Death and Taxes

This morning I met with one of the estate planning attorney's my firm frequently works with and he brought up some of the moral dilemmas that could potentially face planners and families in the coming year.

Without further legislation, there will be no estate tax in 2010. The estate tax can erase nearly half of a wealthy person's estate, so for some time, the joke has been that 2010 is the time people should try to die. For families facing end-of-life decisions, the temporary elimination of the estate tax makes one of life's most trying episodes even tougher.

What if an individual recently suffered a health setback that put them on life support, and their health care power of attorney clearly states that they do not wish to be kept alive in such circumstances? Should the individual with powers of attorney carry out the individuals wishes, or should they keep the individual alive just one more day to avoid estate tax implications?

What if we make it through 2010 without any additional legislation, which would mean that the amount excluded from the estate tax would drop all the way down to $1 million in 2011 (the exclusion amount in 2009 was $3.5 million)? Will people responsible for wealthy individuals who are clearly near death chose to take measures to ensure death in 2010 to avoid hefty estate taxes?

To avoid these difficulties, some individuals are putting provisions into their health-care proxies allowing whoever makes end-of-life medical decisions to consider changes in estate-tax law. Speaking to your estate planner may help save your family from making some of these difficult decisions during such a trying period.

FINRA: Beware of Green Investments

With all the attention green investing has received in the media lately, I thought I would pass along portions of the following article written by Matt Ackermann of Financial Planning Magazine:

The Financial Industry Regulatory Authority issued an investor alert warning investors to be wary of green energy investments, but analysts warn that people shouldn't abandon the sector completely.

“We have seen a lot of email, spam and investment pitches that involved various forms of green energy and alternative energies,” John Gannon, a FINRA senior vice president for investor education, said in an interview. “People are promising advisors and investors low-priced stocks to invest in green energy technology.”

The regulator in a warning issued Tuesday, said that such email pitches promise large gains from investing in companies involved in developing or producing alternative, renewable or waste energy products.

The investor alert, which is titled “Save Your Greenbacks—Don't Fall for Green Energy Scams,” explains how these green energy scams typically work. In some schemes, the alerts says, investors received everything from tweets and text messages to webinars and faxes trying to lure them into “very aggressive, optimistic and potentially false and misleading statements that create unwarranted demand for shares of a small, thinly traded company.”

Gannon said that this is a classic ‘pump and dump’ fraud, in which con artists behind the scheme sell off their shares once demand is built up. Eventually investors are left with worthless stock.

Gannon said that internal sources at FINRA began to identify many of these scams and wanted to alert advisors and investors alike. Last year, FINRA alerted investors about a similar scam that urged people to invest in Chinese stocks, he said.

“It is a pretty straightforward scam,” Gannon said. “These con artists take whatever is hot in the news and use that to lure people. They try to engage attention and then push people to invest in certain stocks. These con artists are trying to pump the price and then they sell and the price drops.”

He said fraudsters are also using green investing as a hook for Ponzi schemes, where a scammer uses incoming funds from new investors to pay purported returns to earlier stage investors.

The alert warns investors to ignore unsolicited investment recommendations and to question the source of investment information. Investors should also be wary of investments that claim to be the next big thing and promise exponential returns.

Despite such legal actions and the warning from FINRA, investors shouldn’t be dissuaded from green investing completely, said Michael Herbst, an analyst covering green funds at Morningstar.

Green investments have performed in line with the market in 2009. Herbst noted that the sector has garnered a lot of media attention and “that interest and optimism doesn’t always generate attractive investments.”

“At the risk of sound too simplistic, if an investment sounds too good to be true, it often is,” Herbst said. “Investors need to keep a longer-term horizon. The idea of immediate gain shouldn’t prompt investments. Any time someone tells me I have to act fast, I usually pass.”

The FINRA warning should prompt a desire for smarter investing, Herbst said. Since the sector is still relatively new, investors may be safer putting money into a green mutual fund rather than a specific green stock because funds have portfolio managers that can provide a level of oversight and protection, he said.

One Step Closer to the Finish Line

As yesterday's blog post indicated, third-quarter GDP growth was expected to come in at nearly 3%. Today, the Commerce Department said the final reading came in at only 2.2%, well below expectations. Clearly, this was negative news. However, the market it up another 0.5% halfway through the trading day. Why?

The National Realtors Association said homes sales rose 7.4% in November, a figure much higher than expected. (However, it is likely that figure received a large boost from consumers' desire to take advantage of the home-buyer tax credit.) Amazingly, one in three homes sold was coming off a foreclosure.

Additionally, the steeper yield curve (meaning investors are starting to be rewarded for buying bonds with longer maturities -- a sign the economy is improving) and the potential of higher interest rates both indicated a stronger economy and kept gains in check amid the GDP uncertainty.

Worse Than The Great Depression?

It is possible the U.S. stock market is less than two weeks away from closing out its worst decade ever.

Since reliable stock market records began in the 1820s, the market has only endured one decade where it lost money -- the 1930s during the Great Depression. From the beginning of 1930 to the end of 1939, the stock market earned -0.2% annually. Currently, the U.S. market is on pace to suffer a -.05% annualized return during the '00s. Consequently, William Goetzmann of Yale University estimates it would take a 3.6% rise between now and year end for the decade to come in better than the 0.2% annualized decline suffered during the Depression.

However, this race isn't over yet. In fact, the market is up approximately 1.15% as I write this article. Additionally, on Tuesday the government will release its report on third-quarter gross domestic product, which has been expected to show that the economy expanded at an annualized rate of nearly 3%. GDP figures meeting or exceeding that figure could provide an additional bump. Further, both J.P Morgan Chase and Credit Suisse Group economist recently boosted fourth-quarter growth estimates to 4.5% from 3.5%.

