PASSIVE vs. ACTIVE

We all believe, or want to believe, that we are winners. This mindset can take us far in life, but it is not necessarily how we should approach portfolio management. Of course we want to win in investing, but investors should focus long term, not on the hot stock, sector or asset class of the year. There is a growing realization that actively trading stocks and bonds for short-term gain is a losing bet. We see this in a University of Maryland Study that shows, adjusted for risk, only 0.06% of fund managers beat their index from 1975 to 2007. 1975 is an important year as this is the conception of the Vanguard S&P 500 Index fund.

The buy and hold indexing approach is being fueled by two things: disenchantment with high-cost, under-performing active mutual fund managers; and the migration of brokers from commission firms to fee-only platforms where a fiduciary responsibility forces a better look at active mutual fund management. These issues have increased the use of index funds, specifically exchange traded funds. As plan participants want their 401k accounts to look like their private accounts, ETFs are building momentum to fill this void, especially in small to mid size 401k plans. Plan fiduciaries also realize that adding indexing to active management plan options reduces their liability.

LOW COST INVESTING

If a plan participant can save 1% a year in investment costs on a $20,000 portfolio, over a 20 year period that participant would have 17% more money, not accounting for any performance differences. The benefit of cost savings are more apparent over the last market decade where portfolio rates of return have been nearly flat after the 2000 tech crash, September 11^th and the 2008 financial crisis. The average mutual fund costs 1.15%, where the average iShares ETF costs 0.45%. Core ETFs would be much less.

DIVERSIFICATION

Index funds offer great diversification. IVV or SPY hold all 500 stocks within the S&P 500, where as a similarly styled actively managed mutual fund may hold only 40 – 60 equities, some not even listed on the S&P 500.

ETFs can also provide plan participants access to harder-to-reach asset classes such as emerging market bonds, frontier markets, international bonds or commodities. All of these asset classes can be held at a cost of less than 0.50%.

TRANSPARENCY

Ask any plan participant, or in some cases the plan sponsor, how much their plan costs. This includes the administration and investment fees. Very few will be able to tell you. In 2012 there is new regulation that will help change this, but up until this point transparency has been about as clear as a muddy river. Exchange traded funds provide a daily look into what is held within the portfolio, and management fees are fully disclosed. Add a report showing the participant plan administration fee and you will have a very transparent 401k.

WHO NEEDS ETFs TODAY?

One can argue that large plans have the negotiation power to lower plan participant investment costs. This is true to a certain extent. In some cases a Vanguard Index Tier may be more beneficial to plan participants versus exchange traded funds. The Vanguard Index Tier can drop investments costs below 0.05% if the plan is large enough. Indexing as an option if desired in these plans, whether it is an index mutual fund or exchange traded fund.

The real benefit for ETFs falls in plans with less than $100 million in assets. These 401k plans are currently being serviced by industry leaches such as the Hartford, VALIC, and other annuity-based 401k/403b plans. Participants in these plans can pay nearly 3% annually in fees. Lowering their costs by 2% would be huge.

For some plans that do not offer any form of indexing, often the plan sponsor has allowed the plan provider to offer a brokerage link account. This is where a participant is allowed to move all or a portion of their 401k balance into a brokerage account under the 401k umbrella. Within this account a plan participant can purchase most equities and bonds including index mutual funds and Exchange Traded Funds.

THE BARRIER

An exchange traded fund trades just like a stock, which means that they can be traded intraday with a bid and an ask spread.  A net asset value (NAV) is also calculated; NAV is the value of the underlying securities.  Mutual funds, on the other hand, trade at day end on NAV. There is a good probability that an intraday purchase of an ETF could be made at a value greater than the NAV, which is not a good thing for 401k plans. This issue has been solved by not allowing intraday trading of ETFs inside a 401k. Transactions will take place at the end of the day, just as mutual funds are currently traded. There has been noise that mutual funds have the same NAV issue but at a different level. There is debate that ETFs could, in the end, be traded more efficiently than mutual funds. This is actually good news for proponents of ETFs within 401ks, as just a short time ago this was a case-closed win for mutual funds.

Another barrier for ETFs has been record keeping. Up until recently, accounting systems would only handle mutual funds. Participants can hold fractional shares of a mutual fund. ETFs trade in whole shares. This has changed; through new techniques fractional ETF ownership is possible.

THE PLAYERS

Several companies are offering ETFs within 401k plans. The larger players are ING’s Sharebuilder 401k, Charles Schwab, Invest N Retire, WisdomTree, iShares and TD Ameritrade. All of these companies have invested into architecture that allows for the efficient use of ETFs within a 401k plan.

USERS

Plan sponsors that use ETFs within their plans are innovators, and the organizations understand investing at a level higher than the average sponsor. Case in point: Apple uses all ETFs within its 401k plans. This technology leader is now demonstrating its core value of innovation in its 401k plans as well.  As other CFOs and HR directors learn about indexing and the use of exchange traded funds, the ultimate winners will be plan participants.

IndexUniverse.com recently published a report with all the ETFs that passed through capital gains to their investors. Apparently in 2011 only 93 ETFs made this list. I was very impressed with this report as it is the only one of its kind that I am aware of. You can see the list directly on their site HERE.

The last place that any financial advisor wants to find himself is with a securities attorney. Especially one from the SEC. For this lunch, I found myself sitting with Pat Huddleston, former SEC enforcer, attorney and now author. Joining us was Mike Bishop also an accomplished securities attorney here in Atlanta. Both go after bad financial advisors for a living.

At this lunch, I was sitting with the “good” guys observing the dark side of my industry.  We talked about those terrible variable annuity products. We discussed some of the local ponzi schemes that had taken place over the years. Near the end, Pat and I discussed his book, “The Vigilant Investor.” I have to say that I have met several authors over the years, mostly financial writers, all of whom are very proud of their accomplishments. I found Pat to be humble, intelligent and very determined to help the individual investor protect their investments from fraud. I promised Pat that I would read his book.

Reading the book as a financial advisor has a different feel than a non industry individual reading the book. While my firm would be able to pass Pat’s vigorous “good” advisor criteria, at times I found myself taking notes to help sure up my firms transparency and how we interact with prospects. I understand that clients trust me and that we have safeguards in place to look out for the clients’ best interests. But what if our clients were introduced to any of the smooth talking, real life characters that Pat displays in his book? Certainly their life savings would be gone either by out right theft or a slow death through an annuity. This reality is scary to me.

This book lays out the threats and tells the readers how to look for the signs of trouble. One of my favorite parts of the book is where Pat says he hopes that a broker someday will be able to tell his prospects the unvarnished truth about annuities. He goes on with a script that such an advisor would read. Fees 3% per year, 10 years to get out without a penalty, so the fees will cost you 30%,  if you want a bonus for investing, that’s fine, but the fee will be 4% to cover the cost of the bonus…. Pat acknowledges that this will never happen, but it is still fun to dream.

From my prospective the book is filled with dark stories of greed and deception. Yet it is these stories that investors need to read to understand the reality of what can happen if investors are not vigilant in their search for a financial advisor. The book confirmed why I left AXA Advisors in Atlanta to start my own Fiduciary Fee Only advisory firm over a decade ago. The book also confirmed my dislike of the business model of independent advisors that are also registered as commission brokers. This model defines the term conflict of interest.

You can go with your gut when choosing between steak or chicken. Use knowledge to choose an advisor. This book will help you do that.

http://thevigilantinvestor.com/

What is a Stretch IRA?

A stretch IRA is not officially in the IRS code.  It is a wealth transfer method that allows you to potentially “stretch” and even grow the IRA assets over several generations.  The strategy involves adjusting beneficiary designations to minimize so-called required minimum distributions (RMDs) over a long period of time.

The stretch IRA is not for everyone.  It is most useful for affluent retirees and those who want to leave a financial legacy for their heirs.  It does not work well when distributions need to be higher than the required minimum.  It also is not for the highly undisciplined, as there is no structure that prevents taking more than the required minimum.

The benefit of the stretch IRA is in taking the required minimum distribution and only the required minimum distribution.  Leaving as much money in the IRA as possible allows the bulk of the assets to continue to grow tax-deferred.  Assuming the growth rate is higher than the rate of withdrawal, the IRA balance can actually grow larger over time, perhaps even double, in spite of the withdrawals.

IRA Distributions

It is helpful to review how a traditional IRA normally works.  Contributions and investment income grow tax deferred – meaning no taxes are paid until money is taken out of the account.  Then it is taxed as ordinary income.

If you don’t need the money, you don’t take the money out, thereby avoiding the tax consequence of withdrawals.  Unfortunately, you can’t do this forever.  The IRS eventually gets tired of waiting for its due.  It requires that you start taking annual required minimum distributions (RMDs) beginning the year you turn 70 ½.   Normally, RMDs must be taken by December 31 of each year.  However, the first distribution can be delayed until April 1 following the year the account owner turns 70 ½; this is called the required beginning date.  Two RMDs are due the year of the required beginning date – one for the previous year (by April 1) and one for the current year (by December 31).  As a point of reference, because there is no tax liability due on qualified withdrawals from a Roth, a Roth IRA is not subject to RMDs.

Failure to take the annual required minimum distribution on time is 50% of the amount the RMD should have been.

The formula for determining the amount of your required distribution involves dividing the prior year-end account balance by the life expectancy factor.   The IRS provides charts as to the life expectancy factor (the divisor factor) that should be used, depending on age and status of the one taking the distribution.  There are three different tables currently in use:

• Uniform Lifetime Table – gives a joint life expectancy factor that is equivalent to the joint life expectancy of the account owner and a hypothetical beneficiary who is 10 years younger.  Only the age of the account owner is needed to find the proper life expectancy factor.

• Single Life Table – used for designated beneficiaries who have inherited an IRA, or for an IRA account holder who dies without a designated beneficiary.

• Joint Life and Last Survivor Expectancy Table – used only when the account owner’s sole beneficiary is a spouse more than 10 years younger.  To find the applicable joint life expectancy, you need to choose the column representing the IRS holder’s age, and then the row representing the spousal beneficiary’s age.

The divisor factor goes down at each year of age.  Because you are dividing by a smaller and smaller number each year, the amount of the RMD goes up each year.  Therefore the older you are, the higher the amount of the RMD.  The amount of the required minimum distribution also rises as the account balance rises.

Therefore the key to stretching an IRA farther is to name younger beneficiaries.  The younger the beneficiary, the higher the divisor.  The higher the divisor, the lower the RMD.  The lower the RMD, the better potential for tax-deferred growth.

Distribution Options for the Beneficiary

Choosing beneficiaries is an essential step for implementing a stretch strategy.  Beneficiaries can be your spouse, non-spouse persons, an estate, a trust, or a charitable institution.  There are a number of beneficiary distributions allowed by the IRS.  Different options are allowed, depending on whether the account owner died before or after the required beginning date of his/her RMDs, and who or what the beneficiary is.

Spouse as Sole Beneficiary

If the account owner died before the required beginning date (meaning RMDs have not yet started), and the beneficiary is solely the spouse, the spouse can leave the account in the deceased owner’s name, treat as his/her own, or use the five-year rule.

If the spouse leaves the account in the deceased owner’s name, he/she must take RMDs no later than December 31 of the year the deceased owner would have turned 70 ½; or if the spouse was already 70 ½, by December 31 of the year following the year of death.  The single life expectancy table is used for this calculation, which has a lower divisor per age, which results in comparatively higher RMDs.  Leaving the account in the deceased owner’s name is the default option.

If the spouse is under 70 ½, and decides to treat the account as his/her own, they won’t have to take RMDs until he/she turns 70 ½.  They are also allowed to use the joint life expectancy table, which has a higher divisor per age, and results in lower RMDs.

The third option is to use the five-year rule. Here the surviving spouse is allowed to do whatever he/she wants until December 31 of the fifth year after the account owner dies.  He/she can take money out each year, or wait until the end to take out the whole shebang.  The 50% annual non-withdrawal penalty does not apply in this case.

If the account owner died on or after the required beginning date (meaning RMDs have started), the surviving spouse has two options.  He/she can leave the account in the deceased owner’s name or treat as his/her own.  The five-year rule does not apply.

If the spouse leaves the account in the deceased owner’s name the same requirements apply as above.

If he/she treats the account as his/her own, he/she must take the RMD for that year, calculated as if the owner was still alive.  If the spouse is over 70 ½, the next RMD is due by December 31 of year following the original account owner’s death.  If the spouse is under 70 ½, the spouse is not required to take any more distributions until he/she reaches that age.

Non-Spouse Individuals or Spouse Not Sole Beneficiary

There are cases where the spouse is not the sole beneficiary, or only non-spouse beneficiaries are designated.  Non-spouse beneficiaries can be any individual other than the spouse or a qualified trust.  Regardless of whether the account owner died before, on or after the required beginning date, RMDs must start by December 31 of the year following the account owner’s death, and for each year thereafter.

If the account owner dies before the required beginning date, then distributions can be made based on the life expectancy of the oldest beneficiary (default); by creating separate accounts for each beneficiary, allowing them to take RMDs using their own life expectancy; or using the five-year rule.

In the case of multiple beneficiaries, if the account is not divided into separate accounts for each one, the age of the oldest beneficiary is used to determine the life expectancy factor.  This means that a lower divisor will be used, resulting in a larger RMD.  If separate accounts are created, then each account will use that beneficiary’s own life expectancy factor, lowering the RMD for the younger beneficiaries.

If the account owner dies after the required beginning date, the same options apply, except for the five-year rule.  The RMD for the year of death must be satisfied if not already done for the original account holder. The following year, the RMDs are calculated based on the beneficiary life expectancy.

Non-Individual Beneficiary

A non-individual beneficiary is an estate, charity or non-qualified trust; or there is no designated beneficiary.  In this case, only the five-year rule applies if the account owner died before the required beginning date.  If he/she died after the required beginning date, the RMD is calculated based on the single life expectancy of the owner in the first year and each year thereafter.

A Note about the Five-Year Rule

Don’t do it if at all possible.  Not only do you lose out on the potential for long-term compounded growth, you’ll have a huge tax liability.  The tax liability could be further exasperated if the amount of the withdrawal raises your tax bracket, since the withdrawals are treated as ordinary income.

Also, Don’t Get Caught

Plan custodians have some leeway as to what kind of distributions they allow, among the options the IRS allows.  In short, they don’t have to offer you all of them; for example, some custodians only allow the five-year rule for everyone. If a custodian does not allow you to take distributions the way you want to, you should to switch to another custodian.

A Final Note

The stretch IRA, when used as designed is a useful tool for transferring wealth and providing long-term financial support in a tax efficient manner.  It requires a high degree of trust that your beneficiaries will use it the way you intended.  You will have no recourse from the grave if they don’t.  However, if your real intention is to simply to leave a financial legacy for your heirs for whatever their needs and circumstances are, then implementing a stretch IRA gives them more options as to how they can use the money.

It’s almost 2012. Your business has done better than expected. Here are a few things you may consider to help lower your tax liability before year end, but you had better hurry!

1. Donations. Cash donations are always deductible, but you may also have items lying around your house that could benefit someone else. Donating these items to Goodwill or similar organizations is tax deductible. We recommend keeping an itemized list of the things you are giving away and assign a value to each item.
2. College Savings. Saving for your child’s college is always advised, but a GA 529 plan carries an additional tax benefit. All Georgia taxpayers may now contribute and deduct up to $2,000 each year on behalf of any beneficiary regardless of their annual income. Georgia taxpayers are not required to itemize deductions to make this adjustment to income. Please note that a transfer of funds from another state’s 529 plan is not eligible for the Georgia income tax deduction.
3. Prepay State Tax. For those who will owe Federal and State tax for 2011, you can prepare a draft tax return to estimate your GA tax liability. If you prepay this tax in 2011, it becomes a credit on your federal tax return, thus reducing your federal tax liability.
4. Small Business Retirement Plan. Look at opening a Simple IRA or a SEP IRA to shelter income and save for your retirement. The amount that you put into these type accounts is not taxed in 2011, but will be taxed when you withdraw the money at age 59 ½ or greater. When you are retired, the idea is that you will be in a lower tax bracket and thus you will pay less tax on your money earned in 2011. See our blog on “retirement plans for the self employed” for more information.

Casey will be on an ETFs in 401k Plans panel at the Inside ETFs Conference in Hollywood, FL in January. The Conference is the largest ETF Conference in the World. CNBC will be broadcasting from the event.

Casey will also be a speaker at the ETFs China Conference in April in Shanghai. This conference is the largest in Asia. Casey will talk about ETF trends around the world and how China investors can benefit from using Exchange Traded Funds.

In light of these changes, Wiser has altered our recommended ASA 401k Models. Please view the models HERE.

Click Here for PDF Version   Click Here For Vanguard Index Tier Information

By now you have received notice that there are some changes happening within the ASA JPMorgan 401k plan. The good news is some of the funds are getting cheaper. The frustrating part is this should and could have happened a long time ago. It should also be known that your ALPA Retirement Committee was not made aware of these changes any earlier than your receipt of the JP Morgan Letter. This is frustrating as the pilot group is the largest contributor to the ASA 401k plan and should have input into their retirement choices.

Despite the secretive and abrupt nature of this change, I will help you dissect these changes and help you figure out what actions you should consider.

Closures

On the “no longer available to us list” are the American Century Ultra and American Funds Growth Fund of America funds. These funds have recently underperformed their peers and or the S&P 500. The replacement for these funds is the JP Morgan Large Cap Growth R6 fund. There are some key measurements that we can look at to dissect if this change is in the participants’ favor.

Alpha – This is the fund manager’s ability to beat the index. In this case the index would be the Russell 1000 or the S&P 500. The higher Alpha, the better. A negative Alpha means the manager has earned too little based on the risk of the investment.

Sharpe Ratio – Most fund managers take on additional risk outside of their assigned index in order to beat the index. Sharpe Ratio does not mean a whole lot by itself. When comparing two funds you want the one with the higher Sharpe Ratio. This means that the additional risk has paid off.

Standard Deviation – This measures the volatility (risk) of the fund from its average rate of return. Ideally an investor wants a high rate of return with little standard deviation, which is hard to find. One certainly does not want a low return with a high standard deviation; this means that risk is not being rewarded with return.

Using the key indicators above we can compare our new JP Morgan Growth Fund R6 to the two outgoing mutual funds.

The data above shows that the mandatory transition from Ultra and Growth Fund of America is not a bad move. Notice how the standard deviation (risk) is virtually the same for all funds yet the end results are very different. This reflects the portfolio managers’ stock picking ability. The American Century Ultra fund has been an underperformer for years. American Funds Growth Fund of America has good ten years risk/reward data; however, it has under performed its peers in the last three years.

As a side note, over the long term 10 + years very few managers actually beat their assigned index. This is why 401k plans that offer Vanguard Index Funds are very desirable. Currently Fed Ex, Hawaiian, SouthWest and United offer 401k plans with a Vanguard Index tier as additional investment options.

Holdings

JP Morgan Large Cap Growth Fund holds 68 total stocks, compared to 310 in Growth Fund of America and 81 in Ultra. The JP Morgan fund has bought and sold (turned over) 84% of its portfolio over the last 12 months compared to 33% in Growth Fund of America and 24% in Ultra. The turnover percent within a fund is important as for every 100% in turnover adds 1.0 – 1.5% in fees paid by the participants.

The top five holdings (as of 9/30/2011) within each fund are as follows:

Fee Changes

Other funds within the ASA 401k plan had fee changes and new tickers assigned.

The new fees average out to be 0.15% in average reductions with the largest change being 0.20% in three mutual funds. In all the funds listed above, the holdings, investment objective and managers remain the same. Only the share class (fee structure) changed. I will note here that the JP Morgan letter shows the JP Morgan Equity Index fee as going from 1.19% to 0.10% in the new index. This has to be a typo as the old fee is published as 0.20%.

Why Did the Changes Take Place?

I have taken many phone calls from plan participants asking why these changes have taken place and what this means to them. The why part is very simple. JP Morgan has been collecting annually an estimated $356,000 in administration fees ($88 per plan participant), which is included in $1,234,000 in fund fees (avg 0.79%).

These fees are not terribly out of line with a plan of our size; currently 155 million in assets.

In my opinion these fees could have been lowered years ago. However, the company certainly has more leverage recently because of the purchase of Express Jet. A joint ASA ExpressJet 401k plan is valued at $400+ million. JP Morgan wants that business and as a result has lowered its fees. With our new fee structure, JP Morgan will still be collecting $238,918 in administration fees ($59 per participant), which is included in $1,072,000 in fund fees (avg 0.69%) just on the ASA 401k, not including Express Jet’s 401k.

This is where competition and larger plan assets benefit the plan participant (you). While this is great news, there is still work to be done. Even though our fund expenses have dropped, we can still do much better.

Three Ways to Invest

There are three ways to invest in the stock market. I love Coca Cola, so lets use cola as an investment example.

I.  Stock

Let’s say we invest $5,000 into Coke stock. Then the evil people at Pepsi infiltrate Coke and poison the syrup.  People are now dying of Coke. What is your Coke stock worth? $0. This is called company risk.  We want to diversify away from company risk such as Enron, Global Crossing and many other bad companies in good industries. This is where mutual funds enter the picture.

II.  Mutual Fund

Investing in a mutual fund is pooling investor’s money together and hiring a fund manager to manage your money. In our cola example, let’s say that there are 50 cola companies in the US. The mutual fund does not know your personal objectives but does operate under a published objective. A mutual fund objective could be to invest in large cap US stocks or foreign bonds. In our example the fund manager is looking for the 20 best cola companies out of an industry of 50. This gives the investor diversification from company specific risk. The funds goal is to beat the index of 50 cola companies.

While very popular, mutual funds have drawbacks. Many of the mutual funds in the ASA 401k plan have over 100% in annual turn over. This means that the fund manager is buying and selling a lot through out the year. For every 100% in turnover we see an added 1.0 – 1.5% in fees. In our cola example, our fund manager would be buying and selling the cola stocks on a regular basis in an attempt to beat the cola index. This type of investing is considered “active” management.

III.  Index Fund

In today’s society we are programmed to think that we are all “winners.” In fact if you think that you are not a winner then you may be depressed and a doctor can proscribe you a pill for that. Applying this thinking to investing can create poor investing behavior. We see this in a study by the University of Maryland “False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas” showing that only 0.06% of mutual funds beat their assigned index from 1975 to 2007.  This draws us to our third choice of investing, indexing.

Through Index Mutual Funds or Exchange Traded Funds investors now have the ability to purchase entire asset classes (large, mid or small caps) or sectors (US energy, foreign, real estate, etc.). In our example we could purchase the entire cola index through an index mutual fund or exchange traded fund. Index funds do not have fund managers as the fund is simply purchasing companies chosen by the index provider such as S&P or Russell. This type of investing is considered “passive” investing

A real world example of indexing would be purchasing the entire S&P 500 (500 US companies) through an index versus buying the JP Morgan Large Cap fund that only holds 68 companies. The JP Morgan Large Cap Fund has an expense ratio of 0.80%. The Vanguard S&P 500 Index Fund costs 0.05%.  This cost savings adds up to significantly more money in the plan participants’ pocket at retirement. In this comparison the performance difference over the last 10 years is in the favor of the index fund. History and research show that for time periods greater than ten years, indexing continues to be favored.

Currently the ASA JP Morgan 401k plan has one Index fund – the JP Morgan Equity Index Select. It should be noted that in time periods under ten years, we could usually find good performing actively managed mutual funds. However, most of you are saving for time periods greater than 10 years. For you, keeping costs low, maintaining diversification and investing long term are your keys to success.

The current line-up of ASA Mutual Funds are some of the best performing actively managed funds to choose from. However, during our research we found that a low cost index portfolio using Vanguard index mutual funds is very competitive, especially with the cost savings.

Wiser Wealth recently researched 401k options that could be available to ASA and Express Jet employees. We found that switching 401k plan providers entirely should be considered as JP Morgan provides very poor guidance to ASA plan participants. However after the recent changes with JP Morgan, Sky West/ ASA seems committed to JP Morgan. This leads us to a less known option.

Vanguard Indexing Within the JP Morgan 401k Plan

ASA/Express Jet has the ability to add an “index tier” to the ASA JP Morgan 401k Plan. This simply means that in addition to the current line up of mutual funds plan participants would also be able to choose index funds representing cash, US Bonds, US large caps, US mid caps, US small caps, international developed markets and international emerging markets.

