Wealthy Thoughts – 1

Collection of thoughts and ideas about various things….

Apple stock “started at Outperform” This was the headline in the Wall Street Journal online edition on 3/31/10, citing a stock recommendation by a French brokerage firm, Exane BNP Paribas. Everyday, brokerage firms make recommendations like this. It caught my eye, as Apple stock has risen incredibly over the past year, from the $80s to $235 per share. So after this terrific rise in the share price, why are they predicting it to outperform now?

Apple certainly has great prospects and is a great company, but wouldn’t this have been a lot more helpful at $80 or $150 per share? This is why we find little value in brokerage firm recommendations. It is hard to accurately predict the future, and very few, if anyone can do it accurately over a long period of time. That is why we follow a different investment philosophy, which is not founded in brokerage firm “predictions” about the future.

Record Retention: There was an excellent article in the New York Times, dated 3/31/10, which accurately provided guidelines for record retention rules for tax and other documents. If you have any questions on this topic, please contact us. The article is: “Retain your Records No Longer Than You Must,” by Jennifer Saranow Schultz (see nytimes.com)

Vanity Fair Magazine: This magazine has become a must read for me, as during the past years they have added a number of terrific financial writers, particularly Michael Lewis, who have provided excellent analysis of world economic events, major individual players in Washington and New York, as well as prominent book excerpts on these topics. If you want more in depth information about these topics, I highly recommend you review this magazine. I’ll leave it up to you if you want to pay attention to the numerous fashion ads.

“Bonds Cap Epic Comeback” This was the leading headline that blared on the top of the 3/31/10 Wall Street Journal. But the much more important question, which I’ve written about extensively, is what will the future hold for bond fund investments?

The article states that investors “poured a record $375.4 billion into bond mutual funds during 2009, while pulling out $8.7 billion from stock funds, according to data compiled by the Investment Company Institute.” (a mutual fund trade organization)

We think this is a huge error by investors, as when interest rates rise (which they will do eventually), these investors will face dramatic losses in these bond fund investments.

Our advice to you is as follows: If you have significant bond fund holdings, please contact us immediately and we would be pleased to review these investments, to discuss why this is a bad strategy and what we would advise as a solid alternative.

If you know someone else who has large bond fund investments, do them a favor for which they will be very grateful and have them contact us, and we will review their holdings and advise them appropriately.

This is the next big mistake in the financial world. This is not an if, but a when.

Truly Free Credit Reports and Gift Card Law Change

Free Credit Reports and Why You Should Do This (at least annually)

The only truly free website to obtain a free credit report is: http://www.annualcreditreport.com/. This site is governed by the Federal Trade Commission (FTC). You may also call 877-322-8228.
Beginning April 1, 2010, other websites offering credit reports must clearly indicate in a box the above information. This site will provide you with a link to get your credit report and you will need to answer a number of personal questions, for identification purposes.

The Fair Credit Reporting Act guarantees consumers access to their credit report information from each of the three credit reporting companies, once per year, for free. The best and only way to ensure that you are getting this information for free is to use the above website, http://www.annualcreditreport.com/.

The 3 major credit reporting agencies are Experian, Equifax and TransUnion. Using the above website, you are entitled to one report from each company every 12 months. You can obtain a free report from all three at one time, or order them one at a time, at various times during a 12 month period.

There are many companies that offer credit reporting services and most will charge various fees, along with the “free credit report.” You should be careful of such services. While they may provide you with valuable services, you should not have to pay for the above credit report. Note that this free credit report is not your “credit score,” which is the basis for most lending, such as mortgages and credit cards.

We recommend that you request your free credit report information from each of the 3 companies at different times during the year, not all 3 at once. This is recommended to monitor if the information maintained is accurate and to spot identify theft. You have the right to inform the agencies if you note any errors.

If you want to purchase an additional credit report, for up to $10.50, you can contact each agency as follows:
Equifax: equifax.com, 800-685-1111
Experian: experian.com, 888-397-3742
TransUnion: transunion.com, 800-916-8800

Source: Federal Trade Commission, www.ftc.gov/freereports

New Gift Card Rules: The purpose of the new rules is to prevent service fees on gift cards unless the consumer has not used the card (or gift certificate) for more than one year. The consumer cannot be charged with more than one fee per month and the fees must be clearly disclosed.The Federal Reserve released the rules on March 25, 2010, which go into effect on August 22, 2010.

Expiration dates for gift cards must be at least 5 years after issuance, or five years after funds were last loaded. These rules are for retail gift cards or network branded cards, like Visa gift cards.

The new federal laws will override any state laws that are not as beneficial to the consumer.

Source: Journal of Accountancy, March 25, 2010, “Fed Issues Final Rules on Gift Card Fees, Expiration Dates”

Fiduciary Standard: Why this matters so much

We make a great effort when working with our clients that they understand their investments and the rationale that supports our investment philosophy. We feel this education is important and a vital part of our relationship.

In some discussions, we are asked how are we different than the “typical broker,” such as Merrill Lynch or Smith Barney. There are many answers to this question. In this post, I want to focus on an important distinction that is based in law, but I think really comes into practice regularly and has significant consequences to investors.

