Incidentally, that was the same year revolving credit was introduced.  Before that such cards were really charge cards, with the whole balance due at the end of the month.  But starting in 1959, you could have a card that offered to let you carry over your balance, so that you could manage your cash flow better.

Better?!  Talk about flimsy getting flimsier.

I know what you want to tell me.  “Yes, I know, debt is bad.  Just look at Europe.  Or the guy down the street losing his house because he over-extended himself.  In this economy I’m all about curbing spending and paying down debt.”

Apparently, not all of you.  Did you know that November 2011 saw the biggest jump in revolving debt in a decade?   A decade.   A decade mostly overlapping the so-called lost decade of investment non-returns.   It’s ironically horrifying, or horrifyingly ironic, depending on how you want to look at it.

Why is Debt Bad?

In a word, control.  The bible says, “The borrower is slave to the lender.”  If you owe someone, they own a part of you.  They control a part of you.  Therefore you control less of yourself.

Also, debt is what contributed to our most recent financial crisis in the first place.  In the housing boom of the early to mid 2000s, people were buying bigger and bigger houses, taking on bigger and bigger mortgages, in part because debt was cheap with record low interest rates.  Banks made the loans, then sold them to consolidators who batched them and who then bought insurance on them to cover defaults.  When the economy slowed down and people started losing their jobs, the number of defaults rose, along with the number of insurance claims.  When it hit the media in September 2008 that the AIG subsidiary that was a large provider of consolidated mortgage batch insurance realized it had over-extended itself based on a flawed computer model, the whole thing crashed.  We fell off the cliff.  And that cliff was so high, we’re taking years to recover from the fall.

So What Do You Do if You’re in Debt?

The short answer is pay it off.  The long answer is how.

Maybe you’re lucky to have enough cash sitting around to pay it all off at once.  In that case, why were you sitting on it, and then paying interest on your debt?  Unless you do not and will not have a way to replenish your safety cushion, it is best to use your cash to pay off debt.  It’s an automatic raise in your discretionary income.

Most probably, though, you do not have that much excess cash sitting around.  There are two schools of thought when it comes to paying off debt over time – the pay-off-the-smallest-debt-first approach, a la Dave Ramsey; or the pay-off-the-highest-interest-rate-debt first, a la every other financial guru with a talk show or book deal.  Whichever way you choose, there are several steps to go with it.

First you need to control your spending.  Limit discretionary items.  Getting your nails done at the strip mall salon may be cheap, but not as cheap as doing your own.  Playing golf every weekend may be fun, but is way more expensive than a mani-pedi.  In some cases, meat for dinner may be discretionary.  The goal is to spend less than you make, and use the excess to pay down debt.

Then pick a debt and concentrate a significant amount of your available excess income on paying that one off first.  This means paying way more than the minimum.  (Credit card statements now conveniently list how long it will take to pay off your balance depending on how much you pay each month.)  When that debt is paid off, pick the next smallest balance or highest interest rate debt and do the same with that one.  And so on until all debts are paid off.  Pay the minimum on all other debts as you concentrate on the one.

This should be obvious, but don’t incur more debt.  If you are spending less than you make on living expenses, this is automatic.  So watch your budget and control your expenses.  And do keep a reasonable amount of emergency savings to cover those unexpected…well, emergencies.  Dave Ramsey recommends a $1000 “baby emergency fund”.  If you have to use it, stop aggressive debt repayment to build it back up, then restart the debt pay off schedule.

If interest rates are too high such as to make your minimum payments too onerous to allow much wiggle room, do not be shy about calling the debt provider to ask for a reduction in the rate.  They don’t have to honor your request, but it doesn’t hurt to ask.

If you’re really in dire straights, you can ask for a reduced payment schedule.  Just expect a ding on your credit score.  If you’re in even more dire straights, you can ask to see if you can settle for less than you owe.  Typically, companies won’t do this unless you’re several months behind and they fear they won’t receive any of it if they don’t take your offer.  You will need to first save enough for a reasonable lump sum payment, however.  And expect a more significant ding on your credit score.  Please only consider these tactics if there is no other option.  Your conscience will thank you later.

What to Do When its All Paid Off

What do you do when all your debts are paid off (at least your consumer debts)?  Pat yourself on the back and celebrate!  You’ve done what most people won’t even consider doing.  And don’t be afraid to tell all your friends. You may inspire, or guilt, someone into doing the same.

Please don’t negate all your hard work by incurring new debt.  Of course, some debts are unavoidable.  A lot of people can’t buy a house without taking on a mortgage, and this is acceptable debt if it’s within reasonable limits.  A house is an appreciating investment (well, in a normal economy, anyway!).  But a car?  You know cars depreciate.  So pay cash for it.  And you should probably buy used, unless you have a significant amount of savings on hand to not notice the difference in your bank account.

While debt is currently the American way of life, including our government, don’t follow the crowd or your political decision maker.  You’ll be grateful for it.

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.

But what if his risk tolerance had indeed been very aggressive, as well?  Would his original investment have been then suitable for him?

In a word, no.

No matter how aggressive an investor you are, investing in one company, or even a few companies, is not a wise move.

A Few is Fine, if They’re Quality, Right?

Let’s say you have your portfolio invested roughly equally in five stocks, all strong companies like Coca Cola, Home Depot, Apple, etc.  Return over the long-term has been good.   You think your portfolio is sound.

But what if something happens to shake the very foundations of one of those companies?  What if poison somehow makes its way into millions of bottles of Coke Zero?  Millions of people die from the poison.  Coca Cola is plunged into a legal nightmare.  Pepsi takes advantage of its foe’s troubles by advertising its production process security and quality control measures.  Stock price plummets amid reports of Coca Cola’s eminent ruination.

Where is the value of your Coca Cola investment now?  What if your kid’s college tuition is due and you need to sell Coca Cola stock a month after the first poisonous death?   You could be selling at a loss.  The tax benefit you gain from the capital loss would be pittance compared to the harm it does your portfolio.

Ok, this is surely an unlikely scenario, as Coca Cola’s own quality control and product testing measures are in place to prevent this from happening.  But it’s not impossible.  And you have 20% of your portfolio riding on Coca Cola’s bottling process.  Even the simple market price variation of the stock could be problematic if you need to sell at the wrong time.

Good Diversification Means More than Five

A properly diversified portfolio does not have large concentrations in any one company.  A good portfolio includes hundreds of companies, even thousands if you use funds and not individual stocks.  In such a portfolio, concentration in any one company could be as low as 1%.  If that one company goes under, the impact on your overall portfolio would be miniscule.

So More than Five is All I Need?

Not exactly.  Good diversification also means choosing the right combination.  You don’t want to own the S&P 500, and only the S&P 500.  You don’t want all American companies.  You need a mix of different types of asset classes.

Correlation in the finance industry is a quantitative measure of how closely two investments react compared to each other.  A correlation of 1 indicates that the two investments are perfectly correlated – meaning they will react the same way to changing market conditions.  The closer the correlation is to 1, the more similarly they will react.

