Earl Hines

No one knows the future, but there are a few signs to watch for

The current recession has already been the longest post World War II, and is expected to be the deepest global economic downturn since the 1930s.  Many economists now expect no clear signs of recovery until 2010.   If history serves as a model, financial markets will try to predict this turn-around and begin to recover 4 to 6 months in advance.   Bottoms are difficult to predict, and time and time again it has been proven that you can’t time the market.   As such, I wanted to offer a few thoughts on what we can expect to see before the economy recovers.    

1.  Housing Market Must Stabilize:    New housing starts in January were down 17%, an all time low, signaling that housing is still in the doldrums.   Though this is very bad news for the construction industry, it may eventually lead to improvements in existing home sales where inventories are at record levels and housing prices continue to plummet.   According to the National Association of Realtors, the national median home price has fallen 15.3 percent during the last year.  Finally, before we see any meaningful economic recovery, the tide of foreclosures sweeping the country must be reduced.   Not only do foreclosures result in families being homeless, it dramatically impacts the balance sheets of the mortgage holders, putting additional pressure on the beleaguered banking industry. Major portions of President Obama’s recent stimulus package are designed to reduce foreclosures and allow for loan modification to keep more people in their homes, and more importantly, to keep payments flowing to mortgage holders.   If this plan succeeds we should begin to see mortgage defaults decline and home prices stabilize.  

2.  Job Market Must Improve:   The US  lost 2.6 million jobs in 2008, and so far this year, another whopping 600,000, the steepest decline in employment in over 34 years.   Unemployment is now at 7.6% and many leading economists predict it will rise to 8.5 or 9.0% before the economy begins to recover.   The causes of job reductions are coming from a variety of places, including, small businesses who can no longer access sufficient credit to meet payroll or pre-pay for inventory; reduced demand because consumers are refusing to buy in favor of saving, or who themselves have been put out of work; and, businesses who are delaying business spending in hopes they can weather the current economic storm.   In my opinion, this trend will be the most difficult to turn around.   The government’s stimulus plan includes a variety of tax cuts for businesses and individuals, and incentives to create new jobs in the construction of infrastructure and alternative energy.  However, job creation programs are slow, and we will not likely see any impact until 2010.  There is also no guarantee that tax cuts will automatically flow back into the economy in the short-term, as many companies are simply trying to get their own balance sheets in order.

3.  Credit Markets Must Normalize:   Banks have to start lending again.   Current rates on conforming loans are at historic lows, making more money available for mortgage lending.  But business credit needs to open up dramatically at reasonable rates to ensure that businesses can access capital so that they can invest again.  To date, many of the banks that have been bailed out by the US tax payer, have been doing their best to fix their own balance sheets, and have been somewhat tight-fisted with the cash.   Rates have to stay reasonably low, and the banks have to lend.

4.  Consumers and Businesses Have to Start Spending Again:   If the current economic crisis has led to anything positive, it’s that many Americans are now saving more money and doing their best to reduce debt.   This is very positive in the long run, but paradoxically, in the short-term, it thwarts efforts to get the economy going again.   Nearly two-thirds of America’s gross domestic product comes from consumer spending.   Unfortunately, many consumers and businesses are currently either flat broke, or doing everything possible to stay financially solvent.  It is for this reason that the US government is doing unprecedented spending (and unprecedented borrowing) in an effort to get money flowing throughout the system.   The belief is that once consumers see that their homes are not plummeting in value, and their jobs are not in jeopardy, they’ll begin to spend again.  As they do, businesses will begin to invest again, in expectation of competing for the consumer’s dollars with new innovative products and services.

And the economic wheels start spinning again from there.

Earl Hines

Don’t Let It Grip You

The Dow Jones Industrial Average fell 248 points on Wednesday, following the latest round of dark economic news.  Retail sales fell 2.7% from a year ago in December, a decline twice as large as economists had expected. Meanwhile, after investors closed the door on a miserable, gut wrenching 2008 - most had hoped the new year would return to a more normal market cycle. Unfortunately, fears about the nation’s banking industry continue, and as the banks go, so go the markets.    

