Money made on currency exchange is taxable at capital gains rates above $200. Maybe 15% depending on your situation. Any loses could be claimed up to a net $3000 per year including any other capital gains or losses. Proceed with caution when investing in currencies. Many people have lost a lot of money speculating in this type of investment.

Private schools K – 12 are not tax deductible.

Yes. If the funds were sold in a taxable account you will still pay tax on the capital gains. If that money was in a IRA then it will be taxed at the regular income rate but you will not have to pay the 10% penalty. In this case you can pull out a maximum of $10,000. If it was in a Roth IRA and you have held it for 5 years then you can pull out the principal tax free.

There are two changes taking place within your retirement plan.

1. The American Century Short-Term Government fund is being removed from the plan. Any participant that is currently invested in the fund will be moved to the JPMCB Stable Asset Income Fund-F which already exists as an investment option.

2. The Columbia Mid Cap Value Z fund is being replace with the JP Morgan Mid Cap Value Inst fund.

The Mid Cap Value Breakdown

The addition of JP Morgan Mid Cap Value (FLMVX) looks to be a good substitution to the Columbia Mid Cap Value fund (NAMAX). The Columbia fund has posted only average returns since the departure of its key manager in 2011. In contrast, the JP Morgan fund’s historical performance has earned it a Morningstar Five Star ranking.

The objective of the JP Morgan Mid Cap Value fund is to beat the Russell Mid Cap Value Index with less risk. Value investing is best described as buying stocks that an investor believes to be undervalued relative to some form of fundamental analysis. The fund currently holds 108 stocks, 28% being large cap, 69% mid cap and 3% small cap. Its largest holding is the JP Morgan Money Market fund at 4.5%. Other holdings that you may recognize, each under 2% of the funds asset, include Ameriprise Financial, Kohl’s, AutoZone, Fifth Third Bank, Family Dollar and Williams-Sonoma.

The fund has a five-year standard deviation (risk) of 19.82 with an average return of 5.3%.  The JP Morgan fund is relatively expensive, especially considering the size of our 401k plan.  However, the fund’s 10-year trailing return is 10.44%, ranking it in the top 20% of its peers.

Even though the fund has performed well, I caution all participants from over allocating to the horse that won last years race. Historical performance has very little to do with future results. The JP Morgan 401k plans Janus Overseas Fund is a great example of this.

Goodbye to American Century Gov’t; Do I know you JP Morgan Stable Value?

The JPMCB Stable Asset Income Fund is a proprietary fund just for JP Morgan clients, thus there is not a ticker to track this investment on any financial site such as Morningstar or Yahoo Finance. The fund brochure shows that it tracks the Citigroup 3-month T-Bill Index.  To back test the performance of the stable asset value fund consider using JP Morgan ticker HLLVX. This fund has a similar portfolio and performance but can and will deviate from the actual performance of the Stable Value Fund.

The American Century Short Term Government fund’s purpose was to hold money that participants did not want to risk placing in stock or the more aggressive PIMCO Total Return Fund. The Stable Value Fund, which takes on more risk, has out performed the American Century fixed income option. The removal of the American Century fund from the plan is not heartbreaking, but it would have been nice to see a more quality replacement.

I have long maintained that the ASA JP Morgan 401k Plan is dangerous for those inside five-years of retirement. This is due to the lack of fixed income options within the plan. Plan participants have little to zero access to treasury inflation protected bonds (TIPS), high yield bonds, or foreign fixed income, and have no way to manage their own duration of corporate bonds and US Treasures. Offering index mutual funds within these sectors would help those approaching retirement. Simply removing a lack luster choice and not replacing it with a quality fund forces me to think that the designers only have young risk-seeking participants in mind.

Wrap up

Overall the fund changes improved the quality of the ASA 401k Plan offering. However the plan still remains stuck in the 1990’s. Modern 401k plans are offering actively managed mutual funds as well as passively managed index funds for all asset classes. There are many reasons why JP Morgan would resist the usage of index funds.  But the company is in the driver’s seat and, if it so chose, can direct JP Moran to make changes as they see appropriate.  Union and non-union employees saving for their financial future would benefit from more low cost indexing choices within the plan.

This and more topics are discussed at the ALPA / Wiser Wealth Management 401k Plan Workshop held annually in Atlanta.

Capt, Casey Smith, www.wiserinvestor.com

When choosing which funds to allocate to within the 401k plan you have to remember that you are picking a fund manager that has his own style of investing. Looking at just the fund name and performance is like judging a book by its cover.

The Janus Overseas Fund has taken a contrarian approach to investing over the last few years. In the funds prospectus, the fund manager, Brent Lynn, stated, “I added significant investments in depressed financials, cycilcals and emerging market stocks. This approach achieved some success in prior years but in the 2011-12 environment of investor risk aversion, contrarian investing clearly has not worked.” Mr. Lynn notes in the prospectus that he has high conviction in his picks.

While the fund is categorized as international, the asset class breakdown is actually 15% US stock and 85% International Stock. 58% of the fund is in developed countries and 42% in emerging markets. The emerging market allocation is high vs the average international fund at 13%. This alone will add volatility to the portfolio.

I receive many questions about how to best manage the Janus Fund. I believe that the Janus Fund should be used in a supporting role within an aggressive portfolio. This simply means that if you are currently holding the Janus fund consider moving part of you allocation out and into the Dodge and Cox or American Century Funds that have better managed the international sector. For those within 10 years of retirement or a risk tolerance below moderate aggressive I would not recommend this fund.