A correlation of -1 indicates that two investments will react the opposite of each other.  The closer to -1, the higher degree of opposite directions.  A correlation closer to 0 indicates that the two investments move in ways that are not related to each other.

In relation to your portfolio, you want to make sure you have investments that are not closely correlated.  This involves choosing investments whose correlation approaches 0.  Another technique sometimes used is hedging.  A hedge is an investment used to offset potential losses that may occur by another investment.  This is most often accomplished by using investments involving negative correlation.

Using the S&P 500 example (the S&P 500 includes the 500 largest US companies), a good companion investment would be bonds. Or money markets.  Or foreign stocks.  A hedge against a falling dollar could be investing in foreign bonds in their local currency.

Of course, diversification does not protect you from systemic risk.  As seen in 2008-2009, if the whole market goes down, your portfolio is going to go down with it.  Highly volatile markets tend to erase the benefits of correlation.  You can’t control this kind of risk, like you can investment risk, but that is no reason to forgo diversification.

Enough is Enough

So it’s not enough to choose just a few stocks.  It’s not enough to choose a large amount of the same type of investment.  A desirable portfolio will focus on global long-term healthy asset classes. Within each asset class, a focus on historical volatility, correlation to the S&P 500 and potential future return will net the best results. Such a portfolio is much more efficient, in terms of risk and reward, than just a few stocks of all one type.

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)

There was a man who considered himself to be a very conservative investor.  He said he could not handle any losses in his accounts.  He asked his newly acquired financial advisor to take a look at his 401(k) account, to which he had been contributing for over 20 years.  His employer used a major 401(k) provider, who offered hundreds of fund choices with the plan.

His financial advisor took a look.  And was shocked.  And well, was not shocked at the same time.  This man was 100 percent invested in company stock.  This is about the riskiest investment you can have in a 401(k) plan.

This man was a US citizen who had immigrated to this country many years back.  With a native tongue that was not English, he was sometimes confused when discussing the more technical aspects of financial dealings.  So he relied more heavily on the opinion of those people who portrayed themselves as experts.  Before his recent foray into using a financial advisor, he essentially used the advice of his employer, the plan sponsor, by accepting the default investment.  In this case, the default was company stock.

Plan sponsors can’t do this anymore – use company stock as the default investment when their plan participants don’t choose their own investments.  This was one benefit of recent disasters where participants lost their life savings when the value of their company’s stock plummeted to zero.  The trend now is to use a life cycle fund as the default, or a very conservative investment.  But this trend change was too late for this man’s original investment choice.

He was fortunate in that he worked for a stable, growing company, whose stock value had increased significantly over time.  However, besides the lack of diversification, this man had one year to go before retirement.  Very aggressive investments were inappropriate on both counts.   Obviously, his financial advisor quickly had him move to much safer investments.

You’d think he’d be happy now, right?  Turns out he liked the rapid growth of his retirement account.  He rather grudgingly accepted the wisdom that conservative investing was appropriate for his life stage and risk tolerance, not liking the reduced rate of return.  But he still had no framework for risk of loss.  Attracted to and overconfident in strong growth (and outside of the advice of his financial advisor) he invested $5000 of other money in the initial public offering of his son’s company.

The IPO opened at $50 per share.  Within a day or two, the value had risen to $52 per share.  After the initial excitement, however, the value settled down to around $49 per share, where it has been holding steady.  At 100 shares, he is now sitting on a book loss of about $100.

Has he complained?  Oh, yes!  Yes, he has.  You see, he is indeed a very conservative investor, having conniptions over an unrealized book loss of 2 percent.  Even though he doesn’t need his investment back, he now wants to sell immediately, not trusting the value to rise up again.

So why the flip flop?  In a word, greed.

Risk vs. Reward

There is no room for greed in investing.  In the investing world you can’t have your cake and eat it, too.  If you want the reward you have to take on the risk as well.  Put another way, you have the potential to be rewarded for the amount of risk that you take.  Notice I said “potential”.  Reward is not a guarantee.  The reason is risk.

To illustrate, let’s look at a savings account.  The interest on savings accounts nowadays is so low it might as well be non-existent.  Your deposits are also federally insured, so there is little risk of loss.  So a savings account would be a baseline investment, illustrated by a flat level line.

Let’s step up the risk.  An investment-grade bond has the potential for higher return than a savings account, but also the potential for higher loss.  The swing can be measured as going above and below the baseline.  For an investment grade bond, the swing will be fairly narrow.

A high yield bond offers the potential for a higher return than for an investment grade bond, and also a higher potential loss.  So the swing on a high yield bond would be wider.  A stock offers an even wider swing than that, with greater potential for both gain and loss.

In short, you have a diagram that looks like this:

The farther out you go in risk, the greater the potential for gain or loss.

I think you’ll agree you’re like most people.  Looking at reward only, you want the biggest reward you can get.  Who wouldn’t?  The question then becomes, how much are you willing to lose?

Ah.  That is the crux of the matter.  It’s the reason why risk tolerance questionnaires focus on how you would react to a downturn in the market, instead of focusing on your reaction to an upturn.  Because this is where your true colors come out – when you are facing the loss of something precious to you.

Investors who have trouble contemplating potential losses should not be aggressively invested, no matter how much they desire big returns.  Investors who are comfortable taking on risk, and who have the capacity to withstand a large loss should it come about, would be fine investing aggressively.

The problem comes in when investors don’t fully understand or appreciate risk.  Take the man in my tale.  In not paying attention to his 401(k), he missed the impact of the ups and downs of his company stock’s market price over time.   He just saw that he started with nothing, put a little money in each paycheck, and ended up with a large chunk of change.  It wasn’t until he invested in the IPO and watched the price go up and down, and saw the impact on his invested principal, that he fully comprehended this thing called risk.  Now he knows for sure that he’s a conservative investor.  And he has stopped squawking about the conservative returns on his 401(k).

His financial advisor celebrated with a slice of pie.

There are two types of plastic in the world today – credit cards and debit cards.  Most financial gurus would say that debit cards are better than credit cards:  while credit cards increase one’s debt liability, debit cards use money you already have, coming straight out of your checking out. 

The advent of debit cards certainly has made life easier.  It fits in with the instantaneous, I’ve-got-a-million-things-to-do-so-hurry-up philosophy of our society.  Check-outs go faster since people no longer have to spend 60 to 90 extra seconds writing checks after their purchase is totaled.  You’d be amazed how much time that saves over the course of a day in the grocery store.  Most of the time, you don’t have to sign a slip of paper to finish the transaction; you merely enter your PIN – and you can do that before the total is rung up.  You don’t even have to do any of that at the fast food drive-through.

The Hidden Cost

But is a debit card really better than a credit card?  Studies have shown that we spend more when using a credit card.  You’d think that using a debit card would alleviate this problem, since you know that you’re using your own money to make the purchase.  This isn’t true.  Some smart college students I know have figured out they do indeed spend more using a debit card, and now use cash for most purchases.

