Monthly Archives: December 2013

Dynasty Trusts

“Dynasty trusts,” are designed to avoid the federal estate tax.  It’s a never-ending trust that pays each generation of heirs only what they spend, while the rest of the money grows. In most states that is not possible because of an ancient rule limiting the duration of trusts to the lifetime of a living heir, plus 21 years.  South Dakota repealed that rule in 1983, and in addition it has no income tax.  As a result, a large number of very wealthy people opened offices in South Dakota to create a trust that can shield a big fortune from taxes for centuries, escaping tax bills as it hands out cash to great-great-great-grandchildren and beyond.

There is a long an informative article about the way South Dakota has used this as a way of attracting big money by literally renting out rooms in a former five-and-dime store in Sioux Falls.

As we head into the New Year, we hope that some of our readers are in the same league as the Pritzker family,  the Carlson Family Trust Co., serving the Minnesota family behind Radisson and the TGI Friday’s restaurant chain, and the heirs of hedge fund pioneer Jack Nash.  If not, we hope you get there soon.

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Retiree vs. Pre-retiree Investment Goals

Factors influencing household investment decisionsIt is often believed that the investment goals of people change when they retire.   That may not be true.  Extended lifetimes make it increasingly likely that people may live decades following retirement.  Combine that with low-interest rates and it’s increasingly common for retirees to continue to invest the same way they did before they retired.

A recent survey by Ignites Retirement Research showed little difference between pre-retirees and retirees in the factors that influenced their investment decisions.

Some additional survey results show that many retirees in the survey (66%) said growing wealth is a crucial or very important financial goal, greater than pre-retirees (51%). And, somewhat strangely, 84% of retirees named saving for retirement as a crucial or very important goal, compared with 70% of pre-retirees. The findings suggest that one psychological result of the 2008 crash is a marked reluctance for investors to shift from accumulation to distribution just because they happen to stop working a steady job.

What’s the essential difference between retirees and pre-retirees?  Retirees are forced to live on the benefits and assets they have accumulated over their working lives.  Given their desire to continue to invest their financial assets after retirement and the importance of protecting those assets from excessive risk of loss, it become increasingly important to have high quality, affordable financial help in retirement.  This makes an important case for getting the services of an RIA who can provide the professional, ethical and unbiased guidance that retirees need.

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The art of complaining

An article in the Wall Street Journal caught my eye.  It spoke of the importance of customer service.  The cost of acquiring and keeping a customer is high.  In addition, while satisfied customers may not say much about their experiences, unsatisfied customers will often tell others, costing those who fail to satisfy not just good will, but money.

Luxury and mid-price department stores increasingly see customer service as their main attraction and the best way to draw in shoppers from discount stores and online sellers. “We spend a lot of time, money and energy attracting new customers,” says Richard Baker, chief executive of Hudson Bay Co. , owner of Saks Fifth Avenue and Lord & Taylor. “The last thing we want to do is, after all that work, lose a customer over a bad experience.”

A good retailer, will go to great lengths to keep their customers happy.  I have found that the best way to get a company to correct a problem is to raise an issue in a positive way.   People react negatively to being yelled at or abused.  My approach has been to begin with a compliment.  For example, if I have been a satisfied customer, I will begin by saying that I have been happy in the past, even complimenting the retailer for their products or service.  I then explain what the problem is.  I have found that this always produces positive results.

One other tip.  I often aim my complaint in a letter to the president of the company rather than people in the complaint department.  The president may send it to whoever is responsible for fixing the problem, but it’s usually done with instructions to make it right.  That gets the attention of the lower level “flack catchers.”

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Death and Taxes

The old saying about death and taxes being the only things that are certain is only partly true. Taxes change. Death is certain. The end of our lives is something that we face only reluctantly, if at all. When someone close to us dies, the effect is al­ways sadness. When a spouse or parent dies, the effect is traumatic.

