LJPR

2012-01-13T08:46:00.000-08:00

Economic and Political Outlook for 2012:

Hang Onto Your Hats!
Leon C. LaBrecque, JD, CPA, CFP™, CFA

Happy New Year, and welcome to 2012. Here are a few predictions and observations that provide you with our economic and political perspectives for the New Year. You may want to sit down with a favorite beverage or even an aspirin. In general, we’re certain this will not be a nice steady year:

We appear to be nearing the end of an oscillation period. Since 1903, the market has been behaving in 13-year oscillations, followed by upswings (1903-1915, 1929-1942, 1968-1981, 1999-2012?). Each oscillation is marked by technological growth, economic downturn then growth, and usually some ‘tipping point’ at the end. We could be at the end of an oscillation, given the right tipping point.
Europe is still messy. The EU still has an immense amount of work cut out for it. The ‘fixes’ of the ECB are still only symptomatic and don’t reflect the underlying problem: Greeks are different from Italians, and Irish are different from Germans. Unless the underlying economies have some governance, the EU will continue to suffer and will probably spend a part of 2012 in recession.
The market has room to run. The S&P 500 has a relatively low valuation (the Price to Earnings ratio is quite low by historical standards); interest rates are so low that bank deposits of CDs don’t offer much of an alternative. Money has been flowing out of stocks, it could very easily flow back in, but probably before late fall (can you guess why?).
The economy has room to grow. Despite all rumors to the contrary, the US economy has grown for nine straight quarters through the end of 2011 (since the 3rd Q of ’09). With low interest rates, we could see real estate start to move, car sales starting to pick up, and companies making more money. Don’t be surprised that our next threat is not recession but inflation.
We have met the enemy, and it is Washington. On November 6, there is a presidential election which we predict will be narrowly decided. Importantly, 33 seats of the Senate are up for grabs, including 22 Democratic Senate seats. It seems very unlikely that the two parties will get along before the election, and barring a Republican sweep (and a senate supermajority), it seems unlikely the two parties will get along after the election. More gridlock seems likely.
Unemployment will likely continue to slowly decline. Corporations have wrung almost every drop of productivity out of their workforce, and it seems likely that the only solution to expansion is to continue hiring. Note that the government workforce is shrinking and the private workforce is growing.
The Bush Tax Cuts Expire 12/31/12. This is a significant issue that no one seems to be taking seriously right now. Expiration of the cuts raises taxes on virtually every taxpayer, changes the rates on dividends to ordinary income, raises capital gain rates, brings back the marriage penalty, eliminates the child tax credit and raises the Alternative Minimum Tax (AMT). Roth conversion and municipal bond purchases will become more useful as the year-end deadline ticks away.
The Sequestration Cuts take place 01/01/13. The failure of the Super-Committee to act will cause an across-the-board cut in Federal spending. Following the normal mentality of bureaucracy, that will go to the employees first (fat chance Congress will cut their pay!). Job cuts by the Feds could lead to more unemployed people.
The Unearned Income Medicare Contribution (UIMC) starts in 2013. The UIMC adds a 3.8% additional tax on upper-income individuals (over $200K on single and $250K on married) on all unearned income, like dividends, interest, and capital gains.
The Debt ceiling expires again in 2013. Remember the fun we had in August of 2011? Well, it happens again, in early 2013.
Iran is a wild card. Iran is being very aggressive about its nuclear program, including trying to block shipping in the Persian Gulf. It is completely plausible that this could escalate into a military situation either with the US, NATO, or Israel (we bet on Israel).

Bottom Line: To say the least, 2012 doesn’t look boring. Be ready to take advantage of opportunities and avoid the downdrafts. And consider whether this combination of events might cause a ‘tip’ in the market that has had virtually no upward movement since 1999.

"Daddy, Are We There Yet???"

2011-10-17T08:37:00.000-07:00

From our Chief Investment Officer, Brad Reynolds CFA

My rather precocious son JR goes to daycare every Tuesday and Thursday, and has been for a year now. I was driving him to daycare this AM, and despite having made this trip a hundred plus times the same way, five minutes into the drive I hear from the backseat, “Daddy, are we there yet?”

I realize that at three years old JR has an extremely short-term view of the world. He doesn’t see the whole trip and how it leads to our ultimate destination. He is only concerned with what he sees out the window at any given second. So, I say to him, “No JR, we're not there yet, it takes time to drive to school.” “But why?” This is a question I have learned is best to pretend I don’t hear (parents know what I’m talking about). A little further along in our journey, we come to a stop light and my backseat bellows “I want to go that way” (motioning for a right turn). “No JR, that’s not the way we go.” ”But I want to” (another statement best to ignore). We finally get to daycare, and JR joyfully runs into the classroom for a day of play and envying his classmate’s Lightning McQueen flashy shoes (which I will of course now have to buy him, but that’s another story).

This got me thinking. Despite making the trip twice a week every week, JR (a very bright child) still doesn’t see the bigger picture. He only focuses on what’s right outside the window. I suppose that’s natural. I mean, he doesn’t drive and has never made the journey himself, I have. I know how to get there. Now granted the trip is not exactly the same every day, there are accidents, construction, weather conditions that delay us or even cause a minor detour. (I won’t mention the poor little squirrel that sadly met his end under my tires this morning). But I know how to drive the car, where I’m going, and different routes to get there despite any obstacles or bumps in the journey.

I suppose I could get JR a car and let him drive himself and figure it out, but I suspect there may be disastrous consequences, and he may not get there safely. I need to reassure him that I know where I’m going and despite any detours or delays I will get him there in time for the morning snack.

I can’t help but see the similarities with my professional life, safeguarding the financial wealth of our clients. It is easy to get caught up in the short-term, and focus on the ‘bad’ news of the day. It is our job to see the bigger, longer-term picture. We know the ultimate destination and the best way to get there despite how bumpy it may seem at times. I can assure you we are watching the road, not speeding, and navigating thru all the obstacles, both expected (traffic lights) and unexpected (squirrelly markets). We will do our best to get you to your destination safely and on time, all the while reducing your uncertainty.

Brad

Letter to the Members of the Super-Committee

2011-10-06T10:33:00.000-07:00

The forgoing is an edited excerpt from an actual letter I am sending to members of the Super Committee.

Dear Members of the Super-Committee:

Congratulations on your being chosen for the task of helping to steer our nations’ fiscal ship in the right direction. The task you face is of significant importance to all Americans, and to the world as well. America stands as the bastion of economic and moral strength in the world. Your recommendations will shape America’s present, and your actions will shape our future. In that spirit, kindly consider my humble recommendations:

1. Conduct yourselves with the respect and decorum expected from your position of leadership and honor. The partisan bickering that surrounded the debt ceiling debate was destructive and divisive. Genteel debate and conduct is a good starting point for reestablishing trust with the American people who are counting on you to lead them to a sustainable fiscal future.

2. Please consider that all of you represent all of us, and that no one of you represents all of us. You should put the country’s best interest foremost, and your Party’s, lobbyist, or contributor’s considerations secondary. To wit, trying to balance a $1.6T deficit by cuts alone is unworkable, as is trying to fund it on the backs of 2% of the population.

3. Please remember that there are two issues here: (a) a short term problem (this very anemic recovery); and, (b) a long term problem (excess debt and deficit spending). Delineating those issues is paramount: Cutting jobs to cut spending in a weak recovery is a destructive feedback loop. In other words, delay spending changes to make sure nothing harms the short term recovery. Get the economy growing first. Remember, the US debt-to-GDP ratio is still the lowest among our peers in the developed world. Therefore, the first priority (short term) should be economic recovery, and the second priority (long term) should be reducing the deficit. If done properly, we do not need to sacrifice one priority for the sake of the other.

4. Simplify the tax code. As a CPA and former professor, I can assure you that our tax code and appurtenant laws are fraught with unnecessary inconsistencies and complexities. In addition, vast tax incentives are an anathema to a free market society. Hundreds of billions could be re-allocated by simplification of the tax code.

5. Have courage in your decisions. Our founding fathers stood with their reputations, fortunes and lives on the line to create this country. Demonstrate a modicum of that courage to protect it, even if you have to inform the country that we need to simplify, spend less and pay a little more.

6. You can balance budgets by less spending, increasing revenue, or both. I believe both are necessary. Recognize revenue comes from rate and volume. A growing economy pays more taxes. Employed people pay more taxes. Your plans should encourage business and job growth.

7. As to the current situation, we have a Fed balance sheet and money supply that should provide some significant stimulus, but for the cloud of uncertainty. To that point, here are two ideas:

a. Lower the Fed lending rate to zero. Banks currently can keep functioning, protect massive store of cash, and moderately satisfy regulators and shareholders by sitting on their assets. Lowering the fed lending rate to zero (only .005 less than the T-bill rate), will force more money out into the system for business and consumer lending.

b. Have GNMA (or if desired, allow FNMA and FRMC) to provide mortgage lending for home purchases or refinancing under the following conditions:

i. High credit score,

ii. Current payment status,

iii. Maximum Loan value equal to the greater of 80% of appraised value or current balance.

This might stop the downward slide of valuations, discourage strategic defaults, and again move money into the system. In addition, it will provide a wealth effect in resetting the perceived value of the home higher to its current mortgage balance.

8. On Social Security:

a. Provide a graded increase on contribution rates, adding 0.3% to the rate each year for 5 years starting in 2014. Raise the wage base to $150,000;

b. Index the Normal Retirement Age (NRA) for participants born after 1960 grading it eventually to age 70. My calculations indicate this reduces the liability by 8-10%;

c. Modify the earned income limitation to incorporate the NRA earned income limitation until age 70. This encourages working semi affluent retirees to delay collecting benefits;

d. Use linked CPI to add increases: it is a logical inflation measure.

9. On Medicare:

a. Link eligibility to Social Security NRA, e.g. Instead of some folks being eligible for full Social Security at 66, but Medicare at 65, make the eligibility ages the same.

b. Raise the Medicare tax rate to 1.5% in 2013, and raise it .15% a year for 5 years.

10. Income Tax Rates:

a. Either let all of the Bush cuts expire in 2012 (raising taxes on everyone), or modify the rates to broaden the base.

b. Consider that the UIMC in the Health Care bill is a strange and inconsistent tax on upper brackets. In addition, it’s an unearned income tax paying for a payroll based program. Link your programs to your taxes (e.g. Social Security taxes pay for Social Security, Medicare taxes pay for Medicare, etc.).

c. Eliminate the vast array of inconsistent and irrelevant individual tax rules. AMT is an obvious example: either use the regular formula or use the AMT formula. Perhaps consider renaming the AMT (if you don’t eliminate it) to the more honest name of ‘Alternative Maximum Tax’. Incidentally, force users of the Earned Income Credit (EIC) to actually support the dependents they claim on the return. There is a level of fraud associated with EIC (I might even ask why we even have an EIC?).

d. Eliminate the vast array of incentives and credits on the corporate income tax and simplify the corporate tax.

11. VAT: Deficit reduction excise tax:

a. Consider a VAT of 3%, specifically earmarked to deficit reduction and not used for anything expect deficit reduction. Link this to a freeze on discretionary spending to 2012 levels.

b. Exempt necessities (food at grocery stores) from the VAT.

12. Spending:

a. Freeze discretionary spending to an acceptable level. Allow increases only by the percentage linked to overall deficit reduction (e.g. discretionary spending can only go up when the deficit goes down, and then only by linked CPI).

b. As a token of good faith, cut Congressional office budgets (except security) by 3%. Freeze them for your terms. Don’t give yourselves a raise until you balance the budget.

c. Thoroughly evaluate each aspect of the budget, but start with the big one that should be easier: the defense budget. The waste in military spending in Iraq and Afghanistan are enough alone to probably cut $50-$100B. I feel you should avoid cutting costs to soldiers, or soldiers’ families. Waste on support programs is another thing.

In short, the budget of the United States is not entirely different than any other budget: Spend money on essentials, get enough revenue to cover expenses, don’t hurt anything, or anyone too much, and spread the pain. My best wishes and thoughts are with all of you. Please recognize that we, the people of America, need you to serve as the advocates of all Americans not just limited groups. Have courage, and stand up for what is right, fair and good for the country.

Leon C. LaBrecque, JD, CPA, CFP^®, CFA

LJPR, LLC

My Friend the Manic-Depressive

2011-08-10T13:31:00.000-07:00

Caveat: I make no claims of the political correctness of my foregoing statements (nor have I ever, in any way, so this disclaimer is irrelevant).

I have a friend, Mark, who is manic depressive, which is more currently called ‘bipolar disorder’. In bipolar disorder, a person undergoes mood swings from euphoria to depression. These swings can be very rapid. There are three basic forms of bipolar disorder, of which poor Mark is type I, which is at least one episode of full mania and one of severe depression. Mark has had multiple episodes of both, and it’s getting worse.

In the manic phase, a person is easily distracted, tends to have a very elevated mood, gets very involved and can engage in ‘binge’ activities. In the depressed phase, the person is depressed, has difficulty concentrating, loss of self-esteem, and even thoughts of suicide.

Take earlier this year: Mark and I were talking about all the wild things that had happened in the first quarter. The protests in Wisconsin and Lansing, the Arab Spring and Libya, Oil topping $115, and the earthquake and tsunami in Japan. Me, I thought those sounded like bad things. Not Mark; he was in a full euphoria and nothing could get him down.

Then the news came that Osama bin Laden had been killed. Oil prices went down and the prospects for reductions in the costs of Iraq and Afghanistan looked good. But by now, Mark’s mood had shifted, and he got depressed in the face of good news.

So I thought around June, with the debt ceiling coming up, Mark would be depressed. But his mood shifted again, and he was happy, almost giddy. Even though the debacle in Washington had me concerned and more than a little embarrassed, Mark didn’t care. And then the debt deal was made. Then as the deal closed at the wire, Mark abruptly shifted his mood and became more depressed than I have seen him since 2008. Mark ran around his place, and started selling everything, from his dad’s gold watch to all the stocks in his 401(k). He calmed down for a day, and then S&P downgraded the government debt, and Mark went crazy. Now he wanted government bonds (even though they were downgraded), sold more stocks and in a reversal from his previous mood, bought gold under the idea that ‘the sky was falling’.

I thought that Tuesday might help him, since he’d been so despondent. And it did. In fact when the Fed announced they would hold interest rates low for two years, which I felt was good news, Mark felt better and bought back in. I gave a sigh of relief and hoped my friend was better. Until Wednesday, when he went crazy again, although this time he bought oil and gold and sold everything he bought yesterday.

Of course, Mark is wearing me out. One day he likes gold, the next he doesn’t. One day he likes stocks, the next he doesn’t. One day he’s afraid of Treasuries, and the next day, that’s all he buys. I called his doctor and asked what to do when a type I bipolar person is on a severe swing. His advice: “Be very careful until they go back on their meds, they can be dangerous.” Poor old Mark(et).

Leon

PS: My apologies to Warren Buffet, who originated this idea of Mr. Market being Manic Depressive. Clever ideas are worth stealing.

Risk Sell-Offs and Feedback Loops

2011-08-04T12:44:00.000-07:00

I’m watching the market dive, and contemplating the thousand or so points it dropped in just over a month. Oil is down to $88, gold dropped today, energy stocks dropped, Europe is lunging lower and the only thing gaining right now is the Treasury. You know, the treasury. Which until August 2nd was going to default and loose its ratings? What we have here folks is a risk sell off. A risk sell off is the panic button call by some investors to ‘sell everything’. Sell stocks, sell Europe. Sell banks, sell oil, sell everything. Stick somewhere safe (which happens to be Treasuries, despite the fact that the same people panicking know were avoiding treasuries last week.

Europe has reversed its course and (surprise) is not finished with its debt crisis. Today the employment numbers were anemic, and the economic numbers for July look like the economy is worsening. Egad! A double dip? Walk three steps back from the TV (even though I have CNBC on now). What happened last month? Only the most unorganized, inconsistent, petty and incompetent political debate I’ve ever seen on the important issue of extending the debt and reducing the deficit. Politics and sausage are two thing you don’t want to see being made, and I’ll vote sausage making is better to watch. No rational business owner would hire in the midst of wondering where taxes, interest rates, or anything financial for that matter was going. Consumers didn’t run out and buy things either. Why? Uncertainty.

Uncertainty caused by, in my mind, deliberate actions on behalf of Washington and uncertainty caused by the lack of reliability in leadership. Our debt may still be AAA, but I’ll rate washing junk status.

So what does it mean? It’s a feedback loop. A feedback loop is when one event happens, and trigger a response that reverses the event. Take oil. When oil prices surge (and the market usually goes down), demand usually curtails rapidly and supply increase, which…drops prices.

So then this feedback loop: investors are panicking because of bad economic news from July, which is driving prices down, oil down and yields on Treasuries down, which make stocks more attractive and Treasuries less attractive, which makes…stocks go up.

Look at it this way: a month and a half ago, we were facing a government shutdown, which was averted. Oil was higher, interest rates were higher, the deficit was higher, and the exact same other problems were in front of us. Today, deficit is lower, debt ceiling is extended, dollars is stronger, oil is cheaper and stocks are cheaper. Panic or Possibility?
I’ll vote the feedback loop is at work.

Leon C. LaBrecque, JD, CPA, CFP®, CFA

LJPR, LLC

A Budget/Debt Tale

2011-07-12T12:23:00.000-07:00

July 12, 2011. With all the hoopla in Washington, I’ve been spending a lot of time discussing budgets. Maybe a little parable is in order:

Ulysses and Simone are married, with five kids (Huey, Dewey, Louie, Sacco and Vanzetti). They support their elderly parents, Franklin, Lyndon and Eleanor. They have some nice property, but a lot of debt; they have about $120,000 in a variety of debts, mostly in a mortgage owed to a big bank (the Bank of Chillicothe). Some of the debt is variable, and some is fixed, but the overall interest rate is low, and U&S have a stellar credit score (800). U&S have a lot of bills, and they’ve added up all their outflows for the year, which come to about $34,560. This wouldn’t be too bad, except they only made $21,620 last year. They borrowed the difference on a home equity line of credit, provided mostly by the B of C.

U&S are looking at this year and are having some serious disagreements about money and budgets (as do many couples). U wants to cut costs, and suggests that S spends way too much on the kids and on wild and lavish things. S thinks that the kids should put more into the family budget, especially Sacco, who has a very good job and makes a good wage. Huey, Dewey and Louie don’t earn enough to help the family, but are supported by U&S, and supporting the older parents is very costly. The cost of supporting the three parents is $7,900 a year for their medical care, and $7,010 a year for their other living expenses. This doesn’t sound like much, but it represents 2/3 of U&S’s income. U&S have a lot of insurance and lawsuits. For example, they’ve been embroiled in a lawsuit with the McCoys, which alone is about $1,000 a year, or $20 a week in legal fees. The total cost of all U&S defense and protection is about $6,890 a year. U&S pay about $1,970 of interest on their debt (mostly to B of C), have other fixed bills of $4,160, and have $6,600 a year of discretionary items. For this year, they have even larger expenses.

Simone’s friends, Barry and Harry, think that Sacco should pay more to the family. They say that if Sacco kicks in more of his pay, U&S can have a lot more money. In actuality, this amounts to only $360 a year, and will surely aggravate Sacco. Ulysses friend, John thinks that Simone should cut back on her discretionary spending. He found a bunch of wasteful items Simone spent money on, like a treadmill for her pet shrimp (she did, but it was ½ of a cent). Harry wants Ulysses to make Simone cut back $360 from her budget. Ulysses and Simone are fighting over whose idea they should use? Cut $360 from Simone’s spending, or make Sacco pay $360 more?

U&S ask a financial wizard (the Wiz) what they should do, make Sacco pay $360, or have Simone cut $360? The Wiz hears the tale and asks if they want some advice. They ask if the Wiz can fix their problem, and Wiz indicates all financial problems have solutions, although some are painful. They say they’re willing to listen and hold hands and ask the Wiz to proceed.

The Wiz clears his throat and starts:

“You’re right about cutting expenses.” (Ulysses gets a grin on his face) “And wasting a half a cent on a shrimp treadmill is silly. However, if Simone cut all of her expenses, all $6,600, you’re still upside down. In fact, if you look at it, if you settle your lawsuits with the McCoys and Hatfields, you’re still in the hole if you just take care of the parents and pay your insurance. In other words, $360 of cuts doesn’t make much of a dent on a $15,000 hole.”

“So you will probably have to make more money.” (Simone now has her turn to smile) “However, merely making Sacco pay more to raise $360 isn’t really going to help much. In fact, raising Sacco’s contribution rate to 70% on his top income won’t fill the hole. You would have to triple the amount contributed by all the kids to fill the hole. And I predict the kids wouldn’t put up with it.”

Ulysses and Simone are silent. “You said you could help us, and now you’re making us feel bad. What kind of Wizard are you anyway?”

The Wiz leans back in his chair and puts his arms over his head: “Does it occur to you that you can’t just keep borrowing money from B of C? What if they decide you’re not a good credit risk? Remember what happened to the Greek family down the street? You need to look at the big picture.”

“Look at your three biggest expenses: you aren’t addressing them. You want to pay for Mom and Dad’s medical costs, and that’s running over seven grand a year. You want to pay for their living expenses, and that’s over seven grand as well. And all your lawsuits and insurances to protect you from threats real or imagined cost just about that as well. It’s great to pay for Mom and Dad, but you need more inflow. Make all of the kids chip in more to take care of the grandparents. Right now, the kids that work pay about 7.6% to take care of the grandparents, parents, and eventually themselves. Up this to 10% and you’ll get a quick $4,000. Have Mom and Dad pay more on their medical premiums. By the way, you seem to be covering a bunch of the neighbors kid on your insurance; quit doing that.”

“Settle the lawsuits with the Hatfields and McCoys, that should save you about $2,000. Cut $500 from Simone’s budget. Go ahead and have Sacco kick in more, he was doing it before anyway. While you’re at it, there’s about $500 more in silly things the kids get away with, like keeping their allowance in the neighbor’s piggy banks. By my math, that gets us $7,360.”

“You’re still in the hole by about seven grand. So here’s what you should do. If anyone comes over to your house as a guest, welcome them and let them enjoy your hospitality. The kids, however, can chip in a little more toward the family, so all the kids can pay an additional 5% on all the stuff they buy, like candy, or clothes. We won’t make them pay on food. I noticed that some of the neighbors kids are hanging around, eating your pizza and sleeping in your garage, make them pay 10%”. The Wiz leaned forward, “And the most important thing is: quit borrowing money to spend!”

Ulysses and Simone are stunned. “This is an awful plan; the kids will hate it.” Simone is looking at her hands. Ulysses is looking at the Wiz. “Would this actually work?”

The Wiz smiles. “Right now, you’re spending $36 thousand while taking in $21 thousand, and borrowing the extra $15 from the Bank of Chillicothe. If you make everybody chip in and cut your spending habits, you’d have expenses of about $33 thousand and inflow of about $33 thousand.” The Wiz leaned forward, “And, as the kids made more money and spent more, you’d actually have extra money coming in, plus with a little inflation, a great thing would happen.”

“What could possibly be great about inflation?” asked Simone.

“As you generated a surplus, you could pay back the Bank of Chillicothe. Except with inflation you’d be paying back with smaller dollars. Eventually you could have the entire debt paid off, and then you could take the money you were spending on interest and use it for research or education, or things that are good for the family.”

The Wiz stood up. “I know this may be tough to swallow, but balancing your budget is essential in the long run. In addition you can’t really grow the family’s finances if you are saddled with giant debt. I have to go to my next appointment; I’m meeting an Italian couple.”

Ulysses and Simone get their brief cases and leave. As they walk out, Simone says “I didn’t like what he said. That isn’t going to work, making everyone pay for things.” Ulysses shrugged. “I hate paying for things, and I know the kids will really hate it. And this idea of not having debt: what a silly notion.”

“What do you want to do?” asked Simone.

“Shall we go out for a nice dinner and drinks? All this budget talk has made me hungry and I want a cocktail.” said Ulysses.

“I didn’t bring my purse.”

“It’s OK, we’ll use my credit card” said Ulysses.

NOTE: Multiply each number by $100 million and you have the federal budget. So, Medicare and Medicaid is about $709 billion, and the shrimp treadmill (yes, there is one) is about $500,000. Raising the upper income tax rates to the pre-Bush tax cut raises $36 billion, which cuts the deficit by 2.4%. China (followed by Japan) are our biggest creditors. Defense, Social Security, and Medicare/Medicaid currently are almost exactly 100% of the revenue inflows (give or take a few billion). You could cut every other federal payment except those three and barely balance the budget. The current budget debates are somewhat absurd: The deficit is over a trillion and half dollars, and borrowing to fill it increases the deficit. Washington needs to have a business 101 lesson: Make more, spend less, grow the business.

Leon

Grecian Formula: Part 2 Do you like your lamb lean or leaner?

2011-06-15T11:10:00.000-07:00

June 15, 2011. I’m watching the strikes and protests in Greece and the prospective rejection of austerity measures. The Greeks are upset because of draconian restrictions on their spending to balance their budget. Greek bonds are now rated junk (the lowest rating of any country, even lower than Pakistan and Ecuador), and French and Portuguese banks are under review for having Greek debt.

Looks to me like the Greeks are in between the proverbial rock and a hard place:

• They can accept the austerity measures, tighten the belt and pay more taxes and retire later. The Germans will bear the brunt of the bail-out costs, but the Euro zone will hold through the crisis, which will probably be repeated (replace the word ‘Greece’ with ‘Portugal’ for example).

• They can reject the measures and get kicked out of the EU, and then default on their debt. This would probably really hurt the Euro, and clearly the Greeks would then have a whole new set of concerns, like a worthless currency and the inability to raise money. The holders of Greek debt would get stiffed, and their ratings would suffer.

I always wonder what would have happened had the U.S. remained 50 separate sovereign states and then tried to get together to form a common currency. Things would probably be OK while the economy was good, but I could picture states like Minnesota, Alaska or North Dakota getting aggravated at Louisiana when a hurricane hit, or if California ran up its debt too high. Families are tough enough to run, especially extended families, like the EU.

Overall, this crisis will come to a head, because it has to (the debt is coming due). The Greeks will suffer, or…the Greeks will suffer. And maybe a lesson might be learned about spending beyond your means: Hello? Washington?

Pass the grape leaves…

Leon

The Estate Planning Letter of Final Instruction

2011-06-01T06:36:00.001-07:00

The ‘Missing Link’ Estate Planning Document

Most of us are aware of the importance of an effective estate plan, which would primarily include a Will, a Durable Power of Attorney for Financial Powers, and A Durable Power of Attorney for Health Care. In many cases this may also include a Revocable Living Trust, funded with assets during the life of the Grantor. These documents are crucial to providing legal guidance to the administration of an estate or trust. However, the creation of effective documents does not guarantee a smooth estate transition. Some of the information family members would need to finalize an estate is not contained within those formal legal documents. The missing link to the plan is a statement by the Testator (you) to expedite and smooth the process. This is usually called a ‘Testamentary Letter’ or a ‘Letter of Final Instruction’. It may cover a variety of topics, ranging from burial instructions to listings of assets and advisors.

