One Size Does Not Fit All in 2011 Tax Season

An unfortunate casualty of this year’s mid-term elections is the uncertainty regarding what awaits tax payers in the coming year.

You may not have heard of Dan Duncan, but rest assured the IRS has.  Duncan was  No. 30 on the Forbes Fortune 400 list in 2009 with an estimated net worth of $8 billion. On March 28, 2010, Duncan died.  With the estate tax on hiatus for 2010, you can imagine the broad smiles spread across the faces of his heirs after their tears, given that much of what Duncan built may not end up being lost to estate taxes.  But, even if you are not a billionaire, there is much to lament in this uncertainty.

First, let’s be clear on what actually is happening with the estate tax.  Until 2009, the value of one’s estate protected from federal estate taxation had been rising, reaching $3.5 million last year.  With proper planning, that meant an individual potentially could shield up to $3.5 million with married couples able to protect up to $7 million.  The same legislation that established these limits abolished them altogether for tax year 2010, but allowed them to revert to $1 million in 2011.

So who does this really affect?  Generally (I say generally, because personal tax situations are very unique), any individual with a net worth of greater than $1 million or married couples with net worth exceeding $2 million, could be affected.  But, what does this mean for your situation, and what, if anything, should you do before the end of the year?

Gifting may allow you to reduce the value of your eventual estate by transferring assets to heirs now.  Keep in mind that gift taxes may apply to any gift of more than $13,000 in value.  But, consider if a married couple wanted to gift to one of the children who was married, each spouse might give $13,000 to the child and their spouse for a total of $52,000.  For those with substantially larger estates, they might consider gifting this year beyond those limits, creating a gift tax liability taxed at 35 percent if they believe the estate tax will be reinstated with rates up to 55 percent.

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Beware of the Wolf in Sheep’s Clothing

Are you confused about what kind of advice you’re getting from your insurance agent or investment adviser? A recent survey by the Consumer Federation of America and AARP revealed that investors are confused about who is held to a fiduciary standard, meaning financial professionals are required to put their client’s best interest ahead of their own. Three out of five mistakenly think that insurance agents have a fiduciary duty to their clients, and two out of three incorrectly think that stockbrokers are held to that same fiduciary standard. At the same time, 91 percent think that a stockbroker and a fiduciary adviser should have to follow the same investor protection rules. Ninety-six percent agree that the fiduciary requirement should extend to insurance agents. And, most importantly, 97 percent of those interviewed believe that a financial professional should not only put the client’s best interest before their own, they also should tell clients upfront about any fees, commissions or conflicts of interest that might influence their recommendation.

On July 21, 2010, Pres. Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. This monumental piece of legislation will change the financial regulatory environment dramatically and affect almost every element of the U.S. financial system. This new law also charges the Securities and Exchange Commission to compile a report on creating a universal fiduciary standard for any broker, agent or adviser who gives investment advice.   A fiduciary standard for the financial industry would require financial salespeople to put their client’s interest ahead of their own.

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Third Quarter Market Commentary

Equity markets finish third quarter strong

Equity markets reversed their August losses, moving sharply higher for September and for the quarter. The Dow Jones Industrial Average, posting its best September since 1939, was up 7.85 percent for the month and up 11.13 percent for the third quarter. The S&P 500 Index gained 8.92 percent in September and 11.29 percent over the quarter.

 The September gains moved both major U.S. indices back into the black for 2010, as the DJIA is up 5.57 percent and the S&P has gained 3.89 percent year-to-date. Markets reacted favorably to further speculation that the economy would not slide back into recession. Although recent economic data has been weak, the reduced threat of a double-dip recession put many market participants at ease.

 Overseas markets also rallied after the August slump, with most major markets again looking past lackluster economic data. The MSCI EAFE Index gained 9.80 percent for September and 16.48 percent for the quarter, as investors’ appetite for risk pushed markets higher. A taste for risk was particularly evident in the emerging markets, which were up 10.87 percent for the month and 17.16 percent for the quarter.