Because death is an unpleasant subject, most people prefer to spend their time thinking of more pleasant subjects.  They believe that they have done their planning if they meet with an attorney to have a will or trust document prepared.  Once this is done the feeling is that the planning process is complete.  Unfortunately that’s rarely true.  This traditional view of estate planning gives your heirs the view from thirty thousand feet but often fails to provide the guidance that surviving spouses or children really need.  Here is an example from real life.

Sue Smith (not her real name) became a widow after her husband, Sam’s, brief illness. Sam had a small account with me but the bulk of his portfolio was distributed among a number of different investment firms and mutual fund custodians.  Only Sam had a complete picture of the family’s finances and he rebuffed suggestions to consolidate his assets and do planning beyond reviewing his will on a regular basis.  Sam retired after a career as an executive at a large corporation.  He had been a take-charge guy all his life, both at work and at home. He had been the sole income earner, made the investment decisions and paid the bills, while Sue was in charge of the home and children. They were a very typical couple.  Both were healthy, until Sam had a sudden stroke that left him incapacitated and led to his death a few weeks later.  Sue was suddenly alone.

In a matter of hours Sue had to make a number of decisions. Some required immediate action, such as the selection of a funeral home and the arrangement of the funeral service.  Shortly after the funeral Sue realized she needed help and asked me to be her “financial advisor” and I agreed.  We met at her home to gather basic information.  I began by asking her basic questions.  What was her income now that she was single? What level of income would she need to maintain her lifestyle?  Did she have any debts?  What were her regular bills and how were they paid?  What were her financial assets and where were they?  Did her husband have a life insurance policy or annuity?

The answer to all of these questions was “I don’t know.”

The psychological result of being left alone and unsure of herself was severe.  Sue was overwhelmed. This was a crushing burden to fall on someone who had never been required to take care of financial issues. It was as if a child had been dropped in the middle of dark woods with wild animals prowling around. The result was not only deep sadness but also fear and paranoia. Since her husband had always taken care of the fam­ily finances, she felt unprepared to handle major decisions and was terrified of being victimized. And because Sam had not left an in­struction manual for her, Sue went through a long period of grief combined with anger and confusion.

Since Sue did not have a the information that we needed, we had to go through Sam’s files, make phone calls and watch the mail and as bills and statements came in to get an true picture of her assets, income and expenses.  It took several months before we had a good handle on her finances.

Fortunately, Sam left Sue with a sizeable estate and I was able to provide all the income she needed as well as leaving a sizeable inheritance for her heirs.  However, Sue never over­came the issues that surfaced after her husband’s death, and it made her life as a “suddenly single” person very unhappy.  Sam never provided her with the guidance she needed once he was gone and it affected her in a very profound way.

As a result of my experience with Sue and a number of other widows who came to me for help, I prepared a manual that became a book, Before I Go, which I provide to all of my clients.   It provides the answers to the questions that are not addressed by the usual estate planning documents but are the questions that those who are left behind need to know.  The view from thirty thousand feet is not enough when it comes to managing the family finances and too often the details are ignored unless couples are made aware of the need for detailed planning that goes beyond preparing the will or trust.

 

 

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Considering 529 Plans?

Saving for college usually involves putting money aside and a popular vehicle for this is the so-called “529” plan.  Here are five things to consider when deciding on this kind of plan.

  1. Don’t overlook prepaid tuition plans.  If you are fairly certain that you know where the student will be attending college, these may reduce the uncertainty of the amount that will be available for college.  The down side is if the student elects to attend a college that does not participate in the plan, then the credits may only cover a very small portion of the tuition cost — or participants just get their money back.
  2. Beware of the strict rules for changing beneficiaries, which could cause a client to incur taxes or penalties. The new beneficiary must be a member of the family as defined by the IRS, within the same generation (or an earlier one) as the original plan beneficiary, in accordance with gift tax laws.
  3. Even if the student does receive a scholarship for any reason, the dollars in a 529 plan are not wasted. Clients have the option to withdraw from the plan the dollar amount of the scholarship. Taxes will have to be paid on the earnings, but the 10% penalty on non-qualified distributions is waived.
  4. The IRS allows 529 plans to be rebalanced only once per year, turning any further trades into taxable events that may incur penalties too.
  5. Consider target date funds as an alternative to choosing your own asset allocation program.