Considering these factors, whether the abysmal last decade turns out to be the worst 10-year period for investments remains to be seen.

On a side note, if GDP figures continue to impress, the Fed may be forced to raise interest rates sooner than expected. In fact, many expert predict that GDP figures of 4.5% would lead the Fed to boost rates as soon as June.

Inflation in Check, Rates Remain Low

The Consumer Price Index (CPI) rose 0.4 percent in November, as expected, amid a jump in energy costs. Core prices, which exclude the volatile food and energy components, were flat.

This came after a report on Tuesday showed producer prices surged 1.8 percent last month.

The inflation readings were being closely watched ahead of today's Fed's decision on interest rates. The tame measurements of inflation enabled the Fed to hold rates at historic lows.

Separately, the Senate Banking Committee voted 16-7 to confirm Fed chairman Ben Bernanke for a second term.

Another Reason To Dislike Wal-Mart

According to the Wall Street Journal, one-quarter of top executives at major U.S. companies actually had gains in their supplemental executive retirement-savings plans in 2008. By comparison, the 50 million rank-and-file employees at America's corporations lost a total of at least $1 trillion in the 401(k) plans.

Supplemental executive retirement-savings plans often offer a guarantee protecting top executives from loses. For instance, thanks to a guaranteed 6.6% return, Wal-Mart CEO H. Lee Scott had gains of $23 million in his supplemental plan, bringing its total value to $46.7 million. Meanwhile, the 1.2 million employees in the retailer's 401(k) retirement plan lost 18% as the market plunged.

Comcast, Honeywell, and McKesson are some of the other firms whose supplemental executive retirement plans actually made money in 2008.

Don't Neglect International Bonds

Oddly, most U.S. investors have a significant portion of their investment portfolio in foreign stocks, but few have allocated a portion of their resources to international bonds. Traditionally, domestic investors have a home-country bias, and prefer U.S. Treasury bonds, municipal bonds, and U.S. company debt.

However, the weakening dollar and low yields on U.S. Treasury bonds have made the case for adding foreign-bond exposure to a fixed-income portfolio more persuasive. First, a portion of overseas bonds may provide a hedge against further weakening of the dollar, which is just off it's all-time low against the euro. Second, yields on international bonds are currently significantly better than yields on U.S. bonds, even in many relatively safe countries with stable governments and economies. For example, Australia's two-year government bond now yields 4.4% versus 0.8% for a U.S. Treasury of the same maturity.

Besides, the debt of some foreign governments may look safer than the bonds issued by cash-strapped U.S. cities and states. For instance, are you currently standing in line to own California state bonds and have exposure to their budget woes?

At Net Worth Advisory Group, each of our clients have always had a portion of their nest egg invested in international debt. On average, I would recommend about 30% of a fixed-income portfolio be allocated to foreign bonds. With questions about how international bonds fit into your investment strategy, please don't hesitate to get in touch with me.

Beware of "Closet Index Funds"

Generally, individuals have two basic options when choosing an investment strategy. First, the investor can simply invest in index funds, which invest in a wide range of stocks or bonds whose performance should reflect that state of the economy as a whole. This strategy will almost certainly provide average results at a low cost. Second, investors can agree to pay a mutual fund manager a fee in exchange for the money manager's expert security selection. This strategy can produce results all over the map, ranging from top-of-the-class performance to bottom-of-the-barrel embarrassment. However, paying an "expert" investment manager will certainly cost more than simply investing in index funds.

The Wall Street Journal recently identified a handful of large-cap mutual funds that are not keeping their end of the bargain to attempt to provide superior security selection. These funds charge high fees but follow a strategy that is very close to simply betting on an index. These supposedly active fund managers, in, effect, are being paid for doing close to nothing.

These funds are termed "closet index funds" and hit investors with a double whammy: they lower the investor's odds of getting superior investment results, and they increase the annual fees and sales commissions charged to the investor.

To identify these index-huggers the Wall Street Journal looked for funds with "R-squared" scores of more than 98% over the past five years. A fund's "R-squared" score, figured by comparing the fund's performance to a benchmark, measures the percentage of a fund's return that can be explained by the index's movements.

It would be worth the effort to identify the "R-squared" score of each of your mutual funds in relation to their index to ensure you are paying managers who are actually pulling their weight. If you need help identifying the "R-squared" score of your investments, please reach out to me as I would be happy to help. By the way, the large-cap blend funds the Journal pinpointed were the Dreyfus Fund, Dryden Large Cap Core Equity, First Investors Blue Chip, Nationwide Fund, Principal Large Cap Blend Fund (both I and II), and the Thrivent Large Cap Stock fund.

Fed's Beige Book Shows Mixed Results

The U.S. economy "improved modestly" since early October, according to the Federal Reserve. Consumer spending picked up, and commercial real estate weakened.

According to the "beige book" survey of economic conditions, business continued cutting employment is November, although at a slower pace than in prior months. Private-sector U.S. jobs declined 169,000 in November, less than the 195,000 drop reported in October. Additionally, the Fed found little to no upward pressure on wages and overall prices remained stable, giving the central bank flexibility to keep interest rates low.

Despite rising unemployment, consumer spending strengthened in November. Auto sales improved, in part a rebound from the dip following the "cash for clunkers" rebate program. Overall merchandise sales improved, with retailers holding leaner inventories during the holiday season. Overall, the Fed's report indicated subdued economic recovery. Manufacturing conditions were "steady to moderately improving," while the service sector "generally strengthened somewhat."

The Fed's assessment of commercial real estate was worse than for the residential market. Conditions "were reported to have weakened in virtually all districts, with rising vacancy rates, downward pressure on rents, and little if any new development.