Think about it.  If you use cash, you are physically limited to spending only up to the amount of cash you have on hand.  Cashiers are reluctant to take less than the amount of the bill, darn them.  If you don’t have enough cash to cover the entire purchase, you have to put something back.  Unlike as portrayed in a certain old movie, the guy behind you probably doesn’t want to cover your shortfall.

In contrast, debit cards usually have an over-the-limit feature, which is tied to a savings account or a credit card.  Which means if you don’t have enough money in your checking account, the purchase amount is still covered because the bank can use money from your savings or credit card to fulfill the purchase amount.  They offer this “benefit” for fee, of course, for each such transaction; hence you’re using more of your own money.

And let’s be honest.  Remember how you subtracted each purchase from your checkbook balance at the point of sale?  (Well, at least you conscientious types did, taking an extra 30 seconds or more.)  With debit cards, you don’t really keep a running balance in front of your face, do you?  This makes it hard to keep track of how much you’re really spending.  Likewise, when was the last time you did a monthly reconciliation of your account?  Yeah, I thought so.

Six of One, Half Dozen of the Other

Debit cards have changed the type of fraud we see.  With checks, the fraud was check kiting.  This was where retail establishments unknowingly took checks written on accounts with insufficient funds.  Some people did this deliberately.  A thief could also steal checks and forge signatures; some even went so far as to print false checks.

If your wallet is stolen, the thief is limited to spending to the amount of cash on hand.  With a debit card (like a credit card or check), the thief can run up untold amounts before you can call the financial institution to report the loss.  I’ll admit to one benefit of debit cards over cash – in theft situations, some financial institutions will limit your loss to a certain amount (generally relatively small), bearing the burden for the rest of it.  You’re out of luck with stolen cash.

Another benefit is the ability to make online purchases; at least with a debit card, you aren’t increasing you debt load as with a credit card.

So Which is Better?

Am I advocating avoiding debit cards altogether?  Not necessarily.  In some cases, debit cards are necessary – such as for online purchases, as mentioned above, or when buying food on an airplane (now that is aggravating, isn’t it?).  For day to day budgeting, however, cash is king.  If money is tight, it is easier to stay within your $300 wardrobe budget if you only take that amount of cash to the department store.

It is best to use cash when possible. Obviously, you’d most often use your debit card at the ATM, of course, to get this cash.  If/when you do use debit cards for other purchases, the key is to use them prudently.  Total up your debit receipts each day – even tie them to budget accounts – to keep track of how much you’re really spending.  This enables you more quickly realize if you’re going over budget in a certain area, and to adjust your spending accordingly.  Be sure to tie your cash purchases to these budget accounts, too, for an accurate picture of your spending habits.

All in all, debit card are a necessary evil.  It behooves you to use them with caution.

Worry can drive investors to behave irrationally, and actually do more harm to their portfolios than good.  When the market is high, investors want to capitalize on the growth and tend to buy stocks.  Conversely, when the market is low, investors tend to run to safety and sell off their stocks.

This is the exact opposite of what an investor should do.

Schoolhouse Rock has it Right

Buy low and sell high is the name of the game.  The Schoolhouse Rock DVD has a song about this truth (although it was not shown as often – if at all – as the one about conjunctions).  The premise is that you want to buy when prices are low and sell when prices are high so that you make a profit.  This makes sense when one is thinking logically.  The problem comes in when emotions swing as high as the stock market swings widely.

Think of it this way.  You have a house.  You bought it at the top of the market in 2007.   Today, the house is worth less than you paid for it.  Are you going to sell your house today because it’s worth less?  Not if you don’t have to.  You’ll wait until the housing market comes back up, and the worth of your house improves.

In another scenario, let’s say you don’t own a house yet, or have some excess cash on hand.  Prices for housing are low.  Now would be a good time to buy, either for yourself or as an investment.  In this case, you would be able to profit in the short-term through rental income on the investment property, and in the long-term if/when you eventually sell the property.

The same goes for your money.  February of 2009 was the perfect time to invest more in the stock market.  Starting the beginning of March, the stock market began rising, and within a three months, had gained back more than 58 percent of its then current value.  That’s a 58+ percent return on the investment.  This phenomenon is so common in the market cycle that it has a name – the dead cat bounce (although a bouncing ball would be a more appropriate analogy).  It refers to the pattern that when the market bottoms out at its lowest point in the current cycle, most of the following growth occurs in the first bounce up.  Then it will drop again, but not as far.  The next growth event will not be as high as the first one.  And so on and so on.

If, due to panic, you sold out of your stock investments as the market was crashing to move to cash or at least safer investments, you’re selling at a loss.  Less skittish folk tend to have a lower stock price trigger point when it comes to selling, thereby making their losses larger.  When the market starts rising again, you may not trust that the run is sustainable, so you wait a while before you buy back into the market.  Not only do you realize the losses at the point of sell, you miss the time period of the biggest gains.  Thus your overall portfolio performance is harmed.

What to Do, What to Do

The only way to benefit from a market drop would be to sell out right before the bubble bursts to protect your profits, and then buy back in at the point where the market bottoms out to take advantage of the low prices and capitalize on the coming growth.  Most people – even professional money managers – cannot time the market this efficiently.

So what do you do instead?  The best thing to do is stay put.  It’s much easier to stay put if you are properly allocated according to your risk tolerance and time horizon.  If market drops make you nervous or if your time horizon is short, you should not be aggressively invested.  Likewise, if significant market losses don’t bother you as much or you have a long time horizon, then a more aggressive portfolio would be fine.  You need to understand, though, that in minimizing your potential for loss, you need to accept that your potential for gain will also be reduced.  You can’t seek high potential for gain with little to no risk of loss.

It can be hard to stomach the idea of staying put when the media sensationalizes the wide market swings.  It helps to limit your exposure to those financial talking heads.  In fact, there is data to support that staying put is the best option.  A Harvard study of investment habits found that investors who consumed no financial news earned better returns than those who were fed a steady stream of it.  Investors in volatile markets earned more than twice as much as similar investors whose trades were influenced by the media.  In financial challenges, maintain your emergency savings and limit debt, sure.  But don’t waiver from a sound investment plan.

Understanding What is Normal

It helps to understand that the market is normally cyclical.  The market goes up, then it goes down, then it goes up again.  It’s like radio waves.  Sometimes the swings are narrow, sometimes they are wide.  Over the very long-term, the overall trend is up.  The definition of long-term is relative, however; due to the 2008 crash, the stock market lost 10 years worth of growth, and 10 years is typically considered long-term.  To an extent, you can control the width of the swing through allocation appropriate to your risk tolerance.

So why does it seem the market swings more widely now that it used to?  You can thank computers for that.  In the olden days, buys and sells were conducted using actual people.  Now a lot of the buying and selling is computerized.  Computers operate much faster than humans, and can be programmed to buy and sell in huge blocks at specific triggers.  Large institutions have created computer programs that set target prices whereby if stock prices reach that point, the computer initiates a wide-spread buys or sells.  The target prices are generally not that far off current prices, but the bulk trading tends to result in driving prices further than the target – sometimes much further.  And it all happens pretty much in the blink of an eye.  There is no way a human can keep up with this pace, so one shouldn’t even try.