After the government airdropped more than $250 billion into the banking system in 2008, investors are increasingly worried that job losses and the slowing economy will soon result in rising defaults on credit cards, auto loans and other consumer debts.   Consumers are under pressure, and the banks, already laden with bad mortgages, could suffer greater and greater losses unless we stem the tide of unemployment, now greater than 7% nationally.  

Our government is hard at work attempting to plug the holes in our economic dike. President-elect Obama asked Congress to release the remaining $350 billion in stimulus from last year’s “TARP” program, a request lame-duck George Bush echoed as well.   President Obama will take the oath of office next week with the prospect of a multi-trillion dollar national deficit looming.  

We need to brace ourselves for the fact that the US government is going to run very large deficits for the foreseeable future.  No one likes this, but the option of borrowing billions more to inject into our ailing economy is only slightly worse than the  option of not doing it.   With job losses mounting, and consumers reducing their spending — we are entering what could be a period of deflation where prices drop because too few consumers are chasing too many goods and services.  This sounds like a very attractive situation, but on the contrary, rapidly falling prices can become a negative spiral where consumers and business refuse to invest in new projects on the belief that prices will eventually go lower.   From there, businesses suffering from lack of demand lay-off more workers, who eventually can’t make their mortgage and credit card payments, coming full circle to put more pressure on our nation’s banking system.

In short - we must stabilize the job market and household income if we are to return to a period of economic growth.  This is going to take some time.  So, in the interim, try not to overact to the negative news and our current economic woes.   Fear cannot drive you a successful long term investment strategy.   We expect job losses to continue through 2009, and that unemployment might rise to 8 or even 9% before it begins to improve.   Even if President Obama gets everything he wants from Congress (not likely) and invests in major public works projects and the development of alternative energy, it will be 2010 before most of the impact of this spending is felt in the jobs market.

Always keep in mind that day to day market volatility is driven by investor psychology, and currently the mood is pretty dour.   But keep your fear in check.   Put 2008 in the history books, expect 2009 to be tough sledding, but stick to your long term investment plan.  Any review of history shows that we have had many more good days in the stock market than bad, an in the fullness of time, markets have always trended up.    At the end of the day, you have to choose to be optimistic about the future.   If you do. at least history (if not the popular media) is on your side.

Earl Hines

Investors want to know: “Who can I trust?”

As if investors didn’t have enough fear to deal with these days, the arrest of famed investor Bernie Madoff has Americans shaking their heads. Madoff, age 70, known as the investor with a golden touch managed for decades to pull off the biggest PONZI scheme in history — a whopping $50 billion!  Granted, most of his investors were very wealthy people (including Hollywood actors Kevin Bacon and Kyra Sedgewick) who should rightly have been a bit more suspicious of his overly consistent performance.  But many Jewish charities, private foundations, and smaller investors were also taken in by Madoff; and in too many cases, entire retirements have now been wiped out.

Investors are asking - how did this happen?   Where were the government regulators?  Indeed, the Securities and Exchange Commission fell down on the job — they had warnings from whistle blowers inside of Madoff’s organization as early as 1999.   They even audited Madoff a half dozen times and supposedly found nothing.   The post-mortem on this tragedy will go on for years, as Madoff’s prosecution progresses, and investors line up to try to recover as much as possible from his remaining holdings.  But there are lots of people to blame for this mess - beyond greedy Mr. Madoff and beyond the SEC; specifically, investors themselves.  

Here are some things that investors should always be on guard against to reduce the likelihood that they will be cheated in such investing schemes:

1.   Don’t get too much of a good thing:  You already know that the best risk management tool is diversification — spreading your investments across multiple assets, asset types, sectors, and geographies.  Madoff’s hedge fund invested in securities and then used complicated options and futures strategies to enhance returns; investors may have wrongly viewed this as appropriate diversification.   His returns became so good and predictable, that investors began to shift more and more of their assets to his fund.   Just as you should not put all of your portfolio in a single stock or bond; don’t commit too much of your wealth to a specific fund manager.  Most investors are familiar with mutual funds; they diversify assets on your behalf by buying underlying securities.  You also want to diversify across fund managers.   Too many of Madoff’s victims were simply holding too much Madoff.