The benefit of an index tier is that it gives 401k participants (you) access to industry leading index funds, low cost investing, plan reduction of active manager risk and historically better performance. The company benefits, as well, in that offering index funds within a plan reduces their litigation risk. A recent court case suggests that having index funds within the plan lower the litigation risk for all plan fiduciaries.

Mike Lucci of Vanguard states,

In closing, Wiser Wealth likes it anytime a plan sponsor (ASA/Express jet) lowers the cost of investing. The recent changes by the company were done with your best interests in mind. We hope that they would consider the benefits of adding indexing to the 401k plan. With a combined $400 million in 401k assets, government encouragement and a fiduciary responsibility to work in the best interest of all plan participants, there is certainly no reasonable rational reason anyone could say no.

See PDF version for more information on adding Vanguard to the JPM Plan.

CLICK HERE FOR MORE JP MORGAN 401k GUIDANCE 

Hi,

The 401k is for retirement. You can always borrow money for other things, but there is not a “retirement loan” out there. Being an airline pilot you have to retire at age 65. Working longer in commercial aviation is not an option.

If you have any other debt to pay down such as credit cards or auto loans, I would look to focus on those first. Reducing debt payments will free up cash flow for reduction in income. A great book for cash flow and debt reduction management is Dave Ramsey’s Total Money Makeover. IF your only debt is your house, then saving money into a cash account to make up for the first year pay at your new airline is another option.

You could also take out a personal loan from your bank or the Delta Community Credit Union to help with cash flow for that first year.

I will give you the name of a mortgage person that we refer to that can help you look at refi options. She is a broker, thus is not pushing any one company’s product. Her name is Christine Lim. You can contact her at 404-388-8800.

Casey

Another most often heard answer is owning foreign currency, which has its own risks. Both this and the gold strategy have something in common – neither pay any type of interest or dividend.

A few years ago we looked at the falling dollar and decided that there had to be another angle to this issue. We found gold to be a difficult purchase. Historically it has not been a good investment, as it has no manufacturing purpose and pays nothing to own it. Owning foreign currency is not as transparent as one would think. Funds that trade or hold currency do not actually hold real currency but track future contracts related to global currency. This creates returns that do not exactly match the movement of the dollar because of additional unwanted variables within the contracts.

Part of the Wiser Wealth solution to a falling dollar lies in our allocation to the ETF iShares S&P/Citigroup International Treasury Bond Fund (IGOV) . IGOV is an international treasury bond fund holding foreign government bonds from around the world in their local currency. With 624 bonds from 20 countries , IGOV has returned 4.35% year to date and yields 3.53% (as of 9/30/11), while the US Dollar index has rebounded to just above flat year to date.  The chart below shows IGOV’s negative correlation with the US Dollar over the last 6 months.

The iShares S&P/Citigroup International Treasury Bond Fund (IGOV) has an expense ratio of 0.35%. The fund has an average duration of 6.35 years. IGOV is a passive index dollar hedge play that has a yield. The ETF tracks the S&P/Citigroup International Treasury Bond Index Ex-US. The index methodology is to track a broad diverse group of international treasury bonds with maturities greater than one year and which are market value weighted. The index is rebalanced monthly, with country weights changing annually using January-end data. There will be no country weighted more than 24.95%, and countries weighing less than 10bps are removed. The top 5 countries are as follows: Japan 23.16%; Italy 8.74%; France 7.99%; Germany 7.81%; and the Netherlands 4.88%. The fund currently has 266 million in assets.

Despite the USD recent comeback, we see any future government stimulus only weakening the currency further. IGOV can be used to help cushion the blow to a falling dollar.

So you quit the corporate rat race to start your own business.  It’s hard work, but you enjoy the freedom and the thrill of being your own boss.  There is nothing that you miss about your old job.

Except maybe your 401(k). 

Traditional and Roth IRAs are nice, but limited as to the amount you’re allowed to contribute each year.  You feel it’s not enough to fully fund your retirement needs.  And you need tax savings now.

Consider the world of small business retirement plans.  There are several plans that are specific or adaptable for small businesses or sole proprietorships.  These include the SIMPLE IRAs, SEP and SARSEP IRAs, and Keogh plans.  Keogh plans (also called HR-10 plans) are qualified plans that include Solo 401(k)s, profit sharing plans, money purchase plans and defined benefit plans.  Each plan has its advantages and disadvantages, and applicability to different business situations.  Each one is highlighted below.

SIMPLE IRA

The SIMPLE IRA (Savings Incentive Match Plan for Employees Individual Retirement Account) is a tax-deferred employer-sponsored retirement plan similar to large 401(k) and 403(b) plans, but with simpler and less costly administration.  The SIMPLE IRA is funded with pre-tax dollars. 

Contributions are currently limited to 100% of net earnings up to an $11,500 maximum ($14,000 for persons over 50).  This is lower than the current limit of $16,500 for traditional 401(k) and 403(b) plans, but more than double that of traditional IRAs. 

Only employers with less than 100 employees may establish SIMPLE IRAs.  After crossing the 100-employee threshold, the SIMPLE may continue for two more years before a different plan must be implemented. 

Employees are not required to make regular contributions, but the plan does require a certain minimum contribution from the employer.  This minimum is either a dollar for dollar match on the first 3% of employee salary, or a flat 2% of salary for each employee with at least $5000 in compensation for the year.

This type of plan would be appropriate for businesses with no employees, or with few employees if you’d like to offer them an incentive to continue to work for you.  The mandatory employer contribution is generally less for a SIMPLE than for a SEP.  If the number of employees is getting close to 100, you may want to consider a traditional corporate retirement plan to save the hassle of having to change it over.

SEP IRA

The SEP IRA (Simplified Employee Pension Individual Retirement Account) is a variation of the IRA.  It has no significant administration costs for self-employed persons with no employees.   

Contributions for the self-employed person is limited to 25% of net earnings from self-employment, or $49,000, whichever is less.  The formula for net earnings from self-employment is all revenues minus expenses minus the deduction for one half of your self-employment tax minus deductions for contributions to the SEP IRA.  (If this sounds convoluted to you, don’t worry; the IRS has a cheat sheet for this calculation.)

If the self-employed person does have employees, the employees must receive the same benefits as the owner (the same percentage rate).  For the employees, the SEP IRA is similar to a traditional IRA only with higher contributions limits and with contributions made by the employer, not the employee.  The IRS maximum restrictions on employee eligibility is be at least 21 years of age, has worked for the employer for at least three of the last five years, and received at least $500 in compensation during the year.  Your plan eligibility may be less strict than this(i.e., younger age, etc.), but not more. 

A SAR-SEP is a variation in which the employee may also contribute a portion of their pre-tax pay.  SAR SEPs are allowed only if the employer has fewer than 25 employees during the prior year.

Similar to a SIMPLE IRA, a SEP IRA would be appropriate for businesses with no employees, or with few employees if you’d like to offer them an incentive to continue to work for you.  The mandatory employer contribution would be higher for a SEP than for a SIMPLE.  Another difference in choosing between a SEP or a SIMPLE IRA is in the amount of net earnings from self-employment.  The pivot point is $46,000.  Using the SEP calculation, 25% of $46,000 is $11,500 – the maximum contribution for the SIMPLE.  At less than $46,000, a SEP actually would allow a maximum contribution that is less than what would be allowed in a SIMPLE.  So for a self-employed person with no employees, and with net earnings from self-employment above $46,000, a SEP IRA would be a wise choice; otherwise, use a SIMPLE IRA.

Keogh Plans

Also called HR-10 plans, these are considered qualified plans for tax purposes.  These include Solo 401(k)s, profit sharing plans, money purchase pension plans, and defined benefit plans

Solo 401(k)

Similar to a corporate 401(k), a Solo 401(k) offers tax-deferred savings for business owners.  The business must be very small, limited to the business owners and their spouses.  It also works for partnerships, including partners’ spouses.  You may have part-time employees who work less than 1,000 per year; they will be excluded from the plan.  If you have an employee that works more than that, you can’t do a Solo 401(k)

Hi Lisa, Yes. You can purchase a foreign currency ETF inside the Atlantic Southeast Airlines brokerage link. The issue I have with this is that you do not actually hold foreign currency, but futures contracts. There are some performance issues with this approach that is very complicated to explain in an email. Another issue is foreign currency funds do not pay you anything in regards to dividends or interest.

A few years ago we researched the best way for everyday investors to benefit from a falling US dollar value. We looked at metals, currency and other alternatives. A surprising option came to light. Through an index fund you can purchase foreign treasuries in their local currencies. This fund is -.95% correlated with the US Dollar, meaning if the USD declines by 1% then the fund gains .95% in value. In comparison gold is much less correlated to the USD than IGOV. This is an iShares product available for purchase through any brokerage account trading under the ticker IGOV. The best part is you get a dividend from the treasury bonds. The current yield is 3.3%. Take a look at their fact sheet attached to this email. For foreign currency index funds take a look at WisdomTree ETFs at www.wisdomtree.com. These funds are actually future contracts but are from a reputable company. 

The stock market experienced a panic attack today. But please avoid confusing the market’s gyrations with what’s actually going on in the real economy.

Stocks are overreacting to the unfortunate confluence of events: the downgrade of U.S. government bonds, some weaker than expected economic data, and the troublesome but manageable U.S. fiscal position. Along with sovereign debt issues threatening Europe, these factors turned market sentiment ugly.

Former Federal Reserve Board Chairman Alan Greenspan put it this way last Sunday on Meet The Press: “The United States can pay any debt it has because we can always print money to do that. So there is zero probability of default.” Greenspan, who is not an oracle but who does have years of experience in running the nation’s central bank, added that the downgrade “hit the self-esteem of the United States, the psyche.”

While such a blow to our nation’s financial reputation cannot be dismissed and must be addressed, it’s also important to remember that there has been no real change in fundamentals driving the economy.

Improving economic data is plentiful. “The leading indicators point to slowly expanding economic activity in the coming months, according to the Conference Board’s most recent appraisal of the economy.

Weekly unemployment claims have tumbled from the April 2009 peak. The Bureau of Labor Statistics reported modest improvement in job growth for July. Layoffs of government workers have masked a jobs rebound in the private sector that looks fairly typical at this stage of an economic recovery. Economists cite renewed July-August auto hiring and a slower pace of state and local government layoffs ahead as reasons for optimism on initial claims for unemployment benefits.

Corporate earnings estimates keep climbing. Q2 nominal Gross Domestic Product is up 3.7%, while Q2 revenues on Standard & Poor’s 500-companies were up a whopping 13.2%!

Earnings estimates for 2011 and 2012 rose again last week, continuing a trend of upward estimate revisions.

The S&P 500 is trading at 11 times 2011 earnings estimates. Investors right now can choose to buy the 10-year Treasury bond with a 2.3% yield or get a 2.2% dividend yield on the S&P 500 plus the potential upside on stocks. Will the relative value of stocks versus the 10-year Treasury Bond ultimately be recognized by investors? History may not repeat itself. It’s possible. But using historical valuations and economic fundamentals to guide long-term investment decisions is prudent.

Hysteria is not new to investment markets. While it not easy to ignore the gyrations, our advice is to resist the panic by staying focused on fundamental factors that drive long-term values in securities markets.

If you need to speak with us, we’re here for you.

Dear Client,

At Monday’s market close the Dow Jones lost more than 6.5% in value. This was not  a result of the S&P downgrade of US issued debt. US treasuries were actually the safe haven of the day, pushing the US Bond Aggregate index up .5%. Today’s sell off in stock was an emotional response to what is happening in Europe and a potential recession globally and here in the US.

Stronger European nations such as Germany, France and the Netherlands are showing signs of an economic slowdown. In addition to weaker economic indications these same countries also hold Greek, Irish, Portuguese and Spanish debt. Greece recently received a second bailout, only to now need a third in order to pay its bills. Last week Italy took the spotlight in that it is rapidly approaching a situation where it will not be able to meet its debts obligations. This situation is slightly different in that many believe that Italy is too large for the European Central Bank (ECB) to completely bail out. Italy’s Government is playing down its financial situation stating that their banks are well funded and that its citizens as a whole save well. This is not reflected in their 10 year treasury bonds, which yield 6%. Comparatively the currently healthy German 10 year treasury yields 3%.  A 10 year US treasury yields 2.6% and a two year note yields 0.336%.

Last Friday the ECB announced that it would begin purchasing Italian and Spanish debt, helping the countries raise additional capital. This is very similar to what the US did here in 2010 when the Fed purchased long term US Treasury Bonds from the bond market. The US stock market has sold off simply because of the uncertainty of the situation. The last large scale treasury bond default we saw was in 1998 when the Soviet Union defaulted on its bonds. The markets worldwide traded down then recovered a few weeks later.

The United States of America no longer has a long term AAA bond rating. What does this mean? Economically in the short term this rating really means nothing, in fact other rating agency’s still maintain US debt at AAA. This was proven on Monday as even after the first trading day after the downgrade the 10 year US Bond traded up in value as investors flocked to safety. In the long term this means that our country must stop the overspending. The S&P said in their report “Our opinion is that elected officials remain wary of tackling the structural issues required to effectively address the rising U.S. public debt burden.”

The Wiser Portfolio’s are built to be held long term. Short-term market volatility is certainly mentally draining.  No one likes to lose, especially money, even if it is just on paper. In times such as these, investor behavior is more important that asset allocation.  Diversification and overall portfolio risk are important, but at this point your portfolio should already be built based on these objectives. Selling and going to cash emotionally feels like the right thing to do, but history shows that this is absolutely the wrong approach. In the chart below we see the market with a bar chart overlay of fund inflows and outflows. You can see as the market peeked in 2007 investors were adding large amounts of new money to the stock market.  In 2009 as the market bottomed out, investors were selling large amounts out of the stock market. This buy high sell low approach is not a winning solution for investing. To make matters worse these investors were selling bonds at their lows to buy stock at their highs in 2007 and then selling stocks at their lows to buy bonds at their highs in 2009. Buy and hold investors will have a long-term higher rate of return, especially when building portfolio’s using index funds.

Over the next few weeks’ European governments will be forced to make tough economic decisions. As these decisions are made the market will become more stable and economic valuations easier to determine.

Assuming that your portfolio is built for your long-term objective, your best action is to ignore the emotional market and do nothing. If you have any changes to your personal financial situation give us a call so that we can reevaluate your personal investment strategy.

Casey T Smith, President, Wiser Wealth Management, Inc

Definition

Emerging markets are defined as those nations with social or business activity in the process of rapid growth and industrialization.  They have a relatively short history of open market relations and foreign investment.  Emerging market is characteristic of a country that has previously had a centrally planned and isolated economy, generally due to long-standing one-party political and socioeconomic systems, or a developing nation emerging from poverty or economic sanctions.

Currently, there are more than 40 emerging markets in the world, with China and India considered the largest.  The ASEAN – China Free Trade Area, launched January 1, 2010, is the largest regional emerging market in the world.  The stock markets of any given emerging market tends to be more volatile than a more established market.

Frontier markets are a subset of emerging markets, and includes countries that have lower market capitalization and liquidity than more developed emerging markets.  They are generally expected to increase in liquidity as their markets further develop, and will exhibit similar risk characteristics as larger, more liquid developed emerging markets.

Classification of countries as either emerging or frontier markets can vary.  The two main classification systems are provided by FTSE Group and MSCI Barra.  FTSE further classifies emerging markets as advanced or secondary by gross national income (GNI).  Advanced markets include upper middle income GNI countries with advanced market infrastructures or high income GNI countries with lesser developed market infrastructures.  Secondary markets include upper middle, lower middle and low income GNI countries with reasonable market infrastructures and significant size, and some upper middle income GNI countries with lesser developed market infrastructures.

The following chart identifies where countries are classified, based on system.  Notice that some countries are included on one system but not the other, and some are considered emerging on one system, but considered frontier on the other.

Impact on World Economy

From 2003 to 2009, emerging markets grew from 4.5% to 13% of the weighting in the MSCI All Country World Index.  At the same time, the US percentage dropped from 52.5% to just under 42%, while all developed countries dropped from 95.5% to 87%.

In terms of ranking, in 1987, only Brazil ranked among the top 10 nations by GDP weight, landing at # 8.  By 2008, China entered the mix landing in the # 3 spot.  By 2030, it is projected that BRIC countries (Brazil, China, India, Russia) will account for almost 25% of world GDP.

According to global management consultancy McKinsey & Co. in April 2011, seven emerging economies – China, India, Brazil, Mexico, Russia, Turkey and Indonesia – are expected to contribute about 45% of global GDP growth in the coming decade.

Impacts on Emerging Markets Performance

Emerging markets tend to exhibit higher volatility, and the quality of economic and financial data from emerging countries tends to be less robust than that of developed markets.  Performance can be impacted by politics, socioeconomic developments and environmental factors.  Investments in the Middle East took a hit due to the political unrest that started in Egypt in early 2011 and spread to neighboring countries, while oil investments surged upwards.  Investments in Japan also took a hit due to the March earthquake and tsunami.  In the case of the Japan earthquake, the markets of South Korea experienced an increase, led by automobile makers such as Hyundai and Kia who were poised to fill the void left by Toyota’s forced manufacturing hiatus.

The Future of Emerging Markets and Benefits to Portfolios

Emerging markets are growing rapidly, more so than in developed markets.  In select frontier markets, growth is even faster, and also exceeds the growth in developed markets by a wide margin.  However, historically we’ve seen a low correlation between GDP growth and stock market returns.  Correlation between GDP growth and emerging market stock returns for 16 countries between 1990 and 2002 is negative .37, and moves to zero from 1950 to 2002.  In 21 emerging markets, stock returns and GDP growth had a correlation of negative .298 from 1999 to 2007.   However, growth is not only economic but also expansion in the breadth and depth of capital markets.  Some markets are becoming larger and more liquid, a plus for investors concerned about investment movement restrictions in emerging markets. Positive fundamentals could potentially enhance performance as well.

One risk is that things can change very quickly.  Due to the regional crises in the Middle East and Japan in February and March, we saw significant investment outflows from emerging markets; a scant two months later, the trend reversed.

What we are beginning to see is increased cooperation among the larger emerging markets.  For instance, Brazil and China recently entered into a number of economic and investment accords in areas such as energy, agriculture, defense, and technology.  South Korea and Peru finalized a free trade agreement aimed at boosting trade and economic relations.  Also, the larger emerging markets such as the BRIC countries are becoming more like developed markets, as they are investing into frontier markets in the areas of construction, transportation, telecommunications, banking and finance.

While individual emerging markets can be more risky than other investments, broad diversification lowers risk.  A properly diversified portfolio that includes emerging markets may see less volatility than one invested solely in developed markets.

During our research we found that the best correlation for the emerging markets fund VWO, which best tracks the MSCI EM Index and FRN, representing the BONY EM Frontier Index was US Small Caps. We often hear that Emerging Markets are tied to commodity prices. We found the following:

Comparison of Specific Emerging and Frontier Markets ETFs

Funds chosen for analysis include emerging market and frontier market ETFs with over $100 million in assets under management.  A total of 14 emerging market ETFs and one frontier market ETF were considered.  The oldest such ETF is nine years old; most are in the 3-4 year range, while a few were established within the last year.  Of the 15 funds, there is very little duplication of associated benchmark indices.  A summary chart of all funds can be found in the Appendix.

Hypothetical Model Portfolios

While a truly diversified portfolio will include emerging markets as a portion of the total investment holdings, for the purpose of this report, we created a model portfolio with purely emerging market ETFs.

To start, we narrowed the list of ETFs to consider to five, based on high Sharpe ratio, low expense ratio and diversification (more than 100 holdings):  EEM, VWO, EWX, DGS, and DEM.  We also included FRN because it is the only one of its asset class.  When looking at the three-year Sharpe ratios, all but FRN were in the top five among all funds (FRN being too new to have a Sharpe ratio).  EEM, VWO, EWX, DGS and DEM had significantly higher Sharpe ratios than the rest of the funds.

EEM and VWO are similar and provide a large-cap blend investment style and broad country diversification.  EWX provides exposure to large- and mid-caps, with concentrations in Latin America, and Middle East/Africa.  FRN is similar in exposures to EWX, just in the frontier markets.  DGS provides a mid- and small-cap value style with concentrations in developed and emerging Asia and Middle East/Africa; it has a dividend yield around 3%.  DEM invests in high-quality large-caps and has a dividend yield in the 3-4% range.

As for regional concentrations, EEM, VWO and DGS all have significant concentrations in Asia.  FRN, in contrast, has large concentrations in Latin America.

When we look as specific countries, EEM and VWO have virtually the same concentrations in the same countries of China, South  Korea, Taiwan,and Brazil.  DGS shows similar preferences for Asia, with Taiwan, South Korea, and Thailand, with South Africa thrown into the mix as well.  FRN’s top countries, on the other hand, are the Latin American countries of Chile, Columbia, and Argentina, as well as Egypt.

The last few days have been very volatile ones for the global stock markets. The headlines of a Greek debt default and the US August 2 debt limit increase deadline are contributing to the uncertainty in the market.  Over the last few days we have taken several calls from investors concerned about these debt issues and what actions we are taking in the portfolios to counteract these events.

It is important to understand that the Greek and US debt issues are not the same. Greece can not generate enough revenues to cover their interest payments nor can they raise the funds needed through the bond market. In the US we are facing a technical default, meaning that we can very easily offer US Government bonds to the market and sell them at relatively low interest rates but the self imposed debt limit is preventing new offerings without expiring existing ones. The August 2nd deadline has become political in that both sides of the debate want to cut spending but have different view points in how to do this. The US may miss a debt payment that could cause short term pain but this does not mean that the US will default as a nation on all its obligations forever.

US Government bonds are the safe haven for investors world wide. If a US technical default were to happen, where would the world go to invest safe money? Recently we have seen gold, FDIC insured accounts and German bonds as alternatives to US Treasuries. It should be noted, though, that amongst this uncertainty we have seen long term US Government bonds decline in value faster than shorter duration US Government bonds. This seems to show that despite a technical default looming, by its investment behavior, the world continues to regard shorter duration US Treasuries as a safe haven. This certainly is not what you hear about on the nightly news.

Here at Wiser we build portfolios for the long term. Two years ago we shortened the duration of our bond allocations to reduce risk. We also added international treasuries in foreign currency to  help cushion the falling dollar’s effect on the portfolios. We know from long term data that market timing is a loosing game. We know that gold does not pay us anything to hold it and FDIC insured accounts pay very little. As investors we do not want to react to emotion or feeling but rather trust that quality investments will prevail over time. This is how we survived the financial crisis and exactly how we will address this current situation.

Looking at current events, we believe that there is a greater risk in not cutting long-term spending than meeting the August 2 deadline. This does not mean that missing the deadline will be a non-event but that any pain caused will be short in duration. Long term we believe that the dollar will continue to decline, interest rates will remain low and we could see another stimulus plan put into place to push along our slowing economy. With this view we are looking at adding to asset classes such as commodities and other alternative investments that have a low correlation with the stock market. We will continue to search for long term healthy asset classes and look for opportunities to lower your overall cost of investing. Our focus will always be long term.

Thank you for your trust and business.

You have done well for yourself.  You’ve watched your pennies, saved aggressively, invested wisely, and now, in your golden years, you have a retirement nest egg that is more than you need.  You have a philanthropic bent – an alma mater you’re fond of, a charity that is near and dear to your heart.  How can you donate to these worthy causes without sacrificing to the IRS more than you think it deserves?

An IRA charitable rollover is one way to do it.  In 2006, Congress enacted the Pension Protection Act.  One item in the act permits individuals to donate – or roll over – up to $100,000 from an IRA to an eligible charitable institution without recognizing those assets as income.  This means, in a nutshell, the amount rolled over isn’t taxed.

Before this act, one would need to withdraw the funds, pay the ordinary income taxes on the amount, and then donate the net proceeds to the charity.  With the enactment of this act, 100 percent goes to the organization.

While this act had an original time limit through the end of 2007, it has been extended a number of times.  The latest extension allows such charitable rollovers through the end of 2011.