It All Comes Down to Risk Tolerance

You should base your investment portfolio on the amount of risk you are willing to take.  There are five major risk profiles:  conservative, moderately conservative, moderate, moderately aggressive, and aggressive.  Risk tolerance questionnaires can be found on the internet or from your financial advisor.  The questionnaires ask questions concerning your time horizon, your realistic expectations for growth, your sell-off trigger points for losses, and your overall comfort level regarding negative market performance.  Your answers to these questions help determine what risk tolerance level would be appropriate for you.  If you have multiple investment accounts, risk tolerance can vary from account to account; meaning your retirement account will likely have a different risk profile than your child’s education fund.  Your risk profile should be reviewed on a regular basis and adjusted as necessary to accommodate changes in your financial picture and life circumstances.

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. 

This reported demise of the credit trust reminds me of Mark Twain’s famous observation, after his obituary had been mistakenly published by the New York Journal, that “The reports of my death are greatly exaggerated.” Like Mark Twain’s “death,” it seems to me that reports of the demise of the credit trust are greatly exaggerated.

Understanding portability involves mastering two new estate tax terms: the basic exclusion amount and the deceased spousal unused exclusion amount (DSUEA). The basic exclusion amount is the surviving spouse’s applicable exclusion of $5 million, reduced by lifetime taxable gifts. The DSUEA is the predeceased

Tax Act Terms

As keen-eyed readers will note, the definition of the basic exclusion amount and the DSUEA provides the first hint that the importance of portability may be exaggerated. Both definitions include a reference to an applicable exclusion of $5 million, which is available under the 2010 Tax Act only for people dying during the 24-month period beginning January 1, 2011, and ending December 31, 2012. As of the date of writing this column, portability will exist only if both spouses die within the next 18 months.

A second fly in the ointment is created by Section 303(a)(5) of the 2010 Tax Act, which provides that the surviving spouse may only make use of his or her predeceased spouse’s DSUEA if the predeceased spouse’s estate files a timely estate tax return that shows the amount of the DSUEA and contains an irrevocable election to the effect that the surviving spouse may use such DSUEA [NOTE: big problem. How many of your clients will do this?  Geri] Advocates of using portability in lieu of credit trusts argue that portability reduces the cost of estate planning because plans relying on portability will be simpler documents to draft and the survivor will be faced with less post-death complexity because the number of trusts the survivor must contend with will be reduced. Both assumptions are questionable.

Portability vs. Credit Trust Costs

Portability may actually increase the cost of administration by requiring the filing of an estate tax return that otherwise would not be necessary. For example, assume that a husband dies in 2011 with an estate of $3 million, all of which he leaves to his wife, who has an estate of $5 million. No estate tax return is required because the husband’s estate is less than his applicable exclusion. In order for the wife to make use of the husband’s DSUEA, a timely estate tax return must be filed with the appropriate irrevocable election. The cost of preparing an otherwise unnecessary estate tax return could easily equal or exceed the cost savings of not including a credit trust in the husband’s estate plan. Moreover, complexity is actually increased because the client must not only file an otherwise unnecessary estate tax return but that return must be filed timely and must contain the appropriate election.

Reliance on portability in lieu of the use of credit shelter trusts creates several other problems as well. Although the 2010 Tax Act provides that the $5 million applicable exclusion amount is subject to an inflation adjustment, that adjustment ceases to apply once the taxpayer dies. Unlike a credit trust that shelters post-death appreciation in value, the amount of the DSUEA is fixed as of the date of the pre-deceased spouse’s death and does not protect post-death increases in value of the pre-deceased spouse’s assets. Returning to the example of the husband who dies in 2011 with an estate of $3 million, all of which is left to a widow with a separate estate of her own of $5 million, assume that the husband’s assets appreciate in value to $10 million and the widow dies on December 31, 2012. Had the husband left his estate in a credit shelter trust, the entire appreciated value of the assets would have been excluded from the widow’s taxable estate, as well as having been exempt from the generation-skipping transfer tax. Because the parties relied on portability, the husband’s DSUEA is fixed at $5 million. The surviving spouse’s taxable estate amounts to $15 million (her $5 million plus the husband’s $10 million) and her applicable exclusion amount is $10 million, consisting of her basic exclusion amount of $5 million and her husband’s DSUEA of $5 million. The remaining $5 million of the widow’s taxable estate would be subject to a 35 percent tax rate, producing an entirely unnecessary estate tax of $1.75 million.

Blended Family Estates

Reliance on portability may also defeat, either intentionally or unintentionally, the testamentary plan of the pre-deceased spouse. It is common today for one or both spouses to have children by prior marriages. There is no assurance that a surviving spouse who inherits outright the estate of his or her pre-deceased spouse will leave that property to the pre-deceased spouse’s children. It is equally common for a surviving spouse to remarry. If such a remarriage ends in divorce, it is possible that some or all of the inherited assets may be subject to division by the family law court. If the marriage is successful, it is equally possible that the surviving spouse will leave his or her new spouse some or all of the assets inherited from the pre-deceased spouse.

It is interesting to note that estate planners were having this same discussion of the drawbacks of leaving property outright to a surviving spouse in the 1960s and 1970s prior to Congress amending the estate tax laws to create the QTIP trust, thereby permitting a pre-deceased spouse to qualify for the marital deduction but still control the ultimate disposition of property left a surviving spouse. I am reminded of a George Santayana remark that those who cannot remember the past are condemned to repeat it. On the other hand, assets left in a credit shelter trust in which the surviving spouse has a life estate—like assets left in a QTIP trust—pass to the designated remainder beneficiaries at the surviving spouse’s subsequent death.

Tax Considerations

A credit shelter trust is also potentially more tax efficient than reliance on portability. A properly drafted credit trust can be used to sprinkle taxable income to beneficiaries in lower tax brackets, which cannot occur when property is left outright to the surviving spouse. Principal distributions may be made from a credit trust to children during the lifetime of the surviving spouse without such distributions being treated as taxable gifts. If portability is relied upon and the pre-deceased spouse leaves his or her estate to the survivor, transfers by the surviving spouse to children during his or her lifetime will constitute taxable gifts to the extent they exceed the surviving spouse’s annual exclusion.

Lastly, planners should keep in mind that portability will sunset for people dying on or after January 1, 2013. Planners relying on portability are limited to factual situations in which both spouses die prior to that date. In most situations, it appears estate plans that use credit trusts are far more practical and far less dangerous than reliance on portability.

Jon J. Gallo, J.D., chairs the Family Wealth Practice Group of Greenberg Glusker Fields Claman Machtinger & Kinsella LLP in Los Angeles, California. Together with his wife, Eileen Gallo, Ph.D., he is a founder of the Gallo Institute and the author of two books on children and money. Their websites are www.galloinstitute.org and www.fiparent.com.

Endnote

1. Officially, the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312, 124 Stat. 3296.

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.