2.  Insist on a Separation of Powers:  One reason Madoff was able to pull off his PONZI scam for so long was because his company served as both the Investment Manager for the fund and as Custodian for clients’ assets.   Investors continued to get rosy statements from the Custodian showing their assets growing and growing, when in reality, the returns were fiction, and the assets they believed they owned were fiction.   The role of the custodian (as opposed to the investment manager) is to keep assets safe for clients; and by having a separate custodian from the fund manager - it’s easier to keep track of any irregularities in account values, dividends and money movement.   As an example, as an independent investment adviser, my clients never provide funds to me directly; I never take custody of assets. Instead they open accounts with a third party broker and custodian, like Charles Schwab, and then give me permission to manage the accounts on their behalf.   They get performance reports from me, but also get trade confirmations and monthly account statements from the custodian as well.    Transparency is what investors need and what they should demand.  This is achieved partially by using advisers that do not also custody their assets.   

3.  Who is Checking the Books?  Good fund managers with billions of dollars should be audited by the best and the brightest of accounting firms.   Mutual Funds publish the name of who audits their books, and investors should find out who the auditor is and do a little research.   According to news reports, Madoff’s auditor was a single CPA working alone in an office in lower Manhatten.  Hard to imagine this poor fellow had the wherewithal to fully scrutinize a $50 Billion hedge fund.

I’m not blaming the victims of Madoff’s scam.  But at the end of the day, investors have to use common sense when managing their assets.   It’s your money; no one cares more about it than you do.   Even though regulators were at best incompetent and at worst complicit in Mr. Madoff’s operation, many investors should have seen the red flags mentioned above.   The old adage  ”if it’s too good to be true…” applies here.      

It is important to find and build trust in an investment adviser you can rely on, and then find out how they evaluate and select the fund managers they invest in.  Don’t allow them or yourself to place too much of your portfolio with a single fund manager.

Earl Hines

 A retirement plan, that is.

401(k) Plans offer business owners valuable tax-savings

strategies and the best employees.

Do you own your business? If so, you already know that today’s employees are more

conscientious than ever about their retirements, and how today’s decisions could affect their future. Many Americans begin planning their retirement as soon as they graduate college (or even sooner!). That means if you aren’t offering a retirement plan, you may be missing out on the kind of highly motivated, self-directed employees you’ve been looking for. That’s right, your 401(k) can be used as a recruiting tool!

What about taxes?

Well, a 401(k) can provide both employers and employees valuable tax benefits. You can get a tax deduction based on salary deferral and employer contributions; your employees get tax-deferred growth of their assets. For 2009, employees can contribute up to 100% of their earned income, up to a maximum of $16,000 ($21,000 for workers over 50). By contrast, without an employee sponsored plan, the same employees can only contribute $4,000 pre-tax to a traditional IRA. Simply by offering a 401(k) plan, you dramatically enhance your employees’ ability to save for retirement. Also, by adding a profit sharing incentive, owners can generally benefit from significant pre-tax savings for their own retirement accounts simply by contributing a small percentage of company profits to their eligible employees.

So you want to offer a 401(k). Now what?

The first thing to consider is how much current interest there would be at work in having a 401(k) plan. Poll your current employees and find out two things: 1) how interested they are, and 2) what (if anything) would be a deciding factor for them that would make them enroll or not enroll. Next, you’ll want to determine the cost (both in terms of money and time) to implement your 401(k) retirement plan. There are many service providers who specialize in the implementation and management of employer plans, and in the end, the cost of offering a 401(k) is far outweighed by the pre-tax financial benefits you will receive as an owner. Getting started. The first step toward offering great retirement benefits is learning all you can about what options are available. With any plan you’ll want to carefully consider what investment options are available and how the plan will be administered. I would recommend that you speak with a qualified financial professional who can help you sort through the choices and determine which options will work best for your business.

Earl Hines

Rates are at 37-year Lows

Though new home buyers will find applying for a loan much more difficult than in recent years, existing home owners with good credit and documented income histories may qualify for a new refinanced mortgage at considerably lower rates.   Rates have tumbled over recent weeks, and homeowners have noticed.   