There are rules, of course.  Individuals must be 70 ½ or older; this is the same age as when required minimum distributions must begin, and charitable rollovers count towards meeting this requirement.  Only eligible charitable institutions are acceptable.  The rollover must be completed before December 31, 2011, per the new extension.  Rollovers can be made only from IRAs, so if you have money sitting in a 401(k) or a 403(b) still, it would need to be rolled over into an IRA before making the charitable rollover.  And as stated before, rollovers cannot exceed $100,000; amounts more than this will be taxed as ordinary income.

There are also exceptions to the tax advantage of this kind of rollover.  Donor-advised funds are one example.  In a donor-advised fund, the donor makes recommendations as to how the money can be used.  The donor also cannot receive any gift of substantial monetary value in return for the donation.

The tax exclusion is also limited to public charities, for the most part.  To enable a charitable rollover to a private fund to qualify as a tax exclusion, the fund must elect to meet conduit rules in the year of distribution.  This means that the fund must pay out 100 percent of the funds received in its tax year by the 15^th day of the third after the close of that tax year.  This is in addition to meeting its 5 percent distribution requirements.  Private funds elect whether or not to be a conduit foundation each year, so one year a charitable rollover may be eligible, and the next year not, depending on how the fund’s board of directors vote.

For a donation not eligible for the IRA charitable rollover exclusion, the amount of the donation from an IRA is considered a traditional distribution and will be taxed to the donor as ordinary income.   However, the donor can then take the charitable deduction on his/her itemized tax return, which would offset at least part of the tax increase (people who’s donation is eligible for the IRA charitable rollover exclusion are not eligible to turn around and use the amount as charitable deduction on their tax return).  There are limits to this deduction, of course.  The itemized deductions are limited to 50 percent of adjusted gross income for gifts to public charities, or 30 percent to private charities; allowed amounts of itemized deductions are also reduced by 3 percent of the amount that income exceeds a certain threshold.

IRA charitable rollovers are not for everyone. Those who could benefit from IRA charitable rollovers include:  people who don’t need or want to avoid receiving required minimum distributions; people who don’t itemize and would otherwise not receive any tax benefit for donating to charity; those who donate charitable gifts that exceed the 50/30 percent limits on adjusted gross income; people for whom Social Security income is taxable; residents of some states; and those who want to reduce their taxable estate.

If you think a IRA charitable rollover is something you’d like to consider, please consult your tax professional.

The research staff here at Wiser Wealth recently analyzed all the broad based ETFs that track emerging market indices. The staple in Emerging Markets is currently Vanguards VWO and iShares’ EEM. The comparison articles on these funds are endless. One fund that filtered to the top of the Emerging Market ETF list that might be less known is Wisdom Tree’s DEM. We compared it in this article to Vanguards VWO. The following report helps compare the DEM and VWO Emerging Market strategies as well as the results of the last few years.

Many firms develop ETFs to track only one world region, or sometimes only one country.  However, the ETFs that expose themselves to a number of regions are more diversified in their holdings and are typically less risky investments.

There are two ETFs of particular interest due to their contrasting natures:  Vanguard’s MSCI Emerging Markets ETF – ticker VWO) and Wisdom Tree’s Emerging Markets Equity Income Fund – ticker DEM).  VWO has been widely used in part due to the size of the fund, holding $48.67 billion in assets. It also has a trading volume of 13,117,869 and a 30-day average bid-ask spread of $0.01. All of these things combined would give VWO a good tradability grade. In contrast, DEM is a much smaller fund with only $1.59 billion assets under management, 300,901 in trading volume, and a $0.50 bid-ask spread. Both ETFs are trading at a premium. Recently, VWO is trading at a 0.676% premium while DEM is higher at a 1.557% premium.

Past Performance

The apparent bias for VWO over DEM cannot be explained by a superior performance.  According to Morningstar reports released 5/31/2011, DEM performed better than VWO.  Since VWO’s inception in May 2005, it has spent every year in the bottom two performance quartiles for its category. Although DEM can only fall back on three full years of historical data since its inception in July 2007, it has shown a more impressive finish. It made a top-quartile placement in 2008, suffering a dip to the second-lowest quartile in 2009, and recovering to the second-highest quartile in 2010. The graph below depicts the actual performance of the two funds against each other.

Country and Stock Diversification

As already mentioned, the greater diversity, hypothetically, means less risk. DEM, the arguably smaller of the two, has 628 total stocks in its holdings, while VWO holds 854 total stocks. The following tables show a percentage breakdown by country and by sector of each ETFs stocks.

VWO is heavily weighted in Asian countries, both emerging and developed, and has a little less than one-quarter of its holdings in Latin America.  DEM has given one-quarter of its holdings to Latin American, another quarter to Asia developed, and around one-fifth each to Europe and Asia emerging.  If a current portfolio already favors one of these regions, it may be of benefit to add the fund that will result in a more diversified regional balance.  Some reports speculate that Latin America emerging markets, particularly Brazil, may have increasing influence on the world’s GDP in the next 5-10 years.

Market Capitalization

Another area to consider when trying to balance and diversify a portfolio is market capitalization, or size of holdings. Both VWO and DEM have the majority of their holdings in large cap companies.  However, VWO has allocated 84.45% of its stocks in giant and large cap companies, while DEM only has 69.89% in giant and large caps.  VWO has little mid and small cap exposure, making it susceptible to downturns in large cap company market prices.  DEM has allotted 21.25% of its stocks to be held in mid cap companies, and 8.85% in small caps.  Smaller cap firms have the potential for rapid growth, but with added risk.  Mid cap companies offer greater stability than small caps due to size, and higher growth potential that large caps.  We also find that large cap emerging market companies are more closely aligned with global economies where mid and small cap companies selling locally are somewhat shielded from global issues. DEM offers better protection than VWO in providing more balanced exposure among all market asset classes.

Analytics

Risk and reward can be measured by standard deviation and Sharpe ratio.  The higher the standard deviation, the higher the risk.  Based on a three-year period ending May 31, 2011, the standard deviation for VWO is 32.59, while DEM stands at 26.52.

The Sharpe ratio helps determine if there is enough reward to make the risk worthwhile.  The higher the Sharpe ratio, the more worthwhile the risk.  As of May 31, 2011, VWO had a three-year Sharpe ratio of 0.18, while DEM had 0.42.  Based on these numbers, DEM offers a higher reward potential for the risk taken.

Indexes and Style

VWO and DEM track different indexes, in different ways.  VWO tracks the MSCI Emerging Markets Index, which examines economic development, size, liquidity and market accessibility, and then weights its holdings based on their market capitalization.  DEM has created a unique mix of companies by following the WisdomTree Emerging Markets Equity Index, which is actually assembled based on the highest 30% of dividend-yielding stocks from another index, the WisdomTree Emerging Markets Dividend Index.  DEM offers some protection from the regular volatility associated with the emerging markets through dividends.  As of August 1, 2011, DEM reports a distribution yield of 6.18% (calculated based on the last divided multiplied times four), which is much higher compared to VWO with a 1.680 distribution yield (calculated based on the last four dividend payments).

Summary and Conclusions

In summary, VWO has a longer history and larger assets under management compared to DEM (roughly a 50/.1.5 ratio).  It has a higher trading volume and lower bid-ask spread.  VWO has a relatively higher number of holdings.  However, VWO performance has trailed that of DEM.

VWO is heavily concentrated in Asia, both emerging and developed, while DEM is more evenly spread among four emerging market regions.  VWO also has a significantly high concentration in giant and large cap companies, with miniscule amounts in mid and small caps.  DEM includes twice as much concentration in mid and small caps, as compared to VWO.

VWO has higher standard deviation than DEM, with lower Sharpe ratio, indicating DEM offers a potentially higher reward for the risk undertaken.  DEM also includes a much higher dividend.

For investors looking for liquidity or to add more Asian investments to their portfolio, VWO would be a good choice.  For investors looking for greater diversity in region, market cap and style concentrations, DEM would be the better choice.  From a pure analytical perspective, DEM offers potentially better return on the investment.

Elizabeth Jones, Intern Research Analyst and Sonja Gonzalez, Financial Advisor contributed to this article.

Actively managed funds, however, have a fund manager that buys and sells the individual stocks and bonds on a frequent basis in an attempt to beat a market index, not just follow it.  The frequency of turnover can be high – turnover being the replacement of all the stocks and bonds in the portfolio with new ones.  The performance of such funds is said to be superior based on the skill of the fund manager, but studies have shown that active fund managers are more a victim of luck than actual skill.  The University of Maryland has a study that shows only .06% of active fund managers from 1975 – 2007 beat their corresponding index.

The benefit to you is lower fees.  Fund fees include the transaction fees of trading, and the salary and bonuses paid to the fund manager. Fees for ETFs are in the 0.07-0.50% range generally, while actively managed mutual fund fees can be in the neighborhood of 1-3% or more, because of more frequent trading and the highly paid fund manager.  Fees are taken off the top of earnings.  For example, if a fund earns 10% but has fees of 3%, you only see a 7% return on your investment.  An ETF that earns the same 10%, but with fees of 0.50%, leaves you with a 9.5% return.

What is the individual investor to do in these volatile times? I would urge you to do nothing IF your portfolio is properly allocated. Why? Investors tend to do poorly when they react to what the market does instead of preparing for what has historically happened over the many years of market history.

Reactionary behavior creates poor performance, thus bad investments. Data from Morningstar indicates that investors tend to buy investments high and then sell investments low. We see this through inflows and outflows in the stock market. The largest inflows come at historical market peaks while the largest outflows come at historical market bottoms. To make matters worse, those outflows from stocks flow into bonds, which are at their historical highs. This seems like a simple, commonsense problem, but each time extraordinary events happen in the stock market, people will ultimately say, “This time it’s different.”

John Templeton, a mutual fund pioneer and asset manager said, “The most dangerous words in investing are ‘This time is different.’”

Going forward into the unknown, investors will make money by creating a wise investment strategy and sticking to it. Good investment strategies may still have time periods where performance lags in times of crisis. For example, during the rise of the tech bubble at the end of the 90s, a good investment strategy lagged the performance of the tech stocks people were using to get rich. However, the good investment strategy didn’t crash like many of the tech stocks. What is a wise investment strategy? When investing, you want to maintain a diversified portfolio, keep cost low and always invest for the long term. Do this by choosing an asset allocation of stocks, bonds and commodities that matches your age and or objectives. Be wary of stockbrokers; they are there to make a sale, not provide advice for individual needs. People in this line of work usually talk fast and may make you feel good, but in the end, you are the one stuck with paying a Cadillac price for a Chevy Nova. Choose index funds over mutual funds. Finally, when the market becomes volatile, stick to your allocation.

There are many free resources to help an investor choose a proper allocation by age or risk tolerance. Morningstar, S&P and Down Jones all have their own allocations that are available on the web.  If you are 15 years away from retirement and a moderate risk taker your portfolio can look something like the following.

A Person approaching retirement or looking for more income growth opportunities can adjust the allocations above and include investments focused on dividends. Wiser Wealth Management uses a model similar to the one below.

Current 12 Month Portfolio Yield 3.9% One Key difference between the most successful investors and everyone else is the ability to do the opposite of your instincts. Look at your portfolio and pick an allocation for today, meaning do not look at the past portfolio performance but simply focus on where you need to be in relation to risk going forward. You cannot change the past, but you can change how your portfolio reacts to major down swings in the future.  When the next correction happens, ignore that temptation to move to cash and stick with you portfolio that has been built to weather the storm.

Employers typically will offer to match a certain portion of your 401(k) contributions to encourage you to invest for you retirement.  The level is most often a percentage of the dollar up to a maximum – i.e., 100% match on the first 5% of your salary that you contribute.  Anything above 5% will not be matched, and anything below 5% will only be matched to the level that you contribute.

In terms of maximum contribution limits, the maximum is much higher for 401(k) plans than for IRAs – $16,500 for 401(k)s in 2011, compared to $5000 for IRAs.

Once you decide how much money you have to invest towards retirement, you should invest in the following order.  Follow this order even if you are not able to invest to all the maximums.

1)    Invest in your 401(k) up to the level of the maximum matching contribution.  This is free money, and you should never leave it on the table.

2)    Maximize your IRA contribution to the annual IRS limit.  You have more control over an IRA than your company’s 401(k).

3)    Go back and maximize your 401(k) contribution to the annual limit, to take advantage of every bit of tax-advantages savings you’ve got.

Investors should never chase yield, meaning simply buying the highest yielding product with no concern about who is paying the interest. No company pays a high yield on its bond simply because they just want to be nice. Yield is based on the risk of getting your money back. A US Treasury Bond pays a lower yield because chances of getting paid back are nearly 100%. If you lent money to General Motors several years prior to bankruptcy, you got a very high yield, but then lost your entire principal after the government takeover. Lending money to Coke would fall in between the US government and GM. Coke is not as secure as Uncle Sam, but the risk of Coke going out of business in the near term is not realistic either.

A way to increase portfolio yield and not increase overall risk is to reallocate a portion of your equity holdings into dividend-paying domestic and international index funds and preferred stock.

Every conservative or income growth portfolio has some exposure to equities. A sample income growth model is listed in the table below. The portfolio is made up of 30% equities, 60% bonds, 3% commodities and 10% cash. The current 12-month yield is 2.7%, with a 5-year 5.78% annualized rate of return through December 31, 2010. The 5-year standard deviation is 9.6. The portfolio is made up entirely of index funds. Over the same time period, the S&P 500 had a standard deviation of 18 and a return of 2.29%.

Below, I explore the options in using exchange-traded funds to supplement the equity allocation in the above portfolio.

DOMESTIC DIVIDEND ETFs

Simply adding exchange-traded funds (ETFs), like Vanguard’s Dividend Appreciation Index (VIG), to a portfolio can increase a portfolio’s yield. VIG holds over 140 large cap companies that have increased their dividends consecutively over the last 10 years. The fund yields 2%; this is 10% higher than the S&P 500. According to Morningstar, VIG is allocated with 50% giant, 35% large, 12% mid and 2% small cap domestic exposure. VIG’s expense ratio is 23 bps. This fund has $4.6 billion in assets under management. As of 12/31/10, VIG had a 3-year rate of return of .2% with a standard deviation of 18.69.

State Street’s SPDR S&P Dividend ETF (SDY) tracks the S&P Dividend Aristocrats Index, which holds 60 S&P 1500 companies that have increased their dividends every year for the last 25 years. The companies must have a market cap of at least $3 billion and an average trading volume of $5 million for at least six months. The fund currently yields 3.35%. Morningstar breaks down this Large Cap Value ETF with 17% giant, 34% large, 39% mid and 9% small cap companies. The expense ratio is 35 bps. This fund has $5.2 billion in assets under management. As of 12/31/10, SDY had a 5-year rate of return of 3.31% and a 5-year standard deviation of 18.63.

The iShares Dow Jones Dividend ETF (DVY) currently yields 3.42%. This ETF tracks the Dow Jones Global Select Dividend Index. The methodology behind this index is to track the top 100 yielding stocks in the Dow Jones US index, excluding REITs.  Morningstar divides this ETF as 11% giant, 37% large, 35% mid and 15% small cap stocks. The ETF has $6 billion in assets under management with an expense ratio of 40 bps. As of 12/31/10, DVY had a 5-year rate of return of -.2% with a standard deviation of 19.02.

Many advisors would consider VIG, SDY and DVY to be the same. However, just a quick study of their underlying index methodology tells a different story. VIG could be used as a core asset allocation strategy to replace value/growth neutral holdings. It should also be noted that this ETF holds only 6% financials.

SDY can be used in portfolios where growth and value holdings are strategically allocated. Traditional large and mid cap holdings could be reduced and SDY used to supplement portfolio yield with equity dividends.

DVY is more tilted towards value compared to SDY and carries more small cap equities. 70% of holdings are in the US manufacturing sector. This ETF could be used as an alternative to SDY, but it is still not an apple-to-apple comparison.

PREFERRED STOCK

Preferred stock is a hybrid between a bond and a stock. I always tell my clients a stock gives them voting rights, but if the company goes out of business they could lose their principal. If you hold the company’s bonds, you do not have a voting right, but you get regular income from the bond and possibly a desk or a forklift (collateral) if the company folds. A preferred stock gets a higher dividend than the common stockholders and preferred shareholders get paid first. The higher dividend is closer to the bond yields and you can get equity-like returns. This, of course, does not mean that preferreds should be chosen over common stock. Preferreds are generally related to financial and utility companies. It should also be noted that, as seen in the chart below, preferred stock did not hold up well during the financial. However, with 7% yields and a financial industry bailed out and healthier, perhaps the future risks of preferreds will be less than the past three years.

iShares S&P US Preferred ETF (PFF) tracks the S&P US Preferred Stock Index. The ETF currently yields 7.32% with an expense ratio of 48 bps. The index is comprised of U.S. traded preferred stocks that meet criteria relating to minimum size, liquidity, exchange listing and time to maturity. The index is calculated with a modified capitalization weighted scheme, with modifications being made to index shares to prevent single issuer concentration and improve index liquidity. The index is rebalanced on a quarterly basis. Virtually all of PFF’s (83%) holdings are in the US financial sector. PFF currently has 220 holdings and $6 billion in assets under management. As of 12/31/10, PFF had a three-year rate of return of 6.81% and a standard deviation of 33.28.

State Street offers SPDR Wells Fargo Preferred Stock ETF (PSK). PSK tracks the Wells Fargo Hybrid and Preferred Securities Aggregate Index. The index methodology seeks to track non-convertible preferred stock and securities that are functionally equivalent to preferred stock, including but not limited to, depositary preferred securities, perpetual subordinated debt and certain securities issued by banks and other financial institutions that are eligible for capital treatment. PSK holds 160 preferred stocks, with $106 million in assets under management. 83% of the ETF’s holdings are in the finance sector; 5% are in utilities. The fund’s expense ratio is 45 bps. This ETF was created on 9/16/2009, thus we have no 3 or 5-year data.

ETF provider PowerShares offers two ETFs covering preferreds. PGX, the PowerShares Preferred ETF, tracks the BofA Merrill Lynch Core Fixed Rate Preferred Securities Index. The index tracks investment-grade preferred securities. The index is rebalanced on a monthly basis. The ETF has 70 holdings, $1.3 billion in assets, a yield of 6.74% and an expense ratio of 50 bps. This ETF began trading on 1/31/08, thus we do not have three-year data.

PGF  – PowerShares Financial Preferred ETF tracks the Wells Fargo Hybrid and Preferred Securities Financial Index. The index captures US listed securities issued by financial institutions. The ETF has 45 holdings, a yield of 7.08%, $1.7 billion in assets and an expense ratio of 65 bps. As of 12/31/10, this ETF had a three-year rate of return of 1.6% with a standard deviation of 39.78.

Each of these preferred stock ETFs is uniquely different, with iShares’ PFF holding the most assets and carrying the title of most diversified. Adding a small percentage of preferred stocks to a portfolio can boost overall yield. Investors should also note the high standard deviation of these indexes/ETFs.

INTERNATIONAL DIVIDEND ETFs

MSCI EAFA has been a staple in investing outside the United States for many years, covering Europe, Australia, the Far East and Asia. Taking another look at dividend weighted or focused ETFs investing in companies outside the US with will help boost portfolio yields.

State Street’s SPDR S&P International Dividend ETF (DWX) tracks the S&P International Dividends Opportunity Index. The index is designed to measure the performance of the 100 highest dividend yielding common stocks and ADRs listed in primary exchanges of countries included in the S&P/Citigroup Broad Market Index. The ETF yields 4.23%, with $343 million in assets under management and an expense ratio of 45 bps. Morningstar indicates that the fund is allocated with 10% giant, 30% large, 58% mid and 0% small cap international exposure. The fund currently holds 101 foreign companies. DWX began trading on 2/12/08 and does not yet have a three-year track record.

iShares Dow Jones International Select Dividend Index ETF (IDV) tracks the Dow Jones International Select Dividend Index. The index tracks the top 100 dividend payers based with country and company weightings, rebalanced annually. The ETF has a 12 month yield of 3.94%, $358 million in assets and is tilted towards international large cap value. Morningstar breaks down the ETF’s 99 holdings cap size as 34% giant, 32% large, 31% mid and 1% small cap. The expense ratio is 50 bps. As of 12/31/10, the ETF has a three-year rate of return of -5.17% with a standard deviation on 31.93.

WisdomTree offers an ETF that tracks the WisdomTree DEFA Index, ticker DWM. The index is fundamentally weighted and measures the performance of dividend paying companies in the industrialized world (excluding Canada and the United States) that pay regular cash dividends and meet other liquidity and capitalization requirements. The ETF is tilted towards international large cap value with a Morningstar reported cap size of 54% giant, 28% large, 14% mid and 2% small. There are currently 636 companies in the ETF, providing the portfolio a yield of 3.24%. The expense ratio is 48 bps and it has $418 million in assets. As of 12/31/10, the ETF has a three-year rate of return of -8.3% and a standard deviation of 26.5.

Reviewing these three options, WisdomTree’s DWM offers the largest diversification and a lower standard deviation. However, the ETF also has the lowest return: -8.3%.

When comparing ETFs or building portfolios using ETFs, the investor often does not have enough history to back test theories and strategies. A way around this is to actually look at the raw index performance. An investor cannot invest directly into an index but it certainly gives him or her guidance as to the expected performance of the ETF. The ETF will not track the index exactly as fees, portfolio optimization and illiquid or poorly priced securities will cause tracking error. Tracking error is something that should always be observed before investing in an ETF.

For the purposes of this portfolio, we will simply focus on yield and risk. Referring back to our original portfolio, we will add 4% of SPDR S&P Dividend ETF (SDY), 8% of the SPDR S&P International Dividend Opportunity ETF(DWX) and 4% of the iShares Preferred Stock ETF (PFF). Our goal is to keep risk virtually unchanged while also increasing yield. In our portfolio, we are willing to have a value tilt in domestic and international large cap and take on a small percentage of preferred stock. The results can be seen on the chart below.

With our changes, yield increases from 2.77% to 3.2%, a 15% increase; 5-year return was up from 5.78 to 6.08%. Overall portfolio risk did increase slightly, but our Sharpe Ratio, a measure used to see if additional risk is being compensated for, increased from .39 to .41.

While investors and advisors may not have chosen the same ETFs used here, the point is to show that a reallocation of equities can increase portfolio yield while keeping overall risk in check.

However, I do want to share with you the blog of an Egyptian-born pastor here in Atlanta. Dr. Michael Youssef is the pastor of the Church of the Apostles (www.apostles.org). He is also the lead voice of Leading The Way, a worldwide outreach ministry also based here in Atlanta. Many of the news anchors that you are listening to, as well as key US government officials, do not understand the root cause of the Egyptian protests.

Here is an excerpt of Dr. Youssef’s recent blog on Eqypt:

“Westerners are looking at what is happening on the Egyptian streets and wondering if it is good for an oppressed people to protest against a semi-dictatorial regime. Most of these young protesters cannot find jobs, and inflation has ravaged the middle class, to say nothing of the gulf between the very rich and the very poor.

On the surface, this is an understandable situation. But before you judge the motives of the protesters, you must know who is really behind those young people on the streets.” Click HERE to read his full blog.

In another blog, Dr. Youssef writes about America’s Role in this crisis:

“The problem with freedom and democracy in the Muslim world is that it is a figment of the imagination that only exists in the minds of Condoleezza Rice and Hillary Clinton.” Click HERE for his full blog.

Dr. Youssef on CNN Television

Youssef on CNN

http://seekingalpha.com/article/245100-casey-smith-playing-defense-with-commodities-emerging-market-debt

TRND is an ETN, so the investor is not actually purchasing the S&P 500 or treasuries. An ETN is essentially a promissory note. The investor is taking on the credit risk of the Royal Bank of Scotland, which received a large bailout from Scotland during the financial crisis. TRND is paying a return based on the S&P 500 200 moving day strategy. Should RBS default, the ETN holder will be left with nothing, as there are no assets tied to ETNs.

TRND is the first exchange traded product to have a two tier cost structure. If the S&P 500 is above its 200 day moving average, then the cost is 1% to investors. If the S&P 500 is below its 200 day moving average, thus tracking the short US treasury index, the fee is .50%. Many ETF commentators have balked at this price, but is it really that expensive compared to the alternatives? Can TRND replace other products?