We are legally established as a “Registered Investment Advisor” and must adhere to a “fiduciary responsibility.” Brokers are subject to a lesser standard, called a “suitability rule.” This topic was addressed in a New York Times article dated February 28, 2010, which I will use to explain these differences.

“Registered financial advisers…adhere to a higher standard – “fiduciary responsibility,” an ethical and legal requirement that the investor’s best interest comes first, not the adviser’s own financial gain…Rooted in trust law, that standard means that an advisor has to act impartially and solely for the benefit of the client, avoiding conflicts of interest and self-dealing.”

“Brokers are governed by the suitability rule, which requires them to have “reasonable grounds for believing that the recommendation is suitable, according…” to industry standards. “They are not obligated to get you the best price for what they advise you to buy or sell – or even to be free of conflicts.”

“What may matter more than the array of services is the mind-set of the adviser. When a broker tells a client to buy or sell something, the suitability rule does not mean the broker has to be free of conflicts of interest. After all, the broker’s salary is ultimately paid by the brokerage firm, which has various products to sell. But brokerage firms say they are trying to eradicate that appearance of conflict.”

We take this obligation very seriously and it is the core foundation of our firm. We will only act in our client’s interest.

As an example, we recently reviewed a statement on behalf of a client, who also has some investments with a major Wall Street firm. The other broker sold a high quality municipal bond, which was to mature in a year, and purchased a bond that was rated as much riskier, based on the rating agency’s credit rating. Upon further research, the new bond that was purchased was underwritten by the same Wall Street firm. Thus, it appears that the only reason for the sale and purchase was to support the firm’s bond underwriting efforts. Was this broker acting in the client’s best interest or his firm’s best interest?

Source: New York Times, “Broker? Adviser? And What’s the Difference?”, February 28, 2010

Health Care Reform: The Tax Impacts

The following summary of the tax impact of the health care reform legislation is based on information available as of March 23, 2010. As more details are learned (the fine print!), I will provide further updates.

Increase in Medicare Tax: Beginning in 2013, the employee portion of the Medicare tax on compensation/earnings will increase by .9% (from 1.45% to 2.35%) for taxpayers with earned income in excess of $200,000, or $250,000 for joint filers. This also applies to self-employment income. It appears that the tax will affect all wages, but only for taxpayers with income above those levels. Implementation of this may be challenging or complicated, as taxpayers may not known until after the end of the tax year, whether this tax will apply, until their AGI is determined.

Investment Income Tax: Starting in 2013, at the same income levels as above, there will be an additional 3.8% tax on net investment income (interest, dividends, capital gains). I have seen some publications that include rental income in this definition, as well as annuity income, royalties. It would not apply to retirement plan distributions. This may cause a review of annuities, if this tax applies to annuity distributions.

Medical Expense deduction: For 2013 – 2016, medical expenses that exceed 10% of adjusted gross income will be deductible as an itemized deduction. This is an increase from the current level of 7.5% of AGI. Thus, for affected taxpayers, this will reduce the amount of medical expenses that they will be able to deduct. The new level will not apply to taxpayers older than 65 by the end of the respective year.

Flexible Spending Accounts and Health Savings Accounts: Beginning in 2011, includable expenses will be limited. This needs further clarification. Based on what I’ve seen, only prescribed medications and insulin will be includable. Over the counter products will be excluded after 2010. Beginning in 2013, the annual contribution to FSA account is limited to $2,500, reduced from the current level of $5,000.

Impact on Children under age 27: Within 6 months of becoming law, employees should be able to keep their children on their medical insurance policies through the age of 26. Currently, this is a state specific law. Michigan currently allows children to remain on their parents’ policies until age 24, if enrolled in college.

IRS: The IRS will be very involved in various reporting and enforcement parts of this legislation, through reporting by employers, individuals on their income tax returns and health insurance companies. Insurers will be providing information to the IRS annually regarding the amount of coverage they provide.

Business impacts: The impact on business are unclear at this point, or too detailed to provide in this format. The impact will depend primarily on the size of a business, depending on employee levels (less than 10, less than 25 or much larger employers), as well as the average employee compensation. Most of the credits available to businesses to encourage or offset the cost of providing employee health insurance are for companies that have average compensation of $40,000 or $20,000 for smaller employees.

Business information reporting: Starting in 2011, employers will need to include the value of employees’ health insurance coverage paid by the employer on each employee’s annual Form W-2.

The act also requires, starting in 2012, businesses to file information returns (a Form 1099) for all payments aggregating more than $600 in a calendar year to a single payee, including corporations. This was reported by the Journal of Accountacy, published by the AICPA, and would be a vast expansion and burden, in the preparation and filings of Form 1099s.

Adoption Credit: For 2010, credit increased by $1,000, to $13,170 per child, and made refundable. This will be adjusted for inflation in future years.

Medicare and “doughnut hole”: For the Medicare prescription coverage, seniors are covered for initial payments, up to a certain level. After exceeding that level, payments are out of pocket (referred to as the “doughnut hole”), up until another level, after which Medicare prescription coverage resumes. The gap amount will be gradually reduced, beginning with a $250 rebate in 2010, and eventually eliminated after 2020. In 2011, there will be a 50% discount on brand name drugs.