At what age is it better to save for retirement?  In your early years of working, money is probably tight.  It’s hard to find the extra money to save towards such a far end goal, when the rent needs to be paid, and you have a more immediate need to build emergency savings.  You might think that waiting until later in life to save for retirement, when your income is likely higher and you can more likely afford to do so, would be the best option.

Or maybe not.

Take Frankie and Johnny.  Both are age 20 and have decent jobs.  Frankie and Johnny want to have money for retirement, but take two different savings tracks.  Frankie wants to save now, when she has fewer expenses; she anticipates she may have to stop saving as expenses rise.    Even though he has a good job, Johnny thinks his current expenses are too high to justify saving right now; he wants to wait until he can get his income up before saving.

Both anticipate they will save $200 per month, and estimate they will earn 6% on their investments, compounded monthly.  They both plan on retiring at age 65.  The only difference is the point in time when Frankie stops saving and Johnny starts.

The 5-Year Plan

In this plan, Frankie contributes for five years, then stops.  Johnny starts saving after five years, and saves for the next 40.

Frankie contributes at total of $12,000 over the five-year period.  At age 65, she has a retirement balance of $153,665.  Johnny, in contrast, contributes $96,000 and ends up with $400,290.  Johnny contributes in total eight times what Frankie contributes, and realizes 2.6 times Frankie’s results.  Still, $400,290 is more comforting than $153,665.  To match Johnny’s results, Frankie would have needed to contribute $5,708 per month for the first five years; that’s 28.5 times the original $200 per month.

The 10-Year Plan

In this scenario, the pivot point is 10 years. Frankie contributes a total of $24,000 over that 10 year period, while Johnny goes on to contribute $84,000 over the course of 35 years.  At retirement, Frankie has a balance of $267,588.  Johnny has a balance of $286,367.  Johnny contributes in total 3.5 times what Frankie contributes, for only 7% more in his retirement account.  To match what Johnny ends up with, Frankie would have needed to save only 7% more, or $214.04 per month.

The 15-Year Plan

Let’s take this out to 15 years.  Frankie saves a total of $36,000 and ends up with $352,047 at retirement.  Johnny contributes $72,000 and has $201,908 at retirement.  Johnny contributes twice as much as Frankie (in twice as many years), but ends up with 42.6% less.  To match Frankie’s gross balance of $352,047, Johnny would have needed to save 75% more, or $348.72 per month.

A Split Pivot Point

Let’s throw one more scenario into the mix.  Let’s go back to the five-year plan, where Johnny ends up with so much more money than Frankie.  This time around, let’s have Frankie save for 20 years, starting at age 20.  Johnny still waits five years, but then contributes for the next 40.  In this case, Frankie ends up with $414,663, compared with Johnny’s $400,290.  But Frankie only needs to save half as much as Johnny to end up with nearly the same results.

So what does this all mean?

The key point is that the longer you wait, the more you pay, the longer you pay, and sometimes the less you end up with.  This is the time value of money.

It is better to live leanly in early adulthood, even though you typically have less income, because you also typically have fewer obligations and perhaps are more used to being “thrifty”.  Later, when income has risen, so generally have your expenses, and it’s hard to cut your lifestyle down at that point.  Saving early gives you a worthwhile discipline that will always serve you well.

If you have put things off, don’t stress; it’s not too late to put a plan into action.  Just know that you will need to pay more for the privilege.   What is important is to not put it off any longer.  Don’t let time pass your money by.

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.

Financial Aid Options

Parents and students who do not have the financial resources to pay for college themselves may pursue other options for educational funding.  These include scholarships, grants and loans, plus several other options you may not have thought of.

Scholarships

Scholarships are free money.  They do not need to be repaid.  Most are awarded on merit, be it academic, athletic, or other skill or talent.  Some are based on need or disadvantage.  Others are based on connection to an organization.  They are offered by the federal government, some states, the college or university in question, and public and private organizations (which can be for-profit companies or non-profit institutions).  There are literally hundreds of different scholarships that are available, waiting to be tapped.  You just have to find them.   A book or reference guide on the subject can help you with this endeavor.

Grants

Grants are also free money, offered by the same groups as scholarships.  These are generally based on need or disadvantage.  The most widely known grant program is the Pell Grant.

The Pell Grant is a federally funded program.  Millions of dollars are awarded each year on the basis of need.  Most go to households whose incomes are below $50,000 per year.  Pell grants are only available for undergraduate studies, except for post-baccalaureate teacher certification in some cases.  Only one per student is granted per year.  The amount awarded depends on need and costs, whether or not the student is full-time or part-time, and whether or not the student attends the full academic year or only part of it.  It is also determined by the federal budget and the size of the applicant pool, making this grant a relatively undependable source of college funding.

Another grant is the Federal Supplemental Educational Opportunity Grant (FSEOGS).  This grant is for undergraduates who demonstrate exceptional need.  The amount ranges annually from $100 to $4000.  It can be awarded in addition to the Pell Grant.

Loans

Loans are offered by the federal government, some states, and banks.  The federal government may subsidize certain student loans if financial need is demonstrated.

Stafford loans are available for undergraduate and graduate studies.  These loans can be subsidized or unsubsidized, and have maximum amount limits.  Stafford loans have fixed interest rates, and loan proceeds are paid directly to the school.  The student must attend at least part-time.  Subsidized Stafford student loans used to be available through a variety of institutions, but as of July 1, 2010, they are offered only through the federal government.

Subsidized Stafford loans offer a slightly lower interest rate than unsubsidized loans.  Interest does not accrue while the student is in school and during the deferment period.  Payment can be deferred until up to six months after leaving school.  Subsidized loans are based on need and require a FAFSA.

Unsubsidized Stafford loans are available to any student regardless of need.  Interest accrues from the date disbursed, but payments can be deferred while enrolled.  This increases the size and cost of the loan.

The Federal Perkins loan program is available for undergraduate and graduate studies.  This low interest loan is granted by the college or university and reimbursed by the federal government.  This loan is given based on need.  All or part of the loan may be forgiven for certain public, military, or teaching service.

A PLUS loan is a student loan offered to parents of students enrolled at least part-time at eligible institutions.  Interest is fixed at 7.9% (higher than for Stafford loans) for the life of the loan, and begins to accrue from the date of first disbursement.  Repayment plans can vary.  Repayment begins 60 days after the final disbursement, or can be deferred until six months after the student ceases to be enrolled at least half-time.  PLUS loans can be obtained for amounts that cover up to the entire cost of education, including living expenses, less other financial aid.  A PLUS loan is a commitment of the parent, not the student.  Parent must have a good credit history to be eligible.  A PLUS loan is also available to graduate and professional students directly; in this case, the student is responsible for repayment and must have his/her own good credit history.

Private student loans are available through banks and other commercial financial institutions.  Rates, amounts and eligibility criteria can vary.

Work Study

The federal work study program offers part-time work on campus for compensation that is applied towards college expenses.  The compensation paid out by the school is reimbursed by the federal government.  Total payments cannot exceed the size of the federal grant to the school.