Many variable annuity sales come from investors wanting S&P like returns with no risk. They can’t find this on their own, so they walk into the bank to purchase a CD. The teller then refers them to the bank “financial advisor,” better known as a commission salesperson. This salesperson tells the investor that there is something called a variable annuity available, but that there is a cost involved. Unfortunately, what most investors don’t find out until it’s too late is that the majority of variable annuities are like bags of potato chips, full of air with little substance.

With these annuities, the investor is purchasing an insurance product that allows him or her to invest their cash value into mutual fund-like accounts. The investor can take on the investment risk being guaranteed that their account will grow by 3% or some other predefined amount. This is great in concept, but there’s a catch, of course. The investor has to pay for a death benefit, a fee for the guaranteed account and a fee for each separate managed account within the annuity. These fees are not cheap and add up quickly, deteriorating the real rate of return.

The variable annuity concept is to reduce the overall risk of investing, but is flawed for several reasons. The stock market has never had a twenty year losing record, so over the long term what is the investor insuring against? This makes using a variable annuity as a means for saving for retirement absurd. The fees on insurance based variable annuities are high and oftentimes hidden. Pending legislation may fix this problem, but for millions of investors the damage has been done. Annuities are also a big payday for the commission salesperson. This is why insurance-based annuities charge a high fee to cash them in for seven years or sometimes up to fourteen years. The point here is that the investor is looking for gain with principal protection, specifically protection from financial crises.

This is where TRND can be viewed as a real deal:  in its potential as a replacement for the variable annuity. The variable annuity can cost up to 4% a year in fees, which makes TRND’s 1% fee seems bargain basement. The ETN will also provide protection, triggered when the S&P 500 goes below its 200 day moving average.

Variable annuities are also pushed by salespeople for their tax deferral feature, meaning that the money that is invested in the product grows tax deferred. TRND, because of its tax efficiency, provides the same benefit. Until you sell TRND, there are no negative tax consequences. This is possible because TRND’s price is adjusting to compensate the investor for the performance of the S&P 500 200 day moving average strategy and not actually trading this concept. This provides another advantage, as the investor does not have the trading cost of this strategy or the slippage in the reaction time to get the trades placed when the S&P 500 drops below the 200 day moving average.

When an annuity is passed through death to its beneficiaries, the entire gain will be taxed. The ETN, under the current estate tax laws, will receive a step up in basis, making it more tax efficient than the annuity.

Currently, the annuity will offer a complete portfolio under its umbrella. TRND is just an S&P 500 allocation, but an advisor with creative thinking could complement TRND with other ETFs and ETNs to build the same concept.

TRND seems to be a great replacement for index annuities as well. The term ‘index annuity’ is a play off the positive connotation of index funds. The devil is in the detail here, and I assure you the math does not add up. Most index annuities are based on the price changes in the S&P 500, not the total return including dividends like TRND. TRND can be liquidated instantly with no penalty whereas many index annuities have a hefty ‘get out’ fee up to fourteen years. The guarantee of an index annuity is the protection, and that would be accomplished with TRND as it will move to treasuries for safety. In the long run, TRND would have greater returns and even at the 1% fee, it is still considerably cheaper.

Will TRND replace variable and index annuity sales? Financial advisors who sell annuities are compensated by commission. They only have to prove that the investor is suitable for the annuity, not that the annuity is the best product for the client. TRND does not pay a commission to anyone, thus it will probably only show up in advisory firms that fall under fiduciary responsibility and are compensated hourly, by assets under management or a flat fee. Will these advisors embrace TRND? Time will tell, but at first glance, these advisors will think the 1% fee is outrageous because expensive products generally do not show up at fiduciary firms.

Casey T. Smith

President

Wiser Wealth Management, Inc

This article also appears at http://www.etfmarketpro.com/an-etn-to-replace-a-variable-annuity.html

This article also appears at http://seekingalpha.com/article/244648-rbs-trend-pilot-etn-to-replace-the-variable-annuity?source=dashboard_etfs

Here is a brief summary of the estate planning components of the new law:

*     Originally there was no estate tax in 2010.  Now there is a RETROACTIVE ESTATE TAX on amounts over $5.0 million per individual which will be taxed at a 35% rate.  However, estates of individuals passing away in 2010 will get to CHOOSE between the RETROACTIVE TAX or the “NO TAX” AND IT’S CARRYOVER BASIS.

*       The estate tax will be imposed on individual estates in excess of $5 million in 2011 and 2012 at a rate of 35%.

*       THE GIFT TAX EXEMPTION WILL BE $5 MILLION.  That’s right – MUCH higher than it has been or anyone anticipated it would be.  This will allow for some incredible, once-in-a-lifetime opportunities to create a legacy that will last for generations to come.

*       PORTABILITY IS ADDED.  This is a new concept to many people (and many attorneys and planners too!).  For married couples, any unused portion of the estate tax exemption from the first spouse to die can be used as an added exemption when the second spouse passes.  Watch out though, as there are certain procedures that must be followed when the first spouse passes for this to work.  More to come on that later.  This doesn’t invalidate the need for proper estate planning – just the opposite.

*       THE GENERATION SKIPPING TRANSFER TAX EXEMPTION amount is increased to $5 million as well.  One significant planning Christmas gift that Congress gave us is NO GST TAX THIS YEAR!  If you have a client who wanted to set up trusts for grandchildren or skip persons – you only have until December 31st to do so!!  The Act provides that for any GST made after December 31, 2009 but before January 1, 2011, the GST tax rate is ZERO.  What Congress has done by reviving the GST tax for 2010 and setting the rate at 0% is to acknowledge that GST’s may be made in 2010 and such GST’s are subject to taxation, albeit at a tax rate of 0%.

The critical thing is that the new tax law ONLY LASTS FOR TWO YEARS!  It seems that hasn’t had much play in the media yet, but two years will go very fast, and what planning do we need to do after that?  Still up in the air. Congress came close to letting the law revert back to 2001 law this time, so what will they do next time?  We still are in a state of flux for planning purposes.

See the flyer for more details.

There are three ways to invest:  buy stock, purchase a mutual fund or invest in an index fund. Purchasing individual stock has its risks and rewards. Often, retail investors think about the successes of Google and Apple, or happily recall the 80s and 90s victories of Coke and others. Unfortunately, it’s easy to forget about stock blowups like Enron, GM and BP, which are examples of company risk. Since the 1980s, mutual funds have served as a great diversifier for individual investors by giving them access to professional money management. However, over the last decade, many of the best fund managers have left the mutual fund business to work in the less regulated hedge fund world. The loss of talent, volatile investment climate, under performance and ethical missteps have brought a lot of unsavory attention to mutual funds recently, putting more focus on a third investment option, indexing.

Indexing visionary John Bogle, founder of Vanguard, brought the first index mutual fund to market. The concept is that over the long term, an active portfolio manager’s rate of return moves back to the average (the index; S&P500). We see this in a University of Maryland study that shows that only .06% of managers beat their assigned index from 1975 – 2007 after fees. Over shorter periods of time, active management improves its record with 33% beating the assigned index, according to Morningstar. This is the same concept that compelled the great investor Warren Buffet to bet hedge fund managers $1 million that they could not beat the S&P 500 over a ten year period. He had also offered investment advice to individuals, stating that most individual investors should consider index funds for long term investments.

The concept behind indexing is to purchase everything within an asset class. For example, if you want to hold domestic large cap stock, you can purchase a Vanguard S&P 500 index fund that holds all 500 S&P companies. This works in opposition to a mutual fund manager selecting 30 to 100 funds and having 100% turnover in annual portfolio holdings. The same system applies to the S&P 600, 400 and International indexes. The indexing approach virtually eliminates company risk, as well as active management risk.

In 1993, the first Exchange Traded Fund, named the Spyder, was created. Today, it still represents the S&P 500. An ETF is very similar to an index mutual fund, but with added benefits. An ETF trades similarly to a stock in that you can trade during market hours rather than waiting for the close of business like a mutual fund. The structure of an ETF allows the fund administrator to rebalance the fund without passing through any capital gains to investors. Because there is no active management involved, the cost of ownership is very inexpensive. The S&P 500 ETF costs 0.09% a year in fees. This is much less than the average 2.2% that a mutual fund costs. An ETF is also very transparent, allowing investors to see the fund’s holdings in real time versus just quarterly with mutual funds. There are currently over 900 ETFs on the market with over $1 trillion in assets. In the last three years, more money has flowed into ETFs than mutual funds. TD Ameritrade says that 80% of portfolio managers, active and passive, use ETFs in some fashion. Charles Schwab says that 15% of retail investors are using this relatively young product. We also see innovative companies such as Fed Ex and Apple now building 401k portfolios entirely with index funds and in Apple’s case, ETFs.

FIDUCIARY

A plan sponsor has the fiduciary responsibility to act solely in the interest of plan participants and their beneficiaries with the exclusive purpose of providing benefits to them. This means carrying out their duties prudently, following the plan documents (unless inconsistent with ERISA), diversifying plan investments and paying only reasonable plan expenses. Adding Exchange Traded Funds to a brokerage link allows the participant to diversify away from active management risk and specific company risk. The ETFs will bring substantially lower investing fees to the plan versus what is currently being offered. Fiduciary duty demands that ETFs and/or index mutual funds be considered in any 401k plan.

COST

The graph below compares the cost of a moderate risk portfolio using the current JP Morgan 401k plan options versus a moderate risk ETF portfolio that could be held within the brokerage link. The difference is 0.61% a year, which would add 11% to a participant’s 401k balance assuming he or she is adding $8K a year to the plan for 30 years. That provides an additional $59K in value to the participant. The two portfolios had essentially the same performance over similar time periods. Low Cost was the contributing factor to the increased rate of return.

ETF DIVERSIFICATION

Many ask why it is a good idea to choose ETFs over Index Mutual Funds. Inside a 401K, it is difficult to compete with Vanguard Index Mutual Funds as a built-in investment option. We would think this is one reason why Fed Ex and other large companies have chosen Vanguard as their 401k custodian and administrator. Otherwise, ETFs inside a brokerage link are a great option compared to expensive plan mutual funds. Essentially, the creation of Index Mutual Funds was the stepping stone to ETFs. ETFs provide low cost index access to areas that many 401k mutual funds do not cover, such as small cap developed international, frontier markets, commodities, emerging markets, Treasury Inflation Protected Bonds, Emerging Market Bonds and various durations of treasury and corporate bonds. ETFs also cover all traditional asset classes much less expensively than traditional index mutual funds and 401k plan options.

CAUTION

Wiser Wealth Management is a leader in the usage of ETFs, as well as developing and disseminating ETF education worldwide. We have spoken in Europe, Asia and the United States about the benefits of using ETFs within portfolios. However, some ETFs are not for retail investors. The Pro Shares product line of inverse funds are for day trading only and in our opinion should never be an option for a plan participant. Other ETFs should be limited based on their low trading volume and low assets under management. We would also recommend that the plan sponsor request a best execution strategy for trading stock and ETFs within the brokerage link to prevent JPM from marking up trades. Additionally, we would recommend that education be provided to all plan participants about the benefits of a brokerage link, as well as the risk (in plain language) just as ALPA is doing with its pilots.

CONCLUSION

In “A Father’s Book of Wisdom,” H. Jackson Brown wrote “ignorance is to reject something that you know nothing about.” Financial advisors, individuals, the media and professors are all still learning about the benefits of Exchange Traded Funds. Undoubtedly, ETFs have shaken the investment world by empowering investors at all levels with quick access to low cost diversification. Adding ETFs to the Atlantic Southeast 401k brokerage link will allow investors low cost access to global asset classes. If used properly, ETFs can increase the standard of living of the Atlantic Southeast retirees and allow for current reduced company risk, active management risk and portfolio liquidity. ETFs will allow plan participants to purchase the indexes that the active managers cannot seem to beat over long periods of time.

Casey T Smith

President

Wiser Wealth Management, Inc

www.wiserinvestor.com

ASA ALPA 401k Specialist

The bank and its securities division are in business to make money. This is okay if the compensation among all the bank’s product offerings were the same, allowing for unbiased advice. This is not the case, however, as annuities provide the biggest payday to the bank and its sales force (6-7% average commission for the salesperson).

Annuities are costly because they are insurance-based products that have to make up the cost of what they are guaranteeing you. For example, many annuities guarantee that you will never lose principle, while at the same time allowing you to make money through separate accounts similar to mutual funds. The reality is, and a better explanation of this offer is, that your beneficiaries are guaranteed your principle upon your death, not you. This guarantee had little benefit during the financial crisis if you were at the doorstep of retirement.

According to Morningstar, the average expense of a variable annuity is 2.2%. If you invest $10,000 into an annuity and the market returns 8%, in 20 years you should have $30,882 including fees. If you instead invested in an index portfolio costing you 0.20%, you would have $44,498; that’s $13,616 more!

For younger investors, the annuity is pushed as a tax deferral investment program. A variable annuity will give you that at a cost. For those investors who are maxing out their 401k and IRAs and looking for tax sheltered retirement savings, I have determined that the best vehicle is a taxable, tax efficient portfolio. With the growing popularity of Exchange Traded Funds (ETFs), an investor can build a very tax friendly portfolio at an investment cost less than 0.30%.

Why do consumers fall for the annuity bait and switch? It comes down to the persuasion of the salesperson and the bank playing to the consumer’s fears of investing. Many bank-going consumers would probably never invest in the market at all, deeming it too risky. The annuity appears to have the safeguards that the consumer wants. Just remember that there is no such thing as a free lunch. If it sounds too good to be true, it is. There are many alternatives to managing investment risk that will cost you one tenth of the average annuity. A fiduciary fee only advisor can help you explore these options.

While the article has some interesting points, the ETF industry has quickly proven the thesis absolutely false. How?

Kyle Waller, research analyst at Wiser Wealth Management, Inc, states that “only properly settled shares, in good delivery, can be delivered to the Issuer for redemption.” This basically means that if you purchase an ETF and the trade has settled, then you own the underlying shares. A person simply shorting an ETF does not own settled shares. Therefore, they are taking on the additional risk.

Matt Hougan of IndexUniverse.com stated in his blog, “the [researchers] concern is addressed in the prospectus and Statement of Additional Information (SAI) of every ETF I’ve ever looked at. Here’s what it says in XRT’s [Retail ETF questioned in the article] SAI:”

“An Authorized Participant submitting a redemption request is deemed to represent to the Trust that it (or its client) (i) owns outright or has full legal authority and legal beneficial right to tender for redemption the requisite number of Shares to be redeemed and can receive the entire proceeds of the redemption, and (ii) the Shares to be redeemed have not been loaned or pledged to another party nor are they the subject of a repurchase agreement, securities lending agreement or such other arrangement which would preclude the delivery of such Shares to the Trust. The Trust reserves the right to verify these representations at its discretion, but will typically require verification with respect to a redemption request from a Fund in connection with higher levels of redemption activity and/or short interest in the Fund. If the Authorized Participant, upon receipt of a verification request, does not provide sufficient verification of its representations as determined by the Trust, the redemption request will not be considered to have been received in proper form and may be rejected by the Trust.”

Hougan goes on to say, “This means, when redeeming shares of XRT, you have to say that the shares aren’t lent out. If there’s high short interest in the fund, you’ll have to prove it, or the redemption doesn’t go through.”

Looking at the ETFs that we use here at Wiser, I agree with the assessments of Matt and Kyle. I do not see the Bogan & Connor report as having much merit for concern, especially with the ETFs that we use in our models.

What does concern me is how quickly this report showed up on CNBC without the completion of any fact checks. The report itself lacked the data to prove its points and also contained a few assumptions that are not correct. The report incorrectly assumes that investors poorly understand ETFs because they represent 70% of the canceled trades on May 6^th, now known as the “flash crash.”  A recent article in Barrons points the finger at Waddell and Reed, a mutual fund company, for starting the flash crash. This triggered other program trading, which resulted in a very volatile day in the market.

Not only did CNBC not do some fact checking prior to talking about the Bogan & Connor report, they also did not really portray ETFs correctly. Kyle Waller picked up on this and commented that, “CNBC called ETFs derivative products, which implies a lot of risk to the average investor.  However, the plain vanilla stock ETF truly represents an un-leveraged position in a basket of stocks, deriving its value from the underlying creation unit.  These kind of ETFs are derivatives the same way common stocks are derivatives of the company’s value.”

It seems to me that more people need to attend the next ETF conference. So many advisors, individuals, institutions, media outlets and, evidently, Ph.Ds do not understand this innovative product.

You can read the Bogan & Connor Report, CNBC’s coverage and Matt Hougan’s blog here:

http://ftalphaville.ft.com/blog/2010/09/18/346406/can-an-etf-collapse/

http://www.cnbc.com/id/39309280

http://www.indexuniverse.com/sections/blog/8122-can-an-etf-collapse-no.html

The providers participating in the free commission trades are as follows:

Barclays Bank PLC

iShares

Vanguard

Deutsche Bank AG

PowerShares

Van Eck

iPath

SSGA

Wisdom Tree

On this list of 100 ETFs, there are eleven that Wiser uses in its ETF portfolio models. There is great news for our younger clients who contribute monthly to their accounts.  The iShares asset allocation ETFs are included in this list.  This means that you can invest monthly into AOA, AOM, AOR, AOK or AOC and 100% of your funds get invested without having to pay a $9.99 commission to TD Ameritrade.

Most accounts at Wiser Wealth hold twelve ETFs.  Assuming a rebalance is needed on an annual basis, this new program at TD Ameritrade will save our clients $60 a year.  Clients contributing to their accounts on a monthly basis will save $120 a year, and new clients will save at least $200 the first year.

Wiser maintains five ETF models managed for overall investment risk.  The listing of commission free ETFs will be added to our screening process during our next model review.

However, all advisors are not the same. So, how do you pick one? Below are five factors to take into consideration when making your choice.

CHOOSE AN ADVISOR WITH FIDUCIARY RESPONSIBILITY

Make sure the advisor accepts “Fiduciary Responsibility” in writing. Fiduciary duty separates a financial advisor from a broker, who is held to a lesser ‘suitability’ standard. Fiduciary requires an advisor to put each client’s interest first and disclose any possible conflicts of interest. While a non-fiduciary advisor may have your best interest at heart, his or her tool box of investment choices is littered with products that may not be the best available.

FEE ONLY OR HOURLY COMPENSATION

Would you want to go to a doctor who gets paid by the drug companies? Essentially, that is what can happen if you work with a broker. Brokers are paid through the products they sell. A fee-only advisor has no incentive other than to search for the best investments. The amount that you pay the advisor will vary. Most fee only firms will charge a percentage of assets that they manage. This percentage varies from 0.25% to 1.5%, depending on the services offered. Some firms will work for an hourly rate.

TAKE CUSTODY OF YOUR ASSETS

Never write a check with funds intended for investments directly to an advisor or his or her firm. You should be depositing your investments into a third party custodian such as TD Ameritrade, Fidelity or Charles Schwab. You are essentially hiring the independent advisor to manage the account. This system creates checks and balances, reducing your chance of fraud.

CHOOSE A COMPREHENSIVE ADVISOR

If possible, choose an advisor who offers tax preparation and estate planning services in addition to financial planning and management. Advisors with a complete understanding of the tax implications to their investing strategy and your individual tax situation will save you money in the long term. In addition to tax planning and preparation, working with a firm that understands and offers estate-planning strategies will help you with the big picture. For example, if your assets are over the death tax exclusion when you die, your estate could be taxed at 55%. The bottom line is that if you hear “consult your tax advisor” or “consult your attorney,” you may consider looking for a firm that offers all three.

DO AN ADVISOR BACKGROUND CHECK

In Georgia, just about anyone can hang out a sign that says “financial advisor.” Make sure to look into the advisor’s background. Does the advisor have a finance, economics or accounting degree? Does he/she have any financial designations? (The CFP® designation is important if the advisor comes from a non-financial background, however it does not guarantee anything other than that they studied the core principles of financial planning.)

You can research independent advisors through the following link:

www.sec.gov/answers/iapd.htm

[Independent fee-only advisors cannot be found at a transaction-driven organization such as a brokerage firm or a bank, which depends on volume and not necessarily relationships when it comes to investing. Independent Advisors often own their own firms and are considered “Investment Advisor Representatives” (IAR) of their firms, which are registered as “Registered Investment Advisors” (RIA) with the State of Georgia or the SEC.]

Hopefully, these guidelines will help you choose a financial advisor whom you can trust and best meets your investing needs.

CASEY TYLER SMITH

Casey Smith is President of Marietta-based Wiser Wealth Management, Inc, a fiduciary fee-only investment advisory firm offering investment management, tax planning-preparation, and estate planning. www.wiserinvestor.com

For long term investors, the Vanguard product would bring value. For investors looking to write options on the index, State Street’s Spyder has the most volume. iShares S&P 500 also offers option trading. However, we have found that the volume/liquidity is not sufficient at some prices in this volatile market. The Vanguard fund does not offer option trading.

iShares IVV reinvests its dividends into the S&P 500 until they are due to be paid out quarterly. State Street’s SPY holds the dividends in cash until payout. This creates a dividend drag in SPY. Although a very slight performance difference, the volatility in IVV is slightly higher. Vanguard’s prospectus was not clear, but appeared to indicate that dividends would be held in cash prior to investor payout.

State Street’s Spyder was the first ETF created in 1993 for institutions to park assets in the market until they found individual companies to invest in. Between 2000 and 2004, many new ETFs came to market, creating a new passive investing strategy that was cheaper and covering more asset classes than ever seen before. Active traders also like ETFs for the ease of access, liquidity and reduced company risk that indexing offers.

Vanguard is a powerhouse in the indexing world and has always been able to bring quality index vehicles to the market.  With the addition of ETFs to access S&P indices, we see additional value at great pricing. Price is not the only factor in choosing an ETF, but certainly is in the top five of considerations.

I do not believe that the Mosque in New York should be placed near the World Trade Towers. There are many Mosques in New York, over 100 I believe. So religious freedom is certainly intact and the argument that such freedom is being penalized is not a valid one. It really comes down to symbolism. The World Trade Towers symbolized something very tangible, American Capitalism created from a free people. The Towers reminded us that Americans have the freedom to invest. The freedom the innovate. The freedom to take risks and earn great rewards. The freedom to learn. The freedom to live…. a free people.

On 9/11 a group of extremist Muslims assaulted that freedom. The 9/11 attack was anti free-thinking. Anti Women’s rights. Anti free speech. Anti freedom of religion. Anti the freedoms that have made America and its people the most blessed people in the world.  The Mosque’s name symbolizes victory over freedom and capitalism, victory over a free people that some Muslims call “infidels.”

We are at war. It does not feel or look like the wars of the past, but nevertheless we are at war with people just like those who flew planes into the World Trade Towers. Why do they get to place a victory mosque over the graves of so many Americans whose bodies were never recovered? Why are they allowed to celebrate on American soil the deaths of innocent Americans? Because of religious freedom? If a sect of a religion has declared war on America, their freedoms should be removed and action taken to protect the American people. The Muslims who condemn the actions of 9/11 should be granted freedom of religion, but ones who refrain from comment should be considered an enemy of the State. From key Muslim leaders at ground zero, we have heard a frustrating and disappointing, “no comment.”

Enough of my view. Here is a good Southerner who also gets the magnitude of this Mosque:

Newt Gingrich

 July 21, 2010 6pm

There should be no mosque near Ground Zero in New York so long as there are no churches or synagogues in Saudi Arabia. The time for double standards that allow Islamists to behave aggressively toward us while they demand our weakness and submission is over.

The proposed “Cordoba House” overlooking the World Trade Center site – where a group of jihadists killed over 3000  Americans and destroyed one of our most famous landmarks – is a test of the timidity, passivity and historic ignorance of American elites. For example, most don’t understand that “Cordoba House” is a deliberately insulting term. It refers to Cordoba, Spain – the capital of Muslim conquerors who symbolized their victory over the Christian Spaniards by transforming a church there into the world’s third-largest mosque complex.