 

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9 Tax Breaks Expiring at Year’s End

From ThinkAdvisor

1. Charity Begins at Home

The days of an easy way for seniors to make a tax-free charitable donation are ending. This provision allows those 70 ½ and older to make direct, nontaxable rollovers from IRAs to charities. It is way to keep income low by classifying mandatory withdrawals as donations instead of income.

2. Small Business, Big Break

Small businesses that use tax provisions to depreciate assets will see a big change in the ability to do so in 2014. This year, business owners can accelerate their depreciable assets up to $500,000 on a $2 million purchase. The maximum depreciation is set to drop to $25,000 next year. If a small business client has the taxable income to offset the deduction, it might be a good move to use the provision when paying 2013 taxes.

3. Forgiving Mortgage Debt

Say goodbye to the Mortgage Debt Forgiveness Act of 2007. Under that law, if debt owed on property was reduced through a loan reduction or a short sale, the amount forgiven was not treated as taxable income as had been the practice in the past. The law is set to expire at the end of the year. Experts say the tax is unfair because the money only existed on paper.

4. Students (and Parents) Beware

After this year, there will no longer be a deduction of up to $4,000 for qualified tuition costs. The tax break was generally available to families with less than $160,000 in income and singles making half as much or less. Payments for the spring semester must be made by the end of 2013 to qualify.

5. Maybe Teacher Will Get an Apple Instead

It wasn’t much, but teachers are losing a $250 deduction for unreimbursed classroom expenses. To be eligible, teachers must be employed in primary or secondary schools.

6. Getting Harder to Be Green

Now is the time to buy that electric vehicle; a tax credit of up to $7,500 on the cars is being dropped at the end of the year. The credit only applies to certain plug-in vehicles based on weight and battery capacity. Make sure the car you purchase qualifies.

7. It Keeps You Warm, for Now

Maybe an electric car isn’t for you. How about making your home more energy efficient? Two tax credits to help defray such costs are set to die at the end of 2013. One is a $500 credit for certain improvements made to a primary residence. Second is the Energy Efficient Home Credit, a $2,000 exemption for home builders.

8. R&D? On Your Own

Congress has repeatedly extended the tax credit for technology research and development since it was enacted in 1981. Those extensions appear to be over, and the law is set to expire at the end of the year.

9. Luxury Has Its Price

For those who pay lots of state sales tax because they buy big-ticket items like cars and luxury items, this is a nice tax break. A federal tax filer could deduct state sales taxes paid if they were higher than state income taxes. The chance to do so ends this year.

 

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Five lessons to be learned from the Madoff scandal

Five years ago we learned about the Ponzi scheme engineered by Bernie Madoff.  How can you avoid being scammed like the people who lost billions to Madoff?  Here are five things to look for when working with an investment firm:

1. Demand Assets Be Held at Large Custodian

Be sure your assets are held by a large reputable custodian like Charles Schwab.  The custodian will be the one sending you your statements and trade confirmations.  In the Madoff scandal, all of the clients’ funds were accounted for only by Madoff’s firm, and investments were held by Madoff’s wealth management operation, which was at the heart of the scam. If client funds were held at a legitimate, large custodian like Charles Schwab, the scam would have been virtually impossible to carry out since the account statements would flow from the custodian, and the discrepancies would have been exposed immediately.

2. Fraud Diversification

Diversification is one of the primary keys to risk control.  No one should have all of his assets in a  single fund or a single stock.

3. Ask Questions and Demand Answers

When clients asked Madoff questions about his returns and management style, he refused to answer them. This is a massive red flag. Clients are entitled to answers regarding holdings, investment strategies and costs. Failure to provide this sort of information is a major warning sign.

4. If Investments or Strategy Can’t Be Readily Explained, Don’t Invest

Often investment scams are hidden in the obscure, opaque and complicated. Madoff claimed to use a “split-strike” strategy for generating steady returns for investors by investing in the largest stocks in the S&P 100 index while simultaneously buying and selling options against either these particular stocks or the S&P 100 index. If it sounds too confusing or can’t be explained simply, avoid it altogether.