Direct Aid from Colleges

Colleges and universities often have their own budgets for scholarships and other aid, often provided by alumni gifts and endowments.  Criteria for award and amounts vary by school.

Armed Forces

Examples of funding sources available through the armed forces include the GI Bill, ROTC scholarships, and Congressional appointments to a military academy.  These require a specified term of service.

Employers

Employer sponsored scholarships are awarded to dependents of the employee.  For the employee himself/herself, employers may provide up to $5250 per year reimbursement for employee educational expenses not related to the employee’s job function.  This reimbursement is not reportable as income to the employee.

Applying for Financial Aid

For many financial aid programs, families need to complete the FAFSA form (Free Application for Federal Student Aid).  This form should be completed as early in the tax year as possible, and needs to be submitted to the U.S. Department of Education.  After review, the department issues and SAR (Student Aid Report) and copy of the EFC (Expected Family Contribution) to each school listed on the FAFSA.

The EFC is the amount the family and student are expected to personally contribute towards the cost of higher education.  The EFC measures family financial strength, and is used to determine the eligibility for federal student aid.  Based on a 1965 formula, financial aid need equals cost minus EFC.

Personal Funding

There are several options available for parents or other individuals to personally pay for a student’s college education, either in whole or in part (the expected family contribution).  Tax treatment differs for each option, and should be carefully evaluated to determine the best option(s).

Private Investment Accounts

Private investment accounts are typically the least tax efficient option for funding education.  The advantages include no maximum on the amount contributed, absolute control over use, and unlimited flexibility in how assets are managed.  However, with each disbursement, earnings and capital gains taxes are realized.  This disadvantage with private accounts is often larger than the disadvantages of lower flexibility, contribution limits and control of assets of other options.

Custodial Accounts (UTMA/UGMA)

Custodial accounts allow minors to have assets titled in their name but managed by an adult (the custodian) until age 18 or 21, depending on the state.  At the age of majority, the child gains full control of the assets.  The advantages are that the custodian maintains full control until the child reaches the age of majority, and earnings generally get more favorable tax treatment than parents’ private accounts.

At the age of majority, however, the child assumes full control of both the investment decisions and the disbursements.  The child can choose how to spend the money – either on college (as earmarked by the donor) or on anything else the child wishes.  Also once set up, the parent cannot give assets to another child.

Contributions to a custodial account are considered gifts and are therefore subject to gift tax rules involving maximum limits to avoid the gift tax.  If the donor and the custodian are the same person, the donor/custodian is considered to have sufficient control over the assets so as to have the assets included in the custodian’s estate until the student’s age of majority.

Coverdell Education Savings Accounts (ESAs)

Coverdell ESAs operate much like IRAs in terms of tax-deferred treatment; however the maximum contribution per year is currently limited to $2000 per year.  Earnings are exempt from taxes if used for qualified educational distributions; therefore, earnings grow faster than in private accounts.  Qualified distributions include expenses for primary, secondary and higher education.  Individuals direct the investments.  All assets must be distributed by 30 days after the student reaches age 30.  Participation is limited based on income; higher income earners are not able to use this type of account for education savings.

529 Plans

529 plans are another alternative for tax-advantaged savings, and are the most popular.  Set up by states, 529s offer higher contribution limits, and greater donor control over the assets.  There are no adjusted income limits.  However, if allowed by income, savers can do both the 529 and the Coverdell.

There are two basic types of 529 plans.  The first are 529 savings plans.  In these plans the contributor makes contributions and selects investments from those offered within the plan.  The donor takes on the investment risk as to whether or not there will be enough money to pay for school.  The second type is prepaid tuition plans.  In these plans the contributor makes contributions to cover future higher education expenses.  Amounts are determined by a number of factors, and there are no investment options to choose from.  In this case, the school/state takes on the investment risk.  If the student attends an in-state public school, he or she does not have to worry if there will be enough money to pay for college.

In either plan, sponsorship is limited to eligible state programs and eligible private institutions.  They can be set up by the state/state agency or by the educational institution.  States offer savings plans or prepaid tuition plans.  Schools only offer prepaid tuition plans.

Contributors may be family members or non-family.  Contributors are able to change the beneficiary, but only to another family member of the beneficiary (prepaid plans may adjust the premium in this case).

Students must be enrolled at least half-term.  Eligible institutions include most colleges, universities, community colleges, vocational schools, and even some foreign institutions.

Contributions are made in cash.  This prevents attempts to avoid capital gains taxes by contributing appreciated assets.  In the case of 529 savings plans, rollovers are allowed from other 529 savings plans, UTMA/UGMA and Coverdell accounts, or certain US savings bonds issued after 1989.

Contributors are allowed to invest in a 529 savings plan from most any state regardless of the state in which the student resides (some states do restrict this).  However, it may be of some tax benefit to choose the plan in the home state. The contributor would need to compare the tax benefit of the home state’s plan with the investment opportunities available in another state’s plan.

Contributors are not allowed to individually direct investments outside of the choices available within the plan.  Assets cannot be used as collateral to secure a loan.  Plan contributions are limited to the cost of five years at the most expensive schools in the U.S.

There are several advantages to these plans.  Investment earnings are tax deferred, accelerating growth potential.  Qualified distributions are not taxed.  In some states contributions are tax deductible.  Contributors are able to take advantage of accelerated gift tax treatment, which equates of tax free transfers in one year up to the annual gift tax limit times five.

If withdrawals are not used for qualified educational expenses – tuition, fees, books, supplies, equipment, or room and board – earnings will be subject to ordinary income taxes plus an extra 10 percent penalty.  An exception to the penalty only is made in the event of death or disability of the beneficiary or receipt of a scholarship; ordinary income taxes still apply on the amount withdrawn.  In the case of a scholarship, this penalty exception only applies to the amount of the scholarship.

For prepaid tuition plans, the contract is purchased for a specific price, which defines the specific costs for a specific student.  These plans may guarantee to pay tuition and fees at in-state public schools.  For out-of-state or private schools, these plans typically pay the average of in-state public tuition; the family must make up the difference.  When the student starts school, the plan pays out at the level required at that time.

Prepaid contract expected contributions are based on a number of factors:  current cost of in-state public school tuition and fees; age of prospective student; number of years of education to be purchased; time period over which contract will be paid (i.e., lump sum or 10-year installments, etc.); and actuarial assumptions on how much tuition and fees will be in the future and future return on investments.

Series EE Government Bonds

These bonds are issued at half of the face value.  Interest accrues each year until maturity.  Interest can be partially or fully federal tax-free when used to pay qualified higher education expenses in year of maturity.  Bond prices range from $50 to $10,000.

Use of Series EE bonds have certain requirements. The purchaser must be 24 years old on first day of the month purchased.  Bonds must be registered in one or both parents’ names.  Married parents must file jointly.  Deductibility is phased out for higher adjusted incomes.  Both principal and interest must be used for qualified expenses.