A Testamentary Letter is not legally binding: that’s why you have your formal documents. The letter’s purpose is to provide your family with guidance. Specifically, it is intended to answer the important questions of who, what, why, how, and where. We have created a Testamentary Letter (click here) that you can use for yourself or give to your loved ones. If you prefer to compose your own letter, provided below are some guidelines.

Style: A testamentary letter is just that: a letter, and not a legally binding document. As such, there are no formalities to the letter itself. It may be handwritten, typed, or generated on a computer. The letter is ‘precatory’ which means that it expresses your intent, but is nonbinding. Any binding instructions should be put in your Will or Trust. When creating the Testamentary Letter, obviously be aware that your administrator or family must know it exists and where it is located. I remember early in my legal career working on and probating the estate of an elderly woman. We went through a house of accumulated treasures and trash, found several things of value, discarded several thousand pounds of junk. Many months later, one of the heirs called with a question about a bill on a safe deposit box. We re-opened the estate, had the box opened and found a letter of her desires (including burial instructions that weren’t followed, a service that wasn’t performed and some gifts that hadn’t been made). Be sure to tell more than one person about the letter and where it is located. Also indicate that ‘if anything happens’ (my favorite euphemism for ‘when I croak’), they should get the letter first before doing other things.

Introduction: The introduction of the letter is up to you. You can address it ‘to whom it may concern’, to loved ones, or your personal representative whatever works for you. You should have a date on the letter, either in the signature or the heading. In addition, you should have a statement that this is a testamentary letter: ‘I’m writing this to provide some guidance and information to you upon my death. I hope you are able to carry out these wishes.’

Who: Logically there are a variety of people who should be contacted, so the names, addresses, phone numbers and e-mail addresses of those people should be provided in your letter. Examples of who you should include are friends, family members and important advisors.

What: This part answers ‘what do you want done with ?’ Here you should elaborate your desires with regard to things such as Funeral/burial instructions and preferences, anatomical gifts (although you should make an organ donation through the organ bank as well), and the disposition of specific personal property or memorabilia (supplemented if possible with a digital photo or other identification).

Where (Valuable Papers): It is also important to list the location of valuable papers such as your Will, original Social Security card, and deeds to your property.

Where (Financial Items): Your family will also need information regarding your monetary assets. You should give them access to the location of things such as IRAs, retirement accounts, safe deposit keys, and brokerage accounts.

How: How do you want the estate administered? Remember your formal legal documents override your letter, so if you want something very specific, you should have it in your Trust or Will. However, if you have stated certain desires in your Trust or Will about ‘sprinkling’ money to children or grandchildren, or you have a concern you want expressed, the letter will help communicate your wishes.

Why: Why are certain things the way they are in your estate plan, if you care to explain these decisions. (If you don’t care to explain them, you’ll never hear about it anyway).

For your own personal use, or to pass onto friends or family members click here for our Testamentary Letter.

Leon C. LaBrecque, JD, CPA, CFP®, CFA

LJPR, LLC

Independent Women Survey - Win a $100 Amazon Gift Card

2011-04-06T06:44:00.000-07:00

Independent Women. Take this survey for a chance to win a $100 Amazon gift card!

If you are an independent woman and are interested in winning a $100 Amazon.com gift card, please take a few minutes and complete the survey.

To better understand the needs of independent women, we recently conducted a focus group where we administered a brief survey. As a whole, the group expressed an importance on controlling debt, having sufficient medical coverage, and having a well-written estate plan. While we found the data from these surveys to be beneficial, we would like to continue to survey independent women in order to understand even further the steps we must take to fully accommodate our current and future independent women clients.

NIMBY: ("Not In My Back Yard"): Budgets, earthquates, and other sundry thoughts

2011-03-15T12:31:00.000-07:00

I’m watching with great heartbreak and concern as the aftermath of the massive earthquake and tsunami in Japan unfolds and can’t help but notice how the Germans and Swiss are putting a hold on nuclear power plant construction, even though I would be willing to bet that plant technology has probably gotten better in the last 40 years, and the probability of a tsunami in Switzerland is just about zero (or at least, if they do have a tsunami in Switzerland, we are all in very deep trouble). Ugly events come to our attention, and then we look at the outcomes and in a flash of human nature, start to actually see the issues.

Take the Michigan budget suggested by Michigan’s Governor Snyder: Seems like an elegant CPA-type solution: rework the tax rates so corporations pay income taxes (6%), individuals pay taxes (4.25% on working or retired), and budgets are cut. Good, right? Not if you receive a pension (NIMBY!). Not if you received the earned income credit (NIMBY!) Not if you’re a state worker (NIMBY!). Cut the budget, but by gosh, don’t cut my piece of the pie.

Or our friends (I use the term loosely) in Washington, they’re quibbling about the spending bill and arguing over a $6B cut. Six billion sounds like a lot, right? The deficit for 2011 is $1.67 Trillion! Six billion on 1.67 trillion is 0.35%. That would be like your daughter in law complaining about her $40,000 credit card balances and then arguing with your son over a $143.72 payment. Sorry folks, but a $143.72 payment does not get rid of a $40,000 bill, nor does a $6B cut on a $1.67 T deficit do anything. Wake up, Washington (I think they are all sitting around a campfire singing NIMBY: ‘Not in my backyard, lord, not in mine…’ to the tune of ‘Kumbaya’).

And then there’s the Middle East. I haven’t seen ‘The Social Network’, but I’m thoroughly impressed that Facebook can overthrow Egypt, disrupt at least 14 countries in the Middle East, and cause our old buddy Muammar to be in a full-fledged battle for his life (and his kid’s million dollar allowances). How will it shake out? I see it like a Greek play: there’s act one, the build up; act two, the crisis; and act three, the finale. I can’t help but envision Osama banging his head against the cave wall thinking ‘I should have used Facebook.’ On the other hand, as we all know anything can happen. I do envision Gaddafi sitting with his bodyguards (look it up, it’s interesting) saying ‘NIMBY!’

What does this all boil down to? Nasim Talib (who I have had the privilege of meeting) wrote a wonderful book called ‘The Black Swan’. A Black Swan is a metaphor (in the 18th century, geneticists were certain there could not be a black swan, until they happened to go to the Pacific, where all the swans are black), for an event that is a surprise to an observer and has a major impact. After the fact, the event is realized by hindsight. It’s amazing how many unpredicted and undirected events happen. Consider this list of black swans from Doug Kass, of ‘once in a lifetime’ events in the last ten years:

Black Swan events over the past decade

• Sept. 11, 2001, attacks on the World Trade Center and Pentagon;

• 78% decline in the NASDAQ;

• 2003 European heat wave (40,000 deaths);

• 2004 Tsunami in Sumatra, Indonesia (230,000 deaths);

• 2005 Kashmir, Pakistan, earthquake (80,000 deaths)

• 2008 Myanmar cyclone (140,000 deaths);

• 2008 Sichuan, China, earthquake ( 68,000 deaths);

• Derivatives roil the world’s banking system and financial markets;

• Failure of Lehman Brothers and the sale/liquidation of Bear Stearns;

• 30% drop in U.S. home prices;

• 2010 Port-Au-Prince, Haiti, earthquake (315,000 deaths);

• 2010 Russian heat wave (56,000 deaths);

• 2010 BP’s Gulf of Mexico oil spill;

• 2010 market flash crash (a 1,000-point drop in the DJIA);

• Surge of unrest in the Middle East; and

• Thursday’s earthquake and tsunami in Japan.

All that and we’re still here. In our case at hand, Japan will rebuild (probably better than before), nuclear plants will be safer and better, earthquakes will continue, some budgets will be balanced, and other budgets will be largely ignored. Markets will rise, and markets will fall. And we’ll be surprised by the next ‘once-in a lifetime’ event. And after the horses have run out of the barns, we’ll close the door.

Don’t be too surprised by Black Swans. (The events, not the movie.)

Leon

PS: Kudos to the late George Carlin on his ‘NIMBY’ skit. And thanks to Mike Reed for pointing out the Black Swans.

Budget Fights: First You Don't Like Spending: Then You Don't Like Cutting

2011-02-21T08:49:00.000-08:00

2/15/2011. I’m watching the current controversy on the budget and the proposed cuts of $1.1T over ten years. Funny, last year, just about everyone I know was raising hell over the spending policies. The new budget has a combination of freezes, cuts and tax increases (on the upper two brackets, of course). The hue and cry abounds: “It’s too much!” “It’s not enough!” I thought I’d risk the pain and have a look at the budget, and based on my first review, here’s what I see:

The Deficit is Worse. This Budget has a deficit of $1.645T. (I think we should require them to list the actual number: $1,645,000,000,000; and also list it by taxpayer: about $12,000 deficit per taxpayer!) Now I may not be too good with numbers, but the 2011 deficit was $1.65T. So to my feeble brain it looks like we’re spending $50B less that we don’t have out of $1,645 billion that we don’t have. By the way, the 2011 budget had a projected deficit of $1.267T when it was announced. So the budget actually was about $380 billion worse than bad.

We’re Spending More than Ever. In 2001, the US budget had a surplus and government spending was at about 18.2% of GDP. It’s now about 24.7% and rising fast. To put it in perspective, the entire 2001 budget outlays were $1.835T, compared to a deficit of $1.645T now. GDP at the beginning of 2001 was about $10T. Today, GDP is about $13.5T. The US economy has grown about 35%, but government spending has just about doubled.

The REAL Big Three. There are three reasons why the current budget cutting program won’t work: Social Security, Medicare/Medicaid, and interest on the National Debt. I bet you thought I’d say defense (which I believe we need). Here’s the stark reality: Social Security, Medicare/Medicaid and interest payments (presuming we don’t borrow another penny) constitute about $2.125T of this budget, or 75% of total receipts (which I might add, the government has projected an increase in their revenues of 18.7%). If you add in defense, you have a modest deficit of $4B. So have a look at that: you could cut out ALL federal programs (including Congress, Transportation, Health and Human Services, Agriculture, Education, Post Office, all international aid, the judiciary, the Congressional barber shop and everything else) except those four things and you can barely balance the budget. Any true action on a budget requires Congress and the President to look at the mandatory programs. It’s like the movie ‘A Few Good Men’ “You want the truth? You can’t handle the truth!”

Japan, for Example. Want an ugly example of what can happen? In 1995, Japan’s per capita GDP was about $41,968 per person, 51% higher than the US. In fact a popular treatise in 1989 was ‘The Japan That Can Say No’ an essay on Japan’s global dominance. In 1995, Japan debt to GDP ratio was 92.43%, compared to ours at 71.02%. Today, Japan’s GDP per capita is just about the same as it was 16 years ago ($42,325). Ours is up 69%, China’s is up 612%. Japan’s debt to GDP ratio today is the second worst (only to Zimbabwe) at 225.85% (It should be said that one good thing about Japanese debt is that they owe it to themselves); ours is at 92.72%. Japan just got their bond rating downgraded. Hmmm? See any comparisons?

Bottom Line: If we want to get serious about deficit reduction, we need more than a $50B cut. Washington sounds to me like a couple in a dysfunctional marriage: they want to argue, but they’re unwilling to step up and solve the problems. Who knows, maybe a good place to start would be the Budget Deficit Reduction Commission. But then again, that might be like the dysfunctional couple listening to the marriage counselor.

C’mon kids, play nice.

Leon

The World's Best Emerging Market: Probably Not What You Think

2011-01-24T09:58:00.000-08:00

The World’s Best Emerging Market:
Probably Not What You Think

January 24, 2011. The markets have improved, the economy has improved and the pain of the great bear-cession is starting to tone down to a dull throb. So, ponder this, what is the world’s best emerging market, based on market capitalization growth from March 9, 2009 to January 21, 2011? To provide some perspective, gold was $923.75 an ounce on March 9, 2009 and was $1,342.50 on January 21, 2011, so my calculation is that’s about a 45% increase over 21 ½ months, not bad. The S&P 500 did quite a bit better, up about 88% from that dark day of March ‘09.

So, what’s your guess? If I use ETFs as a proxy (I use those because you can use an ETF to actually invest in a country basket of stocks), let’s round up some of the normal suspects: China? Nope. The FXI was actually up less than the U.S. SPY(S&P 500), 83%, still good. Must be Brazil! Nope. Brazil (EWZ) was up 127%, which is great in anyone’s book. Close, but no cigar. India? Up 137%. Must be Russia! Up 227%, which is incredible for a little over 21 months. Well, that covers the BRICs, what about Indonesia? Up 243% (IDX). By country, Turkey (TKF) was up the most, a whopping 294%. But I think there was an emerging market a little better, like about a 17 times bigger change in capitalization than the S&P 500, and 5 times better than the best country return, Turkey.

How does a 1,566% increase in stock value sound? The market cap of this region went from $8.5B on 03/09/09 to $142.1B on 01/21/11, and still has room to grow. How about unemployment? The U.S. national unemployment rate is actually 0.8 % higher now than it was in March of ‘09, but this region has actually reduced its unemployment rate by 3.1 percent. (I smile as I write about unemployment numbers, because the reduction could mean that a bunch of people dropped out of the job market). Real estate? This region was suffering -11.94% declines in its real estate, and still is, but down to -3.7%.

Where’s this miracle market? DETROIT! I took a dozen Michigan-based stocks (AXL, ARM, BWA, C (Chrysler, not Citigroup), DPH, FDML, F, GM, LEA, PAG, TWI and VC) and compared what they were worth on March 9, 2009 and January 21, 2011. To be sure, some were in bankruptcy, on total life support, or had no public stock. Ford was $1.74, Arvin Meritor was 35 cents and American Axle was 29 cents! GM and Chrysler we know about: they went to zero. Chrysler still hasn’t issued stock, but probably will. But the fact is the traded market capitalization of those stocks has increased over fifteen hundred percent in a little over 21 months.

What does it mean? Remonetization. Stocks are like money, but better. They can go up, and can pay dividends. Take the employees and all those collaterally affected by the auto industry in 2009. Their 401(k)s were down (to 201(k)s), their house values were down, their stocks were either worthless or almost worthless. Employment looked bleak. Stock Options were so far underwater that you needed a submarine to see their negative value. You probably couldn’t find a nastier spot than Detroit. And from declines come gains. GM is back to a traded stock and has new product, Lear is out of bankruptcy, Chrysler will be out soon, Tower reissued stock, Visteon just had an IPO. All the employees and executives now have a new form of money. Ford stock options from 2003 are in the money. A massive amount of stock market wealth disappeared in the 2008-09 decline in the auto industry. But at least $133B of it returned.

Should we all run out and buy car stocks? NO. But recognize that economic growth takes place when jobs and wealth are created. Detroit plunged into the abyss in the bear-cession. And now it’s coming back and bringing with it collateral jobs and increases in wealth in the form of stock and value. The rumors of the death of Detroit are greatly exaggerated. In fact, $133B of wealth was created in the Motor City.

Leon

Leon C. LaBrecque JD, CPA, CFP®, CFA is Chief Executive Officer at the fee-only, independent wealth management firm of LJPR, LLC. Started in 1989, LJPR manages about $400 million of client assets. The data in the article were determined using closing prices on the respective dates. LJPR is not making recommendation on any particular stock or ETF. LJPR reduces uncertainly in the lives of its clients by applying creative wealth management solutions in tax, financial planning, retirement planning and estate planning. For a consultation on your personal financial matters, contact us or call at 248-641-7400. Also visit our website http://LJPR.com.

Tax Cut Extension: What a Great Present: Who Gets the Bill?

2010-12-22T08:50:00.000-08:00

December 22, 2010. I’m of course delighted that the tax cuts have been extended for two years. My version was that the economic recovery was moving along too slowly, and the uncertainty of taxes left everyone in a state of pessimism and conservative fiscal policy. So now, for two years, we at least know what our tax system looks like in a general sense. We can continue to look at dividends and capital gains with special rates; we can plan for our tax bill and make decisions based on at least some certainty. I wanted certainty, and as the old saying goes, be careful of what you wish for. Because along with the normal extension of the tax cuts to everyone, we got an unemployment extender, and a new estate tax law.

I did view with amusement how the media portrayed this as a ‘tax cut for the rich’ when the actual vote and deal was an extension of current tax rates to everyone, and a ‘tax holiday’ to everyone who pays into Social Security. In the normal fashion of politic-making (which along with sausage making is something you really don’t want to see the process of), Congress decided that the Social Security system didn’t really need the money and gave all workers a 2% cut in their share of FICA taxes. Now don’t get me wrong, I’ll get 2% of $106,800 in my hands, and I like money as much as anyone else. But, if someone makes up to $106,800, they get a 2% tax cut, if someone makes $500,000, they get a 0.4% tax cut. So a $100,000 income person is 2% better this year, a $500,000 income person is 0.4% better this year. That sounds like a middle income tax cut to me (which I approve of, by the way).

Another thing about the Bill I found interesting and good was the estate tax. The new estate tax for the next two years is a 35% tax on estates over $5 million. That means that married couples can shelter up to $10 million if they do their estate plans correctly (if you know people with $10 million who want to know how to do it correctly, have them call us). The media and parts of the Congress went crazy about ‘tax cuts for the very wealthy’. Now, to get the facts straight, last year Congress had the opportunity to pass a new estate tax law, and the front contender was a $3.5 million limit per person with 45% tax. They failed to pass it, and as a result, the estate tax went away totally in 2010. No tax. So George Steinbrenner and Dan L Duncan were billionaires and their estates have no tax. Help me out on this one: if the rate goes from zero to 35%, isn’t that an increase?

Enough griping, we can see that on any cable news channel. The sad fact is that we still have a deficit on a scale that is absolutely mind-boggling. The deficit is estimated at about $1,500,000,000,000.00. So if every one of the 138 million taxpayers chipped in an equal share (never mind that half the taxpayers don’t pay any tax, or get money back they didn’t pay in), of $11,000 apiece, we could balance the budget. What I’m suggesting is that we have a looming, very ugly problem in the form of the deficits. Consider this: If you cut ALL government spending except defense, Social Security, Medicare, and Interest on the National Debt, you’d still have about a $400 Billion deficit.

So the tax bill is like a nice Christmas present someone bought us with our own credit card. We like it, we think it’s great. But the bill will be coming. I think it’s operative that the congress extended the tax bill until 2012. In the Health Care bill, there are hundreds of changes, but none in 2012. Gee, I wonder why. Could it be an election year? It’s crucial we get out of the economic malaise. But beware the cure, it’s going to be painful.

Five Financial Gifts to Give Yourself Before Year-End

2010-12-06T08:31:00.000-08:00

Five Financial Gifts to Give Yourself Before Year-End
Leon C. LaBrecque, JD, CPA, CFP®, CFA
CEO, LJPR, LLC

1. Open a Roth IRA (if you don’t already have one):

Roth IRAs are tax-free and not subject to Required Minimum Distributions. You need to have a Roth account established by the end of the year. You have until April 18th, 2011 to establish your account and make your 2010 contribution. You can contribute $5,000 if you are under age 50 and $6,000 if you are 50 or older. Contact us if you want us to set up a Roth for you and your spouse, or even for working children.

2. Make your §529 contributions or open a 529 for your kid(s) and/or grandkids:

A §529 plan is a tax-free college savings program. The Michigan 529 plan, or Michigan Education Savings Program, has an additional feature of allowing you to make a contribution that’s deductible on your Michigan Income taxes. With the MESP, the first $10,000 (joint filers) or $5,000 (single filers) in contributions can be deducted from income on your Michigan tax return. If you make your contributions before the end of 2010 you get that benefit when you file your 2010 Michigan return.

3. Make your charitable donations:

Clean the house. Empty your closets, kitchen, basement, garage, etc. and get rid of the stuff you don’t use anymore. Get a receipt from the charity and deduct it as a non-cash donation. You can use a nifty program call “ItsDeductible” to value the donation.

If you regularly make cash donations, look at donating appreciated stock from an after-tax account. You will be able to take the deduction on your tax return and you won’t have to pay the tax on the gain. Example: you normally give your college $2,000 as a gift, you could give $2,000 of appreciated stock (say you bought Ford at $4, and now it’s at $16), and get the full deduction and avoid the capital gains.

4. Do a Roth conversion:

In addition to contributing to a Roth, you can convert existing IRAs to a Roth. You pay tax on the converted amount now but all subsequent income and gains are tax free. What’s more, Roth IRA’s are not subject to required minimum distributions. If you convert to a Roth in 2010, you may split the income on the conversion over 2011 and 2012 or report all the income in 2010. We’ve written a White Paper on Roth conversions. However, to get the clock ticking, you need to make the conversion before 12/31/2010. And don’t worry if you change your mind, you can recharacterize a Roth conversion up to 10/17/2011 if you file an extension or filed a timely return. No harm, no foul.

5. Check your estate plan:

Did you buy a second house in 2010? You might need to set up a trust (particularly if it is out of state) or at the very least deed it to your heirs to keep it out of probate.

Did you have another child? Documents should be updated for that. If you had your first child, a Will definitely needs to be set up to name a guardian, as well as establishing a guardian in your Power of Attorney.

Haven’t looked at your Health Care Power since 2006? HIPAA requires certain language in your Heath Care Power of Attorney.

Did you receive an inheritance? Make sure the accounts are titled correctly so they meet your estate planning goals. While you’re at it check your beneficiary designations on your IRAs, 401(k)s and other assets.

There you have it. Five tips for saving you and your family time and money for 2010. If you need help, contact us at LJPR: info@ljpr.com. Leon’s e-mail is leon.labrecque@ljpr.com . Our phone is 248-641-7400.

Leon C. LaBrecque, JD, CPA, CFP CFA, is the managing partner and founder of LJPR, LLC, an independent advisory firm managing about $400 million in assets. LJPR has provided integrated, comprehensive financial advisory services to thousands of people for over two decades. Leon is a practicing attorney who specializes in financial planning, estate planning, business and tax planning for individual and business clients. IRS CIRCULAR 230 DISCLOSURE REQUIREMENT: IRS Circular 230 requires us to notify you that any tax advice contained in this communication (including attachments) is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding tax penalties that may be imposed by law.

Tax Busters - Presentation on Michigan Municipal Bonds and Roth IRA conversions

2010-11-15T09:30:00.000-08:00

Presented on November 10, 2010.

With the tax wars in Washington and a tax increase in the works, two significant opportunities present themselves for 2010: Michigan Municipal Bonds and Roth IRA conversions. Nationally recognized expert Leon C. LaBrecque, JD, CPA, CFP®, CFA, and Chief Executive Officer of LJPR, LLC will be presenting an informative session on these two opportunities.

The GM IPO: Our Analyst’s View

2010-11-11T12:14:00.000-08:00

November 11, 2010. The GM IPO is without a doubt the most anticipated IPO in decades, and has a great deal of interest all over the world from the largest institutions to the smallest retail investor. Obviously a company that is emerging from bankruptcy virtually debt-free and with a lot of cash, is much better off than its debt ridden, cash strapped predecessor. I do, however, have some concerns about the long term prospects of GM from an investment standpoint. During the crisis, GM had to severely cut back its R&D spending and therefore has a lag in its pipeline of new models for the next several years, which in the car business is a big handicap. Additionally, GM is still a huge organization despite the changes they have made, and I think that changing the culture that led to its demise will be a slower process than people may realize; this is not a small hurdle for GM.

GM has been showing some decent sales numbers and revenues the last few quarters, but as evidenced by the most recent report we are already starting to see some slowing. Auto sales are inextricably tied to GDP growth, and historically need more than a 3% increase in GDP to show any real upside in sales. Although the economy is recovering, it is not a robust recovery and it may be several years before we see consistent 3+% GDP growth. More likely we will see fits and starts rather than sustained growth in the near term. This will definitely affect sales.

Despite the tremendous concessions the UAW made, I think they will not sit idly by and let the shareholders keep the lion’s share of future profitability (even though the UAW are indirect shareholders). As the company recovers the UAW will again pressure the company for a share of the profits.

There are few other issues that could limit the upside potential of the stock. Even after this offering the UST (US Treasury), Canada Holdings, the new VEBA, and MLC (Motors Liquidation Corp.) will still own 1,135,000,000 shares that will without a doubt hit the market sometime in the future. I think this will weigh heavily on the stock. In addition, there are a large number of warrants held by the VEBA and MLC, further adding to potential dilutive shares.

GM Management has been telling Wall Street in its road shows that they are concentrating on having appropriate market share goals and a ‘fortress’ balance sheet. But actions speak louder than words, and we all know people have short memories. Only time will tell if they can stick to that, or if they will once again attempt to buy market share at the expense of profitability to return to their former glory of being General Motors. As an investor, I’ll take profitability over market share any day.

To sum up: I firmly believe that the IPO will do well. It almost has to, no one wants to see this deal fail and everyone has a vested interest in it doing well. The investment bankers will price the deal appropriately, the large international and institutional interest will lead to an oversubscription which will assist in the success of the deal, and I think the market will support it. The underwriters also have 54,750,000 ‘Green Shoe’ shares. A ‘Green Shoe’ is the underwriters’ ability to purchase additional shares to cover over-allotments at the public offering price. This gives the deal support. I do think they will increase the offering price from the $26-$29 range and I would expect to see a $32 price when all is said and done (just my thought). I do not think they will increase the number of shares offered, but it is not out of the question. If you can buy IPO shares at the IPO price I would, but I would have an extremely short holding period and look to take advantage of the hype and euphoria surrounding this deal. If you really want to invest in the company I would wait a couple months for the dust to settle. Let the market digest the issue, let all the flippers and fast money exit.

If you cannot get IPO shares I’m not sure I would buy on the open market at the offering date. I think it will be too volatile, once again I would wait a couple of months before making the investment.

Brad Reynolds, CFA
Chief Investment Officer
LJPR, LLC

Using an Unwanted RMD to Fund a Roth: A Different Technique for IRA Owners Over 70 ½

2010-11-08T08:22:00.000-08:00

November 8, 2010. It’s clear from many commentators (present company included) that Roth IRAs and more specifically Roth conversions are an important wealth planning consideration. The Roth IRA has two primary tax efficient qualities: qualifying distributions are free from income taxes; and Roth IRAs are NOT subject to Required Minimum Distributions (the mandatory distribution from a traditional IRA that must begin at age 70 ½). You can convert a traditional IRA to a Roth IRA by paying the taxes on the conversion (and even splitting the income from the conversion into 2011 and 2012) and thereby eliminate/reduce your future RMDs and eliminate income taxes on all the future growth and income.

Roth conversions create many planning opportunities, which are covered in our White Paper on Roth IRAs (click here for a copy). Roth conversions provide tax-free income to heirs, avoid future higher tax brackets for the owner and their surviving spouse, and potentially reduce estate taxes (we’re assuming eventually the folks in D.C. will make a decision). One pre-eminent group that should consider conversion are IRA owners over age 70 ½ who don’t need or want IRA minimum distributions to supplement their income. Starting at age 70 ½ (actually April 1st of the year after you turn 70 ½ for some perplexing reason), an IRA owner must begin taking Required Minimum Distributions (‘RMDs’). By virtue of the mathematical calculation (the denominator is based on life expectancy, which obviously gets shorter as you get older) used to compute RMDs, most IRA holders will eventually take larger and larger distributions until they creep into a higher tax bracket. In addition, the death of a spouse puts the survivor in a potentially higher bracket because the filing status changes. Plus, many retirees don’t need or want the RMD: they don’t need the money to supplement their income, it just causes an increase in their tax bills.