 Today, some of the Mosque’s backers insist this term  is being used to “symbolize interfaith cooperation” when, in fact, every Islamist in the world recognizes Cordoba as a symbol of Islamic conquest.  It is a sign of their contempt for Americans and their confidence in our historic ignorance that they would deliberately insult us this way. Those Islamists and their apologists who argue for “religious toleration” are arrogantly dishonest. They ignore the fact that more than 100 mosques already exist in New York City. Meanwhile, there are no churches or synagogues in all of Saudi Arabia. In fact, no Christian or Jew can even enter Mecca. And they lecture us about tolerance. 

If the people behind the Cordoba House were serious about religious toleration, they would be imploring the Saudis, as fellow Muslims, to immediately open up Mecca to all and immediately announce their intention to allow non-Muslim houses of worship in the Kingdom. They should be asked by the news media if they would be willing to lead such a campaign. 

We have not been able to rebuild the World Trade Center in nine years. Now we are being told a 13 story, $100 million mega mosque will be built within a year overlooking the site of the most devastating surprise attack in American history. 

Finally, “where is the money coming from?” The people behind the Cordoba House refuse to reveal all their funding sources. America is experiencing an Islamist cultural-political offensive designed to undermine and destroy our civilization. Sadly, too many of our elites are the willing apologists for those who would destroy them if they could.

No  mosque. No self deception. No surrender.

The time to take a stand is now – at this site on this issue.

Emerging market bonds are a unique asset class with extraordinary characteristics, which many ETF investors have chosen to make a part of their portfolios.  Emerging market bonds have high absolute returns with low correlation to other markets, and are also high yielding vehicles.

Of the products on the market, The WisdomTree fund is the only local currency and actively managed fund.  The passive US Dollar ETFs have been on the market for some time and Van Eck Global launched its Market Vectors Emerging Markets Local Currency Bond ETF (NYSEArca: EMLC) recently as the first local currency emerging market bond ETF, which is also a passive product.

Because of these two newer entrants into the emerging market bond space, investors have a lot of choices when including emerging market debt into portfolios.

The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) is unlike other emerging market bonds in the ETF marketplace to date. Given in its name, the WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) invests in emerging market bonds dominated in their local currency.  This is in contrast to the other bond ETFs in the category on the market.  For example, the iShares JPMorgan USD Emerging Markets Bond Fund (NYSEArca: EMB) is the largest in the category with assets of $1,962,167,846.  EMB is a passively managed index fund.  The index that this fund tracks invests in bonds issued by emerging market governments in US Dollars.  The reason for US Dollar dominated bonds is to add a layer of currency security.  Emerging market currencies tend to be extremely volatile with wide swings down and up.  With US Dollar bonds, the issuing governments bear the risks from the currency volatility.  Long-term currency valuations are, however, reflected in the value of the bonds despite the issuing currency, since currency can express many relative things to an economy-such as a country’s relative strength to the US or Europe.

The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) affords investors an opportunity to gain access to emerging market bonds issued in local currency and an active edge on the asset class.

“ELD will offer full exposure to local currencies, a feature we consider important for many investors because of the potential lower correlations and currency appreciation against the U.S. Dollar,” said Bruce Lavine, President and CEO of WisdomTree, in a press release.

Currency does have a significant impact on total returns of international investments.  Over the last year, currency has contributed to a 3.80% difference between local currency and US Dollar returns in Emerging Market stocks; the MCSI Emerging Market Index Local Currency returned 13.98% and the MSCI Emerging Market Index USD returned 17.78 over the same time period.  During other time periods, however, this effect has hurt the US investor and can cause a significant difference in returns.

Long-Term Focus in Emerging Markets

In an ETF category with four investment vehicles all offering a small twist on the asset class, it will be a great study on which style of investment works best for emerging market bonds over different market conditions. The WisdomTree Emerging Markets Local Debt Fund (NYSEArca: ELD) is active and will seek to take advantage of inefficiency in the emerging bond markets.  This will be very interesting.  In inefficient markets, bonds can offer many places where a manager can take advantage of including duration, currency, default risks and valuation.

A major concern brought up by many ETF commentators is how passive bond indexes will award issuers who have more debt issues with higher allocations.  In effect, this means that the funds reward debt, allocating more heavily towards more indebted countries and companies.  Active managers should be able to bypass this problem very easily and will therefore lower some of the inherent risks in the bond portfolio.

So What Happens

Bad investments happen when investors buy investments high and then sell investments low.  This seems like a simple, common sense and easy to follow rule, but each time extraordinary events happen in the stock market and the rule is broken, people will ultimately say, “This time it’s different.”  John Templeton, a mutual fund pioneer and asset manager, had this to say, “The most dangerous words in investing are ‘This time is different.’”

As the chart shows, when stocks are historically at their cheapest, investors sell stocks and buy bonds.  When stocks are at high prices historically, investors buy stocks and sell bonds.

Going Forward

Going forward into the unknown, investors will make money by having a wise investment strategy and sticking to it.  Good investment strategies may still have time periods where performance lags in times of crisis.  For example, during the rise of the tech bubble at the end of the 90s, a good investment strategy lagged the performance of tech stocks people were using to get rich.  However, the good investment strategy didn’t crash like many of the tech stocks.

Before getting into downfalls of the market, it’s worth pointing out that corporate earnings in the first quarter have shown that consumers and businesses are once again willing to buy and invest. A very broad example of this can be seen in the hardware sector. Apple’s stock price is up more than 7% due to strong iPad and iPhone sales. This has also benefited Sandisk, a supplier of flash memory for mobile devices.  The company returned 21% in the quarter.

There is still an elevated unemployment rate, and job growth may be slow or delayed for months or even years in the future. The uncertainty among the American population regarding their job security and employment prospects makes it difficult to stabilize the housing market and boost consumer spending. Recent housing data has shown that even though mortgage rates are at record lows, the demand remains significantly down. Of course, it’s just common sense that people unsure of future cash flows will hold off on purchases that require a large monthly obligation, so investors are left skeptical of the housing market’s ability to recover fully after the expiration of the housing tax credit.

In the Manufacturing Sector, energy companies have been harmed by falling oil prices, the drilling moratorium, and fear over increased regulation in the wake of the Gulf oil spill. The anxiety over increased regulation seems to be a common denominator across the market, as there has been a weak performance of the financial sector as well. This is due to Washington and Wall Street turning their attention to financial reform. With this news of government intervention, bank and financial stocks were sold off as investors feared the impact of reform.

Large-cap companies have also been subject to substantial headline risk in 2010 as well. When the public focuses on large companies like banks, oil companies, and healthcare, Congress does so as well. These negative headlines not only affect investor sentiment, but can also affect the company’s underlying business. A general idea of the impact of the financial reform bill being passed should become clear in the upcoming month, as the financial sector gains a little more clarity on what it faces in terms of new regulations and compliance.

Excessive government debt is another uncertainty that has been at the forefront throughout 2010. The flight from the troubled European debt of Portugal, Italy, Ireland, Greece and Spain has led to a historic rally in the U.S. treasuries. The U.S. dollar, like in the past, has been seen as a safe haven to invest in despite growing borrowing needs and fundamentals that might suggest a rise in interest rates. The Federal Reserve, though, has committed to keep interest rates low for the foreseeable future. Although the U.S. still holds AAA status and should be in no immediate danger of a downgrade, the mounting debt issue with the US government will come under pressure unless measures are taken to reduce the record budget deficit, according to Moody’s Investor Service.

Granted, uncertainly will always be a factor in the market. Accurately predicting the future in the midst of reform, regulation, unstable governments, and future debt obligations is an extremely difficult proposition. In these times of negative feelings and general uncertainty, though, we can be certain that the different sectors will react negatively as they have this past quarter. In subsequent quarters, many of these unknowns will begin to come to light and the uncertainty driving the market currently will be clearer to investors.

By Paige Slusser

Casey Smith and Kyle Waller had their article on Fiduciary Responsibility posted at www.tabbforum.com.

Top 5 estate planning mistakes

I recently read a report that suggested that only about 20 percent of the population has a formal estate plan. After reviewing the points below, please take a minute to consider whether it’s time for you to create or update your estate plan.

Here are a few of the top 5 avoidable estate planning mistakes:

1. Dying without a will or trust – If you die without a will or trust, the state in which you reside and the IRS will simply make one for you.  Of course, they have no interest in avoiding or reducing estate taxes, minimizing estate administration costs or protecting your family and legacy. The distribution of your assets will just be turned over to the Probate Court. The probate process is needlessly time consuming, frustrating and expensive. It is also open to the public, meaning creditors, predators or anyone else will have complete access to all information about your estate. For the vast majority of people, the benefits far outweigh any initial costs.

2. Having an “I love you” will – An “I love you” will is one in which all the decedent’s assets have been left to the spouse. On paper, it might seem to be a caring, thoughtful gesture, but the reality is quite different, because such a will simply passes the complex issues and problems associated with transferring and protecting wealth onto the spouse or other loved ones.  It creates more problems than it solves, particularly for future generations.

3. Giving property outright to your children – Here is another solution that might sound good at first, but ignores several important realities. For instance, what if the child in question is too immature to handle the responsibility of a large sum of money on his or her own? What if the child suffers a severe financial setback that puts the inheritance at risk to creditors?  What if the child marries a fortune-hunter, is addicted to drugs or alcohol, gets divorced or remarried? You may need to protect your children and heirs from their own poor decisions.  These assets are also gifted assets which carry potentially large IRS penalties if not handled properly.

4. Owning property jointly – There are two types of joint ownership, Joint Tenancy with Right of Survivorship (JTWROS) and Tenants in Common (TIC).  Problems with JTWROS include postponement of probate only until last tenancy, the loss of the double step-up in tax basis creating more to pay in capital gains taxes, and outright distribution.  With TIC, you also lose the double step-up in tax basis where it’s available, and your property is subject to the estate plan of each tenant as well as probate for each tenant.

5. Not having a trust – A trust is the single most effective estate planning tool available. There are many different types of trusts.  Among the better known and more commonly used are revocable trusts, irrevocable trusts and testamentary trusts. A trust protects your privacy, and will help you leave what you want, to whom you want, in the way you want at the lowest possible cost overall.

Standard deviation measures the risk of an investment. For example, the Growth Fund of America has a 5 year standard deviation of 16.45 and a 5-year average annual return of 4.76. This means that the portfolio historically has moved 16.45% above 4.76 and 16.45% below 4.76 over a 5 year period. This gives you an idea of your downside risk and upside potential. In comparison, the PIMCO bond fund has a 5 year standard deviation of 4.25 and a 5 year average return of 7.17. Adding these two funds to a portfolio at a 50/50 ratio would give the portfolio a 5 year standard deviation and rate of return of 10.35 and 5.96, respectively. In this scenario, we just lowered the risk of the overall sample portfolio by adding bonds. You can use Morningstar.com, a free and independent research firm, to find the standard deviation and rate of return of each fund within our 401k plan. As you will see, some funds in our 401k plan, while they may be in the same asset class, do not have the same risk.

By Kyle Waller, Research Analyst Wiser Wealth Management, Inc & Casey T Smith, ASA ALPA 401k Specialist

In 401K investing, there is a major asset class that does not get the respect it deserves. In fact, it is largely ignored both by investors and plan sponsors. This asset class, small cap stock funds, is a very important element in a 401K plan.

Throughout the history of the stock market, small cap stock funds have significantly outperformed their larger counterparts.  There are some reasons for this that make small cap funds a category that should not be overlooked in your plan. That being stated, the potential for excess long-term performance comes with some serious risks that should also not be overlooked because of downside risks and excess volatility.

The JPMorgan ASA employee 401K plan has three small cap funds. Two of those funds have a management strategy designed to invest in growth stocks, while one fund is designed to invest in value stocks. Below is the Morningstar Style box, which simply categorizes large, mid and small in rows, while placing the “styles,” (value, blend and growth) in columns. Style is something to consider when choosing funds, but size is more important to consider. Size tends to be a larger determinant of returns relative to style. However, most mutual funds have both size and style directives and both should be taken under consideration before choosing one.

Small Cap Stocks as Building Blocks

Building a solid portfolio can be done with many different strategies, but most professionals believe that having a diversified portfolio based on asset allocation is most appropriate. Asset allocation would mean that a portfolio would include diversified investments from different categories, and apply different weighting based on the investor’s individual risk tolerance and how risky each investment is. Most allocations are based on age or years to retirement.

The three small cap funds in the ASA employee 401K plan are the Buffalo Small Cap, Columbia Small Cap Value II Z and the LKCM Small Cap Equity Advisor. When reviewing these funds, it is important to study risk, cost and track record, among other factors. Cost takes away from return, and there are hidden costs to consider like turnover, which is the fund’s trading frequency. This is an important consideration, because these trades incur cost for the mutual fund. A random track record statistic alone should not be the deciding factor; it should be compared with benchmarks. For example, it would make sense to compare a small cap growth fund’s return with a small cap growth benchmark. There are several ways to look at a fund’s risk. One way is to simply look at its standard deviation, which is a measure of variability from the mean. The higher the standard deviation, the higher the risk is perceived to be. Often, standard deviation is just called risk, like you see in the scatter-plot below.

The Importance of Small

Below, we see the difference smaller companies can make. Over last 15 years, we see that small cap companies significantly outperformed the large cap S&P 500, despite underperformance during the tech bubble. Going back further would reveal that this pattern does exist over long periods of time.

So, what is the cause of this higher performance? Put simply, smaller companies tend to grow at a faster rate and, over time, larger companies still grow, but much more slowly. Smaller companies have less economies of scale, less complex capital structures, less debt and lean more on a competitive advantage, which can quickly change. What it all boils down to is that smaller companies are more risky and the investor is compensated for that risk in the long run. This works just the same way a bank demands a higher interest from a person with a lower credit score or a higher risk of default. The market demands that same kind of compensation.

Below is a scatter-plot showing the risk of each investment, plotted against the return. Notice that the small stock index has more risk, (being further to the right) but a higher return as compensation for that risk relative to the S&P 500.

Source: Morningstar

Small cap stocks should not be a centerpiece for a portfolio, but certainly a building block. There is a case for small cap stocks outperforming larger stocks, but we need to remember that larger stocks tend to be more stable, which is why investors, over the long run, are compensated less. Of course, over short periods of time, we could expect small cap stocks to be punished more by the market for not being stable. We could say that many smaller companies’ stock prices reflect the potential for growth or future cash flows while larger firms typically have more established assets, which generate cash flows more steadily.

In this way, a solid investment portfolio will include small cap stocks in relatively modest amounts, while core holdings will be built using larger stock funds and bond holdings.  Small cap stock funds are typically considered satellite holdings.

Building With Small Cap Funds

“Investing has and always been, and will remain, an operation in which wealth is transferred from those without a working knowledge of the financial history to those who have one.” William Bernstein

Knowing your history is the key to building a portfolio that will get you to retirement and into retirement. Small Cap stocks have a place in portfolios. They are riskier than other investments and therefore should be limited in even the most aggressive portfolio. Where your personal portfolio falls in the risk spectrum is up to you, but should be based on the reality of your situation and not an attitude or appetite for risk and speculation.

By Casey Smith, ASA ALPA R&I Committee 401k Specialist and

Kyle Waller, Research Analyst, Wiser Wealth Management, Inc

The saving rate among Americans is decreasing, yet the need for income in retirement is as crucial as ever with pensions and social security becoming scarce and not as guaranteed as they once were.

There is a real cost to not saving, and that cost increases as retirement approaches. This is a particular concern for us as pilots with forced retirement ages, since we will not be able to choose to continue working into our 70s.  That being said, there is still hope at any age and it is never too late to start getting out of debt and saving for future needs. No matter the state of the nation’s economy, focusing on your personal economy should come first.

As we can see above, the saving rate among Americans has been on a sharp downtrend since the late 1980s, dropping to record lows during 2008. Recently, it has risen to just under 4% on average in 2009 and this year.

Saving has risen again recently due to the lower availability of credit. Since credit is never a guarantee, Americans need to adjust their dependency on easy access to credit and put away a higher percentage of what they earn. In general, the upcoming generation of retirees is more accustomed to widely available credit and is more optimistic than previous ‘thriftier’ generations.

Financial Knowledge vs. Time

Financial wisdom is an important key to having a successful portfolio. However, the more valuable factor that is often overlooked is time. Time gives the investor the ability to make it through both economic downturns and market booms. Historically, the market has behaved with large gains or losses over short periods of time. The secret to financial success is having a good strategy and the time to see those investments through the long run. You can see the value of time and saving sooner rather than later in the scenario below.

How Much To Save

A good rule of thumb is for an individual to be able to withdraw 3-4% in retirement without touching principle. This would generate $40,000 annually from a $1,000,000 portfolio.

Source: Morningstar, Inc using a 7% interest rate

Life isn’t as simple as the illustrated example since a professional pilot will most likely receive significant pay increases throughout his or her career. Another thing to consider is that as retirement approaches, it makes more sense to alter the investment portfolio to become more conservative, taking less risk and avoiding major market swings. This is another reason a younger person saving for retirement is at an advantage; they can take an aggressive investing approach and see that strategy through bad market cycles to success.

The ASA matching schedule is given below:  A healthy amount to save each month is 15-20% of your income. The sooner retirement is for you, the higher this percentage should be. At the very least, an ASA employee should be putting 6% into his or her 401K account out of every paycheck. Not doing so is taking a voluntary pay decrease. If you’re not saving this much, stop reading, log onto your account and change the percentage to at least 6%.

The ASA matching program matches a portion of the first 6% of your contribution based on completed years as an employee. Therefore, a second year employee (one year completed) will be matched 1.2% if they put at least 6% away in their 401K account (20% of 6%), this is in contrast to a 5% contribution rate which would be matched 1% (20% of 5%). Therefore, the real cost of not saving at least 6% is 1.2% for a second year employee.  The incentive is increased as the employee completes more years.  The program is designed to make a monetary incentive for saving through the program.

Behavior and Success

When making a plan for saving, it is important to note that good saving and investment behavior is as important as anything else. Saving should become systematic and so should the way you invest. This means no matter what the stock market is doing, you should be putting the same amount into your 401K and investment accounts every month. You should begin to think the same way about investing as you think of your monthly mortgage, a required bill.

Long term investing success really depends on playing great defense, which is sticking to the plan. This involves patience and endurance through market crisis, which will always come and go. An investor with a great strategy and the time to see it through will be successful and profitable in the end.

Why is behavior important? There is a gap in the stock market return and the average investor return, coined the behavior gap (see www.behaviorgap.com).

This behavior gap is caused by investors reacting to the ups and downs of the stock market, and can be very significant. When an investor reacts to the stocks market, i.e. buying stocks when they are rising, that investor is buying high. In the same way, selling stocks when they are falling is selling low.  A profitable strategy is obviously just the opposite, selling high and buying low. To pull off this strategy successfully, a great amount market insight and forecasting is required. Even with good information, it is difficult do profitably over the long run. The better strategy is choosing funds to create a diversified portfolio and sticking to that plan no matter what happens in the market. This is a simplified version of a buy-and-hold strategy, but the “behavior gap” will be completely erased when an investor properly employs a no-nonsense buy and hold strategy.

In Conclusion

Investment and retirement savings success does not depend on financial knowledge or complex strategies. When you are saving for retirement, create a hands off plan for saving, get on board with that plan and see it through to retirement.

You can view more 401k articles, the pilot retirement calculator, 401k model portfolios and research at www.wiserinvestor.com/resources/asa

What does that have to do with you, a US investor? Over 50 percent of the the revenues of the S&P 500, the 500 largest companies in the US, come from overseas. Declining foreign sales and a declining euro hurt our mega corporations. You might be wondering what you should do with your 401k. If you are properly allocated according to your age and risk tolerance, the answer is nothing right now except possibly increasing your contribution to take advantage of the sale. You should also make sure that your portfolio is properly diversified. Is your 401k in all cash? Do you have more than 30% in any one fund?

The biggest risk to your retirement is not saving. The second biggest risk is how you invest. Print off a copy of this connection email as a reminder to look at your 401k allocation. You can also visit www.wiserinvestor.com/resources/asa for tips on allocating your portfolio. Of course, you may also call me anytime to discuss your individual situation.

Casey Smith ASA ALPA 401k Specialist

Gravitating towards shorter duration bond holdings in the TIPS marketplace will mean choosing a higher correlation with inflation, lower volatility and only small yield differences.  PIMCO is currently the only ETF issuer with a full family of TIPS exchange-traded products.

Duration is a measure of the average life of a bond.  The duration of a bond is the percentage change that a 1% change in interest rates will move the bond’s price in the opposite direction.  For example, a bond with a 5-year duration will decrease 5% when interest rates increase 1%, all things being equal.

Currently, PIMCO 1-5 Yr US TIPS Index Fund (NYSEArca: STPZ) is the only TIPS ETF giving investors access to the short end of the yield curve in the TIPS marketplace.  The ETF in this space with the 2^nd lowest duration is the iShares Barclays TIPS Bond (NYSEArca: TIP).  The iShares Barclays TIPS Bond (NYSEArca: TIP) has an effective duration of 4.15, while PIMCO 1-5 Yr US TIPS Index Fund (NYSEArca: STPZ) has an effective duration of 2.55.

TIPS ETF funds are great to compare since the US government equally backs up the income and principle from the bonds held by these funds.  Of the two lowest duration funds, SPTZ and TIP, the yield difference is important when looked at in relation to duration and risk.

Here’s a breakdown of the ETFs on the market today that compares average coupons and duration.  The chart below is similar to a risk/reward scatter-plot, replacing risk with duration and return with the average coupon payment.   Data is from Morningstar, Inc.

There is a very clear pattern formed in that duration is rewarded with risk, but not in an efficient way.  This is not a yield curve, since maturity and yield are not being measured, but rather a measure of maturity and a measure of yield (average coupon).

Inflation Correlation

TIPS, or Treasury Inflation Protected Securities, have a built in feature that adjusts the principle of the bond based on changes in inflation. When investing in TIP Securities, the lower term the bond is, the higher correlation to inflation the bond will have.  This is because shorter-term bonds are effected less by interest rate movements and investors’ interest or inflation sediments.  Therefore, a change in inflation is more clearly reflected the shorter-term TIPS bond.

According to PIMCO’s research, The BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index (the index PIMCO’s STPZ tracks) has a .27% correlation to inflation, while the Barclays Capital U.S. Treasury Inflation Protected Securities (TIPS) Index (the index for iShares’ TIP) has a .07 correlation to inflation. In the current low inflation and interest rate environment, now is a good time to buy inflation insurance and dial down on duration exposure.

TIPS have another unique usage for investors that relates to inflation.  Investors often purchase commodities as a way to protect against inflation and use TIPS as collateral for their commodity futures positions.  For instance, PIMCO uses TIPS as collateral in its Commodity Real Return mutual fund.  Since the yield from TIPS is a real return, meaning inflation is included, investors do not need to worry about losing in a high inflation environment.

Scenarios With TIPS

The main case for TIPS would be during an inflation spike.  The Federal Reserve appears to be committed to low inflation and low rates for the time being, aiding the US Government with a low borrowing rate.  The question is whether or not this is an artificial environment.  Will inflation begin to happen despite the Fed’s best effort because of the country’s growing debt-to-GDP level, currently at 54%?

There are some particular market scenarios where TIP Securities do great and some others where TIPS can be a scary investment and lose a substantial amount of value.

In a scenario mentioned by Anne Lester, a senior portfolio manager at JPMorgan Funds in a May 2009 WSJ article, interest rates rose from 10% to 15% while inflation (CPI) fell from 14% to 10% from July 1980 to July 1981.  She refers to this time (TIP Securities did not exist at the time) as the “perfect storm’’ that could cause TIPS to lose 20% in value.

It is important to note that with TIPS indexes, bonds are being rolled in and out as they fit into or become excluded from the indexes target ranges, and many indexes do not just hold bonds until maturity.  Also, it should be noted that the par value of bonds is changed based on the change in inflation.  Like the situation above, in a high inflation environment where inflation moves down, par values of these Treasury Bonds would decrease.

PIMCO’s TIPS Family ETFs

Although PIMCO is firm about active bond strategies being more efficient than indexing, they seem to be dedicated to running an effective indexing strategy with the ETF vehicle offering a full family of indexed TIPS ETFs, ranging from long, broad, and short term.