Sources: New York Times, Wall Street Journal, USA Today and Journal of Accountancy, as of March 22 and 23, 2010

Fed Actions: What Does it all Mean?

The Federal Reserve met on Tuesday, March 16th and published their rate-setting statement. What does it mean? How did the financial markets react? What can be learned from their statements and actions?

Short term interest rates: The Fed continued their policy statement that they will keep short term interest rates at “exceptionally low levels…for an extended period” of time. Note that in Fed speak, an extended period of time is interpreted as a number of months (some analysts think 6-9 months), not necessarily years, as one would generally think. Thus, short term rates will remain very low, in the near term.

Mortgage rates: The Fed, as expected, is nearing the completion of the emergency measures they undertook in 2008 and 2009, to purchase various mortgage securities and securities of housing related government “agency bonds.” The purpose of these actions was to keep interest rates low on mortgages, to make mortgages and housing more affordable.

It is interesting to observe, as I have written about before, how difficult it is to predict the financial markets. It has been widely anticipated that the Fed would be stopping these purchases, which would cause mortgage rates to rise in 2010. So what has happened? Just the opposite, so far. Rates on 30 year mortgages have fallen from 5.28% in early January to a current rate of around 5.05%. Evidence again that the financial markets cannot be accurately predicted in advance.

Inflation: The Fed expects “inflation is likely to be subdued for some time,” as they feel that there is still significant under utilization of resources and capacity, and that will keep cost pressures down. They also feel that long term inflation expectations are stable.

As advisors managing fixed income portfolios, we do not make predictions about the direction of interest rates. As noted above, to attempt to do that is nearly impossible, particularly over a long period of time. We would prefer to build a diversified portfolio of very high quality fixed income securities, of varying maturities, so that we will get the interest rate return of the market, and not risk losing money by betting on the direction interest rate moves.

What a Difference a Year Makes, or Does It?

Who would have predicted what occurred in the financial markets during 2008 and early 2009? Who could have predicted the huge losses in the stock markets worldwide, financial crisis and major institutions going bankrupt or merging into others?

No one could have predicted these events, as no one can predict the future. Which is why one of our investment principles is based on the concept that “we cannot predict the future.” This may seem startling to non-clients, but give it some thought. It makes sense, doesn’t it?

Much of Wall Street is based on claiming they can pick the best stocks, which countries or sectors to allocate into and out of, etc. To do this correctly over a long period of time, you have to be able to predict the future. Do you know of anyone who can do that correctly, for years in a row?

So what has occurred to the financial markets in past year? It is utterly amazing, and again, something that no one could have predicted. The S & P 500 is up 71% from its low on 3/9/09 to today, going from 667 to approximately 1,140 today. The Global Dow (made up of large companies throughout the world), has risen 74% from it’s low on 3/9/09 to today.

What is to be learned from this information? It reinforces our philosophy and advice that we provided to our clients, that markets would rebound, we just did not know when and by how much. We did know that if you were to wait until clear signs of a financial recovery or stability were apparent, you would miss a lot of the market recovery. Signs are now appearing in the statistics that the government and businesses are releasing, such as retail sales and unemployment claims, that the worst of the financial crisis is behind us.

We believe that our financial principles have survived the test of the past few years. Being well diversified on a global basis and having a very significant international allocation of equities was beneficial. Our strategy of not using active money managers was proper, as most active managers and mutual funds underperformed the markets, and those few that did could not have been identified in advance. Regardless of what Wall Street says (“this is a stock pickers market”), if you cannot predict the future, then picking stocks in this manner is a losers game, in the long run.

We are more passionate than ever that our investment providers are doing the right thing. They are focused, as are we, on providing the lowest cost investment products, as that is something that we can control, without sacrificing investment performance. We know that global diversification means not just having international mutual funds, but having those funds diversified all around the world in a prudent and disciplined manner. It means not having 50% of your international fund be in Europe or Japan, as that is not truly “diversification,” that is actually a huge bet (prediction?) on one part of the world.

We are also very satisfied that our conservatism with regards to fixed income investing has proven to be the correct strategy. By not holding corporate bonds, junk bonds, certain municipal bonds or long term fixed income investments, our clients did not incur the huge losses which many investors did in 2008. Our clients are also well protected for the eventual rise in interest rates (when will that begin?), as their portfolios are not full of bond mutual funds, which will be the “next big mistake” that the media will be writing about some time in the future. When interest rates rise (not if, but when), those bond mutual funds will decline significantly in value. Our strategy of holding very high quality individual bonds and CDs is proper now, and it will be even more evident that is it correct over future years.

In summary, 2008 was very painful. Most of 2009 was very rewarding, for those who were disciplined and adhered to their strategy. We learned throughout the past 2 years that the foundations of our investment philosophies were correct and will withstand the test of time, during both good and bad times.

If you have questions or thoughts about any of these items, please email me at bwasserman@wassermanwealth.com.

Source for investment statistics: WSJ.com, as of 3/8/10.