Enter an interesting strategy, introduced to me by one of our senior partners, Brian Roehl. Our firm has a lot of clients over age 70 ½. In 2009, the Required Minimum Distribution rules were suspended for one year: for ’09, you didn’t have to take an RMD. In 2010, you do. In 2009, we took advantage of the lower tax brackets for many clients by making Roth conversions. Now for 2010, those same folks are taking unwanted taxable RMDs. Brian’s idea was simple: why not use the RMD to pay the tax on a Roth conversion? The law states that you must take a Required Minimum Distribution before you do a Roth conversion (you can’t convert an RMD), but nothing says you can’t use the RMD to pay the tax. Here’s how it would work:

John and Marilyn are both 73. They have $52,109 of pension income, other taxable income of $38,000, and Social Security of $40,895. They have IRAs worth $585,000 and don’t need or want the RMDs. They have kids they like, ages 45 and 42. Let’s assume they make 7 ½% on their investments and inflation is 3% (for tax brackets). For purposes of this illustration, we’ll assume they are Michigan residents.

Scenario One: Don’t convert anything. Under this one, they take their RMD. The RMD percentage is less than the rate of return until age 87, so for that period, the IRA grows. After 87 the RMD starts dissolving principal. At age 95, the IRA is worth about $617,000. By age 95, they would have taken $1.1M of RMDs and paid about $323K of taxes. If they die at 95, the kids inherit the IRA and pay income taxes on the $617K, plus earnings, over their distribution period.

Scenario Two: Use the RMD to convert to a Roth. Under this scenario, they take the RMD and use the entire RMD to pay taxes on both the RMD and whatever Roth conversion they can do. For example, in 2010, their RMD would be $23,684. The taxes on the RMD itself would be about $6,951, leaving $16,733 net. In their bracket, they could use that $16,733 to convert about $60,074 into a Roth. For 2011, their IRA is now $543,340, so the RMD is smaller, not larger. On the projected 2011 RMD of 22,829, they have to pay $6,700 of taxes, net $16,129, and convert $57,120. Same game for 2012, and so on. By age 95, they have depleted the conventional IRA down to $5,895. Their total RMDs were only $222K. The total tax on RMDs would have been about $65K, but they would have paid $157K of taxes on the Roth conversions. But here’s the kicker: at age 95, their Roth IRA would be worth just about $2Million! That’s tax-free to the kids as well. Less taxes, more money.

Looking at the chart, and comparing apples to apples, we’ll presume the IRA owner takes their entire net RMD and invests it exactly the same as they would their IRA (even though evidence is that investors tend to put their RMDs in safer investments at lower returns, or give it to their kids). We’ll presume the kids are in the same brackets as their parents. The use of the RMD to pay the taxes on the Roth conversion is worth about $266,430 to the family in this example.

Optimization: Is this the best way to do Roth conversions? In my opinion, not necessarily. I feel that you can ‘optimize’ a conversion to utilize tax brackets. But this one is simple, works, and if the retiree doesn’t like their RMD’s, they get rid of them.

Mechanics: An easy way to make this work is to withhold 100% for taxes on the RMD, avoiding worry about annualizing and estimated payments. Because we’re making serial conversions, we wouldn’t split this kind of conversion for 2011 and 2012. In addition, you have to do the conversion after the RMD, so do the RMD and withholding, and then do the conversion. Of course, you can then do all of the other wonderful things we talk about in our Roth paper, like segregating IRAs and so on.

Roth conversions are a great wealth management tool. In this case, you can use unwanted RMDs to fund the taxes on the Roth. And, nothing says you have to do this forever, you could convert for a while and then keep the RMD at a reasonable level. Flexible, saves taxes, and makes money.

“I am proud to be paying taxes in the United States. The only thing is I could be just as proud for half of the money.” -- Arthur Godfrey

Stay tuned,

Leon LaBrecque

Gold: Bottom of the 8th Inning?

2010-11-01T06:51:00.000-07:00

November 1, 2010. I get a lot of e-mails and questions from clients and friends about gold. Is it a good investment or bad one? Should I buy some? My friends are buying gold, should I? What if everything goes to hell? I wrote a typical glib response the other day that I thought I’d share as a blog in response to those questions:

On gold, let’s see:

Is gold a good investment? Since the year zero (0) to 1950, gold went up exactly 0%. From 1979 (a year in which gold went up 100%) to 2009, gold went up 5.37%, and stocks went up 11.93%. (Note: from 1257 – 1945, in England, the price of gold went up 0.23%- nice return).
How do you view gold versus equities? Companies (via their ownership through equities) make stuff and services, and sell them. Companies have earnings and can pay dividends. Gold is a metal. It has no earnings and no cash flow.
Is gold an inflation hedge? Gold is not an inflation hedge. From 1871 – 2009, inflation in the US was annualized at 2.12%, for the same period, gold went up 0.58% (the S&P 500 equivalent went up 8.53%). If you measure from 1981-2009, the CPI went up 3.11% annually, the stock market did 9.86%, and gold was 0%.
Is gold a currency hedge? There is no base of currency tied to gold, so its value is tied only to market forces. In other words, no currency is tied to gold, which might make it a store of value.
Is it easy to buy gold? If you buy physical gold, like bars or coins, you have to pay a commission, store it, and sell it at a commission. The commission on gold is vastly higher than the commission on stocks and infinitely higher than no-load mutual funds. (In fairness, you can buy GLD, an ETF that buys and stores gold, but you are still paying storage and commission through the ETF). By the way, gold can be stolen; it’s tougher to steal GE (although I suppose that Enron was stolen).
What about the emergency scenario, if the economy collapses? If everything goes to hell, the argument is that gold will be valuable: you can have a little sack of gold coins to trade with other survivors of the apocalypse. I assure you, if everything goes to hell, my .45 automatic (and a couple of hundred rounds of ammo) will assure me greater possession of food, beer, shelter and gold (although I think I would want food, beer and shelter rather than the gold: more ammo too) than a little sack of gold coins.
But I keep hearing about gold and reading the ads…If gold is such a darn good investment, why are people spending millions of dollars in advertising trying to sell it to me (Why don’t they just buy more gold?).

So, other than the fact that it has not outperformed the markets, has not served as an inflation hedge, does not appear to be a currency hedge, has no cash flow, and high carrying costs, gold seems fine: For a nice gift for my wife. I predict the returns could be good.

All that glitters…

Leon

What Quacks Like a Duck, Looks Like a Duck, and Limps?

2010-10-27T06:35:00.000-07:00

What Quacks Like a Duck, Looks Like a Duck, and Limps?

October 27, 2010. The 20th Amendment of the Constitution, states that regular sessions of Congress convene on January 3 of each year, unless an alternate date is set in the previous session. Since elections are held in November, some lawmakers will lose their job, but will still be members of Congress until the session ends. These un-elected members are called ‘lame ducks’ in a ‘lame duck session.’ Lame ducks are not good, since you have the un-elected voting on and passing laws, even though they won’t continue to serve. Only 11 states allow lame duck sessions, but then most states are required to balance their budget as well.

The worst of the lame ducks (the lamest duck?) is when a party with majority control loses that majority control. Then, the lame ducks can flex some muscle (become mighty ducks?) and pass old legislation, hinder new legislation, or generally be a nuisance to the newcomers. America has had some disastrous lame ducks, like James Buchanan’s transition to Abraham Lincoln, which may have exacerbated the Civil war, or Herbert Hoover’s transition to Franklin Roosevelt, which prolonged the Depression and made Hoover the ‘most hated man in America’.

In some lame duck sessions, legislation gets pushed through, like in the 1980, session when the Democratic congress hastily pushed two major bills through before president Reagan took office. The 111th Congress has a high probability of fitting the Bill as a lame duck, becoming the 18th lame duck since 1940. What will happen?

2010 Lame duck legislation. The 111th Congress has a very full plate of duck. There are at least 17 bills on the agenda. Here are some:

Extension of unemployment benefits

Freezing physician Medicare payments

NASA authorization

China Currency

Renewable electricity standard

Pre-empting EPA action on carbon emission

Defense authorizations (repeal of ‘don’t ask/don’t tell’)

DREAM act (to allow children of illegal immigrants to become citizens)

Cybersecurity

START arms-reduction treaty with Russia

Mine Safety

Child nutrition

The Spending bill

The extension of the Bush Tax Cuts

Now, I could be wrong, but the 111th Congress goes back into session after the election on November 15th. They generally take a break for Thanksgiving, and always for Christmas. Twice a lame duck session has run until January 2 (both during wartimes). The longest a lame duck has run since 1992 is 12 days.

So my question is: which, if any of these bills will be passed, and the most important question to me, is ‘What is the tax law going to be on January 1, 2011?’ I’m skeptical that the direction of legislation will be toward what’s good for everyone and maybe more toward what’s on the party agenda. If the tax cuts expire, everyone gets a tax increase, and a big one. The lowest tax bracket taxpayers get an increase in their rate of 50% (!) and the upper bracket folks get a slew of increases. For example, a married couple with three kids, both working and making $50K each would have their taxes increase by about $3,900, or a 50.4% increase. Anyone with an estate over $1M, could now prospectively be taxed on their assets at 55%.

I’m watching the election closely. Congress is important, the Senate is important, and the governors’ races are maybe even more important (governors set the Congressional districts every 10 years). But for all the elections may say, what happens AFTER the election is directly affecting every American’s pocketbook. And that is one ugly duckling.

Leon

Why We Should Leave The Tax Cuts In Place

2010-09-13T12:01:00.000-07:00

September 13, 2010. Being an economist or a meteorologist is a good job: you can be wrong all the time and still get paid. In undergrad school, I chose to major in accounting: it was hard, it was interesting, but importantly (to me), it had a finite result (well, sort of finite). I had my minor in economics, which had a similarity to taking either religion or political science: everybody had a theory, and sometimes they were right.

Nevertheless, I’d like to take a stab at economic theory and how to fix our economy and the rest of the world’s economies. The first and foremost notion for every economic entity (with the possible exception of the Taliban) is to ‘Provide economic growth’. Simplistic? Yes, but you can’t argue its merit. So the question of economic growth comes down to this: How? The answer is again, even by economic standards, almost universal: ‘Putting money into an economic system stimulates economic growth’. Again, simple. So how do you put money into the system?

Here’s where the arguments start and the similarities to religious and political conflict begin. One school of thought (called the Keynesian school) says ‘put money into the system by providing jobs through fiscal stimulus’. This notion is to build roads, bridges, parks, whatever; get people working, even on government dollars. Provide unemployment benefits, keep wages up and the money will flow into the system from the bottom up. This ‘bottom-up’ approach suggests that money into a worker’s hands will flow into goods and services that the worker buys, putting money into the system. This method has worked before, most notably in the 30’s. During the 60’s and 70’s, not so much. Currently, the government has thrown the entire fiscal stimulus playbook at the economy. Unemployment is still high. The problem with fiscal stimulus is that it takes time to work. In fact it usually starts working after you need it.

Another idea (called the Monetarist school) says ‘put money in the system by increasing the money supply, and banks will lend it out and stimulate the economy, providing jobs and expansion’. This notion is that money is self-regulating and by increasing the amount of money, you’ll increase the amount of activity. It’s worked before (most of the 90’s), and then again, it hasn’t (the late 70’s, it was a total bust). This ‘top-down’ approach believes that money flowing from the top will work its way into jobs by companies expanding and hiring. The government has not only thrown in the entire monetarist playbook, but created new pages, tools and weapons and tossed them in too. The result is that we have the biggest money supply in history, with about the lowest velocity of money (the amount actually making its way into the system). In other words, tons of money, going nowhere, sitting on the sidelines.

So fiscal stimulus isn’t really working, and monetary stimulus isn’t really working. What’s my magic bullet? I’d like to see some ‘Behavioral stimulus’. What’s behavioral stimulus? It’s letting the participants in the economic engine have some confidence that they can make good decisions. It’s reducing uncertainty. We advise about 700 families on what to do with their money. On the estate tax law, you know what we have to say? “We don’t know what the government is going to do”. On the capital gains rates for next year, we have to say “We don’t know what the government is going to do”. On the upper tax brackets, we have to say “We don’t know what the government is going to do”. How in the heck can an investor, taxpayer, businessperson or even an advisor function in uncertainty?

So here’s a grand idea: ‘put money into the system by allowing taxpayers to keep more of their money and have a stable system in which to plan their finances’. In the early 80’s the fiscal stimulus approach had failed, the monetary approach had failed, the Dow was at 870, and interest rates were at 16% on the 30 Year Treasury. The President cut taxes, and the economy took off, with the stock market rising about 1900%. By the end of that wave, the government had a surplus. We should leave the tax cuts in place. We should have a stable environment for people and businesses to do business, not a cloud of uncertainty to keep us on the sidelines. Give us a stable tax system and the economy will do what it wants to do: grow. Then you can have more tax revenue by taxing higher incomes. What a novel idea.

Reduce uncertainty.

Leon

Uncertainty and Double Dip Recessions

2010-08-19T11:44:00.000-07:00

August 19, 2010. There are several kinds of recessions: those which are caused by economic turmoil, by some endemic event as we have seen in 2008-2009, and those caused by fear, the fear caused by uncertainty. My mantra is ‘reduce uncertainty’ and I see the current situation filled with uncertainty. This uncertainty is pushing what I call a ‘behavioral recession’.

What is a behavioral recession? It’s when the conduct of the components of the economy alter their economic behavior to the extent their fears are realized. Consider the three legs of the economy: government, consumer and corporate. The US economy is divided with about 60% of the US GDP in the consumer, and 20% each in government and corporate spending. Let’s start with government. The federal government is spending money like a submariner on shore leave in San Francisco after 6 months at sea. However, the state governments (who, unlike the fed, have to balance their budgets) and local governments (who have to get funding from the state governments who cut the local pass-downs to balance their budgets) are not spending, but cutting costs and cutting costs means cutting jobs. So the ‘leg of the stool’ of government is flat.

The consumers, the bulwark of the economy, are rightfully frightened. Although the evidence is that for the most part, consumers are saving and still maintaining their income levels, they are clearly afraid. If you look at sentiment numbers, or if you conduct a simple ad-hoc poll, everyone, from millionaires to working folks, feel poorer. And one of the main reasons is uncertainty. Uncertainty about employment (what will happen to my job?); uncertainty about taxes (what is happening to tax rates?); uncertainty about inflation (inflation or deflation?). The media doesn’t help: we can find a point of view on about everything, from the oil volcano (sorry boys, wrong on that one) to the conspiracy to destroy the US, to the deflationary spiral to the end of the world on 12/21/12 (which will give me a good reason to celebrate my 57th birthday on 12/12/12 using credit cards). Negative news sells.

What about corporations? Well, the stark truth is that unlike consumers or governments, corporations tend to react quickly, so when the real recession started in 2007-08, the corporations went into cutting mode. Cut jobs, don’t spend. The reality is that the S&P 500 is riding on a wave of profitability and cash build-up. Huge amounts of cash ($1.7T) are sitting on the sidelines. If it went to work, there would be new hiring, or mergers, or expansion. It’s not, yet. In fact, the banks are sitting on more money than ever in history, but the velocity of money is only 2, not 9 like it usually is. Why? I picture a bunch of corporate CEOs at their country clubs (I envision they go to country clubs). My image of a corporate CEO is an older guy, a little overweight (so far, sounds like me), with a pink complexion and a very close shave (not me on those two). A bunch of them are walking around the ‘club’ locker room in towels. The conversation goes like this: “How’s business?” “Fantastic, we have great profits, tons of cash.” “What are you doing with it?” Nothing yet. We’re going to wait and see. This Health Care bill has us worried, we haven’t figured out the tax laws, so we’re holding onto the dividend, and who knows what’s going to happen in Washington. It’s all up in the air.”

So you have the three parts of the economy sitting around the campfire, looking at each other. The consumer is looking at the government and wondering when they’re going to make the economy better. Half of the government is throwing wood on the fire and half is pulling wood off the fire. The government is looking at corporations and wondering when they’re going to start hiring and get the economy moving. The corporations are looking at the government and wondering if they’re going to take away their pile of wood. So what happens? Either someone relents and starts building the fire, or they all sit around looking at each other and let the fire go out. Reduce some uncertainty, and maybe the corporate guys will throw some wood on the fire. Hire some people, and maybe the consumers will feel a little better. Economy expands, and tax revenues will go up and maybe the government can stop spending in deficit (Oops, didn’t mean to make a joke.)

This circle of doubt can go two ways: someone capitulates and the economy goes back to growing, or everyone holds to the Mexican standoff and we go into a double dip, and/or deflation. I’m betting for capitulation. People are the system and the system changes because it needs to.

I’d prefer my double dip on a cone. Stay tuned,

Leon

Progress is Biological

2010-08-11T13:39:00.000-07:00

August 12, 2010. It seems that all I’ve been hearing lately is a huge wave of pessimism. The Dollar is collapsing, the market is crashing, the credit markets are dry, the government is taking over, the US is sliding into socialism and Greece’s credit default will take out the world economy. Part of the problem is a misinterpretation of the ‘I Win/You Lose’. The theory goes like this: manufacturing jobs are lost here, and the Chinese are taking the jobs. We’re running out of oil, the Chinese are taking all the copper; the world is using too much carbon, etc. Jobs are lost, real estate is down, and none will ever recover. The US will eventually become a state of unemployed people on the government dole, sunk irreparably into sloth and lethargy.

Part of the problem is negative news reporting. With the advent of cable TV and the internet, we can now get 24 hours of doom and gloom and an inbox telling us of oil volcanoes and how there’s a pending economic collapse and the latest government conspiracy. And, now you can even send or receive You-tube videos of past or present figures making statements about some other version of conspiracy or foul play. Of course, bad news is easy to sell: if you see a forest of thousands of pine trees, and there’s a birch, which tree do you notice? If I tell you the Greek crisis will cause a domino effect and destroy the world economy, it sells. If I tell you Greece has been in default on its loans for more than 50% of the years since 1829, it is simply uninteresting.

What we fail to see is that progress is expansive in a biological way, not in a competitive way. Progress is caused by the exchange of ideas. If my grandfather Ernie wanted to get some information out, he would write a letter by hand, maybe with a fountain pen, with ink that he had to buy at the store that was 10 miles away. He’d walk to the store and spend about 2-3 days wages to pay for the ink and paper. The letter might go to an Alpena paper, where a typesetter would take tin and lead letters and carefully set them into a frame and print it on a printed press. The paper would then be circulated to the 5,000 people or so who read the Alpena paper. In all likelihood, the idea would stop, presuming it actually got published at all. All the while, Ernie was lamenting the state of the world in 1917.

If my dad, Leo, wanted to get out an idea, he might have written a letter on his Remington typewriter, using carbon paper, so he would have a copy. He could then re-type it if he wanted more copies, or he might be able to use a mimeograph machine and make a bunch of copies. He could mail them to many papers, and they would set them on a typesetting machine, and maybe he would be published. Paper would still be the preferred media, and Leo would be lamenting the state of the world in 1945. I, on the other hand, can push small buttons on a keyboard, sending electrons to magnetic media, and then send those electrons to potentially 5 billion receiving devices, who can then re-send it, argue with it, or agree with it.

The larger the connection of ideas, the faster and stronger the progress. Today, we can share and send ideas ranging from gene sequences of the human genome to scary stories about the oil volcanoes caused by BP (with assistance from Nancy Pelosi). Here is my idea: the speed at which a problem is solved is exponentially related to the number of connections to the problem. Look at your computer, your iPhone, your car, your DVD player. Progress is biological, it expands as ideas have offspring and breed with other ideas. The global world will expand, at a biological rate. Dumb ideas will expand, and are entropic, so they’ll die out. Good ideas will expand, and are syntropic. What is interesting is that while a dumb idea that keeps getting dumber is that it can eventually disappear, losing 100% of its function; a good idea can die or expand, but the expansion is virtually infinite. It’s like a stock: a stock can go down 100% (Hell’s basement, as we like to call it), but can go up 131,000% (or more, but Berkshire is still around). An idea can expand (like cellphones), or fall (like Jimmy Carter’s energy policy). Some ideas are like dinosaurs, expand and then become extinct. Others are like roses, or humans or golden retrievers, they expand and keep getting better.

Expand on.

Leon

How Much Can You Take From Your IRA and Preserve the Principal?

2010-06-14T11:21:00.000-07:00

June 14, 2010. With volatile markets putting retirees on edge, a question we frequently address is “How much can I take from my IRA?” We like to add an additional ingredient “and still preserve the principal.” IRAs are great planning tools for retired police officers and firefighters: they allow the retiree to have a tax-deferred way to preserve their deferred comp (§457) or annuity withdrawals. There are two normal ways of funding an IRA, either through contributions or by rolling over a distribution from another plan, like deferred comp.

The first question in trying to figure how much you can take out is figuring out how much you must take out of your IRA. Traditional IRAs (including rollovers) have a Required Minimum Distribution (RMD) that is mandated by law. You must begin taking money out of your IRA by April 1 after you reach age 70 ½ or face a 50% penalty on the required distribution. The required distributions are determined by a published IRS Table: you divide your beginning of the year balance by the factor on the table, which is based on a joint life expectancy. As you get older, of course, your life expectancy gets shorter, and the amount you take out increases. In general, the RMD at age 70 ½ is about 4% and gets progressively larger.

The second big question is trying to take inflation into account in your withdrawals. Say you have a $200,000 IRA at the Credit Union, all in CDs. Let’s suppose those CDs make 3% (good luck on that one in today’s market!). You take $6,000, or the interest out every year. So it appears that you are easily preserving the principal. However, every year, because of inflation, your purchasing power is declining. The $6,000 you take out in the first year won’t buy as much as the $6,000 in the fifth year. You might also notice that if you’re making 3% and you are over 70 ½, you have to take out 4% or more, and you will erode the principal.

So you must start distributions at 70 ½, but how much can you take, preserve your purchasing power and preserve principal? We’ve done substantial research on this issue and there is one essential factor to preservation: Real Rate of Return. Real Rate of Return is your rate of return adjusted for inflation. In an oversimplified calculation, Real Rate of Return is your return less the rate of inflation. So, if your IRA is earning 7%, and inflation is 3%, your real rate of return is 4%. If your IRA is all in bank deposits earning 2%, and inflation is 3%, then your real rate of return is -1%. Here’s the basic rule: If you want to preserve purchasing power and capital, you should only withdraw at or less than your real rate of return.

Here are three scenarios of how the Real Rate of Return works. Let’s take three examples: Let’s look at a retiree who is age 64. He has $300,000 in his IRA. He wants to take out a $1,000 monthly distribution, have some fun, and stay out of trouble on the Required Minimum Distributions when he hits 70 ½. He wants to increase the distribution by 3% a year. He’s considering three investment options: CDs at the Credit Union (paying 3%), annuity paying 5%, or a balanced investment that should make about 7.5%. For this example, assume inflation is 3%.

First Scenario: 3% CDs. It should come as no surprise to anyone that if you make 3% and take 4% out, you’ll run out of money. What may come as a surprise is that because of the compounding effect of inflation and interest, the 3% investment is doomed to fail quickly. Our retiree will totally run out of money by age 89. The Real Rate of Return is zero (3%-3%=0), and zero is less than the withdrawal rate (4%), so this one will fail (unless our retiree starts smoking, drinking and riding his Harley without a helmet). The total amount our retiree would have gotten from the 3% IRA is about $456,000

Second Scenario: 5% Annuity. Under this scenario, the rate of return (5%) exceeds the withdrawal rate, so the IRA doesn’t blow up as quickly. However, the simplified Real Rate of Return (5%-3% = 2%) does not exceed the withdrawal (4%), so this one also will fail, but over a longer period of time. By age 95, our retiree would still have about $115,000 of the $300,000 left. By 100, it would be gone. To compare, the total amount received or held by age 89 (when the CD based IRA would be gone) is about $689,000 (Distributions, plus the retiree still has about $227,000 in their IRA). 2% more return gets about $230,000 more to the retiree.

Third Scenario: 7.5% Investment. This scenario uses a balanced portfolio that earns on average 7.5%. Here the Real Rate of Return is about 4.5% (7.5%-3%=4.5%). 4.5% is greater than the withdrawal. This plan will work. By age 89, when the CD IRA would be gone, the 7.5% IRA has a balance of over $475,000. In addition, the distributions at age 89 (because of the RMD rules) are a whopping $63,400 a year. By age 89, when the 3% IRA would have been gone, the 7.5% IRA has generated distributions plus a balance of just under $1.15 million.

So the key to a sustainable withdrawal is enhancing Real Rate of Return. You have to make a real rate of return greater than your withdrawal rate. You have to take into account the fact that you must take distributions at age 70 ½. Over history, many studies (including ours) have shown that the key to having a sustainable withdrawal is not being too conservative. In fact, the most conservative portfolios (like 100% bonds) had consistently the highest failure ratios. Similarly, being too aggressive (like all equities) also causes prospective failure when the market does a big drop. The portfolio in historical studies that provided the highest success and highest consistent real rate of return is about 60% equities and 40% bonds. Of course, this presumes you’re not paying a bunch of fees and loads to get your investments, and that you stay invested and keep the mix stable at that 60/40 blend. We frequently modify that blend to 50% equities and 50% bonds which still has a good real rate of return and lets our retirees sleep well at night.

Bottom Line: Invest your IRA like a pension plan. Pensions are designed to provide a sustainable withdrawal for the retirees. It should be no surprise that the average large pension plan has an asset mix of 60% equities and 40% bonds.

Leon C. LaBrecque JD, CPA, CFP® CFA and Matthew Teetor are advisors at the independent advisor firm of LJPR, LLC. Matthew and Leon run the firm’s practice for public safety officers. LJPR reduces uncertainly in the lives of Michigan police officers and firefighters by applying creative wealth management solutions in tax, financial planning, retirement planning and estate planning. To contact us for a consultation or to discuss group programs for your unit, contact matthew.teetor@ljpr.com or call 248-641-7400. Also visit our website http://LJPR.com.

Teachers' Early Retirement Bill for Michigan Teachers: Some Good News, Some Bad News:

2010-05-14T06:14:00.001-07:00

Teachers’ Early Retirement Bill for Michigan Teachers:
Some Good News, Some Bad News:

May 14, 2010. My Dad used to say not much good is going on at four in the morning. He might be partly right as it applies to Michigan politics. At 4:25 AM on May 14, 2010, the Michigan Legislature passed an early retirement bill for teachers. Some good news, especially for teachers at retirement age. Some good news for districts, who can save money. Some bad news for newer hires and for kids, who will lose a lot of qualified people.

Here’s the deal as I understand it:

Teachers and school employees who retire between July 1 and September 1, 2010 who are age 55 and over and have at least 30 years of service (include purchased years) can calculate their pension benefits at 1.6% instead of 1.5%. This adds about a 6.6% sweetener to the pension. I figure about $200 a month for an average teacher with 30 years.

If the teacher or school employee is not eligible for normal retirement, but their age plus service adds up to 80 or more, they can use a 1.55% multiplier (a 3.3% increase).