5. If it Sounds Too Good to Be True watch out.

Investors often fall victim to big lies more easily than small lies. Madoff used decade-long consistency to lure investors in. Don’t believe anyone who tells you that you can earn higher returns while assuming a lower risk. If you’re realizing high returns, then you’re also accepting increased risk.

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Pricking the Stock Market Bubble Debate

We recently posted a note about the definition of a “bubble.”  We thought it would be worth our while to share the thoughts of billionaire Ken Fisher’s firm on this issue.  We share this, not as a firm prediction, but an analysis by an individual who’s more often right than wrong.

Are stocks about to froth over? With many indexes routinely clocking new highs, bubble chatter is easy to come by. One former presidential budget advisor says stocks are in a bubble! Our soon-to-be Fed head and one of her predecessors say no such bubble exists! A popular newspaper weighed in, too, corralling a few “experts” to opine on the issue. All the hoopla suggests there is a bubble … in bubble talk! In stocks, however, evidence suggests otherwise—this bull has plenty of fundamental support and rational reasons to keep on running.

What tends to move stocks most is the gap between economic and business fundamentals and the degree to which these fundamentals are appreciated. A stock market bubble forms when expectations about publicly traded companies’ future earnings exceed reality—when expectations become inflated. In the late 1990s, for example, Tech stocks with little revenue, unproven track record of success and poor business models shot sky high. Euphoric sentiment was defying fundamentals—glee, driven largely by past returns, was the only thing holding them up. Fundamentals eventually won the day, and sentiment followed after investors gradually saw their irrational bets go south. The bubble burst.

But today’s market looks nothing like that. Expectations are pretty low—few fathom that profits can keep growing and the global economy stay firm or even reaccelerate. Signs of optimism are guarded at best, and are often loaded with “yeah buts.” And keep in mind, bubbles don’t form overnight and are very difficult to detect. So difficult, in fact, that if everyone’s talking about them, they probably aren’t there. Constant bubble talk is self-deflating—it fosters fear and skepticism.

So why do some argue that we are in a bubble? Perhaps it’s because of the recent spate of social media IPOs, which may scare folks into thinking that markets are partying like it’s 1999—just before the Tech bubble burst. However, there are many differences between now and then. Sure, there may be some euphoria in social media, but social media is a small subset of IPOs. Consider: In 1999, there were 368 IPOs in tech alone. In 2013, Twitter made 33. Even if you think Social Media firms are frothy, they’re a tiny portion of the overall market and don’t necessarily reflect broader sentiment. Among tech companies, recent IPOs are trading at 5.6 times sales, compared with 26.5 times sales in 1999—investors aren’t placing exuberant valuations on yet-to-be-seen sales. And most of today’s IPOs aren’t Tech—they span most sectors, and many are higher-quality companies with real business plans compared to the flash-in-the-pan tech companies from the ‘90s. Hilton, an IPO scheduled to launch soon, has a rather time-tested business model, if nothing else.

Others believe stocks are propped up by something artificial (ahem, quantitative easing) and once it’s removed, the market will crash. The case: The Fed’s QE program has pushed investors from Treasurys to equities, in search for better return, and this is why the stock market has done well. Once interest rates rise, investors will drift back to fixed income, and stocks will fall. Yet data don’t support the notion of some massive rotation from bonds to stocks since QE began. Nor would that even be necessary for stocks to rise—there is a seller for every buyer. Stocks are an auction market—buyers’ willingness to pay higher prices is what matters, not the sheer number of buyers.

Philosophically, too, the notion fixed-income investors would chase higher yields in stocks is flawed. Perhaps some might, but many investors own bonds to reduce expected short-term volatility, particularly if they have higher cash flows. If they were dissatisfied with Treasury yields, they probably wouldn’t rush headlong into stocks, a more volatile asset class. They’d likely move to another form of fixed income (e.g., corporate bonds).