Trust Accounts

Instead of a custodial account, a 2503(c) trust can be established to pay for educational expenses.  The trust is irrevocable once funded.  The student is entitled to the principal at age of majority.  Income can be retained or distributed; if distributed, amounts are taxed at the child’s tax rate, and is therefore subject to the “kiddie” tax. Contributions qualify for the annual gift tax exclusion.

IRAs and other Parental Retirement Plans

Yes, it is possible to sacrifice your own personal retirement needs to send your kids off to school in style.  While you certainly would not use funds truly earmarked for your own retirement, you might consider opening an IRA for yourself that you personally designate as a college fund.  Remember, this is in addition to what you are saving for your retirement.  For employer-sponsored 401(k) and other retirement plans, loans and distributions are allowed for educational expenses.

Both traditional and Roth IRAs can be used for this purpose.  All IRA/Roth rules apply.  However, for a traditional IRA, amounts used for qualified high education expenses are exempt from the 10 percent early withdrawal penalty; ordinary income taxes on the full amount withdrawn still apply.  For a Roth IRA, such expenses are also exempt from the 10 percent early withdrawal penalty.  Ordinary income taxes are paid on earnings only.

Impact of Personal Funding on Financial Aid

Some forms of personal savings can impact the eligibility for financial aid.  Whole books are written on this subject of how the FAFSA form gets evaluated, and we recommend that you take advantage of these resources.   Here are a few major items to keep in mind, though:

Ownership of the assets has a great impact on the level of financial aid that gets awarded.  Generally, it is better to have assets listed in the parent(s) names, as the expected contribution is calculated lower for parental assets than for student assets.  The advantage of putting assets in the student’s name is to take advantage of the student’s lower tax bracket.  However, this generally does not compensate for the amount of potential financial aid lost in doing this.  Also, when the assets are in the student’s name, they have discretion on how the money is spent, and it may not be for education.

Retirement funds, pensions, tax-deferred annuities and life insurance are not considered assets in the need-based formulas.  However, this exclusion only counts for contributions/premiums made before the base year (year of evaluation/first enrollment).  Small businesses owned and controlled by the family are also excluded.

The only debt that counts in the needs analysis is debt secured by property; credit card debt is not included.  So if you owe a lot on credit cards, it would behoove you to pay it down to protect your cash flow once you are paying for college.

Custodial versions of 529 savings plans, prepaid tuition plans and Coverdell education savings accounts are disregarded if the student can be claimed as a dependent.

If you are saving money for a big dollar purchase, make that purchase before submitting the FAFSA.  Otherwise, that savings must be reported on the form, and it is assumed that money will be used to help pay for college.  Related to this, student assets should be spent before spending parental assets.  So when sending Junior off to college and he needs a vehicle, let him buy his own car.

Income Tax Benefits

There are several tax credits or deductions that may be available when using personal funding to pay for college.  The American Opportunity Tax Credit applies to 100 percent of qualified tuition, fees and course materials for self or a dependant, up to a maximum of $2500 per student (up to $2000 plus 25 percent of the next $2000).  The student must attend at least half-time.  This tax credit can only be claimed for the first four years of higher educational expenses.  Other credits or deductions cannot be claimed in the same year.  This credit is phased out for higher adjusted income levels.

The Lifetime Learning Credit applies to qualified expenses at qualified schools for at least part-time studies to improve or upgrade job skills.  This credit is limited to a maximum of $2000 per family (20 percent of the first $10,000).  This cannot be claimed with others in the same year, and is phased out beyond certain income levels.

Interest paid on private or government-sponsored student loans are deductible from gross income to a maximum of $2500.  This deduction is phased out beyond certain income levels.

Calculating College Costs for Personal Funding

There are several steps to calculating college costs.   But first you need to identify several pieces of information.

Information Needed

The first piece is to determine what scale of college you’d like to fund.  Do you want to send Juniorette to an Ivy League school, or will the local community college suffice?  What about a state school versus private college?  In-state versus out-of-state?  The cost per year can vary widely depending on your preferences.

Current costs for the preferred type of college are easy to obtain.  You then need to make some assumptions as to how much those costs are likely to increase each year.  The usual college cost inflation rate used is 6 percent.

The next piece is to identify how long you have until funds are needed, and how many years you’d like to fund.  Age of the beneficiary answers the first question.  The second involves whether or not you want to pay for just an undergraduate education, or if you’re willing to pay for a masters or professional degree.

The fourth piece is to determine how much you can afford to save, and how much you have saved already.  This is a budget function. You may or may not be able to save the full amount you’d like to save.  You also need to incorporate the current value of any assets already saved, and to estimate an annual return on assets.

The fifth piece is to consider what kind and what level of financial aid you expect Juniorette to receive.  Expected financial aid would reduce the amount you would need to personally save.  As stated before, some forms of personal savings can impact financial aid eligibility, and you would need to carefully take this into account in determining where to put your money.

The Actual Calculation

All this information is used in the actual calculation.  The first step of this calculation is to determine the first year of college costs in the year of enrollment, based on the value of the cost at the time of enrollment adjusted by the annual cost inflation rate between now and then.

The second step is to determine the amount of capital needed to fund the number of years of college.  This step uses the amount obtained in step one and an adjusted rate of return that incorporates the estimated investment return and the expected cost growth rate.

If any assets are already accumulated, we then solve for the future value of those assets for the year those assets are needed.  This amount is subtracted from the amount obtained in the second step to determine the net amount needed to save.

The last step determines the savings needed now to pay for these future costs.  The calculation can be solved for a lump sum amount to be invested, or for a monthly savings program.

A good financial advisor would be able to help you with these calculations.

Conclusion

College is an expensive endeavor, and it becomes more and more expensive each year.  However, with careful planning, you’ll be able to send your child to college without sweating, at least about the paying for it part.  You will still need to nag about grades and extra-curricular activities.  Sorry about that, and good luck!

Best Execution is a very difficult metric to measure since it is such a subjective benchmark. In a “thinner” ETF with a wide spread, such as MNA (IndexIQ Merger Arbitrage), you have a 20 cent spread and very low volume. If you buy on the offer, or sell at the bid, this would be construed as “best execution”, but a position bid (where your broker fills you on the whole order, immediately, at one price) should fill you within the NBBO. (See 43,190 MNA sold on May 25th within the spread). If you consider beating the VWAP/TWAP to be “best execution”, what happens when you beat VWAP/TWAP by 5 cents but have 20 cents of market impact in beating the VWAP/TWAP? For many investors these dilemmas are solved by trading exclusively with their custodians or getting position bids. So, what is the best way to trade ETF’s and achieve Best Execution?

While algorithmic styles such as VWAP/TWAP have been considered as acceptable practices by many investors, many advisors and custodians have sought to minimize their trading costs and market impact by seeking position bids on their trades. The argument that has been made is that by sourcing liquidity and finding a counter-party to “put up the trade” at one price, the investor is getting best execution. While this may be true in some regards, such as the MNA trade example above, in many cases this is an extremely ineffective way to trade, and is the polar opposite of best execution.