In the commodities space, investors continued to demonstrate an insatiable appetite for gold, based on concerns over currency devaluations and the potential threat of future inflation. In late September, gold closed above $1,300 an ounce for the first time ever, and investor interest went unabated. The spot price of gold, as indicated in Figure 1, has increased 18.91 percent year-to-date.

 

Figure 1. Gold Spot Price: April 2007–August 2010

Source: Bloomberg

 

Fixed income flows help support bond prices

Flows into fixed income continued at a record-setting rate throughout the third quarter, helping to support bond prices, while equity flows have been negative for six of the last nine months.

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Financial “Check ups” Vital to Long-term Financial Success

– Beyond cliché’s, such as “A penny saved is a penny earned” and “Waste not, want not,” what does it mean to be financially healthy?

“The simplest approach is to evaluate whether you live within your means,” said Andy Oakes, financial adviser for LeConte Wealth Management. “When clients come to us for investment advice, it’s a lot like going to the doctor. They ask questions like, ‘Am I financially healthy?  If not, how do I get well?  And, how do I stay that way?’”

To find out how to live within those means, Oakes suggests a monthly budgeting strategy. Budgeting is the monthly process of reconciling income and expenses.  No doubt a part of those expenses will include debt, like a car payment or mortgage.  A healthy budget limits debt repayment to one third of income.  For a family earning $5,000 per month, this would mean that their debt payments shouldn’t exceed $1,650 per month (Example could be a $900 mortgage, a $400 car payment, $200 in credit card bills, and $150 student loan payment).  That leaves two thirds (or $3,350) for living expenses, taxes and savings.

“Managing your monthly budget can be difficult and frustrating,” said Oakes. “One of the most important aspects of controlling your budget is to determine where your money is going.”

Click on the Calculators section under the Financial Planning tab for free financial tools and calculators.  The Home Budget calculator helps build a monthly budget.  By entering income and monthly expenditures, you can see how much is left to save and where your money is being spent.  In addition, you can click the "View Report" button to compare your budget breakdown to our targets, which can help identify areas for improvement.  Check out the Net Worth calculator to determine the value of all of your assets minus the total of all of your liabilities.

Financial health, like physical health, is not just about today; it is about tomorrow.

So what does “long term” mean exactly?  From a financial perspective, it means a goal that will require a substantial amount of money to fulfill a savings goal at some point in time, such as five years from now.  This is the hard part of budgeting, because it involves delayed gratification or paying for something today that may not seen for five, 10 or even 30 years.

Unfortunately though, most Americans are disconnected from how their savings are invested, and this puts their long-term financial goals at risk.

So, if you are doing the right thing by saving, how can you be a good steward with investing?  LeConte Wealth Management offers the following simple guidelines for creating a “purpose-built portfolio:”

  • Align. Investments should be aligned with your goals.  If your goal is to create retirement income, bonds paying regular interest may be considered as part of your portfolio.
  • Diversify.  Through exposure to different types of holdings, you may be able to reduce risk.  Investing in one stock is likely more risky than investing in one mutual fund that invests in two hundred stocks. Diversification does not assure a profit or protect against a loss in declining markets.
  • Monitor.  Periodically check your progress to ensure that you are on track to achieve your goals and that what you invest in is performing in line with the overall investment markets.
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The Smart Way to Cash Out

Retirement is suppose to be the time when you check out of the rat race, throttle your stress level down and pursue all of the things that you deferred during your working years. You’ve educated the kids, paid the mortgage off and saved enough to fund your golden years. Now, it’s time to collect your gold watch, stop worrying and start enjoying life.

Does your retirement reality look anything like that description? If it does, I’ll wager that you retired more than 15 to 20 years ago. If you retired in the last decade or you plan on retiring in the next decade your retirement years will be dramatically different. Do you know why? Our more senior generation of retirees likely enjoyed long careers at their company and they retired in an era that provided them with a company funded pension. Recent and future retires face the daunting task of replacing these disappearing company-sponsored pensions with a home-grown retirement income plan of their own design. Our government has tried to help us along the way by creating the IRA, 401K, SEPP IRA, and ROTH IRA savings plans. The problem with these plans is that you are responsible for saving your money.  Investing your money endures market turmoil and eventually figuring out how and when to take your money out so that it lasts your entire lifetime.

