Thursday, May 27, 2010

Appropriate "investor behavior" adds more value than stockpicking

We had the pleasure to attend a presentation last week by one of our favorite fund managers, Christopher C. Davis of Selected American Shares (http://www.selectedfunds.com/).  To underline Chris's credibility, the Davis family, Davis Advisors and their employees and directors have over $2 billion invested in their fund.

Chris presented information from a March 2010 study by Dalbar, Inc. that showed for the period of January 1, 1990 to December 31, 2009 the average stock fund returned 8.8% per year while the average stock fund investor earned only 3.2%.  The 5.6% differential is attributed to behavior of the average investor buying and selling at the wrong time.

The comment that put all in proper context was when Chris discussed how as a portfolio manager he worked with the goal of selecting stocks in such a fashion as to beat the S&P 500 by 1% to 1 1/2% per year.  Chris wanted all in his audience to understand that while he would constantly work to pick stocks that would beat the averages, the real opportunity to improve investor returns was in improved behavior.  Well said!

Thursday, May 20, 2010

The bright side of market weakness

We all know someone that looks at everything with the "glass half empty" mentality.  For those of you who can endulge your positive side, read on.  There's always a bright side to events happening around us- even investment market weakness as we're experiencing today. 

There are wealth planning strategies that can benefit from market weakness- one of them happens to be Roth IRA conversions.  When an account owner converts IRA assets to Roth IRA when the assets are trading at lower values there is a smaller amount of resulting tax and greater chance that corresponding market improvements will occur within a tax-free Roth IRA (after conversion).

Additionally, for those account owners that have previously converted to Roth IRA the weakness creates an opportunity to weight recharacterization opportunities (reversing a Roth IRA conversion) and subsequently "re-converting" after satisfying certain waiting periods required by the IRS.

We'll keep looking at the full half of the glass for our clients.

Tuesday, May 18, 2010

April 2010 Market and Planning Update (Posted to our blog two weeks after sending to clients.)

“We have met the enemy and he is us.”
Pogo, popular comic strip character of 1960’s and 1970’s

You will see below that we divide this commentary into two sections: Market Commentary and Planning Commentary. We do this because we think each is equally important in achieving our clients’ wealth management goals.

PLANNING COMMENTARY

The passing of April 15 reminds us of how important tax planning of all forms is in building wealth plans for our clients. The Economic Growth and Tax Reform Reconciliation Act of 2001 (otherwise known as the “Bush tax cuts”), reduced income tax rates substantially and changed a number of other taxes such as capital gains and the federal estate tax. As part of the Act, “Clinton-era” tax rates were scheduled to be reinstated or “sunset” starting 1/1/2011 as a way to stay within PAYGO rules. If Congress does nothing, top income tax rates will return in 2011 to 31%, 36% and 39.6% (versus current 28%, 33% and 35% respectively). Also the maximum long-term capital gains tax of 15% presently would revert to 20% while the tax on dividends would go from 15% presently to be taxed as ordinary income with maximum tax rate of 39.6%. This all seems quite possible as it would allow current leaders to blame past leaders for the tax increases yet still reap the benefits of increased revenue.

In addition to income tax rates that are scheduled under current law to increase, the Health Care and Education Reconciliation Act of 2010 imposed a special Medicare tax equal to 3.8% on certain taxpayers with taxable investment income (to start in 2013). The tax will be imposed on certain investment income over Modified Adjusted Gross Income limits ($250,000 for Married Filing Joint taxpayers) and will certainly amount to a considerable tax on wealthier individuals.

Most recently economists and tax experts have been whispering about the potential for a Value Added Tax (VAT) as a way to generate more tax revenue (this acts similar to a national sales tax). All these taxes are in addition to what is being paid in a number of other forms (state sales tax, gasoline tax, real estate and property taxes, etc.) and will be increasingly important in fueling entitlement programs promised by our government.

