Is Wandering Good?

As part of our investment philosophy, we develop a specific investment plan for each client. When we determine an allocation for each specific investment category, such as “US Small Value” or “Fixed Income” (cash, bonds, or CDs), we want the investment fund that we use, to remain pure to that classification.

With the mutual funds that we use to purchase stocks and the direct buying of fixed income investments, we have been able to accomplish that goal. Most mutual funds hold stocks across multiple asset classes, so they do not adhere to this discipline.

In an interesting article in today’s Wall Street Journal, according to an SEC filing, the world’s largest bond fund, Pimco Total Return, managed by Bill Gross, will be able to purchase as much as 10% of it’s assets in non fixed income investments, such as “preferred stock, convertible securities and other equity-related holdings, during mid-2011.  Gross has an outstanding track record and his successful is undeniable, so I’m not going to question his motives.

However, this move re-inforces the importance of truly understanding what you are purchasing, when you buy a mutual fund or any investment. When we buy a “US” stock fund, we know that all of the companies in that fund are based in the US. With many other mutual funds, you may think you are buying a US fund, but upon further examination, find out that 20% of the companies are internationally based.

This is important if you want to adopt an investment strategy, an asset allocation plan, and then really be able to monitor and stick to it. If the fund that you buy wanders off and buys different things than you originally thought, than your actual asset allocation will not be what you intended. And that could be a problem.

In this case, we believe in purity.

New Tax Law: What You Need to Know

Updated, Friday 12/17/10:  The House passed the bill that was agreed upon by President Obama and Senate. It appears that no changes were made to the bill that the Senate passed. President Obama is to sign it on Friday. The following is a summary of the legislation, but is not intended to cover all the provisions of the new law.

Tax rates:  The current rates will remain in effect for the next two years, 2011 and 2012. There will be no tax increase, even for taxpayers in the top tax bracket of 35% (for ordinary income) for the next 2 years. Note that these tax rates are not permanent, as the law only covers 2011 and 2012.

Capital gains and dividend tax rates:  Current capital gains and dividends rates of 15% remain for high income taxpayers. For those below the 25% tax bracket, the capital gains rate which is currently at 0% rate will remain.

Estate tax rates:  Major Change:  This has been the major point of contention in negotiations this week. The new law will have a $5 million per person exemption and $10 million per couple.  This is a higher level than most would have expected months ago. The exemption amounts are indexed, beginning in 2012.  The top estate tax rate will be 35% for 2011 and 2012.

The law also allows planning opportunities to shift/allocate assets between a couple, upon the first to die, to maximize the use of the full exemption for each individual.

Payroll Tax Reduction:  For 2011 only, the 6.2% social security tax will be reduced to 4.2%, for the first $106,800 of wages, which are subject to this tax. This will provide up to $2,136 reduction in social security taxes for employees whose wages are $106,800 or higher. A couple who each earns at or above $106,800 will save approximately $4,300.  Note that employers will still need to pay in the employer portion of social security taxes based on the 6.2% amount.

Alternative Minimum Tax:  Technical changes were made, so that the AMT will remain at same level as in 2010. This still has a great impact on many middle-high income taxpayers.

Addition to the Deficit:  The bill did not provide for any federal spending cuts. The bill is projected to cost the Treasury $860 Billion over the next 10 years. This does not include the cost of the 13 month extension of unemployment benefits.

Business:  As for individuals, a number of extensions of items for a year or two, through 2012, such as increased depreciation expense and research and development expense credits.

Not included:  There was no change to how private equity and hedge fund executives will be taxed. Most will continue to earn at capital gains rates, not as ordinary income rates, as once thought might be passed. Congress failed to pass any changes related to issuance requirements of Form 1099s, which will be greatly increased from provisions of the health care bill passed earlier in 2010 (don’t ask how those are tied together!) Hopefully, some of the Form 1099 rules will be modified in 2011.

Sources:  Wall Street Journal and New York Times, December 13-17

When is 3 Really 1?

A new client asked us to review three funds that he had been holding for a very long time in a retirement account.  Each of these funds were managed by the same mutual fund company, but had distinctly different names.

Upon my review, the results were not surprising to me, but startling to the client. Each of these funds were basically holding the same stocks. So while the client thought they were broadly diversified, based on the names of the different funds, the tops holdings read like three interchangeable and almost identical lists. We actually held the three top holdings lists side by side, and they looked almost the same.  Each had many of the same companies like Apple, Exxon Mobil, IBM, GE. You get the idea.

There was no effective diversification at all, if you think about effective diversification as we do. There were no small companies, there were no real estate companies, there were no small value companies. There was minimal international holdings, which is a serious problem, in our view. There were no emerging market stocks.

So while the client had 3 funds, they really just had 1 fund, with 3 different names. They had not achieved the diversification they thought they had, and knew that was in their best interest.

Separate from this client example, the current year’s worldwide stock market performance, as viewed by asset class, provides great evidence of why “effective diversification” across many asset classes is so important. A sample of some asset classes, as evidenced by DFA mutual funds for YTD through 11/30/10, makes the point:

US Large, which is similar to the S & P 500:+7.8%
US Micro Cap (very small companies)+21.38
US Real Estate+22.9%
International Small Company+11.8%
Emerging Markets Value+12.7%

Please note that the above is presented only for illustrative purposes, for an 11 month period of time, and before any advisor fees.

However, the point remains, many people have a portfolio which may hold many mutual funds or individual stocks, but if reviewed carefully, basically acts or is very similar to the S & P 500.

That is not in your best interest, over the long run, for a successful investment experience.

Purely Personal

This has been a very meaningful and eventful Thanksgiving and subsequent week, for our firm, in our personal lives.

Keith’s wife Ann had their 5th child on Thursday morning, December 2nd.  They had a very healthy beautiful girl, Olivia Brooklyn, to join her older four brothers. We congratulate Keith and Ann on the new addition to their family! They are all doing very well.

My daughter celebrated her Bat Mitzvah on Saturday of Thanksgiving weekend. This was a very meaningful and wonderful event, which I was fortunate to share with my entire extended family and friends. My daughter was incredible, and she made her entire family very proud of her accomplishments. She is an inspiration to all of us.

It is events like these that give us reasons to reflect on what is truly important in life and be thankful… for our family, our personal  and business relationships and for good health.

While we work with our clients regarding their money, we truly hope that our ability to be successful enables them to reach, enjoy and celebrate many wonderful family milestones.

As I said on Sunday, we are all very fortunate!