For those who don’t retire, they must now contribute 3% of pay toward retirement health care. New hires would have to pay as much as 11.4% toward their retirement. I figure for my friends who are teachers with 30 years with a Masters degree, making about $80,000, the deal is worth about $4,800 more a year, or $400 a month. If I capitalize that at 5%, for a 56 year old teacher, it’s worth about $75,000 in today’s dollars. That doesn’t account for the fact that the teachers or school employees’ pension is not subject to Michigan income tax. I’m telling my eligible friends to take it.

So, it’s good for a retirement eligible teacher, and it’s also providing a job for a new teacher. I like that too. The districts can save the differential on the pay between a new teacher and a seasoned teacher with advanced degrees.

Who loses? Teachers who are not retirement eligible now go back to their old system and now have to contribute to retiree health care. If anyone thought that retiree’s health care was safe for state employees in this State in this economy, I’d suggest that that was coming a while back. I also see the difference between someone with great experience teaching kids and a brand new teacher. I like the new and fresh ideas of the new teacher, but I also like the sage wisdom of a mature teacher.

Some other provisions of the Bill:

•The new hires have a hybrid pension plan that has an employee contribution of $510 plus 6.4% of their salaries above $15,000. They also get a 401(k) plan where they contribute 2% of pay with an employer match;

•New hires can’t retire with full benefits until age 60;

•Charter school employee are not part of the new retirement plan;

•School retirees rehired by their district can’t draw their pension benefits. This was the former ‘double dip’ where a district could rehire a retiree at a lower cost. I don’t see anything wrong with it and wonder why the Legislature does.

All in all, the Teacher’s Retirement Bill is another sign of the changing times. For retirement eligible, it certainly has a financial incentive. It certainly helps balance the budget. But does it really help Michigan have an educated population?

I’m calling up my fishing buddy who’s a teacher and telling him to get his gear in order: he’ll be using it a lot more now. As to my kids, I’ll be keeping a closer eye on their lessons.

Leon

The Europeans Need a New Grecian Formula

2010-05-07T12:52:00.000-07:00

The Europeans Need a New Grecian Formula:
The One They Have is Giving Me Grey Hair

May 7, 2010. With the maximum overdrive market movements of 05/06, it’s not surprising that I never thought I needed to be concerned with Greece, but now I do. The Greek market has created so much consternation, it caused an overstressed trader to hit a ‘B’ instead of an ‘M’ and set the market on a Cedar-Point like roller coaster ride. Mad markets make for interesting times, but remember that ‘interesting times’ is a Chinese curse.

Let's put this in perspective: Greece is somewhere around 27th in world GDP. Their debt has ballooned from about $30B (I do hit the ‘B’ correctly) in 1990 to about $442B now. (Little less, because the Euro has fallen). When Greece joined the Euro-zone, they agreed to keep their budget deficit to 3%. Of course, that really didn’t happen: Their deficit actually is 13%. Why? They have large expenditures for a variety of social programs; they have a pretty robust Greek pension system (for example one of the reforms they have is to move their retirement age from 61 to 63.), and in general don’t collect their taxes. They’ve agreed to cut costs and reduce corruption. The labor unions don’t like it, and have been striking (who wants their retirement age increased and their taxes increased?).

There is not only doubt over whether the Greece austerity plan will work, but whether the Greek debacle will spread to the rest of Club Med (Spain, Portugal and Italy; Ireland is not on the Mediterranean, but I like the Irish and they have a laid-back Mediterranean attitude, so I’ll lump them in as honorary members). The spread on Greek debt is at all-time highs. On May 6, the EU basically agreed to an austerity plan to get Greece into compliance with the 3% deficit by 2012. An interesting part of the package is that Portugal signed on to loan Greece money at rates lower than they can borrow, which is kind of like Detroit borrowing money to bail out California. We’ll see if it works. I have two versions: a) this is a band aid that will cover the wound long enough for the whole Euro-zone to heal a bit; or b) this is another Argentina-type debacle and the EU is throwing good money after bad.

I’m hoping for a) and I think the market is looking at b). All the while the market, now focused on something bad to look at, is ignoring the headwinds of corporate profits, better than expected jobs number, a real estate market showing signs of life, and no immediate signs of inflation. In my opinion, more tailwinds than headwinds.

Making a government entity responsible for its books and balancing its budget is appropriate. Having citizens pay their taxes is reasonable. Stopping a country from running up debt in excess of its GDP is prudent. Hmmm… maybe it’s something we should try as well.

Ta léme argótera

Leon

PS: Greece has defaulted or rescheduled its debt 5 times since 1829, and Reinhart and Rogoff point out that Greece has spent 50.6% of the years from 1829 in default or rescheduling. Don’t ignore history.

Financial Ramifications of the Health Care Bill

2010-03-30T13:32:00.000-07:00

March 30, 2010. Sausage and legislation are two things you never want to see being made. The big difference is I like sausage. 2,409 pages and 153 pages of amendments and we now have a health care bill. I don’t want to waste blog space with politics, so I’ll keep my political opinions to myself. On the other hand, the Bill has some pretty big financial consequences, which I’d like to address:

Taxes: The Bill increases taxes on households with income over $250,000. The first big increase is that in 2013, the Medicare tax rate for the over-$250,000 household goes from 1.45% to 2.35%. A 3.8% Medicare tax will be introduced for the over $250,000 on investment income (don’t ask me what investment income has to do with Medicare).

For 2011, the capital gains rates are expected to rise to 20% on households with AGI over $250,000. Add in the Medicare tax, and you have an effective rate of 23.8% on long term capital gains in 2013 (if you want to increase your annoyance, add in state income taxes as well). The current long term capital gains rate is 15%, so capital gains tax rates are prospectively increasing by about 58%. The amount received after taxes from a capital gain goes from 85% to about 76.2%, a 10.4% reduction in cash flow. This makes capital gains less attractive.

What’s the effect on stocks? According to David Kelly of JPMorgan, half the stocks are owned by households under $250,000 and half are owned by non-taxable accounts (so roughly one-quarter are owned by high-income individuals in taxable accounts). He sees the prospective effect on stocks to reduce the value by 2.6%. Not enough to warrant bailing on stocks. Bonds don’t fare any better: right now the maximum rate on taxable interest (like the remarkable 0.7% you’re making on your bank account) is 35%. If we look at the 2011 changes (expiration of the Bush tax cuts), then add in the Medicare tax in 2013 the new rate will be 43.4%.

One investment spot that will benefit is municipal bonds. Take a muni bond with a yield of 3.8%. To a taxpayer in the 35% bracket, this is the equivalent of a 5.8% taxable bond (more if it’s a state specific bond). Under the probable new rules in 2013, the taxable equivalent yield on that same muni will be 6.71%. The muni is worth 15.7% more to the high bracket individual.

Drug Companies: Drug companies seem to clearly benefit from the Bill. (I think they should call this the “The Insurance Company and Drug Company Profit Enhancement Act” The ‘donut hole’ in Medicare coverage is removed by 2020. There is an excise tax on medical devices of 2.9% (glad I bought my hip joint in 2008). Drug companies also now get protection from generic drug manufacturers as well (oink). In addition, the Bill pretty much expands coverage without really cutting costs, so medical care companies and drug companies now have a bigger pool of customers. Some commentators think doctors will be OK, I really don’t think the physicians will benefit as much.

Economy: Since most of the tax increases don’t kick in until 2013, and most of the mandates don’t kick in until 2016, I don’t see doom and gloom on the economy. I believe that we’re on the front of a massive global expansion. Health care spending is obviously a decision that our elected officials have made. This may cost businesses, but that can always be adjusted in the wages paid to workers (in other words, you get health care instead of more pay). Capitalism is resilient.

Bottom Line: This Bill did nothing to contain costs:

• It didn’t reform the medical malpractice rules (which probably cost about 10%);
• It kept the drug companies on long patents and protected them from generic manufacturers;
• It ignored the most expensive part of medical care: the last year of life;
• It ignored the premise of preventative health care;
• There’s nothing to encourage the consumer to save costs.

The US spends about 16% of our GDP on health care, 45% more than the country which has the next highest spending (France sacre bleu!). Our life expectancy is 38th in the world. Maybe a better approach would be getting people to take care of themselves as a health care measure.

Stay Healthy,

Leon

Roth IRAs in 2010

2010-02-04T21:39:00.000-08:00

Leon's "Roth IRAs in 2010 - Advanced Conversion Strategies" video presentation from February 3, 2010.

2009 Economic and Market Review

2010-01-25T06:42:00.000-08:00

2009 ECONOMIC and MARKET REVIEW: Food for thought if you have a healthy appetite

S&P 500 rose 26.5% for the year. Dow rose 22.7%. From the peak of the market, (10/09/2007), the S&P is still off 24.9%.
Our Opinion: It’s run hard and fast (probably needs a break), but potentially has more room to run, just to get back to March 2000 or October 2007 levels.

Highest performing sector of the S&P for 2009 was Technology (up 61.7%), followed by Materials (up 48.6%). Worst sectors were Telecom (up 8.9%) and Energy (13.8%).
Our Opinion: Energy sector is still the fuel that drives the world into economic recovery.

Flows into mutual funds shifted in 2009. In ’08, massive inflows into money market funds, while in ’09 over a half a trillion left the money funds. Bond fund inflows were at an all time high. Equity funds still experienced a net outflow.
Our Opinion: Show me the money (flows). Equity funds have experienced three years of outflows. As people get tired of 0.15% returns on their money markets, they will start to seek returns again.

P/Es seem high:

March 24, 2000, S&P 1,527, P/E (tr) 29.6
October 9, 2002, S&P 777, P/E (tr) 17.6
October 9, 2007, S&P 1,565, P/E (tr) 17.5
March 9, 2009, S&P 677, P/E (tr) 13.7
December 31, 2009 S&P 1,115, P/E (tr) 28.2 (fw 14.8)

Our Opinion: Market by PE standards looks overpriced. However, an earnings boost from underemployment and higher productivity (coupled with an economic gain), could bring PEs back in line.

Relative PEs are cheap in some styles: LG is at 78.1% of 20-year historical, MG (82.2%) and SG (88.8%).
Our Opinion: The small cap space has led the markets out of most of the prior recessions. Growth has been battered.

Unemployment, if typical, will reduce gradually (could take 5 years to reach full employment). Prior recessions, market continued to rise as unemployment dropped in 8 of 9 cases. Productivity is up to 4%, well over the 20 year average of 2.2%.
Our Opinion: Unemployment is a lagging indicator and tells what DID happen and not will happen. Unemployment should trickle down and that’s a sign of recovery in progress.

Bull over? Still need a 42.9% gain to reach the 2007 peak. Average bull run is 176%, 68 months. This one is 10 months and 65%. Would be shortest bull in modern history.
Our Opinion: If this was an ‘average’ bull, S&P would run to about 1900, higher than the previous peak.

Inflation? On the horizon for sure, but probably not in the near term (12-18 months). Current Core CPI is 1.7%, well under the 50 year average of 4.1%. Too much unemployment, no consumer inflation threat, and low real estate. M2 has grown at a modest 5.1% (lower than the 80s and 2001-2002.
Our Opinion: No question in my mind that we will have inflation, it’s just when will we have it? Use TIPs for early protection.

Real GDP decline of this recession makes it the worst since the Great Depression; however the bullet was apparently averted: the Great Depression had a 26.7% decline in real GDP. The 08-09 debacle was -3.6% (but still worse than any other retraction since 1933).
Our Opinion: Bad is good. Hard times make people more disciplined, harder workers, better savers, and less prone to take on excessive debt. All ingredients of success.

Cars: Light Vehicle sales are at 10.9 million units, well off the 30 year average of 14.6 million (actually at 1983 rates).
Our Opinion: The US population is 31% higher than in 1983, with car sales at about the same level. If you didn’t notice, cars don’t last forever, so eventually, the sales rate will migrate back to, and probably above 14.6 million units. The question is which cars will be sold?

Houses: Housing starts are down 75% from peak, and 60% lower than the 35 year average, and the lowest absolute number in measurable history from 1975. The number of homes for sale from April of 2008 has declined dramatically (1.1M units). Affordability of the average new home is 14%, the lowest percentage of household income in 35 years.
Our Opinion: Houses are cheap and affordable. Want some ingredients for economic growth? Try no inflation, low interest rates, big supply of available workers and cheap real estate. The US population is still growing and people still need a place to live.

Is the US broke? Lots of overstatement about how everyone is broke and all consumers are insolvent. Total Consumer assets = $67T, Total Consumer Debt = $14T. Personal Savings rate is now 4.8%, highest in 11 years. Household debt service ratio is now down to 12.9% (from 13.9% at the peak of the market). Consumers are borrowing less and saving more.
Our Opinion: Same as my previous point: consumers have sobered up and are saving money and paying down debt. This is way better than it was 3 years ago when people were borrowing from Peter to pay Paul.

Govt. budget: Projected 2010 deficit is $1,502,000,000,000 (I included all the zeroes so you can see the magnitude of the number). Relative deficit (to GDP) is higher than any time since post-WWII.
Our Opinion: This is ugly, very ugly. Some deficit spending is necessary in an economic crisis, but some parts of these deficits are not temporary ‘fix the economy’ fixes, but are structural deficits.

Oil: Sitting around $79-80 a barrel. Global consumption is up; U.S. imports are at 1.9% of GDP, down significantly from 3.8% in the 3Q of 2008.
Our Opinion: Oil seems to have stability at about an $80 level. Geopolitical chaos (like Iran) could change this. So could a marked change in US driving behavior. Let me mull over that in my Ford F-150 Truck (not to aggravate the President, but I drive a truck)

Bonds: Bond spreads have narrowed greatly. High yield bonds have a 6.6% spread (much lower than the 17% spread in March). AAA corporate bonds have a 0.6% spread, lower than the 1.2% ten year average. Even BBB bonds have a low spread (1.8 versus 2.2). Only significant spread still out is municipal bonds, which is only about 16% higher than the historical spread (it was as high as 200%). Michigan municipals are still selling at about a 35 bps yield premium to other states. Emerging market bond spreads are similarly way down.
Our Opinion: It sure looks like we’re in a Treasury ‘bubble’, and the flee to safety has virtually no return right now. I think it’s entirely possible money may move from bonds into other asset classes.

Intl: Brazil, Russia, India and China are all very high performers (Brazil up 128.6% in 2009). Japan is a definite laggard (6.4%). Pacific ex-Japan is a good sector (we’ve expanded it throughout 2009) at 73%.
Our Opinion: The rest of the world is back on track to recovery. There are too many people that want a better life to stop it.

Account Deficit and the Dollar: Account deficit is -3% of GDP, significantly down from -6.5% in 4Q 2005. Dollar is at 73.8, close to bottom (03/08: 70.3). Dollar closely tracks interest rates. Interest rates rise (relative), the dollar rises. Treasury clearly has a weak dollar policy.
Our Opinion: Think about Canadian dollars: when they’re cheap, we go over there to buy stuff, when our dollars are cheap, the Canadians come over here. Our dollar is cheap: it attracts money from elsewhere. Cheap is good, too cheap is not good

“Cash on the Sidelines”: From March ’07 to March ’09, $2.286T went into money funds. Right now close to $10T is sitting in the money supply.
Our Opinion: It’s like the Red Sea in the movie ‘The Ten Commandments’: It’s sitting there and it has to go someplace.

Gold: Gold is at around $1,100/oz and the gold bugs are spending millions trying to get you to buy it. On a CPI-adjusted price level, gold is 33% lower than it was in January of 1980. By the way, in 1980, it then dropped over 60%.
Our Opinion: Gold went up $15 from the year zero through 1950, and failed to keep up with inflation in any relevant time frame I can measure. My other question is: if gold is such a great investment, how come these guys are spending millions of dollars on advertising to sell it to us? Why don’t they take the money and buy more gold?

Other stuff: Hedge funds aren’t the darlings as much (with a few very notable exceptions) CSFB/Tremont hedge fund index is up 3.2%. US Venture Capital funds are down 17.1%. The private equity index is down 20.6%.
Our Opinion: Alternate investments can have a place in a portfolio, if you understand the investment and why you own it. But nothing always outperforms the other asset classes: everybody gets their turn in the sun.

Big Issues for 2010: ROTH Conversions, Small Caps, Global Investing, Tax Changes and Prospective Inflation.

Thanks to JP Morgan Asset Management for a variety of the statistics I used in this blog. We utilize some of their institutional funds.

Leon C. LaBrecque JD, CPA, CFP® CFA is the CEO and Chief Strategist at the independent advisory firm of LJPR, LLC. LJPR reduces uncertainly for their clients and their families by applying creative wealth management solutions in tax, financial planning, retirement planning and estate planning. To contact us for a consultation or to discuss your financial situation, email info@ljpr.com or call at 248-641-7400. Also visit our blog and website http: LJPR.com

LJPR: Reducing Uncertainty™

Layered Roth Conversions - A Way to Capitalize on Tax-free Gains

2009-12-21T15:18:00.000-08:00

December 18, 2009. I’m working on a big case for a Roth conversion and contemplating my usual recommendation: a big vertically segregated Roth conversion. A vertically segregated conversion is isolating specific asset classes into separate Roth accounts. If one or more asset classes declines, you can ‘recharacterize’ those particular Roth accounts back to your traditional IRA as if you never converted in the first place and not pay income tax on those amounts. You even have the potential to reconvert it back to a Roth at a later date (after waiting at least 30 days). The vertically segregated Roth conversion is a great plan if you want to cherry-pick your investments and potentially save taxes on the overall conversion. I’ve written on recharacterization before under the heading of ‘Multiple Mulligans’.

However, while looking at this scenario, another notion hit me about recharacterization. If recharacterizing a segregated Roth account when it declines in value is good, then not recharacterizing a segregated Roth account when it has increased in value is equally good. Hence, our latest plan, the horizontally segregated Roth conversion or the ‘Layered Roth Conversion’. Here’s how it works:

You determine in advance two major things: a) how much you want to remain in a conventional IRA and b) what asset allocation you prefer to use in the combined conventional and Roth IRAs. You then determine what the maximum market gain your asset allocation could return during the allowable recharacterization period. For our purposes, presume you are converting in 2010, so the recharacterization period is from the date of conversion to the due date of your 2010 return, including extensions, or October 15, 2011.

Next step: You set up multiple Roth conversion IRA accounts. One is a ‘base’ conversion Roth with about 75-80% of the converted amount (this is the ‘base’ amount that will be recharacterized under most circumstances). The next group are ‘layers’, of increments of potential market gain. For purposes of illustration suppose I think the maximum gain I can expect on a balanced portfolio for the conversion period from 01/02/10 to 10/15/11 is about 25% (I hope I’m wrong on the low side). I’d set up a base Roth conversion with 80% of my assets and 8 separate Roth conversions of 2.5% each (the “Layered Roths”). So if I had a $1,400,000 IRA that I wanted to stay in conventional form, it would look like this:

Now, here’s where we have some fun. Here are the rules, and note that even though we wanted to keep $1,400,000 in our conventional IRA, we converted the whole thing.

If the market goes down or stays flat: We recharacterize the whole thing, and we are back where we started. No income taxes are due!

If the market rises: For every 2.5 -3% increment the market goes up, we leave one of the Layered Roths in their Roth form. So if the market rises by 2.5%, we recharacterize the base and layers 1-7, leaving layer 8. If the market goes up by 10%, we recharacterize the base and layers 1-4, leaving layers 5-8 in their Roth form.

What we’re doing should be obvious: we’re taking the profits and turning them into Roths. If the market rose 10% during the recharacterization period (I think that’s reasonable), our happy little family of segregated Roth IRAs would grow to $1,540,000. If we recharacterized the base and layers 1-4, we’d pay tax on the $140,000 basis in levels 5-8. We’d still have $1,386,000 in our conventional IRA (because we recharacterized it), and now have $154,000 in our Roths IRAs. Risk? If the market goes down, we recharacterize the whole thing and call it an exercise in paperwork management. Market goes up, we turn the gains into tax-free money with all the tax advantages of a Roth.

Why so darn many Roths? Why don’t you just have one and partially recharacterize it? Simple reason: you can’t. Roth recharacterization is done at the account level, and you can’t partially recharacterize an individual Roth. Coverting to only one Roth account leaves you an ‘all or nothing’ approach. Layering allows you to keep the gains and return the original amount.

You could carry this to the extreme and layer at 1% levels. You can also combine this strategy with the vertical segregated Roth strategy. For example, you could take the part you know you want in a Roth and segregate it into asset class conversion Roths and then take the rest of the IRA and layer it. You’ll drive your custodian crazy, but you save taxes on downswings (with the asset class conversions) and earn tax free gains on the upside (on the layered conversions). This gets complicated, but stay tuned for my next piece on ‘Matrix Segregated Roths’.

How much to layer? Given you have the opportunity to seize gains tax free and recharacterize the rest, I’d go long; Mulligans are free and unlimited.
Leon

Managing Health Care Choices for Seniors

2009-12-20T20:40:00.000-08:00

"Managing Health Care Choices for Seniors" presented by Brian Roehl.

Get Ready for a New Decade

2009-12-15T20:46:00.000-08:00

Leon's "Get Ready for a New Decade" video presentation from December 2, 2009.

Multiple Mulligans - An Idea for Larger 2010 Roth Conversions

2009-11-06T04:48:00.000-08:00

October 31, 2009. By now, most people have heard about Roth conversions and how useful they are. You get to take money from an existing IRA or qualified plan, convert all or part of it to a Roth IRA, pay the tax, and you create a nice tax-free accumulation vehicle. Some obvious rules apply: for example, I don’t think you should convert unless you are either staying in the same tax bracket, or will be in a higher tax bracket later. I am also certain that Roth conversions are most effective if you use non-Roth money (outside monies) to pay the taxes.

But that’s not what I want to talk about now. I want to talk about Mulligans. I used to run marathons, wore out my ball joint (hip) and had to quit running. So, I took up golf. I could spend hours ranting and raving about my golf game, but since I was introduced to the Mulligan the game is a little less frustrating. Apparently a French Canadian named David Mulligan hit a poor shot in his game and set down another ball and hit again. He called it a ‘correction shot’, but his foursome dubbed the do-over a ‘Mulligan’. I like having the Mulligan option: I hit a bad shot and get to do it over. In fact, I maintain that if I had unlimited Mulligan use, I might shoot some decent golf.

So what does this have to do with Roth conversions you might ask? Most of us understand the basic concept of converting an IRA into a Roth IRA, however, a lot of us don’t necessarily know about the ‘un-do’ option of a Roth conversion through what is called a ’recharacterization’. Recharacterization is reversing the Roth conversion. Why is this important? Say you convert an IRA worth $100,000. The market goes down, and now the account is worth $80,000. You can recharacterize the Roth back to a regular IRA, and not pay the taxes (or get a refund if you paid the taxes). What’s more is that you can then re-convert the IRA back to a Roth. In other words, you get a do-over, or a Mulligan.

Just as in golf there are rules, of course. You can only recharacterize a Roth conversion account once (one Mulligan per round), and then only up to the due date of your tax return, including extensions (provided you filed a timely return). This timeline is irrespective of when you file your return. So if you converted to a Roth in 2009, you have until October 15, 2010 to recharacterize. If you convert in 2010, you have until October 15, 2011. If you recharacterize, then re-convert, you pay taxes on the conversion in the year you convert. So if you converted an IRA to a Roth in 2009, then recharacterized in 2010, then re-converted, you’d pay the tax in 2010, or under special rules, pay the tax in 2011 and 2012. Also, once you recharacterize a Roth, you may not re-convert it for 30 days.

As I mentioned earlier, I want more than one Mulligan. (If you play golf like I do, you want to take as many Mulligans as you need.) With Roth conversions, you can have multiple looks at a do-over. Here’s how. The rules on recharacterization are at the account level. This means you can have multiple Roth conversion accounts, and can selectively recharacterize those conversions. By segregating Roth conversion IRAs, each holding different investments you may selectively re-characterize. Suppose you have a $100,000 IRA consisting of $50,000 of AAPL stock and $50,000 of F stock. Suppose further the AAPL goes down to $35,000 and the F goes up to $60,000. If you convert both securities into one Roth, you may only recharacterize the entire account, your tax savings would only be on $5,000 (the original $100,000 conversion, less the $95,000 recharacterization). But suppose you made two Roth conversions into separate accounts, maybe a day apart, one holding AAPL and one holding F? The AAPL Roth could be recharacterized, and the F Roth could be left alone, you are then saving ordinary income tax on $15,000. After 30 days, you could re-convert the AAPL Roth.

Under this segregation plan, if one Roth goes up, you simply leave it alone. If one goes down, you can recharacterize that Roth, and possibly re-convert it at the lower value. This could be taken to the extreme by creating many Roth conversion accounts, encompassing multiple assets classes (a Roth containing Large Cap domestic stocks, another holding Emerging Markets or commodities) but the general idea is to allow flexibility for recharacterizations – numerous Mulligan opportunities. After the recharacterization date has passed, you may want to blend the Roth accounts together to simplify for record keeping purposes. Also recognize that recharacterization and re-converting re-starts the five-year holding period for the Roth conversion IRA.

Of course, like in golf, I really DO NOT want to use a Mulligan: I’d rather have a good round without any bad shots. But in today’s volatile financial world, and lots of Roth conversions on the horizon, segregating Roth accounts is an interesting plan. It is a wee bit complicated, but could be a valuable strategy as you prepare to convert in 2010. Multiple do-over shots: David Mulligan would approve.

Leon LaBrecque

Taypayer and Roth IRA's

2009-11-01T05:08:00.000-08:00

PDF Resource

Taxpayers_and_Roth_IRAs

Now Ford Retirees Have Another Thing to Think About

2009-10-12T10:25:00.000-07:00

October 11, 2009. Brian Roehl and I have been working with Ford employees, both through Ford on a corporate level and on a personal level, since 1985. We’ve seen a lot of issues, ranging from what to do about buy-out offers, to the Ford Money Market Account (now called the Interest Advantage) and now what to do with the SSIP.

On October 8, 2009, Ford announced it was terminating its relationship with Fidelity to administer the Savings and Stock Investment Plan (SSIP) and Ford Retirement Plan (FRP) and transferring the administrative services to ACS. ACS is a large well established benefits company (in the process of being bought by Xerox). A lot of folks we know really like Fidelity, so now they have one more decision to consider.

Brian and I think there are some pretty important questions a Ford Retiree needs to consider before the end of 2009:

If I’m in the SSIP, should I rollover to an IRA to stay at Fidelity? (This one has an age-based answer, depending on whether you’re under age 59 ½)
Should I rollover the SSIP and go elsewhere? (ACS is offering the same investment options as Fidelity, so this question is independent of who administers it)
Should I consider a Roth conversion on part or all of the SSIP in 2009? (Now, in my opinion, this is a much more important issue. Do you have after-tax funds? Income under $100K? Big savings possible)
Should I consider a Roth conversion on part or all of the SSIP in 2010? (2010 eliminates the income limitation on Roth conversions. We believe the conversion is a great future opportunity; the trick is to stay in the same effective tax bracket)
What do I do with any Ford stock in the SSIP? (You can take Ford stock out of the SSIP at the lower of cost [what you paid], or current market value. All appreciation after withdrawal is long-term capital gain. If you think Ford shares are going to appreciate, you could convert what would have been ordinary income [if you left it in the SSIP] into long-term capital gains, which may be taxable at a lower rate.