The PIMCO 1-5 Year US TIPS Index Fund (NYSEArca: STPZ) is the most popular of the three with over $500 Million in assets.  The underlying index, the BofA Merrill Lynch 1-5 Year US Inflation-Linked Treasury Index, is capitalization weighted and is rebalanced monthly.  The PIMCO 1-5 Year US TIPS Index Fund (NYSEArca: STPZ) pays dividends monthly and has a low 20 basis point expense ratio.  Holding only 11 bonds, this ETF is set up to efficiently have low turnover.  The effective duration of this fund is 2.55 years.

Conclusion

With a specialized bond like TIP Securities, keeping maturities low is where the benefit of the inflation hedge is at its best.  The other factors that affect bond price can be minimized in lower maturities.  The primary reason an investor allocates into TIPS is to hedge against inflation.  Low duration TIPS will benefit from increasing inflation (CPI) and the expectation of inflation increasing.  Both of these factors will be directly affect these bonds’ prices and lower maturities will allow the highest correlation to these factors that the investor is looking to access.

This public debt isn’t anything new for our economy; it’s a part of our history. The only time when the U.S. was actually debt free was during Andrew Jackson’s presidency, when he ordered it to all be repaid. Today, our national debt remains at around 53% of our GDP. Compared to Japan’s public debt to GDP of 192%, the US doesn’t look quite as bad. Still, debt is borrowed and has to be paid back eventually. The Federal Reserve could crank up their printing press and increase inflation to pay it all back, or default on government bonds. Neither of these situations are likely, but since the Federal Reserve has done the ‘print more money’ trick before, it’s not improbable to think that something drastic couldn’t be considered.

Below is a comparison of the immense Federal Government deficit to American household debt. If public debt is increasing, it should follow that private debt is on the same path. When plotted on a simple graph, it is true and highly positively correlated at 97%:

Of course, just because two figures are highly correlated, there is not necessarily a cause and effect relationship. When public debt increases, it doesn’t cause private debt to increase. There are numerous other factors that play a role. That being said, seeing the exponential explosion of debt and the relationship between the two figures on a graph can help put things in perspective and lends a little credence to the theory that overall, Americans are becoming desensitized to debt.

With the economic recession and high unemployment levels, it isn’t surprising that household debt has increased. Cardweb.com, a credit industry reporting website, states that American households with at least one credit card owe more than $8,000 in debt. However, this number has been found to be skewed by a portion of the population with a vast amount of debt. After analyzing the credit card debt of those surveyed, Bill Whitt at the VIP Forum, a Washington D.C. research firm, found that only 29% of households owe $1,000 or more on their cards. Although almost 75% of Americans owe less than $1,000 on their credit card bills, the effect on the economy can be huge. The collapse of the mortgage market is an easy illustration of how the default of a small portion of loans can have a tremendous effect on the economy.

How can you safely leverage yourself against the perils of debt? Unlike the Federal Deficit, there are ways to tangibly protect you and your family from debt and potential bankruptcy in your own home. One of the first and probably hardest lessons to learn is to not let your eyes be bigger than your wallet. Simply speaking, don’t buy things you can’t afford – especially if its monthly payments will max out your budget. Small amounts of debt over time will end up accumulating and eating away at your savings. Another couple of steps to take are in the world of credit cards. The best way to maintain good credit is by paying your balances in full and on time. If you are unable to keep track of your different balances, then you many want to consolidate into one or two cards.

There is no simple “cookie-cutter” answer on personal debt that would suffice for every personal situation. The best advice is common sense. Be fully aware of the combination of your personal credit balances (bills, loans, and mortgages), disposable income and spending habits. From there, set a budget and adjust to your own wants and needs. You may find that you’re spending more than you’re making and need to cut back in a certain area, or that you should go ahead and pay off a high interest bill while maintaining the minimum payment on others. You may even find that you are able to save for retirement or other endeavors.

If the general population becomes more aware and averse to debt while they are still able to recoup, maybe the government will learn a lesson from its people – to cut out unnecessary spending and manage current resources wisely.

By Paige Slusser

The bill ventures into some areas that legislation has previously left alone. In many ways, the financial system needs some changes. However, for the most part, the Independence Day bill is more confusing than freedom-promoting.

Business Models

You may have guessed it, but banks will be receiving many new regulations. Economists believe that the increased costs to employ these new regulations will increase the cost of credit to the individual and small business, will drive out smaller banks from the market and exclude many of those who are less creditworthy from receiving credit. Those costs could be acceptable if the bill is effective, but it is largely unclear as to whether it will be. The Senate is somewhat split over the bill as a solution to these issues.

The financial industry landscape is a diverse one, ranging from financial advisors serving individual clients, hedge funds serving unique wealthy investors, and interest groups, venture capitalists and broker-dealers creating the transactions on the stock exchanges. Also to consider are the myriad of other functions and business models like investment banks, market makers and mutual fund-type companies functioning in a wide range of capacities to help the financial sector run.

It seems that some of these business models will have to endure higher taxes and higher audit and regulation fees where there was previously only some oversight.

The Individual

One area where this bill truly gets it right is looking at the standard of care given to the individual investor. After all, isn’t that what it should be all about? The entire bill came into existence so that America and Americans would avoid another major financial collapse and to plug the holes up in the system.

Currently, depending on whom the individual investor goes to for portfolio management, they could have an advisor who is compensated from the products them sell, and is regulated by how the advisor sells them. For example, a broker must only sell a product (like a mutual fund or annuity) to someone who is suitable for the product. There are many philosophies on what this means, but basically it comes down to the question of if a reasonable person would invest with this product.  If the answer is yes, then the investor is considered suitable.

In contrast to the above situation, an individual investor may go to an advisor regulated not by what they sell, but by the advice they give. As such, these advisors are unable to receive any kickbacks from the service they provide. They must give the client their best advice, and act in the best interest of that person. This role is similar to a defense attorney and it is called fiduciary. Registered Investment Advisors have a fiduciary standard of care to clients. Brokers have a suitability standard of care to clients.

Currently, brokers are not required by law to give their best advice. Registered Investment Advisors are.

Why is this an issue?

In 1855, William Travers, a New York businessman, was in Rhode Island and saw a long line of yachts and was informed stockbrokers owned them all.  This led him to ask his famous question, “Where are all their clients’ yachts?”

We have created an industry and a culture inside the stockbroker industry of double-mindedness when serving clients in how the advisor is compensated.

New words like fee-only have come up to express the way Registered Investment Advisors are paid, by a plain, transparent fee, only. They cannot accept payment from mutual funds for selling the product and receive no benefit from not giving the best advice possible.

Last year, in the early talks of the Financial Reform Bill, the problem was raised that people just cannot tell the difference between fiduciary advisors or Registered Investment Advisors and Brokers. Both had a similar “Advisor” type title and from research,  it was determined that these people are all perceived the same by investors.

In The Bill

The bill appears to give the SEC the ability to begin to regulate brokerages in a much stricter way and would allow them to be brought under the fiduciary standard.  Small advisories under $100 million in assets would be regulated by each state. This would greatly increase the level of protection individual clients would receive, as the SEC, who currently regulates those size firms, does not properly look at firms that small in size.

Reform seems to be coming this 4^th of July and though not giving investors more freedom, some protection seems to be on its way, slowly.  Investors do have options available to get fee-only advice, where kickbacks and product sales do not exist, but they will have to know what they are looking for:  an independent, fee-only, Registered Investment Advisor.

PowerShares International Corporate Bond Portfolio (NYSEArca: PICB) is designed to track the S&P International Corporate Bond Index. The index includes investment grade bonds, rated by S&P or Moody’s issued in the following currencies, Australia dollar (AUD), British pound (GBP), Canadian dollar (CAD), Euro (EUR), Japanese yen (JPY), Swiss franc (CHF), Danish Krone (DKK), New Zealand dollar (NZD), Norwegian Krone (NOK) and Swedish Krona (SEK).

Like many other bond indexes, the S&P International Corporate Bond Portfolio uses a modified market valuation methodology. This is similar to a market capitalization methodology, except the allocation of bonds in each currency is limited to no more than 50%. Currently, bonds issued in the Euro have the maximum 50% weighting.

The fund rebalances monthly and contains a feature designed to boost yield. During each monthly rebalance, any currency with more than 10% allocation will exclude the lowest 25% of bonds with the lowest yield. This is an interesting feature and could be viewed as something similar to fundamentally weighting an equity index with a twist. The twist is that the rebalance makes sure the bonds with the lowest yield, which could also mean the bonds with the most recent run up in price, are excluded. Yield reflects risk, so by using this method, the PowerShares International Corporate Bond Portfolio (NYSEAcra: PICB) will keep only average yielding bonds within a currency. Dropping the lowest yielding bonds could possibly mean dropping the strongest bonds in the currency; this could be an unwanted risk, but will make the yield higher than it would be otherwise. In the same way that fundamentally weighting stock indexes use a factor other than price to determine weight, this methodology will be dropping high priced bonds.

Capping Debt

Turnover will also be high, due to this fund’s monthly rebalancing schedule. Typically in investment indexes, a passive investor likes to see very low turnover with not a lot of activity. In this case, however, investors might welcome keeping a tight rein on allocations in this fund, as bond markets can quickly shift. Some ETF investors have argued that bond ETFs do not work because of their overly passive approach to allocating to higher levels of debt.

For example, most bond indexes use a market capitalization style methodology, a system that works great for equity indexes since as a company issues more stock, stock prices will reflect the new ownership dilution. Whereas with bonds, companies and countries can issue debt and artificially get market capitalization as long as the market believes it can repay and will not default.  This is why Japan typically dominates international government issued fixed-income indexes. Japan has a national debt to GDP ratio of 192%. The risk is obvious there, but extremely passive fixed-income indexes will reward that debt level with allocation and not cap it.

The State Street Global Advisor’s two-week-old ETF, The Barclays Capital International Corporate Bond ETF (NYSEArca: IBND), tracks the more passive The Barclays Capital Global Aggregate ex-USD >$1B, which includes bonds over $1 billion in market value. Doing this keeps the fund and index extremely liquid. The ETF is more Euro heavy than its competitor and holds its highest Euro allocation in the relatively strong Eurozone nation of Germany at 18%, immediately followed by US companies issuing in non-US Dollar fixed income at 17%.

The Barclays Capital International Corporate Bond ETF (NYSEArca: IBND) has an expense ratio of 0.55%, while the PowerShares International Corporate Bond Portfolio (NYSEArca: PICB) has a slightly lower cost at 0.50%. With these two funds being issued in such close timeframes, it will be a test to see which ETF emerges as investors’ preferred choice. Both funds have similar targets, prices and coverage zones. The question is whether investors will choose an ETF more concerned with liquidity like IBND, or an ETF capped to improve yield and limited exposure like PICB.

Risk Factors

The international corporate bond market is something that has been missing in the ETF space. There has been exposure to different international fixed income in the arena of emerging market bonds and developed market government debt, but the corporate space has long been empty. International corporate bonds are affected by both the risk factors of the currencies they are issued in and the credit risks of the individual issuer.

The unfolding of credit problems in Europe will be a large determinant of how these funds will perform. Currency will be a major contributing factor if the Euro continues to fall, hurting returns. The funds do contain high quality issues and will be an extremely low cost way to gain exposure to this important part of the global fixed income market. Since these funds are fixed income with total return coming both from price and income, currency will affect income, as it is translated into US Dollar. This could be a huge benefit for income seekers, since currency works in the US investors’ favor.

Bond ETFs are tricky, and definitely not as simple as equity indexes. The differences need to be understood, as well as the historic instances and implications of credit freezes. Bond ETFs can be liquid when the underlying bonds are not, even with large international bond issues such as those in these ETFs. These instances might look like significant tracking error, when the bond market was actually just not trading and no updated prices were being given. An ETF, being liquid, will reflect current prices, even when markets are closed where the underlying bonds trade, like these international issues. Overall, bond ETFs have been seen as efficient even when efficiency measures like tracking error and premiums and discounts look differently.

This is, of course, just an economic theory. What does it mean for you and your investment strategies? While this certainly isn’t true 100 percent of the time, in today’s world of instant information, it is fairly difficult for the average investor to find an undervalued stock, or a specific stock to successfully short. For example, if a newspaper or a magazine suggests that readers buy a certain company now, it is likely that the readers are too late to capitalize on the investment. Maybe the publication’s sources tell them that the stock is undervalued, or that the price will double because of X, Y and Z. By the time the information, already ancient just a few short hours later, is in the investors’ hands, the stock should already have this information incorporated in the current price. The information could have even changed entirely.

Granted, there are anomalies. Consider Enron for example. Bethany Mclean, columnist for Fortune Magazine, looked at Enron’s financial reports and discovered that they were overpriced at their peak. Mclean questioned Enron’s inflated stock price and wrote an article in Fortune entitled, “Is Enron Overpriced?”. If she, or anyone for that matter, had continued to look into the unclear revenues the books showed, they probably would have sold their stock before the scandal hit full swing.

However, a normal investor will probably not take the time to dig through each company’s annual reports, analyze ratios or read the disclosure notes to find these price discrepancies.

Picking out individual stocks can be time consuming, risky and difficult to do without complete information. Of course, the individual investor still usually wants to invest in the stock market. There are ways to do this that are both safe and profitable.

At Wiser Wealth Management, we invest in Exchange Traded Funds (ETFs). ETFs track indexes, such as the S&P 500, and trade on the stock exchange. An ETF is similar to a mutual fund in that it is a combination of stocks, but that’s where the similarities end. Our ETFs do not come with a slew of broker commissions for unnecessary trades or mysterious 12B-1 fees. ETFs insulate the investor from company-specific risk and provide a simpler, more practical way to invest.

Article contributed by Paige Slusser

Among issuers, there are no major changes year-over-year. In April 2009, the National Stock Exchange reported that the number of ETFs and ETNs on the market was 844, 89% of those being ETFs. In April 2010, the ETF/ETN marketplace has grown to 998 securities, 90% being ETFs.

To gain some perspective on how that breaks down and to what extent the market actually utilizes those 998 ETFs and ETNs, the chart below displays the number of ETFs and ETNs above $100 million in assets. This serves no purpose other than to show to what extent ETFs are adopted by the marketplace. As you can see, only a relatively small number of ETFs get the majority of investment. This could be for a number of reasons, including index popularity, for example. It seems that the ETF marketplace is increasingly becoming more educated, and the most efficient ETFs are rewarded with usage. That being said, I do believe that there are many inefficient and useless ETFs out there, and in the past, investors have used the more expensive and less efficient of two ETFs that track the same index. Despite those situations, the chart below lends credence to the idea that investors haven’t taken hold of a majority of ETFs.

Where the Money is Going

Compared to this time last year, when investors were pulling billions from large cap ETFs, there are now normal inflows into that category. Cash flows to note are in the fixed income and global ETF categories. Despite potential worries in both categories, assets have been flowing into the ETFs

To put fixed income ETFs in perspective, there are no fixed income ETFs currently listed in the top ten ETFs, which continues to be largely made up of stock funds and the Goliath gold fund, GLD.

As shown above, over the same time period year-to-date, fixed income has not led to cash flows. Although not hugely significant, we can see this by looking at investors’ usage of both fixed income and global ETFs. Global ETFs are also a statement of currency fluctuations and it is something to note that YTD, currency ETFs have negative cash flows, while global ETFs report inflows.

I am sure that the recent fallout in the market has many of you wondering what Greece has to do with US investors and how we can see a such a large decline in the stock market, even with job creation in the US. We will address that below.

I want to remind you that just as in 2008 when the US markets caused the world’s financial instability, that because we stayed the course and maintained our index allocations, the portfolios recovered with the market. Last summer, we rebuilt our index models to include more short-term bonds and purchased protection for those of you who needed it with a large exposure to the S&P 500. This move to overall more conservative portfolios and equity protection will help us weather this European crisis even better than the US financial breakdown. As of Thursday, May 6^th, all models remain in positive territory for 2010. We will continue to monitor and learn more about the European Crisis to keep you informed.

European Problems and Our Portfolios,

By:  Kyle Waller – Research Analyst

“Because major developed markets are now so highly linked, there is no way for problems in Europe to remain isolated there; we will see a ripple effect here in the US.”

The Greek government has recently agreed to receive a Eurozone government bailout from stronger countries in the EU. This bailout is very similar to the way many large US financial institutions were bailed out at the US taxpayers’ expense. In that case, the US government purchased assets from non-government companies. In the European case, governments are giving money to another government to prevent the risk of default of on bonds and other obligations.

The Greek economy is made of mainly government jobs, either direct government employment or subsidized employment. Overall, they have a weak free market system, which may be why people rioted in the streets Thursday due to 2% tax increases and dissatisfaction that the EU central bank did not choose to do more than its $145 billion rescue plan to stabilize the Greek economy.

Greece may be the first of many other bailouts that takes place to secure sovereign debt of other European countries.

The Effect

Such actions have caused the euro to decrease against other currencies, most significantly against currency alternatives to the euro as a major trade and reserve currency, i.e. the US Dollar, Pound and Yen. Significant losses have also occurred in both European bond and stock prices due to future profits becoming less secure. However, with fast, panicked selling, it is likely that the market has oversold many stock and bond holdings. Therefore, the opportunity to profit from this news has passed and it is unclear whether the market will continue to sell or regain some stability.

Overall, any company linked with global trading will be negatively effected and has already been. According to S&P analysts, the companies in the S&P 500 make up nearly 50% of sales from outside the US in recent years. With the S&P 500 making up nearly 80% of the US market, it follows that this would make US products more expensive to Europeans and therefore drop demand.

As uncertainty in Europe continues, uncertainty in the US will as well.  A Greek stabilization plan was passed on Thursday and should begin to stabilize that economy and its problems. There is still fear that other Euro countries may require the same actions, but the EU is showing its dedication to market stabilization.

Because major developed markets are now so highly linked, there is no way for problems in Europe to remain isolated there; we will see a ripple effect here in the US.

Going Forward

There are many factors affecting what is happening in the global marketplace and the US is a major player in all of it. Global investors are flocking to US Treasuries, increasing price through demand, which will help keep rates low. Low rates, in turn, increase demand for borrowing. In the same vein, though, demand for the US Dollar has grown, which has a negative effect on US exports and will slow a full recovery in the US, just like failing stock prices.

Going forward is about positioning portfolios to be participants in the global marketplace while being keenly aware of potential risks. We know that markets can act irrationally during unstable times and the answer for portfolios is to hold the course, maintain diversification and prepare for future risks.

Weekend Update

Just as I went to publish this note, the European Union, in a 12 hour weekend meeting, put their final stamp of approval on the Greece bailout. Many economists have dubbed the 1 trillion dollar package the “nuclear option,” but the EU sees the bailout as necessary to keep the euro from free falling in value. The risk going forward is repeating these steps with other countries. If Portugal, Ireland and Spain need the same type of bailout, Europe could easily spend another 500 billion euros. Today as this note is published, the US market is up 400 points in a positive reaction that maybe this is over. I believe that there is probably more to come and hope that it only lasts a week like in the Greece scenario.

Sincerely,

Casey T. Smith

President

Wiser Wealth Management, Inc

So why is an increasing employment rate good in this case?

The amount of jobs added went up in April even well above what is expected, adding 290,000 jobs to the market.  This is up from 200,000 added in March.

The fact that the employment rate is down is showing that there are more people actively looking for jobs.

The workforce, defined as those looking for employment and have employment, rose to over 800,000 according to the government, and despite increasing job numbers, percentages are down.

This means that optimism about job growth among the unemployed is rising, which is a positive.

While this is a very simplistic synopsis of the situation, and there are certainly more details to be heard from the defendants, there was a very interesting exchange yesterday between Lloyd Blankfein, the President of Goldman Sachs, and a Congressman. The Congressman asked Mr. Blankfein if he thought that his firm should be acting in the best interest of its clients. Mr. Blankfein paused for a great deal of time and then simply answered with a vague, “We do what we can” answer.

Mr. Blankfein could not answer “Yes” to that question because financial institutions like Goldman Sachs, Bank of America, Edward Jones and AG Edwards cannot legally accept fiduciary responsibility for their actions. Fiduciary simply means to always act in your client’s best interest and to disclose all conflicts of interest. Was there a conflict of interest in this Goldman Sachs product? You bet.

Part of the problem here is that the government allows companies like Goldman and other brokers to act under suitability rules. This means that a client has to be suitable for the investment, but does not mean that the product is the best for the client. To give you an idea of what this means, think of a mortgage. You might be qualified to get a million dollar mortgage, but that does not mean it is your best interest to have one.

I believe that anyone acting under the title “financial advisor” should be held to a fiduciary responsibility, just like your doctor, attorney and even your real estate agent. Brokers, commonly called financial advisors, do not give advice! They are not in the business of giving advice-they are in the business of representing products and completing transactions.

The problem with financial advice comes down to this fact:  advice should be paid for separately from products and products should not pay the advice giver. And guess what, the overall cost of paying for independent advice will most certainly cost less than the expensive products being sold to you.

Brokerage houses have a lot of power in lobbying to Washington and have thus far kept themselves out of being fiduciaries to clients.

Currently, the only fiduciary advisors are independent firms that are not associated directly with any broker dealer, but rather a custodian like TD Ameritrade or similar. TD Ameritrade holds the client’s assets that are being managed, but the advice comes from an independent advisor hired by the client. Fee Only Independent advisors are regulated by the SEC or directly by individual states. Fee only advisors have the entire financial product world available to them, thus they can and should always act in a client’s best interest. If they do not, there are serious consequences. In comparison, the broker can get off scot free, just like Goldman Sachs probably will.

The first ETF came about in the US in 1993 under the ticker SPY, also known as the “spyder.” The spyder enabled institutional investors to purchase the entire S&P 500. This allowed the investor access to market returns, while limiting specific company risk. This indexing concept through ETFs increased in popularity in 2000. Just seven short years later, investors could access virtually any worldwide asset class at a quarter of the expense of mutual funds.

It is these Exchange Traded Funds that have taken hold in America that are just now starting to take root here in Europe. I see a few roadblocks that may prevent ETFs from taking off here, though. A few of these obstacles were present in the US market during the rise of the ETFs, but Europe has some additional issues as well.

At Wiser Wealth Management, we are an independent wealth management firm with allegiance to no one to other than our clients. When we built our tool box of investment models and strategies, we only looked at products that maintained our investing philosophy of investing for the long term, keeping cost low and always maintaining a diversified portfolio. We never chase returns, but rather manage overall portfolio risks adjusted for each client’s investment objective. We will not work for a commission, only a flat fee. This fee only approach to asset management binds our objective to the clients’ best interest. The final seal to the sitting on the same side as the client is our regulatory responsibility as a fiduciary; this is something our brokerage and banker counter parts refuse to accept. They are regulated in a way that allows them to sell products that may be suitable for the investor, but not necessarily in their best interest.

It is this independent fiduciary fee only platform that is lacking in Europe, thus most advisors there are pushing high cost and high advisor commission insurance-based products. Most of Europe’s ETFs are traded by institutions. In the United States, the Institutional/Retail breakdown is 50/50. One of my reasons for coming to this conference is to be an ambassador for fee only advisors in the US and encourage our colleagues across the pond to take up a platform that is more beneficial to their clients.  My concept involves ETFs because ETFs do not pay a commission and are great tools in building portfolios. This does not mean that a commission broker will not use ETFs, it just means that they have an incentive to not use them.

I was speaking with an Italian trader one evening. We discussed how fee only advice could start in Italy. He said that it was very difficult to start your own business in Italy and if it failed and the owner had to declare bankruptcy, he or she could go to prison. Maybe socialism has some drawbacks? So maybe in Italy advisors will not be jumping ship from the large banks and venturing out on their own, but there is always a possibility that they could make a policy change like that of the UK. In the UK, the government has passed a new directive to make their financial institutions look at all investing opportunities, not just their own financial products. This is an open door to more ETF usage in UK portfolios.

Another difference between the US and Europe is how ETFs are traded. This difference causes some liquidity issues in ETF trading. One reason for this is that ETFs can be traded on the local country exchange, OTC (Over the Counter) or directly from the issuer at NAV (Net Asset Value). Currently, the only reported trades are those done on the exchange. This multi-trading platform at times creates large bid/ask spreads. Trading volume would help close the bid/ask spreads. There was a lot of talk at the conference about reporting the ETF trade to a third party to help share information on pricing.