The Mortgage Bankers Association reported last week that its overall Market Composite Index, a measure of mortgage loan application volume, shot up 48 percent on a seasonally adjusted basis, driven by a whopping 63 percent leap in its Refinance Index.    The Federal Reserve again cut it’s Target Fed Funds Rate (now at nearly 0 percent) and announced it would buy more mortgage-backed securities issued by Fannie Mae and Freddie Mac.    The Fed’s cuts tend to lower mortgage rates for conventional home loans, and Freddie Mac’s survey of mortgage rates showed more than a quarter-point drop to the lowest level in the 37-year history of the survey. The 30-year fixed-rate mortgage fell from 5.47 percent last week to 5.19 percent.  15-year fixed rates are even lower.

When calculating the cost-benefit of a mortgage refinance, be sure to get clarity from your bank on all points and fees that are required.  Then based on your lowered payments, calculate when the break-even is on this refinance.  As an example, if the total cost of refinancing is going to be $5,000, but your annual payments are reduced by $2,000 per year - it will take you 2.5 years to break-even on this refinance.   In other words, if you are not planning to keep the home for 2.5 years or longer, this refinance may not make financial sense.

Given the relative “cheapness” of money these days, and the turmoil we’ve seen in bond and stock markets, reducing the cost of your debt can be an effective way to increase your cash flow and net worth — even during recessions.   So, if you have been thinking of re-financing a higher rate mortgage or consolidating that equity line of credit into a fixed rate, now is likely the right time.   Just get the facts and shop around first.

Earl Hines

Consider an Irrevocable Life Insurance Trust

Recently, clients of mine were faced with important decisions regarding the future transfer of their estate.  Because a large portion of their wealth is concentrated in the family’s business, the couple was concerned that their children might not have the available cash to pay estate taxes after their deaths.   Their goal was to ensure the children could keep the business rather than be forced to sell it simply to pay the IRS.  

The Death Tax

Every American is entitled to an estate tax exemption on the first part of his or her estate. With proper planning, a married couple can double that exclusion shelter. The exclusion is $2 million per individual in 2008 and increases to $3.5 million in 2009.   The estate tax is repealed in 2010 but then returns in 2011 with an exclusion of $1 million. 

At your death, your beneficiaries can inherit your estate, income tax free, but the proceeds are not estate tax free.   Estate taxes are a maximum of 48 percent at the federal level, and when you add state taxes, the total liability can easily consume greater than half of your assets.   To say the least, this takes quite a bite out of your estate.  Unless you protect it, your legacy could be lost needlessly to the government.    

Protecting Your Legacy

An Irrevocable Life Insurance Trust (or ILIT) allows you to protect your loved ones without adding to your estate taxes. This trust can acquire and pay for insurance on your and your spouse’s life, and upon your death, the proceeds from this insurance are outside of your estate, and not subject to taxation.    

By working with an attorney, you can set up an ILIT, name a Trustee that is not yourself, and name your heirs as the beneficiaries.   Your Trustee is required to follow the precise instructions you provide in your trust documents.    He or she will purchase life insurance on your lives with funds that you provide as “gifts” to the trust.

Gifts To Your ILIT

Annually, a taxpayer may give up to $12,000 to another person gift tax-free.  This amount increases to 13,000 in 2009.   Married couples, therefore, can give a combined total of $26,000 gift tax-free to any one person. Other than this per-person rule, there’s no limit on the total amount you can give away. For example, if you have three children and five grandchildren, you and your spouse could give each one $26,000, for a total of $208,000 annually!  This can buy a lot of life insurance coverage.    

CAUTION:   It’s very important that you ensure your children, particularly if they are young adults, understand and support this part of your estate plan.    When you provide your Trustee with the funds to pay your annual premium, your Trustee must notify your beneficiaries in writing that a gift has been made in their names. Your beneficiaries will have the option of withdrawing these funds from your ILIT during a specified period, usually up to one year. When they don’t exercise their option, your Trustee will use the money to pay your insurance premium. This written notification of your gift to your beneficiaries is known as a Crummey Letter, named for the taxpayer who won a court case against the IRS resulting in approval of this process.  Obviously, if your children chose to withdraw the funds they would sabotage your entire strategy, so it’s important that they understand the importance of the ILIT and why they should not do this.

Paying Estate Taxes

In the case of my clients, they set up an ILIT to ensure their children would have enough cash after their deaths to pay the estate tax, without selling the family business.  Since the life insurance contract is owned by the ILIT, the proceeds from the policy contract fall outside of the clients’ estate.   Since the proceeds of the insurance are payable to the ILIT, with the children as the beneficiaries, this cash can be used to settle the estate taxes.