There are more issues, like beneficiaries and stretch rules and so on, but if you know a Ford retiree with money in the SSIP, pass this on. If they have questions, they can e-mail us at info@ljpr.com.

Money Mondays - September 19, 2009

2009-10-08T12:16:00.000-07:00

LJPR's Leon LaBrecque joins Murray Feldman on Detroit Fox 2's 'Money Mondays'.

Surfing, Waves and Why This Decade is Very Different (Part One of a Very Interesting Series)

2009-09-16T06:47:00.000-07:00

September 15, 2009. Back when I was doing a lot of retirement seminars, I was working in Manhattan Beach, California (I know, tough spot!). On a break day, I was watching the surfers in the surf, and decided to try my hand at it. I paddled out into the Pacific and attempted to catch some waves (surfing is quite hard, for a skier like me at least). I sat on the beach and couple of locals approached me: muscular, blonde, and clad in worn wet suits. “Dude, are you from Minnesota?” “No, Michigan” I answered. “Why, am I that lousy?” “No dude, you’re ok, but like you don’t have on a wet suit. You northern dudes are polar bears!”

We laughed and learned some things about surfing (and local bars). The surfers paddle out to look for the waves, and the good ones tend to come in patterns. True surfers will communicate on a network to find great waves and drive 400-500 miles down to Mexico to ride them. Sometimes, waves can converge, or meet. If the crest of a wave meets the trough of another one, they cancel out. If the crest of one wave meets the crest of another, hey converge and the height of the wave doubles. Waves tend to travel in triads, and the frequency of the wave is the distance between them. Since the frequency can vary, sometimes these packs of waves meet and either cancel or converge. Many waves of different frequencies can converge as well. They create ‘rogue wave’ or monsters. The guys I was hanging out with called them ‘Raouls’. “When there’s a Raoul, dude, the whole ocean seems small and this monster comes in and gives you a ride of your life!” This was peppered with surfer-speak and gestures of total excitement.

Physics confirm the Raoul theory, and you can see it for yourself by plopping yourself on a beach and watching the waves (while wearing sunscreen, of course). It’s easier to watch waves if you have a refreshing drink with local libations. An umbrella in the drink seems to help. I recommend this academic exercise.

Now, to finances. I’ve watched, studied and taught economics and finance since 1977. I’ve also been a student of history. In history, there are a series of documented waves of human activity. For example, in the great book The Fourth Turning, the authors (Neil Howe and William Strauss) very accurately render the 26 generations of Anglo-American culture into a series of archetypes. In general, we’re in what the book refers to as the Fourth Turning (Crisis). There are a variety of other waves as well including:

Waves of economic activity (Kondrotieff, Goldstein)
Waves of political control (Schlesinger, Burnham)
Waves of War (Toyenbee, Wright)
Waves of Religion (Wallace)

I’ll discuss these waves in a future blog. What is intriguing to me is that the waves are converging. Now, maybe history creates the waves , or the waves create history; I don’t know the cause and effect. But in the next blog, I’ll go over what happened in the past. After that, I have some ideas on what we can do to ride this Raoul.

The market just gave us the biggest 5 month gain since 1983. Look back in history: that was followed by another 1900% gain over the next 17 years. When the surf’s up, you get the big ride. And on the horizon, there’s something big…
Hang loose.

Leon

P.S. To check out my most current YouTube cast, please click here

How to Thrive in the New Decade - preview video

2009-09-11T19:00:00.000-07:00

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2009-09-06T05:02:00.000-07:00

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Engineering Retirement

Coming Soon - a Recovery Near You

2009-08-26T05:32:00.000-07:00

I often think I might have liked to be an economist or a meteorologist; you can always be wrong and still keep your job. The economists are indicating that we’ll have recovery in the end of the fourth quarter, and if they measure the national economy, I bet they’re right. Although, hearing about the national economy is good, it is like watching the national weather report on CNN (“wow, its 106 in Seattle!”). Nice to know, but doesn’t help me much if I don’t live in Seattle. What does Michigan look like?

Bob Dylan has a line in a song ‘you don’t need a weatherman to find which way the wind blow’ (yes I am aware that this line also spawned the Weatherman underground movement, Daniel and Philip Berrigan were Jesuit priests at U of D when I was there). But I wanted to know the economic activity around Michigan. The numbers are dismal, enormous unemployment, devastated real estate, shuttered businesses. To be sure there are signs things are getting better. The decision by GM to use the Orion assembly was big, Wisconsin was offering everything under the sun and moon. The nabbing of four lithium ion battery plants was huge, and Michigan had to offer everything under the sun and moon to get them from Kentucky.

But in my humble experience and studies, nothing is ever really solved by governments. Solutions come from entrepreneurs, from workers, from creativity. Lee Trevino said ‘a hungry dog hunts best.’ I think we Michigan dogs are plenty hungry. To look at the weather here, I stuck my nose out the window to see which way the wind blows. Here are some observations:

Unemployment increases productivity. Everywhere, in every business I talked to, they are doing as much or more (maybe with no profit) with fewer people. This ranges from the car companies (GM has way fewer employees now, in addition to no debt and two shareholders (or 300 million shareholders, depending on how you look at it) to suppliers (a friend at a big supplier said they were at the lowest head count in years) to more importantly, small businesses. More productivity is good, but it also makes it clear that increases in demand will generate demand for jobs. 
Unemployment increases creativity. We have a client who started a car company. And it’s working. Start a car company in the worst recession since the Great Depression? It’s crazy, crazy like a fox: he’s finding all kinds of smart engineers, excess plant capacity and deals on everything. When times are tough, businesses and people get creative. Creativity fosters innovation. Innovation fosters growth. 
The rumors of the death of the world are greatly exaggerated. For about 12 months, for sure 6 months, it looked very grim. The sub-prime, or as it might be better defined, the credit-derivative mess made it appear as if the entire financial system may collapse. Everything retreated accordingly, from oil to stocks to housing. Everything, except GDP, which retreated, but nowhere near as much as everything else. So if we do a little math, the GDP is now probably even to its normal level, but we have 6% fewer people working (unemployment was 4% at the beginning of the recession), we have commodity prices lower, and everything cheap. We have doomsday prices, but we are now in a regularly scheduled recession. 
Stuff is now just moving. The new car companies are back in business, and I have seen a whole range of new contracts being let. Funny thing though, there are way fewer suppliers out there, so new GM and new Chrysler are not trying to squeeze every penny out of the supplier, they just want to get going. Copper, small parts, and shipping are moving. Suddenly, this first week of August, a flurry of activity is going on in the car business. And as we painfully know, a buck in the car business moves about 7 bucks around elsewhere. Suddenly, we’re looking at real estate closings. Suddenly, we’re seeing mortgage applications approved.

Brad Reynolds, our chief investment officer and I, are calling this the ‘coiled spring’. The economy is like a coiled spring: nothing took place for the last 12 months or so, no real estate, no cars, no major business. Now we’re getting back to the races with 12 months backlog. In the last 12 months, every car in the United States got a year older, and 7 million less were sold. To me, that means that there are 7 million more that will be sold, someday. The spring is coiled, and I think it is about to be sprung. Stay tuned for the recovery, I think it could be a doozy.

Cheers,
Leon

The New Car Business - Count Five New Car Companies

2009-06-11T05:24:00.000-07:00

June 10, 2009. I guess the benefit of blogs is that they can travel at the speed of light. Light-speed is what we need these days to keep up with the auto industry. At today’s scoreboard, I count five new car companies in Detroit (or maybe four in Detroit and one in Canada): the New Chrysler (sposato con la Fiat, courtesy of the Supreme Court), the new GM (with new chairman), the new Opel (Magna and Russians), the new Saturn (with Penske at the wheel), and the new Hummer (Szechuan style). Here are a few of my takes:

What chapter are we on? The first take I have is that I would have never believed that GM and Chrysler would both go bankrupt. Even more unbelievable is how fast Chrysler went “un-bankrupt”. I suppose when you have the President (of the United States, not your company) announcing your bankruptcy and calling your shots, things happen fast. There must be some new chapter of the bankruptcy code, like chapter 1.1, where the government does what it wants and everybody goes along, whether they like it or not.

New Chrysler. The New Chrysler will have a new partner, Fiat. The definition of ‘fiat’ is “a legally binding command or decision entered on the court record”, which I suppose is appropriate in this case, given the actions of the Supreme Court. Fiat is basically getting a free car company out of the deal and now has the opportunity to make itself into a car giant. On the surface, this could be a nice marriage, Fiat gets Jeep and a truck line, plus some American cars. Chrysler gets small cars and engineering and design (though I actually think Chrysler’s designers are pretty good except for whoever made the Durango out of a minivan and a truck). Uncle Sam gets the tiny cars it wants (never mind most Americans don’t want them). Detroit gets a new car company and no liquidation. Fiat is a worldwide company, with a presence in India. It could work.

New GM. The new GM will probably be a little less speedily created than the new Chrysler, but everything looks on track, including the new Chairman of the board, appointed today, Ed Whitacre. Whitacre did a very good job at AT&T (taking Southwest Bell from one of the babies split off from AT&T and eventually re-acquiring the parent company). The Board of GM will be further shuffled (an action long overdue), and Henderson will now answer to a boss (besides the government). New GM is going to be different from New Chrysler: it will be a standalone new company with virtually no debt, no laggard brands, and lower costs. No outside buyer is buying GM; GM is shedding its old problems and re-emerging. If the government actually keeps its hands out of the pile, this could be a very good thing. I am curious how the new chairman will react to tight CAFÉ standards, or how the UAW contracts are negotiated in light of the fact that the UAW is the second-largest shareholder. But, new company, almost no debt, reduced labor costs, good brands, new board. Could be good.

Opel. Hey, it looks like Canada will now have a car company (besides the Bricklin). Magna, with some deep pockets from OAO Sherbank, a Russian lender, will probably own Opel. Magna has been on an acquisition tear and is Canada’s largest part manufacturer. Magna has some very interesting technology, access to cash, and probably more importantly, some guts. Could be a new variation on the theme of small getting big. With one little tiny exception: the German government. German labor laws and rules make building anything there difficult at best. At least the beer will be good. Between German beer and Canadian beer.

Saturn. Roger Penske could be called Roger Midas. It seems like anything he does, from Penske Automotive to the Super Bowl, works. Penske is basically getting Saturn for next to free from GM. He ends up with a dealer network (who’s glad to still be in business, much less with him), some production and a nice product line of small energy efficient American cars, that people actually buy. Penske will be the distributor of the Aura, Vue and Outlook cross-over SUVs. Penske already distributes the Smart car (that little dinky one made by Daimler). Penske seems to be in the midst of working out a deal with Renault Samsung to make Saturns in 2011 (GM quits making them in 2011), and also is rumored to be working up a Chinese car to be sold at Saturn dealers (Geeley and Chery are rumored). Roger picked up a money machine. Could be a big one.

Hummer. Hummer was sold to Sichuan Tengzhong Heavy Industrial Machinery Company (you remember them? I don’t either). This one baffles me. The company is not well known, Hummers don’t sell well here, and may not sell as well with a Chinese owner. Gas prices seem on an upward trend, and hummers are gas-guzzlers. As far as I know, the Hummer is built on a GMC large drive train. Good luck!

New Ford. A quiet riot in this whole series is Ford. Ford is in a good, but strange, position. Ford’s plan to fix itself for a shrinking market and rising gas prices turned out to be a very good fix for how to get out of the worst recession since the 30s. Ford benefits collaterally from any UAW concession and supplier concession, and benefits collaterally from the stigma of bankruptcy on Chrysler and GM. That’s not why I really think Ford will do well. Ford will do well because their products rock. Chrysler hasn’t really put out a new product for 3 years. GM is stuck in the too many brand position. Ford has some great mid-size cars, including the best mid-size hybrid. They have great trucks, and yes, people will still drive trucks, including me. Ford has hot rods like the Mustang, and luxury like the Lincolns. They even have weird but cool cars like the Flex. To be sure, Ford is going to have to contend with two relatively debtless competitors, but I would vastly rather have my majority owner being a guy who’s name is Ford, than have my majority owner the US Government. Ford will be a winner.

Other players. Toyota, Honda, BMW, and Mercedes are facing the same problems as the domestic players, but aren’t getting any ‘get out of jail free’ cards from bankruptcy, or having the pre-problem planning of Ford. I think Toyota will do fine: they’re a well run company with a very good product. But Toyota and Honda now have to live in a new landscape, with a very different set of opponents. It’s going to be interesting.

Watch 2010-11. What everyone seems to ignore is that this whole new car business is based on 10M units of cars being sold, or about 60% of what was sold in 2007. As far as I see, the population didn’t decline by 40%, nor did GDP. What will happen when unemployment goes down (it will) and people start buying cars (they will)? What happens in a 12M unit year, or a 14M unit year? As they say in China; we live in interesting times.

Here’s to new Detroit muscle,

Leon LaBrecque

Thoughts on the Chrysler Bankruptcy, Steven King and Vegetable Stands

2009-05-05T13:39:00.000-07:00

I was driving on April 30th and listened to the President’s announcement about Chrysler almost completing a deal to avoid filing chapter XI, if not for a couple of hedge funds (notably Oppenhiemer, Xerion Capital Fund, and Stairway Capital Management). I was astonished by a couple of things:

That the President of the United States (rather than the CEO of the company, a spokesman for the President or even the Secretary of Treasury) would announce a bankruptcy;
That the President of the United States would do a commercial for a private corporation;
That the President of the United States would out a hedge fund.

I’m not surprised in the least that the hedge funds would buy Chrysler debt and hold out for more money, they are called “Vulture Funds” after all. This is what they do.

I’m not surprised by the bankruptcy (in the light of the hold-outs), but I’m relieved we don’t have liquidation. I’m hopeful (and probably right) that this will be a fast, businesslike affair, like the airlines (I don’t think anyone ever missed a flight in the airline bankruptcies).

What I got to thinking about (it was a long drive) was that what Chrysler, GM and Ford need more of are car sales, not money. And that got me to the Presidential ad to buy American. I’m an outspoken advocate of ‘Buy American’, and have argued, cajoled, and even beseeched my friends and clients to buy a Ford, Chrysler, or GM product. We drive a Yukon (2009), Sierra, and Jeep. To be sure, there’s a blurry line on the actual manufacturing of American cars (the awesome Ford Fusion Hybrid is assembled in Mexico). But the engineering, the shipping, the dealers, and the headquarters are in the US. The people affected by the construction of cars are the people whose kids play soccer with our kids, who go to our daughter-in law’s store, who dine at the local restaurant.

Don’t get me wrong; as Americans, we have the absolute right of freedom of choice and free-market economies. I am the last person to ever deny the right of the consumer to be able to buy and choose what they want. If their determinant of purchase is quality, so be it. If their determinant of purchase is sustainability, so be it. In Japan, countless studies have shown that in blind taste tests, Japanese consumers’ actually prefer the taste of California rice over Japanese rice. Yet when presented with the purchase, the Japanese consumers will always opt for the Japanese rice. Sustainability versus taste preference. What a concept.

In Steven King’s monstrous series The Dark Tower, the main character, Roland, is the last gunslinger in a very bizarre apocalyptic world (it is Steven King). When telling his newly found companions about the fall of his society (in the story, the gunslingers are basically knights or samurai), he states “They had forgotten the face of their father”, a reference to giving up on the values that the traditions had built. I was going through some of my Dad’s stuff this weekend and found his Dodge Main badge (it’s cool, and is in the shape of a Star of David). Dad worked all over Detroit, at Dodge Main, at the Book-Cadillac hotel, at Packard, at Burroughs and finally at GM. Dad lugged a BAR though Europe in WWII. He was a machine repairman with a finicky perfectionist streak, and respected quality.

When we would go on road trips (always in an aging American car with a big engine, like a ‘64 Ford Galaxy with a 392 Police Interceptor), Dad would stop at the vegetable stands to get vegetables. He’d peel each ear of corn, inspecting for worms, and heft the tomatoes. But he’d always buy something. “Fresh is best, and the local guys don’t spray that junk all over their vegetables (probably not necessarily true). Besides, if we don’t take care of each other, nobody will.”

I could tell you American cars are as good as or better than imports; and they are, in my opinion. I could tell you that American cars get better gas mileage, and for the most part they do (by the way, despite the view of Congress and the President, I don’t really give a damn about gas mileage, compared to being able to get all the junk I haul around in my truck.)

But I have an interesting reason: Buy American to sustain your community, and your country. If you shop on the internet, get the price and buy it locally. If you pass a roadside stand, buy the American tomatoes instead of the Chilean tomatoes. Remember the face of your father. He made enough to get you here because someone hired him to work. Sustainability is a valid version of consumerism. We’re all in this together: let’s take care of each other.

Peace,

Leon

Nature Abhors a Vacuum

2009-04-06T09:00:00.000-07:00

Nature Abhors a Vacuum: How Recessions Fix Themselves
(And How the Government is Accidently Fixing the Economy Faster)

April 1, 2009. My morning ritual is to get up, wake up the kids, make some coffee, let my dogs out and enjoy my first (always the best!) cup of coffee before getting ready for work. The other morning I noticed a colorful photographic business card near my place at the kitchen table. It was for my brother-in-law’s new photography business. My brother-in-law is my kayaking buddy, a talented master electrician at an unnamed car company, and a great guy. I called him and asked about the business, and he told me he was going to do photo collages of sports teams, and explained he had just done a successful series on a soccer tournament. I was curious about why he decided to start a business now. “These are tough times. I have a good job, but I want to make sure I’m using all of my options, in case something happens to F**d”.

This lead me to thinking about another friend and client, who retired under a package from another unnamed car company, who retired from one car company to actually set up another car company (they actually already have a car). I found it ironic and interesting that someone would set up a car company in this dismal market. “There’s a need out there for this type of vehicle (this is an unusual specialty vehicle), and we know exactly how to do it and how to get it done. There’s plenty of hungry talent and suppliers who will work with you.”

So, in this thought exercise, it occurred to me that bad times bring us out of our ‘Comfort Zone’. In good times, it’s easy to take the overtime in your electrician’s job, wait your 30 years, retire and kick back. In good times, if you want a job, you just put an application out and hold out for the best one. In tough times, you have to push the edges out. You have to try new marketing ideas, you have to be more visible, you have to try new things. You have to make a value proposition for yourself or your business that’s compelling. In real tough times (like now), everyone gets humbled. Maybe you inherited some stock from Grandpa, and now the stock is in the dumps and it cut its dividend. Maybe you’re a city employee, and now you have to be competitive and be service-oriented in a tight budget year. Maybe you want to sell a house and have to come up with a whole new version of its value, or a way to sell it.

Aristotle said “nature abhors a vacuum”. In natural science, when a vacuum is created, the surrounding gas tries to enter the vacuum. When a vacuum of security and prosperity is created (thanks to our boys in the credit derivative departments of the major invest houses!), energy seeks to fill the vacuum, with creative solutions, hard work, innovation, and better, entrepreneurship.

Which leaves me with an observation. By happenstance or maybe by very clever calculated intent (nah!) the federal government may have given the biggest boost to the economy by firing Rick Wagoner and potentially stuffing a 95% tax onto AIG executives. The feds showed their teeth in the last few weeks, first by getting outraged at the AIG execs for getting their contractually agreed upon bonuses, to the extent that they passed a 95% tax on the bonus. Then they didn’t like the leadership at GM (never mind the UAW leadership or the AIG or Citigroup leadership), so they kicked Rick Wagoner out. [Actually, Rick may be OK, since he went from a $1 a year job to a $20 million dollar retirement. Talk about a ‘work or retire’ analysis]

Now, I’m a capitalist. I actually think that our government should protect us when we need it, like from bad guys with nuclear weapons. I think they should provide a valid justice system. I think they should uphold the Constitution. But I don’t like them running businesses. That’s never worked in prior history, and won’t work now. To be sure, as the 77% shareholder of AIG, I think the Treasury could have had a shareholder’s meeting, fired all of the members of the Board (which they should have done day one), and hired some very nasty lawyers to sue the guys with the bonuses under some alleged breach of contract, like ordinary businesses do. If the government is the largest creditor of GM, it’s within their power as a creditor to go to the Board (who also should be fired) and tell the Board that they don’t have confidence in management (even though it looks like the management only changed by one person).

But, here’s the cool accidental benefit. What we learned in the last three weeks or so is the stark truth that we don’t want the government running businesses. How is it that a group that has pretty much never held a real job, runs an entity at a deficit, and has expenses vastly in excess of its revenues; should be running businesses? Then, if the group gets mad at you, they create taxes for you or fire you arbitrarily (never mind some of the transgressions by members of the House and Senate that have not caused them to lose their jobs). What I see is rapid and stark: nobody wants the government as a partner. Today the NY Times reported that Signature Bank of NY, Old National Bancorp, Iberiabank, and Bank of Marin all paid back their TARP funds. Yesterday, Mark Fields of Ford gave a great interview where he basically said that Ford was going to do anything in its power to stay away from government money.

Want to get things moving? Be a petulant, unreasonable, inconsistent bully. All the kids will walk across the street to avoid you. If the bully loaned you lunch money, pay it back as fast as you can. If the bully wants to loan you lunch money, don’t take it. Because living with the bully is worse than living away from him. That lesson was clear this week. Now watch the new Treasury crow victory, when all they did was scare everyone into fixing the problem. Nature abhors a vacuum: they suck.

Triad of Capitulation

2009-03-18T11:05:00.000-07:00

Part 1 Leon's live presentation on March 5, 2009.
Go to Part 2

Bear Market Tactics

2009-03-18T06:43:00.000-07:00

Part 2 of Leon's live presentation on March 5, 2009.
Go to Part 1

The More Things Change

2009-02-13T13:03:00.000-08:00

I’ve been reading the news lately and find it amusing and interesting how many times history repeats itself. The latest one to amuse me is A-Rod, or Alex Rodriguez. For those of you who don’t know, A-Rod is the third baseman for the Yankees. He is the youngest player to ever hit 500 home runs, and has a 10-year, $275 million dollar contract (to do something that’s fun). Recently (February 7), it was reported that A-Rod tested positive for steroids during the 2003 season (when he won the MVP and broke 300 career home runs). So, we have a high profile top athlete, cheating to achieve success. Gosh, what a surprise!

Then we get Michael Phelps. Michael Phelps, as I think everyone knows, is the human porpoise who garnered 8 gold medals at the Beijing Olympics. Michael was playing with another banned substance, but this one wasn’t a performance enhancer. Michael led a Spartan life of training for years to reach the pinnacle of his sport. His endorsement value was purported to be $50 million dollars. Yet Michael seemed to think it was a good idea to be photographed drinking beers (I’m OK with that) and smoking a bong (a bong, for readers who didn’t grow up in the 60s-80s, is a marijuana pipe). So we have a 23-year old being stupid. Gosh, what a surprise!

Oh, and Bernie Madoff. Now A-Rod and Michael Phelps may be high-profile stupidity poster children, but Madoff is a truly impressive criminal. For years, Madoff ran the largest investment fraud (by a factor of almost 100!) ever committed. He swindled $50 Billion from investors, including Steven Spielberg, Kevin Bacon, John Malkovich and Zsa-Zsa Gabor. What’s truly impressive is that Bernie kept the scam going for over 20 years, and stiffed mostly his friends. A monstrous crook, who if we saw him in a movie, would find the plot too preposterous. Crooks near money. Gosh, what a surprise!

I was talking to my mom, who was fretting about stupid athletes and crooks. I pointed out that stupid athletes and crooks have been around as long or longer than sports or money. The more things change the more they stay the same.

Which leads me to some observations about the current financial mess (‘abomination’ also is a suitable descriptive word). Whenever we are in a crisis, we tend to see the trees, and miss the forest. There are, to be sure, some unique aspects of this bear-cession; but there are some historical precedents as well:

“This is the worst market since the 30s.” Well, maybe. This market is awful, and down over 40% from its peak. The media is running around making gruesome comparisons to the Great Depression. However, I’ll bet many of us can remember a really ugly bear market, where the S&P 500 dropped 49%. It was 2000-2002. 1973-74? Dropped 48%. So this is ugly. But we’ve seen ugly before. Oh yeah, and 12 months after the trough in 2002, the market had regained 34%. 12 months after the trough in 73-74, the market had regained 38%. They go down, they go up.

“Unemployment is going through the roof and that will drive us into a depression.” Unemployment is spiking (now at 7.6%) and people out of work is bad. However, unemployment has spiked 7 times in the past 50 years. In 1975, it was well over 8.5%, and in 1982, it was over 10%. Oh, and guess what happens after the spike in unemployment? The market goes up. 12 months after the 1975 spike, the S&P 500 was up 31%. 12 months after the 1980 spike, the market was up 31%.

“Consumer Sentiment is in the toilet!” The U of M Consumer Sentiment Index (which may explain Michel Phelps recreational activities) is near a 28-year low of 57.9. That’s about what it was in February of 1975 (and the market went up 22% in the next 12 months), but not as low as it was in May of 1980 (when the market went up 18.1% in the next 12 months). It’s close to the plunge in confidence in October of 1990, (when the S&P 500 went up 29.1% in the next 12 months). The consumer confidence level behaves like a 15 year old teenage boy at a dance: the low confidence is eventually followed by more confidence.

“The debt load on this bail-out is going to kill us!” With the Stimulus package now passed, and the bank bailout bill, the United States will be running a monstrous deficit. This deficit can only be funded through debt, which increases our national debt load. However, measurement of numbers in absolute is not as relevant as numbers in perspective. If we look at National debt as a percentage of GDP, even with the Stimulus/bailouts, the National debt as a percent of GDP is lower than all the years from 1942 -1960, and is still lower than in 1993-94. Gross debt (public and private) is high, but I’m thinking the new rules of banking (like you need a real job, a real credit score and some security) will modify that debt load.

“This time it’s different!” This statement is probably right in more ways than those that utter it realize. There are some unique characteristics of this bear-cession: zero interest rates, 75% declines in energy prices, global asset declines, low real estate prices, and more money out of the market than in the market. Never in any prior downturn have the economics been so good. We’re just missing that one little important ingredient: Confidence. When confidence comes to the table, we will see an economic recovery.

As I talk about the causes of this debacle with people, I usually hear a common theme “I can’t believe all of those greedy crooks on Wall Street could get us into this mess!” Gosh, greedy crooks on Wall Street. What a surprise. The more things change, the more they stay the same.

Happy Spring

Leon and the Team

PS: As a practicing Catholic, I noticed that the Church is re-instituting indulgences, or the practice of paying the Church for absolution of sins (never mind it’s why Luther started the Protestant Reformation in 1517). I find the use of indulgences interesting in these times, and wonder if Madoff may convert?