For this reason, recent retirees are facing more financial stress than ever. Regardless of how successful you were in accumulating assets during your working years, retirement now is the transition from one career to another - the retirement income specialist. You need a plan to cash out of the retirement and investment accounts that you saved all those years. Your plan (and hence your retirement lifestyle) needs to be flexible enough to adjust as inflation and economic realities change.

The Tools of the Trade

To build your retirement income plan you may want to consider some bonds, because they can potentially generate steady income-cash that you can withdraw and spend. At times, bonds can be as risky as stocks, so you have to educate yourself on the risks. The main thing you must understand is the relationship between the bond’s price, its maturity and the rate of interest it pays. If you are good with numbers or a spreadsheet you can use the set of price/yield functions to run these calculations. As interest rates change in the future it will have a direct effect on the value of the bonds you bought to seek income. Since interest rates are very near zero right now, you need to know what will happen to the value of your bonds when (not if) interest rates rise.

It would be helpful if you could calculate how sensitive your bonds will be to future interest rate changes. This calculation would help you assemble a portfolio of bonds together that would react differently as rates fluctuate and help to reduce the risk that they all decline in value at the same time. By calculating the second derivative of the price/yield function we can solve for the duration of a bond. Duration measures the sensitivity of a bond’s price to changes in interest rates which is just what we will need. For example, if you have a bond with a maturity of 19 years and you calculated its duration at 9, then you know that if interest rates rise 1 percent, the value of the bond will decline about 9 percent. If you find these calculations intimidating, then you might want to cancel that fishing trip to free up more time to spend on your retirement income plan.

Compared to stocks, bonds can potentially provide stability to your income and your assets. Unfortunately, the bond portion of your retirement portfolio will be exposed to inflation risk. Should inflation rise and push the cost of living higher, your bonds will decline in value. As inflation pressures build, investors demand higher rates from fixed rate bond investments to help offset the risk. When the Federal Reserve actually starts to raise rates, the bond math that we discussed earlier becomes applicable. There is only one way for a bond with a fixed annual interest rate (its coupon) to generate a higher rate of return to an investor. They have to be able to buy it at a lower price.  This presents a dilemma for you as you manage your retirement income. Do you cash out of your long term bonds and forgo the higher yields in order to protect the principal value? Do you keep collecting the income from the bonds and hope that inflation doesn’t get out of hand, decreasing the value of your bonds? There is a third option ..

 

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Market Commentary - September 2010

Equities ease lower, bonds up again

In August, markets gave back more than half of their July gains, and most equity markets saw negative returns for the month. The S&P 500 Index lost 4.51 percent for August, and the Dow Jones Industrial Average lost 3.91 percent; the indices are negative for the year by 4.62 percent and 2.11 percent, respectively. It has been the worst August since 2001 and the only losing August in the past five years. The markets threw investors a curveball, and we did not see the summertime market rally that many analysts had predicted. Now markets need to regain momentum in what has been a slowing economic recovery over the past several months.

Interest rates continued to plummet across all maturities in the U.S., as investors showed a healthy appetite for U.S. Treasury debt. Yields on the 10-year Treasury fell from 2.91 percent at the end of July to 2.48 percent at the end of August—the largest monthly decline in yield since the credit crisis began in November 2008. Yields on the 2-year dropped further, ending the month at 0.47 percent, within a couple basis points of the August 24 all-time low in 2-year yields of 0.45 percent. The fall in rates helped bolster bond returns yet again, and the Barclays Capital Aggregate Bond Index rose 1.29 percent, leaving it 7.83 percent higher for the year.

Municipal bonds had a very strong month, with the Barclays Capital 10-Year Municipal Bond Index returning 2.77 percent and now up 8.76 percent for the year. Longer-maturity municipal bonds have been helped both by the move lower in interest rates and improvements in bond prices relative to Treasuries. Although many municipalities are feeling the strain of the economy, it seems that investors are looking past these issues and are less fearful of longer-maturity paper in general.

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