The examples of when position bids achieve less than “Best Execution” and why. Selling In A Rising Market/ Buying In A Falling Market:

Since most ETFs (there are caveats depending on if the ETF is domestic/international equity based, fixed income, commodity, or otherwise based) trade around the IIV (Indicative Value) of the underlying basket of securities, asking or taking a position bid for a sell order in a rising market not only takes you out of the market at significantly lower prices than you can achieve but also creates a volume spike that skews your benchmarks. Conversely, taking a position bid to buy an ETF in a falling market only achieves an immediate execution at a worse price than you would receive if you waited a few more minutes. While all of the above would seem to be very obvious to an educated investor, there is still a hidden side of the position bids that impacts an investors’ execution. This would be “Rebates” or “Payments for Order Flow”. The ETF Industry relies on Authorized Participants (AP’s) and Market Makers (MM’s) being enabled to trade the underlying basket of securities in the ETF and converting the underlying basket to ETF shares for the client. In many cases, these AP’s and MM’s will pay a rebate to the executing broker as an enticement to get the order. This rebate is added into the client price, so the investor does not see the rebate being paid out, but it is baked into the execution price. For example, if you buy 50,000 shares of XYZ as a position bid and your execution price is 25.69, and your broker received a penny rebate, then your buy order would have been filled at 25.68 (or less as discussed later) and you paid the extra penny rebate through higher execution costs, as well as your broker commission. This does not only affect institutional customers such as Investment Advisors, but retail customers as well.

If you are a retail investor and trade through your custodian, and your custodian receives rebates on your orders, while you do not pay a per share commission, your execution price is still impacted by the rebate that is baked into your fill and paid to your custodian. As a retail investor buying smaller share amounts the cost of paying a rebate is not as great as for institutional investors, but the costs for Institutional Investors is much larger than just the rebate.

Penny Assumption

These examples assume that a client is paying only a penny a share as a rebate back to the client. While that may be the case, the price received may not only be skewed by a penny. For example, when pricing an ETF for position, some firms will have different pricing for rebated versus no rebated orders. In selling MNA an AP indicated a price to sell at 25.25 without a rebate, but 25.22-25.23 with a penny rebate added in. The price to the institutional investor is not always skewed by only a penny because the broker is receiving a penny rebate. But in the following example we will assume a penny rebate and penny commission to outline the potential costs to the Institutional Investor and their clients: Assuming the Large trade on May 17 was a position bid with a rebate Institutional Investor sells 3.4 million shares of EWY as a position bid around 11:12. The bid is about 63.75 and the order is filled at 63.60. If the broker was rebated a penny, and paid a commission on the trade, they received $68,000 in compensation for the trade with the investor paying $34,000 and a minimum of $34,000 in a lower execution price. Assuming the price to the client was only impacted one penny for the rebate, that client lost 1.57 basis points on that trade, not including the fact that there was 15 cents of market impact. The ETF closed at 63.95 that day, and the Institution in essence paid 2 cents per share to execute the trade. I’m sure the Institution considers their fill to have met Best execution, but in the above scenario it would have been AT LEAST 1.57 Basis points away from best execution, andmost likely over 3 basis points away from where it should have been executed. This is a high dollar value stock, where the basis points missed is going to be lower, can you imagine the number of basis points you give away to rebates on lower priced stocks? Or the cumulative result of losing 3-5 basis points on every trade you do for a year. You would lose 3-7% off your annual performance just because you paid your broker or custodial desk, rebates on top of commissions. That is 3-7% of your assets that you do not get paid on, and a reduction in your performance number when you are trying to grow your business and attract more assets. With all of these examples, how can an investor truly achieve best execution? For one, make sure your custodian goes to counter parties for pricing and does not receive a rebate for the flow. If trading outside of your custodian, make sure your broker informs you of the rebate they received on the trade (if any), and do not trade exclusively on position bids. Your broker is there to work for you. Make your broker seek best execution through the marketplace, over time and with position bids if necessary as a combined strategy to get you—the client—the best price, not to pay the broker twice as much in compensation. Recapturing basis points through better executions is the broker’s job, not to double your fees paid to the broker. You built your business and you are the one who should reap the greatest rewards from it. It will benefit you, the advisor, in the long run through better performance numbers, being easier to attract new assets and having a larger AUM.

Scott Freeze is the President of Street One Financial. Scott has been involved in ETFs from both a trading/execution and a product strategy standpoint since the beginning of the decade. He brings his relationships with RIAs and institutional portfolio managers to Street One where he helps construct better portfolios, and recapture basis points that would otherwise be lost in the marketplace, through better trade execution. Scott holds the Series 3, 4, 7, 24, 53, 55, and 63 licenses.

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.

Diversification spreads your risk among many different investments.  Appropriate diversification involves investing in hundreds of different companies across many industries and sectors.  It usually involves investing in a number of different funds, unless you are mega wealthy and can buy the stock outright of hundreds of companies (this does not take into account the higher investment fees for doing that, of course).  If one company goes sour, the impact on your total investment is minimal.  If a whole sector takes a hit, the other sectors can mitigate the damage.  Diversification does not protect you from systematic risk, however – if everything tanks, such as in the downturn in 2008-2009, then so will your investments.

Also see this post about diversification

You can view her full bio HERE.

Some advisors look at making this decision based on rates of return.  For instance, if you can make a larger return on your investment than you will pay in interest on the money borrowed, then the argument is that it would make sense to invest with debt.  However, there is a hole in this argument.  What guarantee do you have that your investment return will truly actually be larger than your interest paid?  It would sure be nice to have an absolutely guaranteed high rate of return with no potential for not reach the mark.  (If you do know of one, I’d love to hear about it!)

However, high return investments virtually always involve taking on a high degree of risk –the risk that the return will turn out to be much lower than expected, or even be negative.  Also, keep in mind that credit card interest rates are pretty high.  Sure, you can find rates in the 7–10% range.  I also see ranges in the 10–16% range, or even into the 20% range or higher if you’ve had some payment trouble.  Second mortgage rates are generally lower than credit cards, making it a little more likely that that the interest paid could be less than the potential investment return.  But do you really want to risk your house on a just a potential return?

Based on this, our recommendation is to use your money to aggressively pay off consumer debts before investing.

With a Roth IRA, you do not save on taxes on the amount you contribute, but you do not pay taxes on the amount you take out on both the contributions and the earnings.  This means that essentially, the earnings in a Roth are tax free.  Tax-free!  Name another instance (available to most people) where the IRS allows that.  If you have a long time horizon – let’s say you’re in your 20s – the benefit of tax free earnings is humongous.

Both options have certain stipulations.  In both options, you cannot take money out without penalty until you have reached age 59 ½.  With the Roth, you also cannot take money out until the account has been in existence for five years.

Some argue that the traditional is best if you believe you will have a lower tax rate during retirement than you do now, but this really does not take into account the taxation difference on earnings.  An instance where indeed a traditional IRA is best is when you have less than five years to go until retirement, and will need to dip into the money right away.  Otherwise, a Roth will be more advantageous.

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.

Details on how you can support his project are HERE.

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.