New 2009 Rules on IRA Distributions

2009-01-12T05:55:00.000-08:00

New 2009 Rules on IRA Distributions For Those Over Age 70 ½:
Required Minimum Distribution (RMD) Relief

January 8, 2009. A 2008 tax law change gives retirees and beneficiaries some much needed flexibility in managing their personal finances for 2009. A key provision in the recently passed Worker, Retiree, and Employer Recovery Act of 2008 provides relief to retirees and others by allowing them to temporarily suspend their Required Distributions from their IRAs during 2009. The The Act provides relief only for 2009 distributions. Here's a summary of this new provision:

Required Minimum Distributions Basics. Under the required minimum distribution (RMD) rules, participants in individual retirement accounts (IRAs) are generally required to begin taking distributions no later than April 1 of the year after they attain age 70½. The amount of the RMD each year generally is measured by dividing the account balance as of the end of the prior year by a distribution factor (generally, a life expectancy factor from the Uniform Lifetime Table published by the IRS). If an individual dies while taking an RMD, the beneficiary of the individual's retirement plans and IRAs is also required to take distributions measured by dividing the account balance as of the end of the prior year by a distribution factor. The distribution period is generally equal to the remaining years of the beneficiary's life expectancy from the IRS chart. If the surviving spouse is the designated beneficiary, distributions can be continued under the greater of the spouse’s life expectancy (again from the IRS table), or the life expectancy of the individual receiving RMDs. If the beneficiary is a non-spouse, then the amount must be distributed over the remaining life expectancy of the beneficiary or the life expectancy of the beneficiary, whichever is greater. You can always take more than the RMD; however, taking less results in severe penalties.

Roth IRAs are not subject to the RMD rules during the IRA owner's lifetime. If a spouse inherits a Roth IRA they may elect to treat the Roth IRA as their own and are not required to take distributions. However, Roth IRAs are subject to the post-death minimum distribution rules applied to traditional IRAs for non-spouse beneficiaries. For Roth IRAs, the IRA owner is treated as having died before the individual's required beginning date. So, the non-spouse beneficiary has the option of taking distributions over their life expectancy or to take the full amount out of the Roth by December 31 of the fifth year following the year the Roth IRA owner dies.

Failure to take an RMD triggers an ugly 50 percent excise tax (which we fondly call the ‘Alzheimer’s tax’, since you usually don’t forget it more than twice), payable by the individual or the individual's beneficiary.

New Law. The 2008 Recovery Act provides a one year suspension of the RMD rules for 2009. Specifically, no required minimum distribution is required for the calendar year 2009 from Individual Retirement Accounts and defined contribution retirement plans (such as §401(k) plans). The exemption also applies to §457(b) eligible Deferred Compensation plans maintained by a state, a political subdivision of a state, or any agency or instrumentality of a state or political subdivision of a state. Thus, any annual minimum distribution for 2009 from these plans is not required to be made. The next RMD will be for calendar year 2010. This relief (referred to as the "2009 RMD waiver") applies to lifetime distributions to employees and IRA owners and after-death distributions to beneficiaries.

The 2008 Recovery Act's relief provides that a taxpayer who attained age 70 ½ in 2008 but chose to wait until Apr. 1, 2009, to receive their first RMD (for 2008) would still have to make that first RMD by April 1, 2009. However, they would not have to make the otherwise-required RMD for 2009.

For beneficiaries who are otherwise required to take RMDs using the five-year rule, the five-year period under that rule is determined without regard to calendar year 2009. Thus, for example, for an account with respect to an individual who died in 2007, the five-year period ends in 2013, instead of 2012.

The 2008 Recovery Act's suspension of RMDs for 2009 helps retired taxpayers who don’t need to rely on RMDs to meet living expenses. By not taking the RMD for 2009 (or withdrawing less than the RMD) from their qualified plan accounts and/or IRAs, they will wind up with less taxable income for 2009. This bracket shift can be substantial for someone with a pension, Social Security and an IRA RMD. For example, for a couple with taxable income over $78,850 is in a 25% or higher bracket; not taking the RMD can substantially reduce the current tax burden. In addition, not taking an RMD can avoid (or mitigate the effect of) AGI-based phaseouts of tax breaks. Some of these phaseouts include:

The threshold of taxation of Social Security benefits at income above $25-$32,000 ($25,000 for single, $32,000 for married). Suppose a person has interest of $5,200, Social Security benefits of $21,000, and the balance of their income is an RMD of $25,000. Assuming they took the RMD and took a standard deduction, their tax would be about $4,250. Without the RMD, their tax would be zero.
The threshold for college credits and deductions (you may be old and have kids in college, though I hope not) is:
- HOPE and Lifelong Learning credit: $50,000 ($100,000 for joint filers) of modified Adjusted Gross Income (AGI) for qualifying education expenses for the HOPE credit.
- Student Loan Interest: $60,000 ($120,000 for joint filers) of modified Adjusted Gross Income (AGI) for qualifying student loan interest.
- Education expenses: $65,000 ($130,000 for joint filers) of modified Adjusted Gross Income (AGI) for qualifying tuition and related expenses.
AGI floors. There are certain deductions that have ‘floors’ based on adjusted gross income. Reducing income reduces the floor and increases the deduction. For example, there’s a ‘floor’ of 7 ½ % of AGI for medical expenses. Suppose a taxpayer has some Medicare premiums, a Medigap policy and some significant dental expenses to the total tune of $8,200, and they have other itemized deductions totaling $7,000. They have a projected 2009 AGI of $125,000, which includes a projected RMD of $36,000. If they take the RMD, they will not be able to deduct any of the medical expenses. However, by not taking the RMD, they not only reduce their income by $36,000 (which saves about $10,000 of state and federal tax), but they also get to deduct $1,525 of medical expenses, which further reduces their taxes by about $400. Some of the AGI limits for deductions are:
- Medical expenses, at 7 ½ % of AGI;
- Casualty losses, at 10% of AGI;
- Miscellaneous Itemized deductions (like investment expenses) at 2% of AGI.
Michigan’s pension tax. The state of Michigan taxes pension income on private pensions (from a company or an IRA) if the total private pension income exceeds $43,440 for single and $86,880 for joint (these are 2008 numbers). The RMD counts as a private pension. So if a person were taking a pension from their company (say Ford or GM) and the pension income exceeded the threshold, suspending the RMD would save 4.35% Michigan tax.
Personal Exemptions phaseout. Your personal exemptions start getting phased out at $166,800 ($250,200 for joint filers). If the RMD puts you above the phase-out, you get an additional benefit from suspending the RMD and using your exemptions.
Itemized deduction phaseout. Itemized deductions in total start getting phased out at $166,800 for single and joint filers. If the RMD puts you above the phase-out, you get an additional benefit from suspending the RMD and increasing deductions.
Roth IRA conversion threshold. One thing we really like to see in this down market is Roth IRA conversions. When the market recovers, any dollars converted to Roth IRAs will appreciate tax-free. Money left in a conventional IRA will have any market appreciation taxed as ordinary income. The income threshold for Roth conversion is $100,000 for single or married persons. If suspending the RMD puts income below this threshold, we feel it presents an excellent opportunity for a Roth conversion. In addition, in 2010, the income limit is suspended, but making a partial conversion in 2009 would allow a ‘splitting’ of the conversion into two separate tax years (not to mention getting the Roth tax-free advantage for any 2009 appreciation)

There are other considerations, ranging from the passive income loss limitations to the dreaded AMT. Needless to say, the ability to suspend an RMD may mean significant tax dollar savings in terms of phaseouts and tax deductions, as well as tax brackets.

Another point worth noting is that Medicare Part B premiums are increased for single taxpayers with AGI over $85,000 and married taxpayers with AGI over $170,000. Not taking a RMD to keep your AGI under the thresholds may save you significant dollars in the following year for the Part B Premiums. The base rate of $96.40 can go as high as $308.30 a month. This can save $2,500 per year for a single person and over $5,000 for a married couple. Not taking the RMD also allows the IRA owner to leave more to their beneficiaries. Older recipients will benefit the most, because their (short) table-life expectancy factors would otherwise compel them to take large RMD payouts in 2009.

For some taxpayers with large estates, taking the RMD (or more) reduces the taxable estate by the amount of the income taxes paid on the RMD. (Sounds strange, doesn’t it: pay taxes to save taxes?)

From a nontax standpoint, those taxpayers that can afford to forgo their 2009 RMD will have an opportunity to allow their investments to recover (if the market rebounds over the next 12 to 24 months) before having to sell assets in order to make withdrawals.

Update on charitable contributions for IRA’s. The IRS has also extended through the Pension Protection Act through 2009 the ability to make a tax-free donation of up to $100,000 to a charitable organization of your choice directly from your IRA. That donation does not get included in your taxable income for 2009. In addition to the potential benefits listed above from lowering your taxable income, you may actually get an additional benefit if you do not itemize your taxes or if you are near the standard deduction of $11,400 Married/Joint or $5,700 Single. As an example, if you normally take the standard deduction and you fall in the 25% tax bracket then you would save 25 cents for every dollar you donate to charity when normally you would have gotten no benefit. To take advantage of this benefit you must direct your IRA custodian to send and make the check out directly to the charity. If those rules are not followed it will not qualify for the deduction.

The new rules provide some excellent tax-planning opportunities. However, the benefit of suspending your RMD requires a case-by-case analysis and we suggest an individual review of your situation. Contact your financial and tax advisor (or us) for a review.

LJPR, LLC is an independent fee-only advisory firm in Troy, MI. LJPR specializes in independent wealth management for retirees and their families. Our staff performs comprehensive analysis of financial situations, including investment management, tax analysis and estate review.

Leon's article recently featured in Businessweek

2009-01-07T12:42:00.000-08:00

Leon's advice featured in this BusinessWeek article:

http://www.businessweek.com/investing/insights/blog/archives/2008/12/in_our_recent_i.html

2008 - A year for the history books, but it reads like fiction

2008-12-26T08:32:00.000-08:00

2008 was a weird year for predictions. We think it was possible to say almost anything and there was a notion of truth, especially if it had anything to do with the markets, politics, or sports. Before we bid 2008 good bye and good riddance, let’s share some observations about 2008:

Real Estate. What we thought would happen: we thought real estate would be flat or slightly down. After all, the real estate market was hot for 10 years and hadn’t had a down year, on a global basis, since 1945. What we didn’t foresee was 20-60% declines all around the country. Think Detroit is bad? Try Vegas. Have a look at Florida. Biggest downward plunge in a very long time.

Recession. What we thought would happen: We’ve been harping about there being a recession for quite some time – Detroit usually leads the way. What we didn’t see was the massive slowdown that was caused by the sub-prime debacle. We now have a 70’s variety, or even a 30’s variety, big tough recession. Add a nasty bear market, and you have the third worst bear-cession in 80 years.

Market. What we thought would happen: We thought the market was a little pricey last year and rebalanced to take some profits. What we didn’t think would happen is the tidal wave of fear that gripped all markets globally and took the US market down 50% (Russia down 71%, China 68% and Brazil 56%).

Subprime. What we thought would happen: We saw subprime as a problem over a year ago. What we didn’t see (and neither did anyone else, apparently) is the colossal greed of Wall Street investment bankers, leveraging the paper 19 times, leaving us with a subprime mess bigger than the whole mortgage market. The end result was a litter of bodies; including Lehman Brothers, Washington Mutual, FNMA and Freddie Mac, Merrill Lynch, Morgan Stanley, and a host of others.

Auto Industry. What we thought would happen: We figured the car companies were in for a hard competitive push, particularly with oil topping $145 a barrel. We thought their challenge was going to be making small fuel efficient vehicles, and buying enough time to retool to avoid bankruptcy. We figured Chrysler was on the block and thought China or India would buy them. What we didn’t think would happen is that two of the Big Three would be on life support, and have to have an emergency transfusion in the form of a government loan. We knew the industry would change, but there was no way we thought it would change in the blink of an eye.

Crooks. What we thought (knew) would happen: We figured that where there was money, there would be crooks (no big surprise there). We thought the subprime would bring some evil doers out, and the hedge fund business was bound to have rogues. What we didn’t expect was that one of the guys who started the NASDAQ would create a totally fabricated monstrous Ponzi scheme 100 times bigger than any previous fraud. Very wealthy folks got wiped out in a flash. Oh yeah, and his kids turned him in.

Olympics. What we thought would happen. We figured the Chinese would put on a good show (they did). We thought there would be controversy in gymnastics, especially the Chinese gymnasts. What we didn’t think would happen is China would lead in medals. And we didn’t think a human porpoise would sweep the medals in swimming.
Football: What we thought would happen: We figured Michigan (U of M) would have a mediocre season with the new coach. We also figured the Lions would have a crummy year (relatively). What we didn’t think would happen was that Catholic Central (or Toledo) could beat them both…with their JV team (or their cheerleading squad)…after a party.

Politics. What we thought would happen: We thought it looked like a Clinton/McCain race in the standard far left/far right fight. We thought the big issues would be taxes and the war. What we didn’t think was that Barack Obama would be the candidate and victor. We didn’t have a clue who Sarah Palin was, much less that she’d be a vice presidential candidate. We didn’t think Hilary Clinton would end up as Secretary of State. We didn’t think it would be Christmas and they still wouldn’t know who the senator from Minnesota was.

Oil. What we thought would happen: As we wrote in July, we figured the oil problem was supply and demand. Make the price high, and more people look for oil, while using less oil. We thought oil would go down quickly to $80. What we didn’t think would happen is that oil would go below $40. We also thought people might notice the extra $50 in their pocket per week. We also didn’t think that the F-150 truck would be Ford’s best-selling vehicle in October.
Interest rates: What we thought would happen: Last year, we thought rates looked like they were increasing, with commodity inflation all around the board. By mid 2008, it looked obvious that rates were falling. What we didn’t expect is that rates would go to zero…and no one could get a loan.

2009. What we think will happen: Let’s see, we have cheap gas, cheap commodities, cheap labor, cheap real estate, cheap money, and a government that seems to be willing to print money on toilet paper. Cheap everything is good. Hard times are good, in the long run; it brings discipline, perseverance and innovation. Tough times don’t last: tough people do.
To all of you, we wish you a healthy happy holiday. Good riddance to 2008!

Your Team at LJPR

Bear-cessions: What happened before when we had a bear market and a recession?

2008-12-01T08:30:00.000-08:00

This ugly mess has me pondering the prior results of bear markets and recessions. I view our current scenario as the credit crisis (with all the resounding greed, lack of oversight, and ineptitude) having caused the bear market and amplified the recession. Accordingly, I think the fixing of the credit crisis will fix the bear market and the recession. But, I was curious to see what had happened before?

Since 1926, we’ve had 13 bear markets , which is a decline of 20% or more (including this one). We’ve also had 15 recessions (including this one). Nine times (including this one), the bear markets and the recessions overlapped. Three recessions skipped a bear. Two bears skipped recessions (or straddled between them). What I’m interested in is the nine times they went together.

Here are some of my observations about eight prior bear-cessions:

The average length of the recession part of the bear-cession was 14 months;
The average length of the bear part of the bear-cession was 23 months;
The bear market always preceded the recession, and did so on an average of 7 months;
With two exceptions, the bear market ended before the recession. When the bear ended before the recession, it usually did so about 4 months before the recession ended.
The average decline in the bear part of the bear-cession (on the S&P 500), was -39%;
The average 1-yr return on the S&P 500 after the trough of the bear was +46%;
In 3 of the 4 most recent recessions (excluding this one), the date the recession was declared was either after or near the end of the recession.

So, let’s look at the bear-cession of 2008:

The market peak was 10/09/2007, so as of November ’08, we’re 13 months into the bear market;
This recession hasn’t had a formally declared start date, but it probably started around November 2007 (I’ve seen the date 11/16/2007 bandied about)
If the recession part is leaning to the average, the recession should be ending 4 months after the bear market ends , or about 14 months from the start (April 2009?)
After the trough in the market, the market should recover reasonably. If the trough is 8,000 on the Dow, the recovery would be to about 11,200 by June of 2010.

The Big Nasty: The one bear-cession I’d like to ignore is October 1929 to July of 1932 (recession went to March of 1933). This is the Grizzly of all bears, with an 86% market decline and a 34 month bear market. The recession lasted 42 months. The resulting one-year stock market recovery was 124% (which sounds good, but isn’t, off of an 86% decline. I think the Great Depression was an example of what NOT to do in a bear-cession (like raise interest rates, tighten credit, and pass tariffs, plus generally ignore the malaise). If we toss out the Big Nasty from the prior observations, the average bear market was 20 months, the average recession was 9 months (3 quarters). I think we’ve effectively moved away from Great Depression mistakes, with lower oil prices, lower interest rates and (I can’t believe I’m going to say this) smarter government.

All in all, I believe the bear-cession of 2008-2009 is more than half over. That is, if history repeats itself and we all know it does.

Leon LaBrecque

Bear Ammunition - 5 More Good Ideas

2008-11-14T06:17:00.000-08:00

Dump down annuities. We’ve rarely been a fan of variable annuities. They generally have high fees (because of the internal expenses), surrender charges, and more importantly, they turn capital gains and qualified dividends into ordinary income. In fact, when you die, the gain in an annuity is taxed as ordinary income to your beneficiaries, as opposed to the step-up in basis heirs get from appreciated assets which results in zero income taxes. Lately, with the big market declines, we’re seeing two situations that present a nice opportunity. The first is when you have a variable annuity that has declined significantly and the death benefit has also declined (VA’s will sometimes set the death benefit at the highest market value: we tend to leave those alone). An example would be a variable annuity that you bought for $30,000, went up to $52,000, and then went back down to $29,000 (and the death benefit went down to $29,000). You can cash it in with no tax consequence. You could then re-buy the exact same mutual funds that the variable annuity had and get the full value of recovery. Actually, you’d get a higher value of recovery because you wouldn’t be paying the insurance company fees. Oh yeah, and now the appreciation is taxed at capital gain rates instead of ordinary income rates. Oh, and no surrender if you want to get out of the investment and buy a cruise or a boat or a cup of coffee.

The second scenario involves equity indexed annuities (which we really didn’t like) that have reset their cash value to the last year’s index value. Here the solution is simple: If you have a guaranteed cash value at last year’s index value (which was higher), you can cash in the annuity, even paying the surrender charges, and be up dramatically from current market levels. It will probably will take quite a while to get back to last year’s value, so this option would let you cash in the indexed annuity and buy an index. Now the gain is capital gain, rather than ordinary income. Oh, and now you actually get the dividends paid by the index. Oh, and no annuity fees. More importantly, most index annuities cap your percentage gain in any given month, so when the markets recover you may not participate fully in the recovery.

Take IRA distributions in- kind in declined equities. This is a fascinating opportunity that presents itself in this ugly market. You can take an IRA distribution in specific securities. If you have a stock or fund you really like, you could take the distribution in that security and reap any future appreciation as a capital gain, having taken the IRA distribution at the lower fair market value. If the stock goes down, you could at least deduct the loss. Here’s an example: Suppose you held some GE stock in your IRA and you were over age 70 ½ and are required to take minimum distributions. If you took your distribution in GE stock, you’d receive the shares (or transfer them into your trust account or whatever. You would now have GE stock and receive the dividend (which is pretty nice) at preferential dividend tax rates (for now at least). Any appreciation would be at capital gain rates (which will likely stay lower than ordinary rates in any case). If GE goes down further and you sell it, you would get to deduct the loss.

Use in-kind distributions for Roth conversions. Similarly, but not quite as compelling is to take individual securities and convert those into a Roth. This basically entails identifying the securities you want and getting them into your Roth IRA conversion. In the above example, you could take the GE and put it in another IRA and convert that to a Roth IRA (pending income limitations or 2010). Now your GE appreciation and dividend are tax-free, and you paid a very small amount of tax to get it into the Roth.

Know anyone at Ford or GM? If you know anyone at Ford or GM with company stock in their 401(k) plan (called the SSIP, SSPP, TESPHE, or PSP), they may be able to use this one. If you’re retired or over a certain age, you can make withdrawals from the plan. If you own company stock (GM or Ford stock), you can take that out and pay tax on the lower of cost or market. With the automaker’s stocks in the toilet, the market value is lower. So if you had 10,000 shares of Ford and you took it out and it was all-pretax, you’d pay tax on about $19,000 (assuming the price is $1.90). If Ford goes up to $6, you have a capital gain of $41,000, which would be a lower tax rate than if you left it in the plan. If Ford went down and you sold it, you have a capital loss that you could deduct against your regular income. Stock goes up, you win with capital gains, stock goes down, you at least get a subsidy for the loss, that you would not get if you left it in the plan.

There you have it. 5 more rounds of Bear ammunition. Feel free to pass along these tips to your friends and co-workers. In our next blog/communication installment, we’ll be looking at past recessions and bear markets. Stay tuned!

Suzanne Antonelli and your team at LJPR

JUMP - INTO THE MARKET, NOT OFF THE LEDGE

2008-10-27T13:48:00.000-07:00

JUMP
into the market, not off the ledge:
How to take advantage of a sale

During times of wild and excessive swings of the stock market, investors have two choices: run and hide (go to cash or CDs), or take advantage of the situation. The run-and-hide approach can permanatize your losses, and furthermore requires you to time your re-entry. There are a few who think this is the end (although I reject the notion that Rock Financial has the ability to cause the end of the world). Under the doomsday scenario, you are betting on the end of the world, but since you can’t collect from anyone if you win, you win nothing. Thus, this nasty and ugly mess is likely to be temporary (temporary is an ethereal term, and could mean three quarters to three years). Notwithstanding the time frame to some semblance or recovery in prices, this market presents opportunities. Assets are on sale.

If you landed on earth today with cash, you’d find that houses are cheap; stocks are almost half off (more in many cases); interest rates are low, and oil prices have been reduced by half, all in a year’s time. There is a big sale going on. Think of it this way: if the Dow goes back to where it was in October of 2007 (back when real estate was higher, interest rates were higher, and gas was higher), you’d make 80-100%. If you want to take advantage of the sale, here are some of our ideas:

Tax-free returns, part one: Roth IRA contributions. We like Roth IRAs; they’re a virtually perfect vehicle for accumulation. You put after-tax money into a Roth, and your withdrawals, including any appreciation and income, are tax-free. Roth IRAs do not have required minimum distributions at age 70 ½ like a conventional IRA. If tax rates rise (which we think they will), Roth IRAs provide a way to get a shift in tax brackets. In addition, Roth IRAs have a built in superiority of providing growth on the taxes paid on the contribution. It goes like this: suppose you contribute $5,000 to a conventional IRA or 401(k). You get a $5,000 deposit, plus $1,250 in tax savings (assuming you’re in the 25% bracket). Let’s assume the deposit doubles (which it probably will, although we don’t know when) to $10,000. When you withdraw the money, you’ll pay $2,500 in taxes, netting you $7,500. If you made the same contribution to a Roth, you’d have a $5,000 deposit and a $10,000 balance, with no taxes. You would however, have to pay taxes up front on the Roth contribution (on the earnings) of about $1,667. The Roth allows you to keep the compounding on the taxes you would have paid upon withdrawal.

The Catch: Roth IRAs are great, but they have rules. First, you can only make contributions to a Roth if you have earned income, like wages or self-employment income. If you’re married, only one spouse needs to have earned income. You’re limited in your contributions to a Roth to the lesser of your earned income or $5,000 per spouse ($6,000 if you’re over 50)[1]. Second, once you start a Roth, you must wait until the longer of 5 years or age 59 ½ to take the money out tax-free[2]. Third, there are earning limitations to contributing to a Roth. For single filers, the limit is $101,000 of Modified Adjusted Gross Income (with a partial contribution for income between $101,000 and $116,000), and for married filers filing a joint return[3], the limit is $159,000 (and partial contribution for income between $159,000 to $169,000)[4].

A loophole around the income limit: There is an interesting strategy you can use to get around the income limitations for a Roth. We normally consider two types of IRAs, Roth’s and conventional. There is a third type, which is mostly ignored (for good reason), a nondeductible IRA. Nondeductible IRAs do not have an income limitation (you do need to have earned income to make a contribution). The income earned by a nondeductible IRA is taxable upon withdrawal. The loophole is that in 2010, you can convert non-Roth IRAs (like nondeductible and conventional or rollover IRAs) into Roth’s by paying the tax. So, you could have high income and make an on-sale contribution to a nondeductible IRA for yourself (and potentially your spouse) now for 2008; make another one in the beginning of 2009, and make a third in the beginning of 2010, and then convert in 2010 and pay the tax on the income portion and have yourself a Roth IRA. If you do the conversion in 2010, you’ll pay the tax half in 2011 and half in 2012. There are more rules, so check with your advisor before proceeding.

Overall, Roth IRAs are good wealth accumulation tools. They’re even more attractive in a market sale.

Roth conversions. What could be better than sticking five grand or ten grand in tax free at a market low? How about sticking a lot more in. Here’s where we look at a Roth conversion. A Roth conversion is where you take an existing IRA, whether nondeductible, traditional, or rollover, and convert it into a Roth by paying the tax on the earned income of the IRA. In a market decline, converting to a Roth can be very attractive. Say you have an existing traditional IRA that was $40,000 in October of 2007, and is now worth $25,000. If you convert to a Roth, and are in the 25% bracket, you’ll pay $6,250 in taxes to make the conversion. If your investments revert to their original value of $40,000, the entire IRA will be tax-free. You need to be aware that Roth conversions are neutral if you use the money in the IRA to pay the taxes. But if you can fund the tax on the conversion out of other after-tax funds, you clearly gain if you’re in the same bracket in the year of conversion or the years of withdrawals. Even with the 2010 conversion window opening (see above), we think that a low market allows for a conversion at lower prices and hence lesser taxes. Have a good look at your tax bracket: it doesn’t make sense usually to convert to a Roth if it takes you into a higher bracket.

The Catch: Like Roth contributions, there is an income limitation for Roth conversions as well. The Modified Adjusted Gross Income limit for all taxpayers not married filing separately (i.e. single or married filing joint returns) is $100,000.

Taking care of the kiddos, tax-free. Obviously, if we like making on-sale retirement deposits or conversions tax-free, we also like making on-sale education funding deposits tax free as well. §529 plans (Like the MESP[5]) and Coverdell ESAs are tax-free education savings vehicles. Making a deposit to a §529 in a down market gives more potential appreciation on a tax-free basis. Most education savings vehicles have age-based allocation for a child or grandchild. These age-based programs allocate toward cash as the student approaches college age. They also usually have conservative, moderate or aggressive allocations as well. Many parents and grandparents have established, prior to the rules of §529 or Coverdell ESAs, a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA) custodial arrangement. The UGMA or UTMA is only partially tax-free. In fact, they can be taxable at the parent’s rate. In a down market, getting rid of the UGMA/UTMA and depositing the money into a §529 or Coverdell would take a portion of the taxable gain away from the UTMA/UGMA and make it a tax-free gain in the §529 or Coverdell. There is an extra advantage to getting rid of UTMA/UGMAs as well: §529 and Coverdell ESAs are not counted as a child’s asset for financial aid purposes. This provides a prospective change in financial aid eligibility of about 29% of the balance of the account[6].