For the most part, ETFs in the US are simply purchasing an entire index, like one share of SPY buys you the entire S&P 500. Should the provider of the ETF ever fail, the ETF assets are not in question. The fund would simply be liquidated and you would receive your investment back at the current market value of the underlying securities. In Europe, some ETFs are not this straightforward, as there are two types. Physical ETFs are what we are using here in the States. Europe also has Synthetic ETFs, which are more complicated, and not necessarily straightforward for retail investors. If not used properly and with caution, these synthetic ETFs could get bad press and hurt the overall impression of Exchange Traded Funds. This is much like the inverse funds here in the United States.

Another challenge for ETF providers in Europe is that while each country shares a common currency, tax laws can be much different. Because of this, we see ETFs being purchased within each country’s own exchange. US ETFs are not purchased off our exchange, as a European investor may have to pay US tax.

I will also note that the conference of several hundred delegates only had about 12 actual advisors. The others were institutional managers, traders and lawyers. This tells me that ETFs have really not made it to the individual European investor. Next year, should I be invited back to the conference, I would expect and hope to see more retail advisors.

Dawn R. Levine – Attorney at Law – Marietta, GA

www.GaEstatePlan.com

As of December 2009, the national unemployment rate was above 10%. In Cobb County, we are not far behind at 9.3%. Each month, the unemployment rate increases and many agree that the real national rate is around 15%. (Chart HERE) The US Government has tried unsuccessfully to stimulate the economy. It has spent more time debating the unaffordable health care bill that makes us more dependent on Government Bureaucracy than on ways to stimulate the economy. They still plan to raise taxes in 2011, making small businesses reluctant to hire. What will return America back to solvency and prosperity? The same thing as during the Great Depression, WWII, 9/11 and many other times of hurt in America- the will of the American People. In times of crisis, the American people band together to help one another get back on their feet and once again work for the American Dream.

Wiser Wealth Management wants to help those currently unemployed by offering a free, CPA prepared 2009 Federal and State tax return. There are no strings attached. We want to use our tools to help those in our community in this time of need. We hope that other businesses follow our example and offer services to help those in our community get back on their feet. All you need to do  is to call our office at 678.905.4450 ext 1 or 3 to set up an appointment.

Casey T Smith

President

Currency is a huge contributor to the total return of any international investment; so, naturally, falling foreign currency against the investor’s currency hurts its performance in the same way falling US Dollar benefits its return. For this reason, many investors have included foreign investments in their portfolio, recognizing its importance to the global economy.

Shown above is the iPath Euro/USD Exchange Rate ETN. This is an ETN that tracks the spot rates of the Euro/US Dollar exchanges, showing a short history of the two currencies. The Euro makes up 44% of the currency hedged by the WisdomTree International Hedged Equity (HEDJ). ETNs have no tracking error because of their structure.

As shown in the graph, the Euro has recently plunged against the Dollar similar to the way it did in the 4th quarter of 2008 when the Dollar was globally relied on as a safety currency during the September credit crisis. In the years before, the Euro steadily rose against the Dollar. This recent Euro downturn has been caused by Greece’s and other struggling Euro countries’ economies under the euro currency, unlike in 2008.

The new ETF, issued by WisdomTree, is the first of its kind to hedge international currency risk in the ETF space.  The fund, WisdomTree International Hedged Equity (HEDJ), is intended to invest in the WisdomTree DEFA index, which is tracked by the WisdomTree DEFA ETF (DWM); only HEDJ hedges the currency exposure of DWM. This means that investing in HEDJ is designed to be similar to investing in local markets with local currency. If an investor were to switch between the two funds, the expense ratio would not be prohibitive- a ten basis point difference. The newer WisdomTree International Hedged Equity ETF (HEDJ) is charging 0.58%, while the WisdomTree DEFA ETF (DWM) charges investors 0.48% annually. These expense ratios aren’t cheap by ETF standards, but both ETFs offer unique qualities not found elsewhere on the market, which may justify the cost.

How WisdomTree Delivers the Hedge

WisdomTree, as an ETF issuer, is a true innovator in the area of fundamental indexing and providing currency exposure inside of an ETF package, thus allowing the investor to avoid the ETN structure. To date, WisdomTree has a full line of currency income ETFs, including the WisdomTree Dreyfus Emerging Currency Fund (CEW), which tracks a basket of emerging market currencies.

The company has been able to provide this kind of exposure through its expertise in managing currency forward contracts. The WisdomTree International hedged Equity ETF (HEDJ) will hedge currencies by using the same kind of rolling forward contracts. The fund will replicate owning the index as if the investor were investing in the local markets.

Erasing Currency in Your International Investment

This ETF is interesting because the short-term movement of currencies is extremely volatile, making up a good deal of the volatility in the MCSI EAFE Index (an index benchmark for Europe, Australasia, and Far East)-a market cap weighted index in a similar space as the WisdomTree DEFA Index.

In the last 3 years, currency has added about 21% more variability than a local investment would have incurred over the same time period. Currencies also tend to trend against one another in a long-run generalized way. Until 2008, the Euro and many other developed currencies have gained against the US Dollar.  With the problems in the Euro’s economies, the Euro has been floundering against the US Dollar. Investors with this viewpoint can use WisdomTree International Hedged Equity ETF (HEDJ) to stay invested in the international developed markets while dropping their currency exposure.

This strategy is sensible when investors like the long run growth potential of developed nations covered in the ETF, but would prefer not to see direct losses if the US Dollar strengthens.

Furthermore, the WisdomTree DEFA Fund, DWM, and WisdomTree International Hedged Equity (HEDJ) can be ‘twin’ ETFs, allowing investors to switch fluidly between them, exchanging currency risk (benefiting when the dollar falls) for a currency hedged fund (safeguarding against falling foreign currency).

Currency is often associated with national economic growth and regularly reflects the relative growth of national growth. This trend is what makes emerging market currencies attractive when the economies of those nations eventually develop.

A Fundamental Index

WisdomTree employs a fundamental indexing strategy in its equity ETFs. For the two ETFs discussed, this means a value-tilt to the funds. According to WisdomTree, this allows for better long run performance. Whether this is true or not, these two funds allow for access to unique investment qualities- the ability to hedge or not hedge the same equity stocks.

The Board of Visitors was established in 1966 with the purpose of bringing together a dynamic group of advisors to Berry College. The Board of Visitors meets annually to provide insight and perspective on a wide range of issues. This input helps Berry College fulfill its mission to integrate academics with a strong work experience, community service and opportunities for spiritual growth.

This report shows that only one third of fund managers had a positive alpha over the last three years. The report also goes on to show that expenses and taxes greatly degrade fund performance. Another interesting note is that active fund managers tend to outperform in poor performing areas of the market, but in “hot” areas they tend not to keep up with the index.

Overall, there is really nothing new, just a reminder that low cost passive investing should have a place in everyone’s portfolio. This report supports the Wiser investment philosophy of maintaining a diversified portfolio, keeping cost low and always investing for the long term.

VIEW THE MORNINGSTAR BOX SCORE REPORT HERE

Those investors looking to invest in ETFs, but still only desire to support companies within their values can now turn to a company called Faith Shares. Faith Shares has recently launched five new ETFs that invest with Christian values in mind. The company’s product line includes a Catholic Values Fund, Baptist Values Fund, Christian Values Fund, Lutheran Values Fund and the Methodist Values Fund.

All funds are built by selecting the 400 largest US companies. These companies are screened by the fund’s religious values and then ranked by their Environmental, Social and Governance (ESG) score by industry. The companies are then sorted by industry in a way that mirrors the FTSE US Index. The top 100 stocks will make up the fund, allocated at 1% each. The passively managed portfolios will be rebalanced and could have company changes each June.

This equal weighted approach to investing allows the funds to be non-cap size biased. In comparison, the S&P 500 (SPY) ranks companies by size, thus the investor has a larger portion of the mega size companies. The equal weighted approach (RSP) has outperformed the traditional S&P 500 weightings 1.54% to 0.41% over the last five years.  However, because the equal weighted approach allocates with smaller companies, there is additional risk. The five-year Standard Deviation of the S&P 500 is 16.0 whereas the equal weighted approach is 19.96 (as of 2/12/2010 comparing SPY to RSP as Faith Shares does not have an actual 5 year record).

The funds have virtually the same holdings with a few minor differences. For example, the Baptist fund is restricted to hold alcohol companies while the Catholic fund will. Investing with your values in mind certainly does not come without a price, though. The ETFs currently have an exceptionally high cost of 0.87% in annual management fees. In comparison, the S&P 500 index (SPY) is less than 0.10%. Faith Shares does donate 10% of its funds revenue to a charity and hopes to lower the fee as assets grow.

Faith Shares is also planning a launch of an international product in the near future. Currently, Faith Shares has the only Christian faith based ETF product line on the market. The company’s website nor third party sites show the size of the ETFs, so due to the newness of the funds we assume that the assets in each fund are less than $100 million. This throws up a caution flag. We can see that the daily trading volume of the funds is relatively low, so if you want to trade this ETF, make sure that you use limit orders based on the intraday value of the fund.

With proper trading techniques and a realization that these funds should complement a bigger asset allocation strategy, these funds should fit well with faith-based investors. My biggest issue is the fee. Hopefully with success, Faith Shares will do the right thing and lower the fee below 0.50%. Below 0.20% seems even more reasonable.

The speaker at the dinner is David M. Ratcliffe. David M. Ratcliffe is the CEO of the Southern Company, a leading U.S. producer of electricity. Elected by the board of directors in December 2003, Ratcliffe became president of Southern Company in April 2004 and assumed the additional responsibilities of CEO and chairman in July 2004. Tickets to the event are $30.

To clarify, there is nothing wrong with selling products; many salesman have become successful by being honest when others are not and by giving honest opinions even when it means they don’t get the business.

However, would you see a cancer doctor who was only compensated by selling drugs by certain drug manufacturers?  Would you hire a lawyer that was selling something?

So, why would we seek investment advice from those whose main source of revenue comes from selling mutual funds, annuities and stock trades? This happens all the time, under the guise of “Financial Advisor.”

Not all Brokers take advantage of clients; they usually just do not have the freedom not to.

Trading Tips

A while back on the Front page of the Wall Street Journal was an article uncovering some disturbing practices by Goldman Sachs. Goldman Sachs has been sending out written research reports by their analysts to thousands of their clients, all the while holding weekly analyst conference calls with select clients called the “trading huddle.” During these conference calls, analysts give their true opinions about company stocks, the overall market and which stocks are likely to rise in value over the short run. Often these conference calls go against the written reports.

There is also an example given that after one day after the Janus Capital Group, Inc was given a neutral rating, research analysts called 50 of the firm’s selected clients to tell them the stock was likely to move higher. Unfortunately, news leaks out like this all the time, where unethical practices take advantage of clients to the gain of the company.

Other major brokerage houses do the same thing; however, they disclose that they may give advice to premium-paying clients that differs from the written reports.

T.V. Selling

When you watch interviews with CEOs and leading market strategists, they explain with great enthusiasm what they are doing for their clients-today. To be clear, chief strategists and research analysts are hired by large security firms to sell advice to clients in order to generate income through the trading of stocks and bonds.

Something that drove this home for me was watching a guest host-a chief strategist for some well-known securities firm one day, say in a very long winded speech that he agreed with others at the table that traders should raise their cash allocations, but should do so by taking a short position in their stocks equal to their long position in order to quickly reenter the market when they became more bullish.  If you’re confused about this, know that I am too.

Close to Home

We use TD Ameritrade to hold all our client’s assets and also use them to execute transactions for us. TD Ameritrade is responsible for a large percentage of daily trading on the US stock exchanges. They have two main “sides” to the business: retail and institutional. Retail is a place for individuals to keep traditional and Roth IRAs or to have a regular trading account. Institutional is for professional money managers to keep assets there; this is called a custodial relationship. The institutional side has many features and functions retail investors do not have access to.

The main difference between the two sides is that the retail side of individuals is flooded with reports and features for the technical, frequently trading, active investor. On the institutional side, there is no such push or functionality for this kind of charting. Why? Because most professionals who do not receive compensation for trades do not invest clients’ assets in this way.

Most independent money management firms invest with a long term outlook.  This is true of most pension consulting groups, endowments, bank trusts, mutual funds and financial journalists.

The reason for this difference is because TD Ameritrade receives a very reasonable $9.99 per trade.

What It Comes Down To

The problem with financial advice comes down to this fact: advice should be paid for separately from products and products should not pay the advice giver. And guess what, the overall cost of paying for independent advice will most certainly cost less than the expensive products being sold to you.

An industry word we throw around a lot called fiduciary is the difference here.  Doctors, lawyers and even real estate agents have this same standard. Fiduciary means to act on someone else’s behalf; simply put, to act in a person’s best interest. Brokerage houses have a lot of power in lobbying to Washington and have thus far kept themselves out of being fiduciaries to clients.

What most independent, fee-only, Registered Investment Advisors see as the largest problem, is that the general public and many politicians see brokers and Registered Investment Advisors the same. Brokers, for years now, have put “Financial Advisor” on the business cards and in their titles. Titles like financial advisor and financial planner blur the lines between the two. All major brokerage houses run commercials that further blur the lines. Many people, now, are not even aware that there is anything else.

Many clients that come to us from Brokerage houses are confused when we plainly disclose the predetermined fees we bill them each quarter. This is because when you work with “financial advisors” or brokers, fees are hidden and reported as decrease in return. In this way, “financial advisors” can charge you fees no one would agree to if they knew. This is how not even the most honest, most genuine financial advisor could possibly serve the best interest of their clients.

If you’re new to ETFs, the simple way to explain them is to compare them to mutual funds.  A mutual fund manager is buying and selling stock throughout the year to try and beat an index, say the S&P 500, which is made up of the 500 largest companies in America.  History shows us that fund managers have a hard time doing this over the long term.  If you buy an ETF of the S&P 500, you are buying and holding all 500 companies in the index at usually at least 1% less than the mutual fund managers cost.

So now that there are over 900 ETFs to choose from, covering everything from domestic large cap to frontier markets, it leaves one to wonder why these ETFs are not showing up in 401ks.  There are several hurdles that 401k providers have to overcome to have ETFs actually inside the 401k plan choices for a participant.  One of these is the trading of the ETF.  ETFs trade on exchanges just like stocks, so for each transaction there is a cost.  This trading cost can quickly erode returns and each transaction could cost as much as $15.  For a participant depositing $100 per paycheck into a 401k, this does not make sense.  Another issue is the automatic reinvestment of dividends.  ETFs do not trade in partial shares like mutual funds.  Additionally, for companies like Vanguard, there is really not any reason to offer ETFs in their 401k plans, as their offerings include their index mutual funds at virtually the same cost to the investors.

The good news is that for all the other smaller 401k plans that Vanguard will not work with, these problems have been solved.  Companies like Wisdom Tree, Ishares, and a few other smaller players can now bring ETFs to a 401K plan, as well as traditional actively managed mutual funds.  Now the issue seems to be education.  In many cases, a company’s HR department is the gateway for 401k change.  Unfortunately, most HR people seem to be treating ETFs as some form of investing voodoo!  This is partially understandable with all the negative press surrounding inverse and leveraged ETFs.  If you take a closer look at leveraged and inverse ETFs, you will see that they only make up a small percentage of ETFs, are usually traded by professionals, and can be easily excluded from 401k plans.

The debate as to why ETFs should be in 401k plans could be argued on fund performance.  The active vs. passive debate has been covered a lot over the years.  The winner is usually a mix of both strategies, although in the interest of full disclosure, my firm uses a buy and hold global indexing approach to investing.  This keeps to our investing philosophy of maintaining a diversified portfolio, keeping cost low, and always investing for the long term.  Allowing index funds or ETFs into a 401k plan would certainly increase diversification and lower cost dramatically.

The cost of investing is something that is very hard for individual investors to follow.  The brokers gloss over the cost of investing.  Most that I have met don’t even understand that a mutual fund’s transaction fees aren’t included in the management or 12b-1 fee disclosures.  The average mutual fund costs 1.42%.  The average iShares ETF costs .41%.  The average index mutual fund costs .69%.  Since most 401ks have actively managed index mutual funds, in this cost comparison, there is a 1.01% difference in cost between ETFs and mutual funds.  If an investor had $20,000 in his or her retirement account and switched to an ETF portfolio, growing at 7% per year for 20 years, paying .50% in fees, the fund would grow to $70,500.  If the 401k participant used mutual funds at a fee of 1.5%, the money would only grow to $58,400.  This is a 17% difference!  Add in the fact that a University of Maryland study showed that only .06% of fund managers beat their assigned index from 1975 to 2007, performance is not even an issue; proper asset allocation and low fees are the key to success.

I don’t believe that rapid change is coming to 401k plans across America, but it could if employees understood what their real cost of investing is, and understood the power of global asset allocation indexing.  Certainly if Congress understood how insurance companies and America’s large financial companies are stealing from Main Street 401k plans, we might get change that we could invest in.

Until the day when indexing has its rightful place in 401k plans, there is a work around; a brokerage link.  Many 401k plans secretly have the ability to move a portion of a plan participant’s balance into a brokerage account.  Through this brokerage account, a participant can invest in individual stocks or… you guessed it… ETFs.  Buying individual stocks in your 401k is borderline reckless in my opinion; however a mix of large cap, mid cap, small cap, developed international, small cap international, emerging market, US bonds, US treasuries, international treasuries, and commodity indexes would be incredible.  I say brokerage links are secretly available because plan sponsors usually do not advertise this option. Why?  Most companies do not want their employees taking their retirement choices into their own hands.  I have met a few individuals that I would want to exclude as well, but in a free country, you’re fee to be stupid (or smart, as the case may be).  Another reason to do this is the low cost of ETFs.  A plan provider such as Merrill Lynch, Fidelity, or JP Morgan receives revenue from the mutual funds that are in the plan.  If a participant moves money to a brokerage link and purchases an ETF, the participant will pay a transaction fee to the plan provider; however if the participant uses a buy and hold strategy, the plan provider will not receive any more revenue.

I recently worked with the Atlantic Southeast Airlines Airline Pilots Association (ASA ALPA) on how to get more index mutual funds within the group’s 401k plan.  Despite the company’s fiduciary responsibility to look out for the best interest of the plan participants, the company continues to allow their plan provider, JP Morgan, to fill the 401k with proprietary funds like a Morgan Stanley mid cap that has not been in the top 50% of its peers in the last 5 years.  The company fails to understand the concept of indexing, asset allocation, and probably standard deviation and the Sharpe ratio as well.  These are things that someone who selects a 401k plan should know.  ASA  ALPA is in a unique situation in that the company wants a new pilot bidding system.  In return the pilots get a list of things, including a brokerage link.  Finally, the employees of ASA can buy and hold the ETF, thus saving them thousands in management fees.  Well and good, you would think, but JP Morgan has just put into place a new brokerage link policy that does not allow ETFs to be held in 401k plans.  Why?  Of course no rightly minded JP Morgan call center employee would go on the record, but let’s look at the facts.

In 2008, when billions were flowing out of mutual funds, ETFs saw record inflows, gaining assets from the mutual fund business.  There are over 900 ETFs on the market offering diversification in virtually any global asset class, many at less than 0.25% a year in fees.  Who loses here?  Well, besides the fund companies, plan providers such as JP Morgan will lose.  In this case I believe that the company (ASA) has the ability to say “Give it to us or we’re moving to one of the other providers (all of them) that do,” and the case will be closed.  The pilots have the ability to motivate the company to do this by simply stating, “No ETFs, no new bidding system.”  After all, we could be looking at a 17% difference in fund performance at retirement.  That is a pay raise they, and the rest of America, cannot afford to give up.

We have now come full circle here, and I believe that it all comes back to education.  An educated investor, armed with the understanding that no one is responsible for their financial freedom other than themselves, will be a successful investor.

Now go out, diversify, keep your cost low, and always invest for the long term.

Casey is the principal of Wiser Wealth Management, Inc., and has spoken around the world about ETFs and passive index investing, including the recent Inside ETF Conference in Boca Raton, FL.  He is also a pilot for Atlantic Southeast Airlines and works with ASA ALPA’s retirement committee but in no way represents the committee, ASA pilots, JP Morgan or the ASA, the company.  This article was written for www.ETFmarketpro.com.

What is your strategy and why do you use ETFs?

Matt, there are three ways to invest.  You can buy a stock, buy a mutual fund, or invest directly into indexes (ETFs).  The easiest way for me to explain this is if you purchased Coke stock and the evil people at Pepsi poisoned the Coke syrup, causing people around the world to die from Coke, your investment would be worth 0!  This is called company risk.  While everyone one tells you about their Google-type investment success story, many fail to mention the Enron type losses.  The next way to invest would be through a mutual fund.  While there are certainly some outstanding fund managers out there, the industry as a whole has had a hard time keeping up with the indexes over long periods of time.  If you hired a fund manager to pick your next cola investments, you are beting on his or her ability to avoid the Coke scenario I just mentioned.  A less expensive, more transparent, more liquid, and better diversified choice is investing directly into the index using an Exchange Traded Fund.  This is like buying all the cola companies out there, which greatly reduces your company and manager risk.  Our advisory fee plus the .25% cost of the ETF portfolio is over 1% cheaper than where you are today.  In real world terms, Wiser Wealth will purchases ETFs like the SPY that actually purchases all the companies in the S&P 500.  The same applies to TIPs, corporate bonds, small cap international, emerging market bonds, and stocks.

Wiser builds portfolios using mostly ETFs like the ones I just described to access various types of indexes around the world.  Our core investing philosophy is to maintain a diversified portfolio, keep cost low, and always invest for the long term.  We consider ourselves passive indexers with a buy and hold strategy.  However, each year we review our models to see if there is a need for rebalancing.  While our overall strategy is to buy and hold long term healthy assets classes, we essentially rebuild our 4 main models each summer.  While most of the indexes and allocations remains intact, this forces us to look to see if there is access to new ETFs/indexes/asset classes that will help us achieve a portfolio’s objective.  We build our portfolios in two ways.  Our aggressive model strives to achieve the maximum amount of gain for the least amount of risk.  All other models, such as conservative through moderate, strive to achieve the maximum amount of gain for a given amount of risk.  Here are some examples……………. Let’s compare the cost and performance of these models to where you are now.

What are the risks of ETFs that you’re not telling me about? What could go wrong?

The ETFs that we trade in are large, proven investments that have been around for a long time.  There are ETFs that use leverage or investing formulas that are not very clear.  These ETFs have additional risks.  We do use a commodity ETN that gives you the returns of a commodity index; however, you do not actually own any commodities.  What you own is a promise to pay the index’s returns.  Should the provider go out of business, you could lose your investment in that ETN.  We monitor the financial health of the issuer in this case.  For example, when Lehman began having issues, we looked closely at the health of Barclays.

Why not use index mutual funds?

Wiser uses a complete indexing approach.  We do not seek out actively managed mutual funds, as they generally are more expensive than indexing.  We do not believe that timing the market has proven successful.  There are index mutual funds that work for individual investors, but at our custodian, trading an ETF costs half as much as trading an index mutual fund.  Index mutual funds do have some tax disadvantages compared to ETFs and, for the individual investor, index mutual funds are more expensive.

I’ve heard commodity ETFs don’t actually deliver the spot returns you expect.  Why is that?

The way commodities get represented in commodity indexes and inside ETFs are typically through rolling futures contracts.  Returns from these contracts come from the change in the expected future price of the commodity; this price is very different from the actual price of the commodity that can be bought today, which is the spot price.

Many investors were surprised this year when the oil fund they thought was tracking oil prices was actually tracking the expected future price of oil.

Why should I pay an advisor to manage a passive investment strategy?  Can’t I do it myself?

For many investors, asset allocation is built on feeling rather than using standard deviation, the Sharpe ratio, and other types of risk measuring tools.  Will you rebalance your portfolio on your own?  Will you be able to understand economic events and how to adjust the portfolio accordingly?  Do you ever have tax questions or estate planning questions?  Our AUM fee covers not just portfolio management, but also tax and estate planning.  These are the questions that I would ask a do-it-yourself investor.  You have to take the emotion out of investing.  Many individuals have a hard time doing this, which is why at my firm, we manage by committee.

If you really want to invest on your own through a company like Vanguard, you do have the option to hire us by the hour.  However, it is usually cheaper to become a full service cleint.

How do you ensure you get good trade executions?

