Massachusetts bonds. After Governor Weld came to office, the rating went back up and investors who held or bought the bonds had a nice profit. The equivalent today would be to buy treasuries.

Second, as it is shaping up, the deficit reduction package contains major tax reform provisions as well as huge spending cuts. This could ultimately be good for the economy and our markets, as it would bring corporate tax rates in line with other countries, falling in the 23 to 29% range. However, the base would be broadened, possibly including depreciation over longer periods, eliminating deductions for domestic production and trimming or dropping the R&D credit.
The tax overhaul raises substantial revenue, $1 trillion over 10 years. However, this less than half the amount that would have been raised by simply letting the Bush tax expire as scheduled.

New Tax Law: Many specifics will not be known until a new tax law is enacted, which is not likely to occur this year. What Kiplinger’s Tax Letter and others are predicting the following: Instead of six tax rates or brackets, with the highest at 35%, three are expected: one in the 8 to 12% range, the next in the 14 to 22% range, and the in the last in the 23 to 29% range. The Alternative Minimum Tax (“AMT”) would be repealed. The earned income credit and child credit would remain.

To do all this, there will be pain: itemized deductions would be significantly reformed, changing home interest and property tax deductions as well as charitable deductions. For example, deduction of interest might be limited to a mortgage of $500,000 used to purchase a home, but not any for a second home. In addition, the deduction of equity line of credit interest may be eliminated (no one knows what will be grandfathered, so better to have a line in place than to wait). Higher bracket taxpayers may see the deductions converted into a 12% credit.
Something of a surprise, given the push over the last ten years or more to increase personal savings, the deductions for retirement contributions may be cut back, lowering the ceiling and amount of the contributions that will be allowed for 401(k), IRA, Keogh, SEP-IRAs, profit-sharing plans and so on. Similarly, flex plan and health savings accounts may be curtailed or repealed.

We will continue to monitor the information on tax reform, and post updates when appropriate.

Any changes that are this sweeping will require serious tax planning, so that should be on your “to do” list for this fall!