The Catch: Coverdell ESAs may be used for K-12 or college; §529 plans may only be used for college or higher education. Coverdell ESAs have a $2,000 per year per student limit; §529 plans generally have much higher limits. Coverdell’s have an income limitation for contribution of $110,000 of Modified Adjusted Gross Income for single filers ($220,000 for married filing joint returns)

Wealth Transfers on sale. Here’s one for folks with some significant assets. The decline in real estate and stock values provide an opportunity to make a gift to heirs (or better, a trust). Right now[7] taxpayers can make a $1,000,000 gift and use a portion of their Unified Gift and Estate Tax credit.[8] If someone had a significant portfolio or some appreciated property (business, ranch, real estate) that had suffered a market decline, this may be an optimum time to make a gift. The reason is that on larger estates (right now $2M for married couples, $3.5M in 2009 and after the year 2010 there is a very likely possibility of a change in that number for estate taxes), the use of a gift in a down market can potentially save all of the estate taxes on any future appreciation on the property.

First, the fear of a gift to errant or frivolous heirs is unwarranted. A gift can be made to an LLC or to an irrevocable Trust. There are some specific advantages when gifting through an LLC where the beneficiaries get a minority interest. It may be possible to gift significantly more than the $1 million dollar gift limitation using an LLC. Trusts and LLCs can restrict the use and transferability of assets to outsiders.

The basic idea is simple. Suppose Mike and Sue have a piece of property that was worth $6 million in 2005, but is now worth $3.5 million, as attested by the average of three appraisals. They want to keep the property in the family. They create MS Partners LLC, contribute the property to the LLC, and gift an LLC share equal to about 40% of the value to their various heirs[9]. Suppose they collectively live an additional 20 years, and the property appreciates to about $9 million[10]. On their death, the taxes saved by the gift would be about $1.8 million[11]. Use stocks or a closely held business, and the savings are more dramatic. The LLC can have Mike and Sue as the managing members and they can run the show.

The Catch: There’s a whole bunch of catches. You need to set up an effective gift vehicle (like an LLC or irrevocable trust), you need effective valuations, and you have tax returns to file for the reception vehicles. There are income tax consequences to consider as well (there are weird rules about the basis of property transferred by gift: usually we want something appreciated and not at a loss.) In addition the valuation procedures are critical. But in many cases, the rewards to the family can be substantial. Overall, it’s a complex transaction with substantial benefits.

Wash the losses right out of your head. In a down market, it makes some sense to harvest losses (‘harvest’ being the euphemism for simply ‘take the losses’) in your taxable (non IRA or 401(k)) accounts. However, losses are strange: you can only net losses against gains and then take a portion (currently $3,000 a year) against ordinary income. However, since you can carry-over losses indefinitely, it makes sense to realize losses. In a weird and volatile market, you could miss a 1,000 point run by being out of the position. The Internal Revenue code requires that you cannot take a loss on a security if you hold substantially the same position within 30 days of the sale. So if you had a loss on the sale of shares of a stock you had owned, you couldn’t deduct the loss if you owned the same stock for 30 days prior to or after the sale. This problem, called a ‘wash sale’, can be overcome simply in some cases, and less simply in others.

The wash sale rule disallows losses on substantially identical securities if a purchase is made within the 61 day period centered on the sale. So If you had XYZ stock that was $2, which you had bought at $8, that you sold on March 15, 2008, you couldn’t claim a loss if you bought XYZ anytime on or after February 14th (30 days before) or before April 15th (30 days after). You can’t get around this easily either. For example, you can’t buy an option on the company in the wash period to deduct the loss. You also can’t apparently make a wash in an IRA you own[12] (sell at a loss in your taxable account and buy in the IRA). You can however, possibly switch among similar mutual funds (for example, the jury is out on what happens if you swap an S&P 500 index fund for a SPDR, but you could clearly switch an index for a bounded index or a social index). You can also follow the ‘rising tide’ theory, in which you might have a loss on Citigroup, and sell it and hold JP Morgan for 31 days to get the loss.

There you have it: five ideas to take advantage of a sale in the market. Stay tuned for our next installment on bear market ideas.

Leon LaBrecque

[1] For 2008.
[2] There is an early withdrawal rule called FIFO (first-in, first-out) that allows earlier withdrawals of contributions only.
[3] For some unforeseen reason, the income limit for married filing separately is $0, and a partial phase-out to $10,000 of MAGI.
[4] For 2008.
[5] For Michigan residents (the custodian, not necessarily the child), there is available a deduction from Michigan taxable income of up to $10,000 for contributions to the Michigan Education Savings Program (MESP). Note that the student can go to any school under the MESP, not just Michigan Schools.
[6] For financial aid calculations, 35% of a child’s assets (including UTMA/UGMA) are counted toward the cost contribution. Only 5.6% of the parent’s assets (§529 plans or Coverdell) are counted.
[7] 2008.
[8] If the tax payer dies within 3 years of the gift, and the gift is considered “incomplete”, it will be added back to an individual’s estate for estate tax purposes. You should consult with your advisor or legal counsel to ensure you are making a completed gift.
[9] We’re using a relatively standard discount on a non-transferable, minority interest in a closely held business.
[10] About 5% appreciation, not grossly unreasonable.
[11] Assuming a 50% estate tax on estates larger than $3.5 million per estate, which is close to proposed changes in 2008.
[12] Rev. Rul. 2008-05

Chapter 2

2008-10-06T14:01:00.001-07:00

“No man’s life, liberty, or property are safe

while the Legislature is in session”

Daniel Webster

Well, the ‘rescue’ package passed (we’re glad). Following the notion of not wanting to see politics or sausage being made, the bill not only raised the FDIC insurance level (good), and kept the reverse auction of mortgage securities (good), but also gave a tax break to children’s wooden arrow manufacturers, fishermen in Alaska affected by the Exxon Valdez, NASCAR, and Hollywood. When the dust cleared, some of the mess is fixed, and some still needs to be fixed. The market lost more during the week than the bill cost. While everyone seems to be running for the exits, I can’t help but feel like a kid in a candy store (or maybe a kid on Christmas morning???). The fear and panic is causing opportunities that don’t make sense to a rational person, but then again this market is completely irrational. We’re seeing large multi-national manufacturing companies with extremely strong credit ratings paying exorbitant rates to borrow money, and their stocks are trading at levels that imply they are on the verge of closing their doors. Municipal bonds are trading at levels never seen before and likely never to be seen again. It is time to start exploiting the panic.

Warren Buffet, who has a reputation for making some reasonably good investments (Berkshire Hathaway is the best-performing stock in history), jumped in with big investments in the preferred stocks of Goldman Sachs and General Electric. Wachovia Bank, one of the apparent victims of the crisis, was scheduled by the FDIC to be sold to Citigroup; then Wells Fargo (established in 1852) rode in on the stage coach with a chest full of stock, and trumped Citi and the FDIC. The smart money is starting to move.

You obviously know we have watched with dismay the ugly spiral of greed and fear that this crisis has caused; but through all of this, we know the turbulence ends and business continues. We also know historically that every major change in the financial markets/system has caused turmoil and created opportunity, and this time is no different. It appears likely that the Central banks will cut interest rates in an effort to further restore the troubled financial sector, which should eventually lead to loosening of the credit markets. However, rest assured more chaos will ensue. Yet, “In chaos lies opportunity.”

We all feel the affects of a recession (haven’t we been saying there was recession for over a year now?), and very few of us remain untouched by the lack of lending in the credit market, but the notion that the sky is falling is misguided. First of all, if the sky is actually falling, there is no where to hide (e.g. your bank is no safer than a stock). Second, a vast majority of companies, particularly U.S. companies, although they need credit and banking, make something or sell something. And they’re on sale.

We will be carefully analyzing the markets and finding the best opportunities and allocations for your portfolios. We will be evaluating the world markets, looking at how they have been acting and reacting to each other, as well as seeing how future expectations have changed. You may see some over weighting of certain areas and underweighting of others. It is situations like these that give proof positive to the Asset Allocation philosophy that we annoyingly preach. A good portfolio is a recipe: some ingredients are on sale and we’re going bargain hunting. Chapter 2 has started.

Leon LaBrecque

Credit Crunch 2.0

2008-09-17T09:12:00.000-07:00

Sunday, September 14, 2008 (7:40PM): Unless you’ve been living under a rock recently, you have undoubtedly heard of the troubles plaguing Wall Street firms and banks. Whether it’s the government takeover (conservatorship) of Fannie Mae and Freddie Mac at the expense of common and preferred shareholders this past week or the potential bankruptcy of Lehman Brothers. I say potential as I write this at 7:40 p.m. on Sunday 9/14/08, but I’ll bet if I get up and walk over to my Bloomberg in the next few minutes it will be the actual bankruptcy of Lehman Brothers. This firm’s troubles are not the beginning nor the end of this crises; there are other firms that may have problems. Now apparently Bank of America is in negotiations to buy Merrill Lynch.

These past few weeks have been unprecedented and historic to say the least. I call this “Credit Crunch 2.0” because this is the newer bigger credit crunch. Does anyone remember New Century Finance??? Maybe, maybe not, but New Century is arguably the first domino in this disastrous situation. New Century was a mortgage company that filed for bankruptcy in April of 2007 (seems soooooo long ago), and this weekend we have a 158 year old Wall Street institution suffering the same fate. In emergency talks this weekend attended by the Who’s Who of Wall Street and the Feds, they tried to come up with a solution to save Lehman Brothers. On Friday, Secretary of the Treasury Henry Paulson said there would be no government money as with Bear Stearns. Despite the markets negative reaction to this news it appears that he has stuck to his guns, and without government backing the potential buyers of Lehman (Barclays & Bank of America) walked away leaving Lehman with almost no other choice than bankruptcy. This clearly has the potential to be a nuclear bomb for the world financial markets. The sheer magnitude of the potential ramifications has everyone scrambling to help facilitate an orderly market tomorrow morning. The International Swaps Market held a special “netting” trading session today so firms could zero or net out swap transactions that they had with Lehman. The Fed is expanding the quality of collateral it will take even including equities, banks are reportedly pooling up to $70 Billion to lend to troubled firms, and it is being reported that the Fed ‘forced’ Merrill to sell to Bank of America. Yes, that has become a done deal since it was mentioned a few sentences ago. This is an extremely fluid situation with many players, AIG is said to have turned to the Fed for help, rather than give itself over to private equity.

So what does all this mean? To say this is unprecedented is an understatement of proportion that rivals the crisis itself. The market reaction is decidedly negative right now, but that is partly due to the tremendous uncertainty that is still out there. The entire system has been shaken and tomorrow morning we will begin a new era. There will only be two independent investment banks, the government will have participated in the public market system in ways that were almost unimaginable a few years ago, and how Wall Street operates will forever be changed. I don’t know what will happen tomorrow, but my guess is that after tremendous chaos in the morning, the markets will most likely stabilize in the afternoon. By stabilize I certainly don’t mean recover, but even in severe downslides they need to be orderly in order to prevent panic. In the long run this will be good for the markets. I know it seems that is what I always say, but 2+2=4 no matter how many times you compute it.

The Morning After

Monday, September 15, 2008 (11:38 AM): The reaction to this weekends historic events has been dare I say relatively organized. It may be tough to be positive on such a gloomy day, but I’ll give it a shot. The bottom line is the financial system is NOT going to collapse, period end of story. There are going to be casualties, there always are. The investment banking industry will not be your father’s investment banking industry, but it will exist. We must remember that the core of the financial system is the deposit institution. Mr. and Mrs. Smith put their money in the bank, and the bank loans that money to Mr. Jones to buy a house start a business or whatever. The system got greedy and over extended itself and those that were the greediest are suffering the consequences. What we must remember is Mr. and Mrs. Smith still have money to put in banks and Mr. Jones still wants to borrow. Of course there is fear of bank failure and credit standards are going to get tighter, but the fundamentals of the system remain and therefore the system will survive, the markets will survive and yes, we too will all survive. You can see the evidence of this in the relative strength of deposit banks like Northern Trust, JP Morgan, Wells Fargo, etc. The institutions that stayed true to this core business model are weathering the storm. Like these institutions, we stay true to our core business (asset allocation) and we also will weather the storm.

Brad Reynolds, CFA

PS from Leon (September 15, 2008: (1:16PM): This crisis has had me look seriously at Schwab and Fidelity. I spent a pretty good amount of time on Friday talking to Schwab folk about their situation. Fortunately, Schwab isn’t in the investment banking business or involved in this sub-prime debacle. In addition, Schwab currently has a zero default rate on home mortgages (which is no surprise since you have to have a significant Schwab account to even get a Schwab mortgage). In addition, Schwab has very nice positive cash flow and lots of insurance: $21 million per account SIPC, and a $600 million dollar Lloyds policy. For now, I’m satisfied with Schwab’s safety (note I said ‘for now’). In the meantime, I’m with Brad: stick to the basics; eventually, I don’t know when, the storm will pass.

5 Reasons to Roll Out of TESPHE… and 1 Reason to Stay

2008-09-11T05:11:00.000-07:00

The Tax-Efficient Savings Plan for Hourly Employees (and the salaried sister plan the SSIP), is a remarkable financial planning tool for wealth accumulation. No other tool allows the ease and expanse of tax-deferred accumulation as a 401(k) program like TESPHE and the SSIP. However, once you retire, we frequently advise considering a rollover to an IRA. You can make a tax-free transfer (make sure you do a direct rollover) from TESPHE (SSIP) to an IRA. Here are some pros and cons.

Reasons Why an IRA is Better than TESPHE:

1. IRAs have much broader investment choices. In your TESPHE/SSIP, you have a limited number of investment choices with a pretty good range of asset classes, but still limited. In an IRA, you have virtually unlimited choices. Want to buy a mutual fund that covers India? Buy some GE stock? An ETF? You can do it in an IRA. You can even buy investment real estate in an IRA, though we don’t recommend it. Our approach to IRA investing is to create an optimum mix of asset classes and then find the best funds in each asset class. Of course, we use no-load funds. Does a bigger choice of ingredients make a difference? Here is an example: In the TESPHE/SSIP, we feel international investments are very important. The normal choice for international equities is Fidelity Overseas. According to Morningstar®, Overseas had a 10-year rate of return of 5.38%, putting it in the 33rd percentile rank in its category. The Large International fund we use had a 10 year rate of return of 12.37%, with a rank in the 2nd percentile. Over ten years, Overseas would have made $6,888 from a $10,000 investment. The other fund would have made $22,100. Returns matter, and more choices are better.

2. IRAs have better non-spouse beneficiary options. If your primary beneficiary is your spouse, TESPHE/SSIP and IRAs are virtually the same; your spouse can roll it over to their own IRA. If you have non-spouse beneficiaries (like your kids), the process can become considerably more complex in a TESPHE/SSIP. With an IRA, you can ‘stretch’ the IRA to be paid out over their lifetimes (this stuff is different if you’re over 70 ½, but you’re probably not there yet). The ‘stretch’ minimizes the tax bite to the kids and allows them to have a nice retirement income of their own. Be careful with any beneficiary designation. We like to carefully craft the right designations for minimizing taxes, and assure your beneficiaries don’t get overlooked.

3. In an IRA, you can buy or sell any stock at any time of the day. We don’t like day trading, in fact we discourage it. But a nice feature of an IRA is that you can buy or sell a stock (or bond, for that matter) at any time during the trading day. In the TESPHE/SSIP, the Ford stock is actually a ‘Ford Stock Fund’, which allows you only to trade at the close of the day. With an IRA, you can sell Ford stock at any time of the day. In an IRA, it doesn’t have to be just Ford either; you can buy or sell any stocks, bonds or ETFs.

4. You can link an IRA to a bank account. Sooner or later, you will withdraw from your retirement savings. An IRA allows you to ‘link’ your IRA to your checking or saving account. For most of our retirees, we set up a monthly link to deposit the money right in their account without a check that could be lost or stolen. Most of the time we take the taxes out up front, so the retiree doesn’t have to worry about those either. A word of caution: be careful about how much you take out. We strongly suggest avoiding over-withdrawing (like more than 5% a year or so). In these troubling times, try to preserve your principal. Don’t eat your seed corn.

5. You can get money out of an IRA before age 59 ½ using a 72(t) loophole. Normally, you can make any type of withdrawal from an IRA after age 59 ½. If you take money from an IRA before 59 ½, you may be subject to a 10% penalty. There’s a special tax loophole for early IRA withdrawals called 72(t). 72(t) allows you to take money out of an IRA at any age. You have to take substantially equal withdrawals and they have to be computed under a set of rules. In addition you can’t change the withdrawal stream once you start it until the later of age 59 ½ or five years. But, this allows even a 49 year old to make some regular withdrawals from an IRA. How much? Say you’ve been at Ford for 30 years and you’ve accumulated $140,000 in TESPHE. You take the $50,000 buy-out and wisely roll it over into TESPHE, bringing your balance up to $190,000. Say you’re 50, so there’s not a penalty-free way to take your money out of TESPHE directly. You can roll over the $190,000 and start taking distributions. Using the rates and numbers for September, 2008, you could take $10,484 a year (or $874 a month) without penalty until 59 ½. More good news? If you made 7 ½ % on your IRA and took out the $10,484 a year, you’d have about $243,000 by age 59 ½. Take money out and grow the nest egg. Good idea. [Note: 72(t) has some complexities. We recommend you call us or your tax advisor before you make a 72(t) election.]

A Reason Why TESPHE is Better than an IRA:

1. You can take flexible withdrawals at age 55 or older. One good feature of leaving money with TESPHE/SSIP is that you can make penalty-free withdrawals from TESPHE (they are still taxable, just not subject to penalty) if you separate from service in the year you attain age 55 or older. This allows you to use TESPHE/SSIP for recurring withdrawals or a one-time penalty-free withdrawal. The rule is that the withdrawal must be made after you separate from service and have attained the age of 55. You can actually be 54 at the time of the withdrawal. Leon’s birthday is in December, but as long as he separated from Ford and made the withdrawal in the year he attained 55, no penalty. We sometimes recommend to retirees to leave some money in TESPHE/SSIP and do a partial withdrawal to maximize this provision.

If you’re interested in help with your IRA rollover, or have retirement or financial planning issues, LJPR is an independent, fee-only advisor that specializes in Ford retirements. Our staff includes experts in law, accounting, investment and financial planning. To schedule a complementary consultation, call 248-641-7400 or check out our website at http://www.LJPR.com.

Note: The forgoing information is provided by LJPR, LLC and represents the sole opinions of the authors. LJPR is an independent firm and does not work for, nor provide the official position of Ford, the UAW, or Fidelity Investments. The comparison in item 1 is a comparison of Fidelity Overseas mutual fund versus Julius Baer International (Load-Waived A share) as provided by Morningstar®, Inc. as of July 29, 2008. All information and tax rules are as of the beginning of September 2008.

©2008 LJPR, LLC. All rights reserved.

Leon says...Free Money In Your Tax Return

2008-09-10T07:38:00.000-07:00

Listen to: Leon says...Free Money In Your Tax Return

Description: Leon talks about income tax refunds and why you do NOT want one. Think of it as an interest free loan to the government funded by you. If you want to save money and have it taken out of your paycheck look into other investment options.

10 Things to Consider in the Ford Buyouts

2008-09-05T05:23:00.000-07:00

LJPR is a fee-only advisory firm that specializes in the financial, tax and estate planning needs of retirees. Among our expertise is the Ford system. Our advisors wrote the UAW-Ford FEIP and FEIP-II programs, provided the salaried employees with financial education and pre-retirement planning programs and the UAW-Ford members with a ‘Work or Retire’ video program to assist potential retirees with their decisions. We’re independent, we don’t work for Ford and we don’t work for the UAW and we don’t work for Fidelity. We work for our clients: you.

The following is list of items we like to cover with pre-retirees.

1. Define Your Decision. The first thing we tell people is to look at the decision. First of all, the decision is not Work or Retire (even though that’s what we named our program), but rather ‘Work at Ford’ or ‘Don’t Work at Ford’. There are no restrictions on what you can or can’t do. You can go the conventional retirement route, or you can work elsewhere, or take classes, or play golf or whatever. So the first range is to get the frame of reference into “Work Here” or “Don’t”. The second part of this decision is to understand that you will retire someday (either on your feet or otherwise). The next wave of your question should be “Do I Retire Now?” or “Do I Retire Later?” Here’s where you have to take a hard look at the offer and what it entails. Maybe I was going to retire in a couple of years. A $50,000 (or $70,000) lump sum could really make me reconsider. So the questions you should be asking yourself are “Do I Want to Work at Ford Now?” or “Do I Want to do Something Else Now?”. Then you can add in the money to see if it’s worth it to you.

2. Look at the Bottom Line. Our managing partner likes to say “It’s not how much you make…its how much you keep!” When you take a hard look at a retirement decision from Ford, you have to look at the bottom line. For assembly workers, you’re generally looking at gross pay without overtime (which is how you should look at it: overtime is certainly not guaranteed!) of about $5,051 more a month. Your retirement income, if you have 30 years or more and are under age 62, is $3,140 a month. At first, this looks like a big difference, about $1,911 bucks. But, its not how much you make, its how much you keep. From your paycheck, you pay federal taxes, Michigan taxes (maybe City taxes too), Social Security taxes, Medicare taxes, TESPHE contributions, Union dues, and other job related expenses (like driving to and from work and so on). From your pension check, you still pay federal taxes, but NO Michigan taxes, NO Social Security taxes, NO Medicare Taxes, NO TESPHE contributions and NO job-related expenses (by the way, we think the retiree union dues are absolutely worth it, so you do have about $2 of union dues to have an organization bargaining for your pension and health care). Your bottom line might be that there’s only about a $378 a month difference between working at Ford now and not. So you may be working for Ford for $2.18 an hour. Your mileage may vary, but look at the bottom line for you.

3. Don’t Forget about What Happens to the Pension at age 62 and 1 month (or the 80% level in this Contract). The UAW-Ford pension is a very good pension. If you retiree before you’re eligible for Social Security, you can get a supplement. If you have 30 or more years of service, this supplement is an amount that can reasonably replace your Social Security benefit. The supplement currently drops off when you become eligible for 80% of your Social Security. What you need to know is a couple of things. First, your Social Security is calculated based on the highest 30 out of 35 years before you collect benefits, not on your highest 30 years. If you retired at age 49, you wouldn’t be eligible to collect Social Security until you were age 62 and 1 month (which would be reduced to about 75% of your Normal Benefit). If you didn’t work from 49 to 62, you’d have 13 years of zero earnings in the calculation of your Social Security benefits. Social Security will throw out five years, so you’d have your benefits reduced, and then reduced again by 25% (for retiring at 62). This can be a significant problem, you could have a pay cut when you hit 62. So, if you’re retiring before the age of 57 (62 minus 5 years), consider working or seeing someone who knows this stuff to give you some advice on keeping your Social Security benefit healthy. The second thing you need to know is that Social Security (at least for now) is not fully taxable. Social Security benefits can be tax-free, or partially taxed at 50% with a maximum of 85%. The added tax gain is useful in your future plans.

4. Keep TESPHE/SSIP in the Decision. TESPHE (the Tax-Efficient Saving Plan for Hourly Employees) and SSIP (the Saving Stock Investment Plan for salaried employees) are tremendous wealth accumulation tools. TESPHE/SSIP provide an opportunity to defer income into an investment account, further defer income taxes on the contributions and the investment return, and then withdraw the funds later at a tax advantaged rate. In the current round of buyouts, you can take the lump sum of $50,000 or $70,000 and transfer it tax-deferred to TEPSHE without any current taxes. TESPHE/SSIP (and 401(k) plans in general) have a variety of complexities, including:

a. Taxes. The tax rules on TESPHE distributions relate to your age. There’s one set of rules if you are under 59 ½ and another if you are over. Over 59 ½, you pay taxes on what you take out. When you reach 70 ½ you HAVE to begin withdrawals, or face a stiff penalty. If you’re under 59 ½, you may take funds out without penalties through an IRA (called an IRA rollover and a loophole called 72(t)) or through TESPHE directly if you are at least age 55 or older when you separate from service.

b. Capital preservation. These are trying times (we suppose all times are trying times). In these times, we’re advising you keep as much in your TESPHE/SSIP as possible. Either don’t start withdrawals and retain TESPHE/SSIP as a nest egg, whether within TESPHE or maybe better, in an IRA; or take small enough withdrawals to never use up the TEPSHE/SSIP balance. Preservation of principal, plus preservation of inflation purchasing power. That’s our motto for TESPHE/SSIP.

c. Beneficiaries. Taxes aside, you can structure your 401(k)/IRA into a tax treat or a tax nightmare for your beneficiaries. There are a wide variety of considerations for picking your beneficiaries. For most people with a spouse and kids they name their spouse primary beneficiary and the kids as secondary (word it correctly!). The beneficiaries can stretch the tax over many, many years, giving more money to your family, and not the IRS.

d. Investing. TESPHE/SSIP is retirement money, not gambling money. Retirement money should follow established principles of investing, like diversification (don’t put all your eggs in one basket), fee management (look for no-or low-load investments) and asset allocation (having a variety of types of investments). You should have your retirement nest egg in a moderate global portfolio to minimize your risk, and to maximize the one thing we see as certain: the growth of the world.

We wrote another piece (and blog) called ‘Five Reasons to Roll Out of TESPHE…and One Reason to Stay’. Grab a copy, or go to http://www.LJPR.com to get a copy.

5. Gain perspective on the buyouts. We’ve been to many plants talking to many prospective retirees. To us, the $50,000 (or $70,000), or any of the other varieties of enhancements are significant enough to at least get a piece of paper and a calculator out to look at the situation. Among a variety of other issues, we see two big ones: First, how long would it take you to save $50,000? If you were making $50,000 a year and saved 10% of your pay in TESPHE, it would take ten years to get gross contributions into your account. The second consideration, and it’s a touchy one is this: Once you retire, you’re being paid by a 95% funded, federally insured (fully insured for the age 65 benefit) pension plan. If you stay, your paycheck comes from a domestic auto company with a significant debt load, ferocious competition, and an unstable oil market. Will your pension still be there later? We’re pretty certain of it. Will the buyouts be there later? Who knows?

6. Watch out for the Social Security Disability Trap. Besides the retirement trap we mentioned above in item 3 (the 30/35 rule), it’s important to note that you are not eligible to receive Social Security disability benefits if you do not have covered earnings in 5 out of the ten years prior to disability. This mean that if you retire at age 53, and don’t work anywhere to get Social Security coverage, and become disabled at age 59, you will not receive disability benefits (regardless of how many other years you paid in. It doesn’t take a lot to stay in the system (it actually is a little over $2,000), but it’s worth having some earnings to not only buff up your retirement benefit, but also to keep your disability benefits. Go paint houses with your brother in law or work at the golf course (‘move along please’) or sell sporting goods. Do something fun, make some money, keep some money.

7. Watch out for the Social Security Earnings Trap. Since we’re on traps, there’s another one you should know about. Once you retire from Ford, you can pretty much make as much as you want and your pension still comes in. However, once you start collecting Social Security, there is an earning limitation that can reduce or eliminate your Social Security benefits. If you work (or have earned income) between the ages of 62 and your Normal Retirement age, your Social Security benefit will be reduced for every dollar you earn above $13,560 (for 2008: it changes every year) by 50%. In other words, earn $2, lose $1 of benefits. Watch out when working past 62. Once you reach age 65 there is no reduction.