Most trades at Wiser Wealth are done through batch trades.  Batch trades allows us to pull all the investors’ trades together.  We then set limit prices on the ETF buys and sells.  Our limit prices are based on the NAV of the ETF at that moment of trading.  A simple way to get the real time NAV is through Yahoo finance.  Just add ^iv to most ETF symbols.  A Bloomberg terminal is the other way to get NAV.

What about currency?

We do not invest in currency as an asset class, but some of our indexes, like IGOV and EFA, have benefited from a falling dollar.  Last summer, we added TIPS to the portfolio while they were cheap, as no one was talking about inflation.  Currency ETFs are trading on currency futures, not actually buying the foreign currency.  This has additional risk in an abnormal market.  Long term investing in currency is not somehting that we see as healthy at this time.

I read about all the blowups in the leveraged ETFs.  How do I know who to trust?  Would you use leverage ETFs in your account?  What’s wrong with them anyway?

There is nothing wrong with leveraged ETFs IF you understand them.  We do not use leveraged ETFs.

I just don’t want my portfolio to go down 50%.  What can you do to help me?

For all our models other than the aggressive model, a loss of that magnitude is virtually impossible.  However, if losses are not an option, we can employ an option strategy on the S&P 500 to add income and create short term insurance on a portion of the portfolio.

Should I buy an ETN?

Yes, but carefully and probably only for commodity exposure.

I’ve read that you can only buy ETFs with $100 million in assets.  Is that true?

That is a good point, but there are 250 ETFs with less than $20 million in assets.  You can buy them, but if not traded carefully, you may end up purchasing at a premium.  Only one of our ETFs, IGOV, approaches that asset level, with $134M in assets.  We noticed when we added IGOV during our last rebalance that it took much longer to purchase at our limit price near the NAV vs. the quick trade at market.  The performance has been just fine, it just took a few extra hours to move the trade through.  Should it have taken longer, we would have simply called the TD Ameritrade trading desk to call the exchange to get the trade processed.

As a bonus here is a great link concerning the recent run up and fall of GOLD prices!!

            Salespersons, often disguised as “financial advisors,” sell mutual funds for a commission.  What many people don’t know is that the mutual fund industry organizes how these salespeople can receive their commission.  There are primarily three types of classes of mutual funds; A, B, and C.  All of these give the client access to the same manager and portfolio.

            ‘A’ shares are the most common type.  When a client chooses these, he or she will pay upwards of 5.75% of their initial investment in commission.  On top of that, the client will also pay an annual 12b-1 fee and management fee, usually greater than 1%, just for holding the mutual fund.  This means that the salesperson will receive the bulk of their commission at the beginning of the sale, followed by a smaller amount each quarter.  The ‘C’ share of a mutual fund does not have an upfront sales commission, but carries a higher annual management fee.  The ‘C’ share offers the salesperson the highest quarterly payout.

            The ‘B’ share of a mutual fund is often referred to as the back-end load fund.  This term is used because there is no fee charged for the client’s initial investment, but if the client wants out over the next 5 to 7 years, a penalty fee is assessed.  The salesperson in this case may still receive the bulk of the commission upfront from the fund company, so the back-end fee is placed in order to make sure that the company can recoup their commission payment.  The ‘B’ fund also carries an annual management and 12b-1 fee, usually more than the ‘A’ share, and equal to a ‘C.’  If the client holds the ‘B’ share for the 5 – 7 year period, it will convert to an ‘A’ share. 

            In 2000, Morningstar reported that ‘B’ share mutual funds made up 7% of mutual funds offered.     9 years later, this number has dropped to only 1%.  The Wall Street Journal (WSJ) recently reported that Goldman Sachs, Allianz, and American Century have all exited the ‘B’ share market, citing low client demand.

            According to Larry Light of the WSJ, ‘B’ shares were created to compete with the no-load mutual funds offered by Vanguard and T. Rowe Price in the late 80’s.  No-load funds do not have any upfront fees and comparatively low annual fees.  Mr. Light’s WSJ article also states that the brokerage firms are tight lipped about why they are getting out of the ‘B’ share market.

            At the beginning of the article, I mentioned the term financial advisor using quotations.  This was to help explain the difference between the two current standards for financial advisors.  The brokerage houses (Edward Jones, AG Edwards, Morgan Stanley, etc.) are not held liable if they sell the client a product that isn’t in his or her best interest.  The client only has to be ‘suitable’ for the investment.  (For more information about what this means, follow this link for an article on the Cruel World of Financial Advice ).  On the other hand, an Independent Advisor is required to put the client’s interest first.  This is called fiduciary responsibility.  The Obama Administration believes that every advisor should be held to a fiduciary standard.  On this point, I agree with the President (for once).  Brokerage houses are fighting this fiduciary standard because when they look at the bulk of their “tool box,” they see that this requirement would wipe out their under performing overpriced products.

            So is the “lack of demand” for the ‘B’ product because brokers are cleaning up their act and ditching one terrible product to show that they really don’t need to be fiduciaries to have the client’s best interest at heart?  And so they can shill other overpriced products instead?  Or, are investors wising up and letting “advisors” know that these are bad investments?

            In my opinion, ‘B’ shares were never really good investments.  In fact, the regulators capped the maximum that could be placed in a ‘B’ fund at $50,000.  They probably wanted to do away with them completely, but, as things often go, the big brokerage lobbyists worked a compromise to keep these unfair investments alive.

           For many, the benefits of creating a long term diversified index portfolio are well known.  In fact the emergence of ETFs, with their easy access to small cap international, emerging markets, commodities, foreign currency, and many other hard to reach asset classes, has helped passive indexers achieve more diversification and many index professionals achieve higher returns.  I have seen a resurgence this past year in the active versus passive debate, due to the S&P 500 having a negative 10 year track record. On our news media outlets, the defenders of passive investing always seem to refer to the dilemma of buying and holding individual securities vs. actively trading securities.  However,  there is also a debate on whether to buy and hold index funds or buy and hold mutual funds.  Active fund managers want you to believe that they can always time the market’s ups and downs and that, for the most part, they will pick winning stocks.  This is absurd, of course, but many individual investors, confused by all the debate and different investing schools of thought, fall for the sizzle of short term performance without thinking of long term results.

            There is an old joke that financial news journalists write about the hot stock or mutual fund by day and privately invest in long term healthy index funds by night.  Could this be true of active fund managers as well?  This is where the term “closet indexer” comes from.  A closet indexer is a fund manager that mimics the index, or benchmark, that he or she is assigned to outperform.  For example, if a fund manager has the same holdings as the S&P 500, thus the same performance, the manager would be a closet indexer.  The problem here is that the investor is probably paying 50bps (0.50%) or more for the performance, and thus would have been better off buying the S&P 500 index, SPY, or the Vanguard S&P500 index mutual fund equivalent with fees less than 1/10 of a percent.

            Job security and fund size are two major reasons why a fund manager would mimic its assigned index.  Fund managers have their performance measured quarterly, so they do not want to stray too far from their assigned index.  While they may take additional risk at times to attempt to make up for their fees or try to outperform the market, the overall portfolio is invested in the same sector percentages as the index.  The idea is that fund investors would not pull their money out for poor performance if the fund manager performed near the index or his or her peers.

            The size of the mutual fund may also push the manager towards being a closet indexer, since only so much can be invested in companies that the manager sees as outperforming the market.  The remainder of the fund’s assets are then invested in securities that match the index so that overall performance versus the index will not go awry.

            Closet indexers are fairly easy to spot.  The most common way to find one is to take the R Squared of the fund.  R Squared is a statistical measure that represents the percentage of a fund or security’s movements that can be explained by movements in a benchmark index.  For example if a fund has an R Squared of 97, then 97% of its movements matched that of its assigned index.

            A search within Morningstar’s database of 24,900 open ended mutual funds for a 10 year R Squared greater than 96 and fees greater than 0.50% found 742 funds.  In most cases, an ETF should not cost you more than 35bps (0.35%), but I gave the fund managers the benefit of the doubt by searching for management fees greater than 50bps (0.50%).  This means that 3% of all open ended mutual funds perform no better than their assigned index over a ten year period and cost double what they should.

            When I dropped the R Squared to 95 or greater, 1,723 funds were returned, making 7% of open ended mutual funds subject to our closet indexer title.  I then looked for an R Squared of 97 or greater over the last 12 months with a management fee greater than 0.50%, and the return increased greatly. 5,377 funds were returned, making 22% no better than the index itself.

            As you look at your mutual fund, you have to take into account the cost of active management.  Maybe your manager beats the market by a few percentage points, but what kind of fees do you have to pay for this performance?  Is the net performance near the index returns? Is your fund manager a closet indexer?

            This New Year, you should resolve to consider putting your portfolio on a diet and look at the benefits of low cost Exchange Traded Funds (ETFs).

The death tax has always been a hot topic as many believe that this money has already been taxed and should be left alone. Others see the dead as easy targets to generate tax revenues for their favorite government projects.

You should always do financial planning on current laws versus what might be.  In this case, it appears that the tax is not going away.

Casey T Smith, Master of Estate Preservation (MEP)

Today was my first day on the job as stay at home dad. Well, we did not really stay home. Since the kids were in school, I got a half day in at the office and by the time I got the kids home at 1:30, our two year old was trying to climb into her crib as she was telling me “nite nite” and our four year old was equally sleepy. So, my work continued while they slept. Later, Banks, our English Springer Spaniel, informed me that the mailman had arrived and that I must act immediately. This also meant that my wife may soon be home and my first day as king of the house might end with no screaming, crying or broken bones, and the house left in better condition than when she departed at 6am this morning. Only 14 days left!

As I sorted through the mail, I noticed a postcard advertising “401K Maximizer.”  This caught my eye since most 401k plans are loaded with unnecessary fees, underperforming fund managers, and are usually the most under advised assets in the industry (from a participant perspective). To further my curiosity even more, it was geared only toward airline employees, the most underpaid and overworked population outside of stay at home moms and dads, teachers and a few others.

This 401K Maximizer appears to only be available to those employed by Southwest, Northwest and American Airlines. The service chooses the best (we would say the least worst) mutual fund available in the 401K plan for that particular airline each month according to a conservative, moderate and aggressive risk strategy. The service also will measure the risk of the market and move out of the market based on certain indications. This requires a subscriber to make monthly allocation changes to their 401k.

The website boasts significant returns vs. the S&P 500 since 2001, using an investment method described as “actively upgrading” and said of passive investing, “Buy and hold asset allocation is a recipe for under performance.” For example, the subscription service shows $1,000 invested in 1998 using their service now worth $5,000 vs. the S&P 500 worth just over $1,300. We must note here that back testing must have been used since a quick search on the website shows this as a relatively new product.

Citing the University of Maryland’s Study on the long term performance of mutual funds managers, where only .06% actually beat their assigned index, and recent reports from Morningstar showing that even short term performance leaves little to be desired, we certainly would like to see another strategy used in 401ks other than active mutual fund management and the buying and holding of underperforming mutual funds. However, I am very skeptical that any market timing monthly trading model can hold up over a long term investment time horizon. If this is indeed it, then it would fall into the .06% of managers that can beat the market over the long term. Actually, they are not really managers, but managers of mutual funds, which would make them active traders of actively trading fund managers!

Buying and holding 12 Exchange Traded Funds in asset classes such as commodities, emerging markets, foreign treasuries, emerging market bonds and other traditional long term healthy asset classes, an investor can easily beat the S&P 500 with much less risk. This buy and hold passive approach with a investing cost less than 25bps (0.25%) has a much higher probability of long term success and is much cheaper than active investing.

To avoid repeating myself, I will refer you to my recent entry on indexing HERE.

To those of you eager to make monthly changes to your 401K plan, I urge you to do four things first.

1. If you have access to a brokerage link within your 401k, invest using ETFs vs. the mutual funds within your plan.
2. If no brokerage link is available, then email your HR Benefits department and request that a brokerage link be added in order to access lower cost, better performing ETFs. You can also request that Index Funds be added to your plan, or if you are really shooting for the moon, ask for a Vanguard 401k plan.
3. Resist the urge to day trade your retirement. Open a brokerage account with money you can lose and experiment with that rather than your life’s savings.
4. If I still can’t convince you, then read the disclosure page on the 401 Maximizer website:

“The publisher does not analyze the suitability of any particular fund or investment approach for individual investors nor make specific recommendations tailored for individual investors. These portfolios have significant risk and are for the sophisticated investor willing and able to assume a high degree of risk. It is up to the investor to decide their risk level and investment method. Model performance results may have inherent limitations, some of which are as follows. No representation is being made that any account will or is likely to achieve profits or losses similar to those shown. In fact, there are frequently significant differences between hypothetical performance results subsequently achieved by following a particular strategy. There are numerous other factors related to the markets in general or the implementation of any specific trading strategy which cannot be fully accounted for in the preparation of model performance results and all of which can adversely affect actual trading results. This material has been prepared or is distributed solely for informational purposes. Past performance is no guarantee of future results. Further, 401k Maximizer, Inc. does not accept any responsibility for gains for losses an individual may experience. All trading is done at your own risk”.

I certainly welcome a new approach to 401k management, but I believe that it is through employer sponsored education on investing and a passive approach using index funds. I will acknowledge that the 401k Maximizer approach may achieve superior short term results, but the higher probability of success lies in the less flashy, more boring buy and hold approach. We also have the data to prove it!

Keep your investing cost low, maintain a diversified portfolio, and always invest for the long term.

By breaking down the global sector ETF products on the market, the investor can get a grasp of the best way to capture sector returns throughout the globe, in domestic, developed and emerging markets.

Businesses throughout the globe seem to correlate most with other companies within sector groups even before country, region, size and style.  Therefore, when using a strategy involving sectors, reaching outside the US, even into emerging markets, makes sense as a way to add better risk and reward possibilities while controlling sector exposure, which tends to be correlated even across regions and borders.

Global returns can be explained by sector returns. Correlations among countries can even be explained in a great deal by sectors and the differences in asset allocations between their respective market indexes.

The Global Benchmark

The 10 global sector iShares ETFs represent the sector makeup of the S&P Global 1200, which represents 70% of the world’s market cap. The sectors are broken down from this index based on the 10 GICS (Global Industry Classification Standard) sectors, which are jointly managed by S&P and MSCI Barra. Below is a chart of the iShares global sector ETFs. Each ETF represents a GICS sector from the S&P Global 1200 Index. Also included are each ETF’s total net assets.

The GICS sectors are designed to place companies throughout the globe into sector categories.  Currently, the S&P Global 1200 Index, which is made up of the 10 GICS sectors, is broken down below as of 9/30/2009.

Data: Morningstar Office 9/30/2009

Why Global

Since sectors have a higher correlation globally compared to different sectors domestically, investing on a global sector basis could provide significant risk reward profiles, as making sector decisions for the US is benefited by global correlations and the higher growth possibilities abroad and the lower correlations to the overall US market. Instead of concentration on sectors domestically and adding international exposure, moving to a global sector strategy is a way to capture both domestic and international exposure. Since sectors seem to correlate throughout the globe, from US companies to companies within emerging markets, using global sector ETFs is a way to efficiently execute an investment strategy involving sectors.

Data: Morningstar Office 10/1/2004-9/30/2009 (US sectors are the S&P 500 GICS Sectors and Global Sectors are the GICS Sectors from the S&P Global 1200 Index.)

The above scatter plot displays the similar risk and total return characteristics of the US sectors, shown as circles, and the global sectors, shown as squares of similar colors. Note that the global sectors do include a significant allocation of US holdings and the chart merely shows the movements of a sector as international developed and emerging markets are added. In general, the movement from US to global has a positive risk reward effect.

Comparing global sectors to the S&P 500 GICS Sectors shows the benefit that could be added to US sectors by adding international holdings. The differences vary throughout the different sectors; however, typically, the global sectors (squares) are above and often to the left, showing higher total return and less risk throughout the last five years. This is what using global sectors would have added even if the investment decision was based on the more familiar US sector analysis. Based on the above chart, over the past five years, adding international sector holdings to US sectors had a positive effect.

Reaching Out Internationally

The Global Sector ETFs, being market cap weighted, have heavy US allocations. This provides a way for the investor to make global sector allocation decisions while leaving domestic and international, developed and emerging market and market cap decisions to the index or marketplace since correlations among sectors run high across borders.

This means that the risk of adding international sectors to sector strategy decisions has a low marginal affect on risk relative to the overall sector decision. This is because correlations have been proven to be high within sectors, explaining returns. Therefore, the largest risk factor is in the sector and the risks associated with it.  Emerging and developed international markets will bring unique risks; however, the risks of the sector are among the most dominant.

The graph below breaks down the exposures of US, international developed and emerging market  holdings within the iShares ETF series. It is interesting to note that the breakdown of developed versus emerging markets shows the areas where emerging markets have the greatest effect on the global economy. For example, the iShares S&P Global Materials Sector Index Fund (NYSE Arca: MXI) has an 8.5% exposure to emerging markets, which shows the growth of the world’s demand of developing countries’ mining products, metals and other materials.

Data: Morningstar Office 10/6/2009

Sectors Have A Place

Keep in mind that this is not necessarily a call to abandon broad diversification, but a need to focus on the importance of sectors as they relate to global return. Also, when investing with sectors, using and adding international exposure has returned benefits to almost every sector. In this way, an investor can analyze and invest among US sectors, while gaining correlated international exposure, which has higher long term risk and reward potential.

International bond ETFs are an asset we can no longer ignore, but as some industry experts have brought up in the past, bond ETF construction has many inherent flaws.

The construction flaws in ETFs often stem from the methodology of the indexes which the ETFs track. Bond indexes use a method similar to market cap weighting, sometimes called market value weighted, in which bonds are weighted by debt outstanding, rewarding companies and countries that have more debt with a higher percentage of the index’s allocation.

Below is a chart of the growth in the iShares Barclays Aggregate Bond Fund (AGG) compared to the two international Treasury bond funds,  iShares, S&P/Citi International Treasury Bond (IGOV) and SPDR Barclays Capital International Treasury Bond (BWX), 1/23/2009 through 11/15/2009 (Source: Morningstar Office).

As the chart shows, there’s been significant growth in the international bond funds, with a AA rating for both the international funds. This outperformance is mostly due to the favorable change in the dollar relative to other currencies.

The low correlation and ability to capture returns from a falling dollar inside of a fixed income product can be extremely beneficial when investors want exposure to international markets, but are wary of the potential risks from overexposure to international stock markets.

Structural Risks In Bond ETFs

As discussed above, bond ETFs weight by the amount of debt outstanding, and this applies on a country level for these international Treasury bond ETFs. When looking at international debt market indexes, we notice a significant slanting towards Japan, because the large amount of debt the country holds.

As shown in the graph, Japan makes up large percentages in both ETFs and The SPDR Barclays Capital International Treasury Bond (BWX). Italy also has a large holding. Because of the diversification rules for the funds, any country weight is capped at 24.95% and the bond ETFs are rebalanced monthly to maintain the country exposure, set annually in March.

These two bond funds represent the developed international treasury market as determined by debt amounts. Countries with higher debt levels are given higher allocations. This is a risk, since countries with larger liabilities have more risk and a higher chance of defaulting on those bonds, despite the low probability of that actually occurring.

Investors are compensated for the extra risk they carry. Currently, The SPDR Barclays Capital International Treasury Bond (BWX) has an average coupon of 4.32%, as of 10/31/2009. The iShares S&P/Citi International Treasury Bond (IGOV) has an average coupon of 3.85%, as of 11/11/2009. For a comparison, a US intermediate Treasury benchmark ETF, iShares Barclays 3-7 Year Treasury Bond (IEI), has an average coupon of 3.58% as of 11/11/2009.  Keep in mind that the international Bond ETFs have seen large returns this year, which has pushed down yields. The iShares S&P/Citi International Treasury Bond (IGOV) has risen 13.02 in the last six months, ending 10/31/2009, and The SPDR Barclays Capital International Treasury Bond (BWX) has returned 12.68% during that same time period. Meanwhile, US Treasury ETF, iShares Barclays 3-7 Year Treasury Bond (IEI), has returned 0.70% in those last six months (Source: Morningstar Office).

When analyzing bond ETFs, it is important to consider the diversification and allocations of the underlying indexes and where the fund’s risks may be. The international developed treasury asset class has many aspects that would be a powerful addition to a portfolio, giving access to profiting from a falling dollar with less volatility than would be present in international stock portfolios, all while providing income and low correlation to US bond sectors.

My first stop is with my friends at Index Universe. www.IndexUniverse.com is a great resource on ETFs and their quarterly newsletter “Journal of Indexes” is a free publication to financial advisors. This quarterly publication is treated like gold in our office. Each quarter, some of the best talents in the world of finance write articles about indexing. The cover of the current edition reads “death of the dollar?”

In the first article, “Currency the Overlooked Asset,” authors Dave Nadig, Matt Hougan and Lara Crigger describe what moves currency. This will help you understand the basics of what makes the dollar move.

You have to understand that the dollar does not have a value alone on the market like Coke or GE stock, but we must compare the dollar to other currencies to get a relative value. The world’s major currencies are the US dollar (USD), the euro (EUR), the British sterling pound (GBP), the Japanese yen (JPY), the Swiss frank (CHF), the Australian dollar (AUD) and the Canadian dollar (CAD). We can now take a look at what moves these currencies. I quote the article directly.

“Interest rates: Every currency lives in the context of the interest rates being paid by a country’s central bank for purchases of government bonds. Comparatively high interest rates tend to attract investor to a currency. Lower interest rates, on the other hand, tend to depress a currency’s value.

Inflation/Deflation: Countries with low inflation will see their currency appreciate, as their purchasing power rises relative to other countries. High inflation, on the other hand, usually depreciates currency values.

Economic Indicators: Employment data, retail sales data, GDP growth and other economic health indicators can influence the value of a country’s currency, but these signals are often highly contextual. For example, strong employment data after a market crisis might support a currency, as it suggests economic recovery. But in a healthy economy, it could signal inflation which would depreciate a currency.

International Trade: Countries that import more than they export (e.g. Japan) must sell their own currency in order to purchase the currency of their export partners and thus will see their own currency value depreciate as a result. Thus, shifts in macroeconomic international trade metrics such as current account, capital account and financial account data can all influence exchange rates.

Geopolitical or Global Economic Events/Default Risk: Wars, coups, civil unrest, elections, fiscal policy decisions and local or worldwide financial crises can all change a country’s underlying economic health, and even increase its default risk, thus affecting its currency.

Commodity Prices: If natural resources drive the bulk of a country’s economy, then the country’s currency is also move with value of the commodity.”

So now that we see the basics of what makes a currency move, my second stop is Bill Gross of Pimco. Mr. Gross is probably the best bond fund manager in the world and has the track record to prove it. He recently appeared on CNBC to discuss king Dollar. My summary of the discussion is as follows: (Full article here)

Bill Gross believes that the dollar will continue to decline. He believes that the dollar is “over owned” in that the government has increased borrowing and this will make the dollar “more and more owned and less and less desirable” but this is necessary for balancing the world economy, as it may result in higher production in the US and lower production in China.

He also adds that the US Government talks that it wants a strong dollar but its actions are the opposite and maybe for a good reason. ”Let’s face it, a lower dollar is basically a protectionist barrier,” he said. “The Federal Reserve is likely to keep rates at the same level for a while, because the economy would need to grow by nominal rates of 4 percent or 5 percent to prevent debt from destroying growth,” he said. “They [the Fed] have to stay low because the embedded cost of debt in the economy is 67 percent,” said Gross.

Gross also talks about a “new normal,” where companies will be de-leveraging and where home buyers are just going to have to put 20% down as opposed to 0%.

The US workforce is currently at a high level of unemployment, the Feds are keeping interest rates low and the government is borrowing money at record rates. This is a very simple explanation as to the decline in the US dollar. There are certainly more complicated issues, but the point here is that we need an economic recovery to regain the value of our currency.

Additional Note: As I write this, the US Government is debating entering into the health care business for which it currently does not have the funds. Certainly, curbing government lending would help the dollar. After all, as Bill Gross mentioned, China and other foreign countries will only lend so much. At some point, we have to stop borrowing. Maybe a health care bill should wait until we have money to spend, or we better hope China will be offering no payment and 0% interest for 100 years!

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