The reason we point out these current and potential tax changes is to remind ourselves and our clients of the importance in having a meaningful plan to deal with these tax-related headwinds. Only through purposeful and truly comprehensive wealth planning is one able to envision strategies that can help their family protect their future against risks like these.

MARKET COMMENTARY

The stock market strengthened in April as corporate profits grew and investors became more convinced of the sustainability of the economic recovery. As we write this, the S&P 500 has returned 2.0% in the month of April and 7.4% year-to-date (through April 28). Further, investors who didn’t sell during the credit crisis are seeing their accounts move closer to the levels before the 2008 credit crisis and are becoming increasingly more confident.

While we are glad to see accounts recovering, our views are toward wealth preservation at least as much future market gains. There are many concerns, including the debt levels and budget deficits of U.S. and other developed countries. The U.S. dollar and other currencies are not backed by gold or silver (as was the case at points in the past), but instead by confidence in the issuer’s economy. Unfortunately the fiscal policies in the U.S. may not continue to instill sufficient levels of confidence and we believe it is most likely that the U.S. currency will fall over time as compared to those countries who act in a more responsible fiscal manner. It is popular sport in America to blame our politicians, however those same politicians merely are a reflection of the general electorate—and sadly the electorate has shown no willingness to accept the shared sacrifice (of entitlement cuts and tax increases) necessary to restore fiscal health. Thus the quote to start this letter: “We have met the enemy and he is us.”

Given our concerns about the U.S. fiscal policies, we are increasing our client portfolio positions in emerging markets bonds. These emerging countries do not have the high public debts (as compared to GDP) of the U.S. and other developed countries, nor do they generally have the structural budget deficits. We are funding this emerging bond increase with reductions in U.S. dollar denominated investment grade bonds. We recognize that these emerging market bond positions would suffer if we had another market similar to 2008 when money fled to the perceived safety of the U.S. dollar; however our belief in the story for long-term dollar weakness is so strong that we would very likely use such an occurrence to further build emerging market stock and bond positions.

We are not diversifying further into currencies of other developed world countries (like U.K., France, Japan) because we think their fiscal problems are as bad or worse than the U.S. (with the exception of Germany). One merely needs to read current headlines of bond downgrades in countries like Greece, Portugal and Spain to get a feel for these problems.

Thursday, May 13, 2010

Spain and Portugal to enact austerity measures

Spain and Portugal have each announced austerity measures aimed to reduce the size of their budget deficits.  Spain will reduce public-sector wages by 5% this year and freeze them next year, along with freezing pensions.  Portugal is cutting salaries of government ministers and other top officials by 5% and raising their value added tax by 1% to 6% for necessities, 13% for restaurants and 21% for other items.

These countries are part of the European Union countries that market concerns about their debts led to a $1 trillion European debt backup plan that was announced last weekend.  All of this was kicked off by Greece and their economic problems.

The issue is simple.  At some point lenders (those that buy your countries debt) no longer believe you have the financial strength necessary to support your debt at its present rate, and they demand much higher rates.  The 2-year notes of Greece went up as high as 18% rate of interest.  Portugal and Spain are trying to get their house in order before something similar happens to them.  The question is when will the U.S. get serious about its financial situation!?

Friday, May 7, 2010

April employment information for U.S. is positive surprise

The Labor Department announced today that April saw 290,000 jobs added to U.S. payrolls (as compared to expectations of 180,000).  Additionally, March job creation was revised up to 230,000 from the originally announced 162,000.  For the last 4 months, job create has averaged about 140,000 per month.

It is important to consider that the U.S. continues to experience an economic recovery that is stronger than most economists and market observers were expecting.  This is just one piece of data that investors must digest, as concerns over a possible debt default by Greece (the costs of a Greece bailout are similarly concerning) spread over Europe and the world.

We simply remind investors not to lose sight of the hard economic data (like job creation) in the midst of all of the attention given to items like dramatic market swings and chaos in Greece.