Even if you’ve engaged in estate planning in the past, it is important to revisit your documents periodically as the law and your specific circumstances may have changed.  An ILIT may be a useful tool in your estate plan, but it is only one of the tools available to you.   You should work with your financial advisor who can lead a team including your estate attorney and CPA to evaluate your specific needs and make recommendations.

Earl Hines

College Savings Plans Still Most Attractive Vehicle for College Funding

Since the Oregonian’s story on December 19th highlighted the eye-popping 38% loss in the Oregon 529’s most “conservative” fund, I’ve had numerous clients ask me whether or not they should rely on 529 Plans to save for their children’s future education.  

Oregonian’s invested in the state’s plan have every right to be upset and concerned about the poor performance of  the Oppenheimer Core Bond Fund, which lost 38 percent of its value this year, when other comparable funds actually gained 4 percent.   Morningstar reported that the losses stemmed primarily from the fund’s considerable exposure to Mortgage-backed securities (the same type of toxic assets that have plagued investors all year).   The most shocking part of this large loss was that investors believed that their college savings were actually invested conservatively, but instead had a lot more exposure to stocks and corporate bonds than they were aware.  

While we cannot undo the past, it’s important not to throw the baby out with the proverbial bath water when it comes to 529 plans.   Though Oregon residents do get a small tax incentive to invest in their own state’s plan, you are not restricted from investing in another state 529.   You can actually invest in any of the state 529 plans (there are over 80) nationwide, and these are not all created equally.   In fact, according to Savingforcollege.com, which ranks the separate plans, Oregon’s ranks 37th in the nation on its three-year performance and 43rd on its one-year performance.  So, as with all investments, buyer beware.  Just as investors should compare the performance of mutual funds among other managers; the same is true of 529 investment managers.

Here are some key advantages offered by College 529 plans:

• Tax Savings:   The biggest tax incentives come at the federal level when funds are used to pay for college.  Although your contributions are made with after-tax dollars, your investments grow tax deferred—potentially boosting your investment growth.  
• Withdrawals are federally tax-free when used for qualified education expenses, such as tuition, fees, books, supplies, room and board.   You can even contribute a lump sum of up to $60,000 ($120,000 per couple) in a single year without incurring gift tax.
• For estate planning purposes—as an account holder you can move assets out of your taxable estate while still maintaining ownership and control of the assets.
• The beneficiary (the student) of the account can be changed at any time to an eligible member of the original beneficiary’s family without penalty.

When selecting a 529 plan, in addition to looking them up on Savingforcollege.com, you can also find useful information on Morningstar.com.     There, you will find the State and Name of the plan, the Plan Administrator, which is usually an investment firm, the plan’s expenses (which eat into your possible returns), performance, and underlying holdings.  Check the plans out thoroughly.  You can also see the various portfolio strategies, usually based on when your child expects to enter college.   Find out how your specific 529 plan is performing; don’t simply invest in a plan recommended by your state.  You could also consider opening a 529 plan in two different states, using two separate program administrators, which allows you to diversify your risk across investment managers.

Earl Hines

Contribution Limits Increase in 2009

If you are eligible to participate in an employer-sponsored 401(k) or 403(b) retirement plan, you have a tremendous opportunity to build tax-deferred wealth. In 2009, the contribution limits for individuals goes up from $15,500 to $16,500, so it’s a good time to increase your withholdings to ensure you take advantage of this tax-deferred savings.   For those over 50, the catch-up contribution goes up to $5,500 in 2009, allowing those folks to contribute up to $22,000 next year to their retirement.

Even if you can’t afford to fully maximize your contribution, you should absolutely be contributing to this savings vehicle.  If your employer offers a match, based on your contributions, don’t miss out on these monies.   When planning for retirement, time is your best ally - if you miss such “free” employer contributions, you’re not just losing the money today, but the future money it would have become.    As an example, if your employer matches your $5,000 contribution in 2009, and you have 15 years to retirement, assuming a growth rate of 8%, that $5,000 matching contribution from your boss will be worth over $15,000 when you retire.   Since you had to put in $5,000 to get the match, this one year’s contribution would be worth over $30,000 when you retire.   So, in tomorrow’s dollars, your failure to secure this matching contribution is very, very expensive.