8. This is a timing decision. When we’re faced with advising on what to do in a financial decision, our recommendations always start or end with “this is based on what the deal is now”. A lot of Ford employees are thinking they may wait for a better deal, or better circumstance, or until they have more money. There are three scenarios we see: the good the bad and the ugly (cue some Clint Eastwood music). Under the ‘Good’ scenario (which is what we hope for), Ford regains some market share, transfers production, sell cars, keeps people employed and America stays healthy in the car business. Under this arrangement, no more buyouts (good!). Under the ‘Bad’ scenario, Ford continues to struggle, has problems in the credit market, oil prices stay unstable and Ford suffers. The credit markets have stretched Ford pretty far, but under this scenario, Ford may continue to offer buyouts. Under the ‘Ugly’ scenario, Ford doesn’t survive at all under its current status, either seeking court protection, or a buyer or merger. Under this unpleasant option, we would see no buyouts (for example, when Kmart went out, the buyout was two weeks pay). Analyze your situation based on what’s in hand.

9. Watch your common sense. If you take a buyout or don’t take a buyout, you still should be concerned with your money. Get a Will; get a good Financial Durable Power of Attorney and Health Care Power of Attorney (even think about a trust). Set up and follow a budget. Save some extra money, either in TESPHE or in a Roth IRA. Stash some money away for the kids in a good §529 plan (like the MESP). Pay off high interest credit cards. Save some money, you can never have too much!

10. Get help if you need it. You are going to retire once from Ford. If you need help in this decision, consult an advisor. We think we’re the top advisors on these buyouts for this decision (especially in Michigan). First seek out someone competent in tax issues. Make sure they understand the Ford benefits. Be sure they have the interaction of Social Security. Look for someone who can advise on investments and withdrawals. And most important, look for someone unbiased. Your advisor should work for you, not for a brokerage house or an insurance company or a bank or anyone other than you. You’re the end result and this is your decision. Good luck!

Note: The forgoing information is provided by LJPR, LLC and represents the sole opinions of the authors. LJPR is an independent firm and does not work for, nor provide the official position of Ford, the UAW, or Fidelity Investments. All information and tax rules are as of the beginning of September 2008.

©2008 LJPR, LLC. All rights reserved.

10 (OK, 11) Things Every Fire Fighter Should Know About Money

2008-09-04T10:28:00.000-07:00

Here are the slides from Leon LaBrecque's presentation to the Southfield Firefighters Association on September 3, 2008.

10 (OK, 11) Things Every Fire Fighter Should Know About Money

An video version of this presentation will be available shortly.

Leon says...Credit Card Protection

2008-09-02T07:36:00.000-07:00

Listen to: Leon says...Credit Card Protection

Description: A simple and effective way to protect yourself just in case your credit cards are lost or stolen.

Mutual Funds

2008-09-01T09:00:00.000-07:00

10 (OK, 11) Things Every Cop Should Know About Money

2008-08-30T10:37:00.000-07:00

Here are the slides from Leon LaBrecque's presentation to the Police Officers Labor Council on August 29, 2008.

10 (OK, 11) Things Every Cop Should Know About Money

An video version of this presentation will be available shortly.

Ford Work or Retire

2008-08-19T07:00:00.000-07:00

This video covers the topic of Working vs. Retiring and which option is best for you. Leon steps through various scenarios to show how much money you may actually save by deciding to retire.

Leon says...Brown Water

2008-08-05T07:30:00.000-07:00

Listen to: Leon says...Brown Water

Description:Leon LaBrecque talks about being attentive to where you are spending your money. He gives the example of spending over $165/month on everyday beverages such as coffee and pop.

Is There a Ford in Our Future?

2008-08-05T06:56:00.001-07:00

It’s interesting times (darn Chinese curse!) for the US car business. The world’s third largest automaker is now…VW! VW sold 3.31 million cars in the first half of 2008, while Ford sold 3.09 million. Ford’s US sales are down 14% for the first half of 2008, but worse, truck sales are down 36% (and probably more). For July 2008, Ford’s sales were down 15%. It would be about the equivalent of a couple making $100,000 a year suddenly making $85,000, but still having car payments, house payments, medical bills, kids, and so on. The auto industry’s annualized selling rate for July was 12.5 million cars and light trucks, the lowest since March 1993. Full-year sales in 2007 were 16.1 million. The industry is in trouble. So the question on my mind is: what’s going to happen next?

For Ford (I’ll talk about the other car companies in a minute), what I see is a glimmer of hope in a sea of darkness. The basic fact is that Ford is bleeding in North America. As most readers know, I feel that North Americans (what the heck, let’s indict the Canadians as well) have been drunk on oil and profligate with energy use. We figured it out for a while, and then my 105 pound petite wife decided she needs to drive a Yukon XL, along with a myriad of other moms. (Don’t get me wrong, I drive a GMC Sierra pick-up, so I’m equally part of the problem). We guzzled oil at a rate almost twice other countries. Now, oil speculation did what no president or elected official had the mettle to do (insert alternate adjective of your choice). Suddenly, everyone has oil prices on their mind, and the Truck/SUV business is in a ‘loop’. Oil prices rise, causing consumers to look at smaller cars. Pick-up and SUV sales fall. Trade in values on SUV’s and pickups fall (26% decline in trade in on full size pickups in one year 5/07-5/08), causing sales of pick-ups and SUVs to fall more, which causes used prices to fall more, etc.

The loop is ugly, and Ford (or anyone else) can’t escape the loop easily. If you go on the Detroit River, you’ll see the big lake freighters heading down the river. If a loaded freighter encounters a problem, like a wreck by the Ambassador Bridge, the captain can reverse the engines, kicking two 16 cylinder engines generating 19,500 horsepower to work. And the 78,000 tons will stop…in two miles. Ford has to get out of the loop and stop the freighter, but in much less than two miles. Ford’s approach is an unprecedented gambit to switch a Truck Plant into a car plant, fast. If they pull it off, the freighter might dodge the crash.

What could you switch to? How about a Ford Fiesta, which in the ECOnetic gets a mere 63.6mph/city or 73.5mph highway. 0-100kph in 12 seconds, top speed 111mph. Or a Mondeo (go see the James Bond flick) that gets 28/48 mpg and looks very cool (I’ll take the Titanium). Or the one that has baffled me, the European Ford Focus, which is an awesome fast car that gets combined gas (diesel) mileage of 42mpg. I love the idea of great fuel efficient cars, why do we have to be on our deathbed to get them?

So my bottom line is this: Ford makes money in Europe and makes great cars. If Ford can switch to European style cars here, it might just be the ticket. IF they can switch before they run out of money and time.

What about the other two of the formerly Big Three? (Or as I’m starting to think, the Little Two, or the Little One?) I’m starting to think GM now stands for “Giant Mess”. GM needs about $10B in cash and is possibly negotiating with the UAW to borrow $8B from the Union’s VEBA (now there’s an interesting twist!) If the VEBA can strike a deal with GM, it will allow the car company some breathing room. Until then, Wall Street is making Wagoner dance and sing about how GM is not going bankrupt. On August 1, GM announced a quarterly loss of 15.5 Billion dollars (the 3rd worst qtr in the companies history), a 26% decline in July sales, and is further offering pension buyout packages to salaried workers (my intelligence on the package suggests that it’s a very good deal and most eligible with 30 years or more should take it). Take that onto the 53,000 hourly workers that have left and you will have a lot smaller car business (The Little Three have cut 150,000 jobs since 2005). On the other hand, GM has a profitable business overseas (same North American Malaise as Ford), and is hanging a lot on the Chevy Volt. The Volt is a unique EREV (Extended Range Electric Vehicle) that allows you to drive up to 40 miles a day with NO GAS. The Volt has a supplemental motor, but doesn’t work like other hybrids. If you drive less than 40 miles, you get infinite gas mileage. GM has some dandy overseas vehicles with good mileage figures as well. The GM North American question, like the Ford North American question is can they re-tool and move the freighter before it hits the bridge? All this while the clock ticks…

And then there’s Chrysler. Chrysler’s July sales fell 29% and recently announced it will no longer lease cars. In my humble opine, this is very bad news. Car manufacturers have used leasing as way to move cars by modifying the residual values. Without Chrysler Financial, buyers will have to lease through banks or other finance arms. It is unlikely that banks will utilize the same residuals, so lease deals will vary from place to place and dealer to dealer. Chrysler is owned by Cerberus, a private equity firm. Cerberus has had its hands full with GMAC announcing a $2B loss (Cerberus owns 52% of GMAC). GMAC, by the way, announced it was no longer leasing in Canada. I’m thinking it’s highly likely that Chrysler will be sold, or more strangely, is already sold. Cerberus bought Chrysler (and GMAC) with a ‘bundle’ of 90 other investors. The wild thing about private equity is that they don’t have to disclose who the investors are. So, Cerberus can create a private equity pool (e.g. ‘Cerberus Pool X’) and spin investments (like perhaps Chrysler and GMAC, and maybe Tower) and have the investors own the pool. Who are the investors? They could be Renault or Tata, or private investors. It could be stranger partners. The Chinese government (unlike the US, the Chinese actually have$66B in their Social Security fund) owns an 8% stake in Blackstone. Private equity makes for strange bedfellows: The Carlyle Group has investors that include the United Arab Emirates, Osama Bin Laden’s brother, George H. Bush, and the government of Dubai.

My bottom line: Oil prices dropping is good (see my previous blog on Wyoming wheat and Canadian Crude). GM borrowing from the VEBA is good. Ford being able to pull off the retool from trucks to cars is good. Buyouts of salaried retirees is good. Chrysler? My mom always told me if I didn’t have anything good to say, don’t say anything.
Regards,

Leon LaBrecque

Stocks

2008-08-01T07:52:00.000-07:00

Time Management

2008-07-26T07:31:00.000-07:00

Taxes

2008-07-21T06:34:00.000-07:00

Leon says...An Umbrella You Might Need

2008-07-16T11:45:00.000-07:00

Listen to: Leon says...An Umbrella You Might Need

Description: Leon LaBrecque discusses the importance of an umbrella insurance policy and how it can help protect you.

Chaos in the market: Our analyst’s viewpoint on the current turmoil

2008-07-16T07:38:00.000-07:00

Apparently, the markets are attempting to prepare me for the upcoming birth of my first child, giving me many sleepless nights. It would be extremely naïve, if not downright ignorant, not to be concerned with the state of things. Oil is near 150.00 a barrel, housing prices continue to fall it seems with no foreseeable bottom in sight, Indy Mac Bank being taken over by the government, and people even casting aspersions on the viability of the GSE’s (Fannie Mae and Freddie Mac). Every one of these is worrisome, some very much so, but let me try to give a little perspective and maybe a more positive analysis.

Let me start by saying, I am in no way an expert on Oil, or an Oil analyst, and I’ll be honest I’m not sure even Oil experts could give a plausible explanation for the severe run up in price. Of course on a base level it is extremely simple, more buyers than sellers. Now are there more buyers because global demand has increased (domestic demand is dropping); there are more speculators; China is consuming more; all of which I have heard, in addition to countless more explanations. It is my belief that oil at these levels is overpriced, taking into account demand, supply, alternatives, the dollar, geopolitical risk, and a myriad of other factors. As far as a target price goes, those “are like opinions” and we all know that saying, but seeing as how everybody does have one I throw a dart and say mine is $85.00 a barrel 18-24 months out. Unfortunately, you will see $175.00 before that. Why? Because bubbles (yeah I said it) always last way longer than anyone expects, and people believe the price will go there (NASDAQ 5000????). Oil will come down in price, we will adjust to consuming less of it, and companies and the markets will “get over it”.

Housing is a little different, but much much simpler. A piece of dirt on this planet is worth money. Throw some bricks, lumber, and glass on it and its worth a little more. Is it worth 20% more than you paid for it? Is it worth 20% LESS, who knows? Residential real estate has a very emotional component to it. It is one of the only investments that I can think of that people utterly refuse believe is worth less than they paid for it. We got away from the “your house is your home” mentality in this country and went to the "my house is my biggest investment and my piggy bank." Housing will bottom when people realize they aren’t necessarily entitled to a 20% annual return on a house. I know there are mortgages, debts, etc and it will be extremely painful, but unfortunately its stage that needs to be gone thru.

The GSEs. Hmmmmmmm. Government Sponsored Entity. The only way these agencies have been able to operate and fulfill there mandate is/was the implicit backing of the US Government. Without it they would be just like any other mortgage company, and at the size they are probably would have a bleak future. The Chicken Littles, Short Sellers, and all around Negative Nancys can point out all they want that it’s an implicit not EXPLICIT Gvt guarantee. So as we have seen from the rather unusual (like there hasn’t been a Sunday treasury announcement since Eisenhower was president!) Sunday statement from the Treasury Secretary, Uncle Sam will make sure its kids continue to operate.

You may think I’m insane, but the most positive news to me this weekend was the Government takeover of Indy Mac Bank. What?!!!!!! Let me explain. We have seen this situation before (S&L crisis), and we built a system to deal with it. THE SYSTEM WORKED. The Office of Thrift Supervision came in, took over and is now cleaning it up. It’s terrible if a person had more than 100,000 dollars in the bank, no system is perfect and can guarantee against all lose. If a building catches fire and the sprinkler systems goes off and contains the fire, there is always damage, when the system works the damage is minimized. In this case the system worked, we know it still works after all these years and can move on. Imagine if it didn’t, Yikes!

All that verbiage may not make you feel any better, maybe nothing will; but I’ve been doing this a long time, and studying it even longer. The one thing I can say with 100% certainty is our investment philosophy works. If you invested $100,000 in the S&P 500 on September 30, 1973, on June 30, 2008 it was worth……..$3,565,612, an average annual return of 10.83%. That return includes the Crash of 1987, the recession of the 70’s the tech bubble, 09/11, and you name it. Although that result may not meet everyone’s return expectations, I dare say the majority of investors would be very happy with it.

Guess how much that same $100,000 was worth on September 30, 1974?...$61,007.00. A -38.99% annual return. How about September 30, 1975?...$84,266.00. Two years later you were still down 15.73%. My point is (as it always is) we invest for the long term. Short term market moves can be extremely distasteful, they can make you want to run and hide under your bed (or at least put your money there). But we will continue to look long term and stay the course. Regards.

Brad Reynolds, CFA

Leon says...A Free Health Club that Pays You

2008-07-15T11:00:00.000-07:00

Listen to: Leon says...A Free Health Club that Pays You

Description: Leon LaBrecque discusses how buying a new pair of walking shoes can save you money and have you feeling better.

IRA Rollovers

2008-07-09T07:55:00.000-07:00

Getting Organized

2008-07-01T07:09:00.000-07:00

Auto Insurance

2008-07-01T06:11:00.000-07:00

Fox 2 Detroit - Lunch Money with Murray Feldman

2008-06-24T11:49:00.000-07:00

Air Date: 6-11-08

Part 1
TRT: 20 minutes

Part 2
TRT: 20 minutes

Part 3
TRT: 20 minutes

Wyoming Wheat and Canadian Crude: The Myth of the Straight Line

2008-06-17T11:15:00.000-07:00

I went out to Wyoming a couple of weeks ago for an annual trip to a modest (140,000 acre) ranch to do a little shooting and have some fun. Wyoming is a very cool place: there are more pronghorn antelope than people, there’s no income tax and everything is far away (like the beer store is 46 miles from the bunkhouse). Every other time I’ve been, you could have an official Wyoming coloring book with two colors: blight blue for the sky and brown for the ground. This time it was quite a bit different. First, they had some massive spring rains, which made everything lush and green. It looked like Nebraska. The second thing was more impressive. On all my former trips, the terrain was sagebrush and pasture. Now for miles and miles, there were wheat fields.

I asked the ranch manager (manager is a stretch, think head cowboy) what was up. In normal Wyoming cowboy fashion he looked at me and said: “I’d think you’d get this: Wheat’s up, so we make more money on wheat than on grazing land. With corn through the roof, everybody has been planting corn instead of wheat. Corn don’t grow good here, but wheat does. So, we like to make money.” Well you can go to the University of Illinois and get historical agriculture price (what a surprise!). And wheat prices stumbled around $1.80-$1.25 until a little tiny energy crunch in about 1973, then wheat went up 300%. No surprise here, oil is up, fertilizer is up, fuel is up, hence wheat is up. Wheat dropped back to about $2 a bushel, then took a run again in 1981, this time about a 250% increase (again oil prices up). Run out to about 1996, another run, and now 2008, where wheat went from $2.93 a bushel in spring of 2005, to about $24 a bushel in February of 2008 (at the time of this blog, wheat is back down to about $9.25 a bushel, still historically high).

Now wheat and corn and any growing crop is subject to vagaries of weather, government subsidies and a whole range of external factors. But the plain truth is as Joel the cowboy put it: ‘If we can make money on it, we’ll find some way to get it.’ This subtle nuance is the foundation of economics for 20,000 years. If you can make money on something, whether a commodity, real estate, or whatever; capital and resources will be drawn to it, and eventually, the price will decrease when demand and supply stabilize (Sorry for the painful reminder of economics class).
Take oil (please). Oil prices are through the roof, today the futures are over $140 a barrel. In 1955 (a very good year), crude was $2.93 a barrel ($23.47 in inflation-adjusted terms). In 1972, crude was $3.60 (only $20.48 in inflation-adjusted terms), and I was driving a 1955 Buick Roadmaster that was big enough to take me and about 6 friends out on the town. By 1975, crude had surged to $12.21, almost tripled, and by 1981, Crude was $35.75, or dectuple the price nine years earlier. (Actually 1980 wins for high inflation adjusted price). By 1998, crude had dropped back down to $11.91 a barrel, ($15.70 inflation adjusted, or cheaper than any previous year since 1946!)

So the chart shows the ugly truth that oil is at an all-time high and the price is way up. Heck it looks like 1977 all over again. But then I like to look at what happened after 1977. After 1977, the price dropped, and dropped and dropped. Why? I can think of a whole bunch of reasons, but two come to mind as possible (and one of them was not the ‘Windfall Oil Profits Tax of 1976’). I think the price came down because we cut back on our consumption (decreased demand) and went out and found more (increased supply). On consumption, have a look at the table below. It shows that 1973 started a decline in consumption, which then went up through about 1979 (when our gas guzzler wore out and we bought Pintos) and consumption dropped from a high of about 21 million barrels a day in 1978 down to about 15 million barrels a day in 1983. A 6 million barrel a day drop in consumption is significant: That’s 150% of Iran’s daily production, or one-fifth of OPEC’s production, or 240% of Venezuela’s production. If we used oil at the rate we did in 1983, we could tell Iran and Venezuela to kiss off (a concept I like to envision). It’s not a hard concept: gas is expensive: drive less and find alternate means of energy usage.

The consumption chart is part of ‘the Myth of the Straight Line’. Someone, usually a journalist, takes a chart like the one above and looks at 1991 to 2007, and draws a straight line through the middle (If they took statistics, they use something called the ‘least mean square’ method which draws an accurate straight line through the middle.) Oil consumption is going up, the Chinese are using it all, the Indians are using it all and our consumption is continuously rising. Ask Ford how many Expeditions they sold in 2008 so far, or ask GM how many Suburbans. The stark truth is that the US uses more barrels of oil a day than China, Japan, Germany, Russia and India combined. If we had our usage the same as we did in the early 80s, the US would basically be able to have 15.7 million barrels of oil a day from our own production, Canada and Mexico. Imagine the fascinating geopolitical repercussion of North American using only its own oil and no mid-east imports.

The second leg of oil prices is supply. There’s a lot of oil in the world, about 1,200 billion barrels. Some is easy to get, like in Saudi Arabia, or Texas. Some is tougher, like getting oil from coal, or tar sands or oil shale. There are some big reserves, like ANWAR (10.3 billion barrels) or offshore West Africa (100 billion bbl). The notion is that there’s $15/barrel oil and $40/barrel oil. However, at $140/barrel, there’s a lot of oil. Take the country with the world’s second largest oil reserve, Canada (that’s right, Canada has more oil than Iran or Iraq, and more oil than Venezuela, Russia and Nigeria combined). In the Athabasca oil sands, it takes about $30 -$40 a barrel oil price to make oil sand production feasible. With oil prices where they are, Canada has increased investment in oil sand projects by $100 billion. Canada’s production is forecasted to increase through 2020. Another simple indicator is the number of drilling rigs in use. I like to read Barron’s magazine and I always look at the ‘economic barometer’ section where it tells about the week’s numbers on paper usage, gas, timber, housing starts, and number of drilling rigs in use. In 1991, when oil prices were low, it wasn’t surprising that a lot of drilling rigs were sitting dormant. As prices rise, more people look for oil (like Wyoming ranchers planting wheat) and the supply goes up. Here’s chart showing the number of rigs:

Notice anything with the lines? The number of rigs went up dramatically as prices rose in the 70s. Notice that the peak number of rigs was after the peak in prices. And do you notice the number of rigs now? From June of 2007 to June of 2008, the number of oil rigs in the US has gone up 36.5%! Oil exploration and drilling is up, and supply will increase.
The myth of the straight line is that a trend will continue. We’ve seen this countless times, from the notion that Internet stocks would continue to rise through the late 90s, to oil prices in the 70s to real estate in the 2000s. The simple truth is that the laws of economics have an eerie way of righting themselves. Wheat goes up, farmers plant more wheat. Oil goes up, we use less oil and drill for more. My bottom line: this energy crisis will fix itself. Crisis’s always seem to do that.

But I am enthralled with the idea that the US, Canada and Mexico could basically become energy self-sufficient. Have an ethanol cocktail (shaken, not stirred) and drive slow.

Leon

When Someone Dies

2008-06-16T08:14:00.000-07:00

Five Retirement Planning “Tax Tips” to Avoid… like the plague

2008-06-11T06:25:00.000-07:00

1.IRA owned real estate + “sweat equity” = potential IRA disqualification

You’re at a party and are introduced to a “tax planner” who shares the following retirement “tax tip”. Purchase a run-down home (there are lots of them in today’s market) in your IRA. Fix it up, rent it and, when the market turns around, resell it. Right now “cash is king” and the liquidity in your IRA could purchase bargains that will generate big future returns. Like the idea? I did too until I thought about how this strategy could make your IRA implode.

If you, as the IRA owner, personally fix-up and/or manage the property (e.g. soliciting tenants, collecting rents, making repairs, etc.) you risk a possible tax evasion charge! Here’s why. The IRS could determine that the labor contributed by you is an assignment of income. They would argrue that the increase in value due to your labor is really income to you that you’ve “assigned” to the IRA by not charging for your services. So, if the IRS is in an ugly mood, they could claim you should have paid income and self-employment taxes on this value and that the value of your services should be treated as an IRA contribution, which might result in you having made “excess annual contributions” subject to additional income and penalty taxes.

Alternatively, the IRS could argue that your contribution of services is a “prohibited transaction” (as the IRA owner, you are a “disqualified person”) and the furnishing of services by a “disqualified person” can cause your whole IRA account to lose its tax exempt status. Or, if the IRS is in a more benevolent mind-set, they could argue that your IRA was running a home remodeling/rental business and all of the income is currently taxable as UBTI (Unrelated Business Taxable Income).

Don’t worry about all of the above legal “gobble-dee-gook” but to remember, if it sounds too good to be true… ask your tax advisor.

2. “Shifting” business income to your Roth IRA… to make it tax-free

Wouldn’t it be great if you could take an appreciated asset or business and transfer it into your Roth IRA so that the appreciation and income could later be withdrawn tax-free? If this sounds a bit like our prior discussion, then you’re a quick learner. Here’s the parable and, like above, it has a moral.

Some overly-sly taxpayers decided to have their Roth IRAs create a wholly-owned entity (typically an LLC). They then sold property to the LLC at a bargain price with the goal of sheltering future (and even existing) gains and income to the tax-exempt Roth. The IRS has attacked these transactions as disguised contributions, pushing the IRA owner above the annual contribution limits. The moral of our story? It’s OK to sell appreciating property to your Roth but make sure you have a qualified, independent appraisal and be prepared to defend it.

3. Naming a trust as your IRA beneficiary… when you want these funds to be fully accessible to your spouse

Assume you want your retirement benefits to go to your spouse. However, your attorney has just drafted this nifty revocable trust that your dieing (forgive the pun) to use. You notice that your trust creates a “Marital Trust” that your spouse has full access to upon your death. Furthermore, upon the death of your spouse the assets in this Marital Trust go to your kids. “Ahhh”, you think, “This is perfect! I’ll name my trust as the beneficiary of my retirement plans and have them go to my spouse via the Marital Trust it creates.” Sounds great and it works… but at a price.

If your IRA names a trust as its beneficiary, then your surviving spouse must start distributions the year after your death and your spouse must start taking these distributions over a predetermined number of years (the payout period is based upon a single life annuity table that references your spouse’s age). Now that might not sound too bad; however, the result would be better if you named your spouse directly as the beneficiary. If your spouse is the named beneficiary (not the trust), then he/she would not need to start taking IRA distributions until reaching age 70 1⁄2 and the required annual distribution amount uses a different table which allows for smaller annual required distributions. The moral of the story is that naming your trust as the beneficiary of your retirement benefits can make sense but it does have a potential tax cost.

4. Converting a traditional IRA to a Roth… when to doit and when you can’t

Converting a traditional IRA to a Roth before death can reduce estate taxes by removing the income taxes due on the Roth conversion from the taxable estate. (Of course, paying your investment advisor lots and lots of professional fees will also accomplish this goal… but most of us wouldn’t get excited about this “planning strategy”… so what’s the advantage of a Roth conversion?) The advantages are two-fold:

First, you want to consider a Roth Conversion if your estate is taxable. The savings in estate taxes (the estate taxes rate is currently 45%) compensates for the fact that you’re paying the income taxes now.

Second, your life will be simpler as you don’t have to take any distributions from your Roth plus your heirs will receive their distributions income tax-free. (The tax-free aspects of Roths will become more valuable if income tax rates increase… as is probable.)

When shouldn’t you convert to a Roth? Even if you have a taxable estate, you CANNOT convert an inherited IRA to a Roth! That means a nonspouse beneficiary cannot convert an inherited IRA. (There are special rules that allow a spouse to convert an IRA received from their husband our wife if your spouse did not previously inherit this IRA.)

The moral of this story? If you have a taxable estate, consider converting your traditional IRAs to a Roth. You can do this with any IRAs you have created or were inherited from your spouse. However, before making a Roth conversion, talk to your tax advisor as there are income limits that might prohibit your ability to make a Roth conversion.

5. Charitable Bequests from Retirement Assets…let the IRS partially fund your philanthropy

Upon your death, your estate donates $100,000 dollars to your favorite charity, the “Save the Nutria Foundation”. (Nutria are really big water rats that live in Texas swamps.) Your estate is comprised of an IRA worth $200,000 and other assets with a total value of $800,000. If your charitable donation is made from your traditional IRA, the charity will receive the income (tax-free) and your estate and it’s beneficiaries won’t be taxed on this IRA distribution. It’s a double win! In effect, the IRS has funded your donation by not charging you the income taxes that would be due from the IRA distribution. Furthermore, if your estate is large and taxable, you get an estate tax deduction for the full $100,000 contribution.

However, this doesn’t work with charitable bequests from Roth IRAs. Since Roth distributions are income tax-free, you lose the income tax benefit.

Bob Weins

Financial Advisors

2008-06-10T06:53:00.000-07:00

Budgeting

2008-06-08T07:05:00.000-07:00