Finally, some suggest hot stock markets are detached from slow economic growth. True, this expansion is one of the slowest in modern history, but stocks aren’t the economy. Stocks are shares of publicly traded companies and reflect the private sector. While headline GDP growth hasn’t been stellar, much of the detraction has come from state, local and Federal government spending reductions. Business investment is closing in on all-time highs, profits are at all-time highs and rising, and S&P 500 earnings and revenues continue growing. Heck, earnings hit their first all-time high two years ago! Stocks hit theirs earlier this year. Stripping this influence out shows a stronger private sector—and the gap between how folks perceive the economy (pervasive claims of a sluggish, flat, fake or only “technical” recovery) is a great illustration of the dearth of euphoric sentiment. With this in mind, it seems tough to argue stocks are wildly higher than reality warrants. It seems more like the reverse.

 

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What’s a “Bubble?”

The word “bubble” has been thrown around a great deal with the Dow Jones Industrial Average (DJIA) at 16,000, the S&P 500 at 1800, and the Nasdaq Comp above 4000.  The term “bubble” is a scare word that makes people think of a repeat of the Tech Crash of 2000 or the real estate bubble that led to the financial crisis of 2008.

Cluifford Asness, whose firm manages $80 billion has a pet peeve and one of them is the loose use of the term “bubble.”

“The word “bubble,” even if you are not an efficient market fan (if you are, it should never be uttered outside the tub), is very overused. I stake out a middle ground between pure efficient markets, where the word is verboten, and the common overuse of the word that is my peeve. Whether a particular instance is a bubble will never be objective; we will always have disagreement ex ante and even ex post. But to have content, the term bubble should indicate a price that no reasonable future outcome can justify. I believe that tech stocks in early 2000 fit this description. I don’t think there were assumptions — short of them owning the GDP of the Earth — that justified their valuations. However, in the wake of 1999-2000 and 2007-20008, and with the prevalence of the use of the word “bubble” to describe these two instances, we have dumbed the word down and now use it too much. An asset or a security is often declared to be in a bubble when it is more accurate to describe it as “expensive” or possessing a “lower than normal expected return.” The descriptions “lower than normal expected return” and “bubble” are not the same thing.

Bloomberg columnist Barry Ritholtz comments:

“It would only take a small marginal improvement in the economy, or a small uptick in hiring, or heaven help us, even a modest increase in wages to increase revenues and drive profits significantly higher,”he current market valuations do not, in my opinion, have the characteristics of a “bubble.” “

Whether stocks, bonds or commodities are fairly valued, undervalued or overvalued will become apparent over time.   In the meantime, unless you are being paid to opine, it’s best to realize that fortune-telling is not the way to manage your portfolio.  Creating an all-weather portfolio with the asset allocation that will allow you to face any reasonable future is the best strategy.

 

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Municipal Bond Risk

Municipal bonds are found in the portfolios of many higher income investors.  They have experienced great returns over the last 30 years.  Part of that has come from interest payments and part has come from bonds price appreciation.  Remember, falling interest rates (and we have seen interest rates fall since 1980) leads to higher bond prices.

The problem for bond investors is that rising interest rates have the opposite effect: bonds go down in price when rates go up.  And today’s low rates are largely being engineered by Federal Reserve policy of low, low rates to spur a slow-growth economy with high unemployment.  When the Fed stops easing, we can expect rates to rise, and perhaps rise rapidly.

Here’s Morgan Stanley’s take:

Investors in the $3.7 trillion municipal market will probably face negative returns in 2014 following declines this year, the first back-to-back annual losses since at least the 1980s, according to Morgan Stanley.

The company’s base-case scenario for city and state debt in 2014 calls for a loss of 1.7 percent to 4.1 percent, Michael Zezas, the bank’s chief muni strategist, said in a report released today. A year ago, he correctly predicted that munis would lose money in 2013 as yields rose from the lowest since the 1960s.

In addition, we have seen a rash of municipal bankruptcies which causes investors to be concerned about getting their money bank if a city defaults on its obligations as Detroit is set to do.

For investors who have accumulated large municipal bond positions either as individual bonds or as bond mutual funds, caution is the watchword.

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