No RMD Penalties for 2009

Congress passed the Worker, Retiree, and Employer Recovery Act of 2008 this past week, mostly to provide the Big 3 Auto makers their Christmas bail-out package.   However, they also threw a bone to current retirees.   

If you are age 70 1/2 or older,  you are required to withdraw a certain percentage from your tax-deferred assets annually, including those in traditional IRAs, 401Ks and 403Bs, and pay the appropriate federal and state income taxes.  This percentage is known as your Required Minimum Distribution or RMD. The amount is based on your life expectancy and the prior December 31 balance of your account.  Failure to do this results in a stiff penalty of 50 percent on the amount that you should have withdrawn.  This is in addition to your regular taxes!    

The new legislation provides some relief to Americans who have suffered significant losses in their IRA accounts this year by suspending this rule.  The penalty is waived for 2009, which means that seniors will not be required to take withdrawals from their tax deferred retirement accounts next year — hopefully giving them an opportunity to recover.   RMDs resume as normal in 2010. Unfortunately, this law does not apply to 2008, when it would have done the most good for investors, many of whom have already arranged to take their 2008 withdrawals. ]]> http://fearless-finance.com/2008/12/16/retirement/seniors-get-break-from-required-distributions/feed/ http://fearless-finance.com/2008/12/01/retirement/year-end-recession-survival-tips/ http://fearless-finance.com/2008/12/01/retirement/year-end-recession-survival-tips/#comments Mon, 01 Dec 2008 03:12:03 +0000 earlhines http://fearless-finance.com/?p=173

Don’t Ignore Your Accounts

The October stock market crash has probably wreaked havoc in your 401K and  erased significant value on many of your other investments.    It’s perfectly human to feel a little sea-sick right now.  These are trying times not only for investors, but everyone in the country, especially now that home foreclosures and unemployment is rising. It may provide only minor comfort to hear that, yes, we’ve survived these cycles before, and that we believe that even though this recession will be more painful than others in recent history, the economy will indeed recover. 

Even though you can not control the economy, there are some things you can do to take charge of your finances now and prepare for the possibility that things might get a little worse before they get better.

Here are few things you can do now to weather this recession: 

1)   Cash is King.  The first thing I recommend you do is evaluate your cash position.   Maintaining 3 to 6 months of fixed-spending for emergencies is always prudent, but if you’re worried about the possibility of one or more breadwinners being out of work, try to increase this position, to 9 months or even 1 year.  Having cash on-hand can provide  peace of mind.  This cash should be in highly-liquid and safe instruments, like your savings account, FDIC-insured CDs, money-markets, etc.   Do not invest this cash in the market.

2)  Delay Big Purchases.  Put off any new large cash commitments until 2009.   Try to pay-down any recurring credit card debt to reduce non-deductible interest expenses; and leave sufficient open credit for emergencies.   Of course, only do this after you have your cash position in place from #1 above.

3) Budget.  Commit to making and tracking a family budget for 2009.  Most of us rarely think about budgeting, because we don’t have to.   But budgeting can give you a very comforting sense of control.   By reviewing and categorizing the family’s expenses you can more easily interrogate fixed versus discretionary expenses, and make informed decisions on what can be reduced or even eliminated.   If you can’t measure it, you can’t manage it.

4) Review and as Re-balance your portfolio.  For your retirement accounts, it’s time to analyze your holdings and see if you are taking too much risk given your time horizon.   Are you too heavily concentrated in Growth?   Do you have enough dividend paying Value?  Are you appropriately diversified between stocks, bonds, sectors and geographies?   Bottom-line:   Your portfolio is almost certainly  not appropriately balanced after this year’s market sell-off,  and there are attractive “buy-low” opportunities that you can take advantage of now.

5) Stop Ignoring your Concentration.   It’s time to have a hard talk with yourself about being too concentrated, or refusing to cut losses.    If you have losses in the portfolio, now is a good time to “book” some of these before year-end.   For tax planning, these can help you diversify your holdings, dump losers, and off-set capital gains in the future.  This can also help you raise some cash in your emergency fund if you’re concerned about your job.   

Talk to your Financial Advisor who can make suggestions based on your specific situation.