The ASA MEC Retirement and Insurance Committee

Announces the annual

Retirement Planning Workshop

 For Legacy ASA Pilots and Flight Attendants

The workshop will be presented by Express Jet Captain Casey Smith, President of Wiser Wealth Management, Inc.

The workshop is specifically designed to cover the Legacy ASA JP Morgan 401k plan.  Materials will be provided to help you determine how much you need to save for retirement, how to choose the best mutual funds, asset allocation and diversification, and many other critical retirement planning topics.

 Tuesday, February 5th  or   Saturday, February 9th

 10 am – 3 pm

Complimentary lunch provided

 Hilton Garden Inn Atlanta Airport North, 3437 Bobby Brown Parkway, East Point, GA 30344

Seating is reserved.  You must RSVP to Sterling Roach at sterling.roach@alpa.org or 404-218-3647

2013 IRS Limits - 

The annual exclusion from gift tax has increased to $14,000 per gift recipient.  The gift recipient can be any individual, not just family.  And you can make gifts to an unlimited number of people.  You are just limited to $14,000 for each one in order to avoid gift taxes.

The foreign earned income exclusion is now $97,600.  This means that you can shelter up to $97,600 of income earned while working in another country from US taxable income.

The maximum wage used to calculate Social Security tax is now $113,700.

401(k) Plans

The employee contribution limit has been raised to $17,500, up from $17,000 in 2012.  The catch-up provision for those age 50 and older remains the same at $5,500.  Which means an employee aged 55 can shelter up to $23,000 in his/her 401(k).

The above limits do not include company matching money.  However, there is a limit as to the total amount of money – both employee contributions and employer contributions – that can be contributed to a 401(k).  It is known as the 415 limit, and for 2013 that limit is $51,000.  The 415 limit does not include the $5,500 catch-up.

Traditional and Roth IRAs

The contribution limits for IRAs have increased to $5,500.  The catch-up provision limit remains at $1,000.

Contributions to traditional and Roth IRAs are subject to income phase out ranges. Income phase out ranges have been increased for both traditional and Roth IRAs.

For traditional IRAs, the income phase out range for deducting IRA contributions is $59,000 to $69,000 for single taxpayers, and $95,000 to $115,000 for joint filers.  Above $69,000 and $115,000, respectively, you will not be able to deduct contributions from your taxable income.

For Roth IRAs, the income phase out ranges for contributions is $112,000 to $127,000 for single taxpayers and $178,000 to $188,000 for joint filers.  Above $127,000 and $188,000, respectively, you will not be able to contribute to a Roth.

Long Term Care Premiums

You are able to take a deduction for premiums paid for long-term care insurance, subject to certain limits.  These limits are defined by age.  For those 40 and younger, that limit is $360.  For those from ages 41 to 50, the limit is $680.  For those between 51 and 60, the limit is $1360.  Between 61 and 70, it’s $3640.  For those over age 70, the limit is $4550.

A chart is included below for ease of reference:

Limit Category                                                                  2013 Limit

Annual gift exclusion                                                         $14,000

Foreign earned income exclusion                                    $97,600

Wages subject to Social Security tax                                $113,700

401(k) Limits

Employee contributions                                                    $17,500

Catch-up (age 50 and over)                                             $5,500

Defined Contribution Plan limit                                       $51,000

IRA Limits

Contributions                                                                     $5,500

Catch-up                                                                             $1,000

Roth IRA Income Phase Out Range

Single taxpayer                                                                  $112,000 to $127,000

Joint filers                                                                           $178,000 to $188,000

For Deducting Contributions to Traditional IRAs

Single taxpayer                                                                  $59,000 to $69,000

Joint filers                                                                           $95,000 to $115,000

Deduction Limit for Long-term Care Premiums

Age 40 or under                                                               $360

41-50                                                                                  $680

51-60                                                                                 $1360

61-70                                                                               $3,640

Over 70                                                                            $4,550

This is the eighth piece in Seeking Alpha’s Positioning for 2013 series. This year we have taken a slightly different approach, asking experts on a range of different asset classes and investing strategies to offer their vision for the coming year and beyond. As always, the focus is on an overall approach to portfolio construction.

Casey Smith is President of Wiser Wealth Management, a Marietta, Georgia-based fee-only fiduciary wealth management firm offering asset management, tax preparation, estate planning and financial planning services. Wiser’s unique investing techniques have earned Casey speaking engagements at top ETF conferences around the world. When not running Wiser Wealth, Casey doubles as a pilot for an Atlanta-based commercial airline.

Seeking Alpha’s Jonathan Liss recently spoke with Casey to find out how he planned to use ETFs to position clients across a range of healthy asset classes in the coming year.

Jonathan Liss (JL): How would you describe your investing style/philosophy?

Casey Smith (CS): We have a passive investment management style. However, we are always in search of new ways to best allocate to long-term healthy asset classes. We focus on building portfolios based on the client’s risk tolerance so that changes do not have to be made when there is uncertainty in the market or rapid growth. This allows for broad diversification and eliminates the mistakes made in market timing.

We manage five core risk models using all exchange-traded products. Our low risk models focus on portfolio income. The more aggressive models are built for income and growth as wells as pure growth. Our core philosophy is to maintain a diversified portfolio, keep costs low and always invest for the long term.

JL: As we approach 2013, are you bullish or bearish?

CS: Bullish, but not in a 1990s way. As we muddle through the fiscal cliff headlines the market will be nervous. But as we continue through 2013, I see the market overall trending upward.

JL: What are the major catalysts for markets in 2013?

CS: The Fed has shown its playbook and all the plays are pumping money into the economy as the market moves up on each announcement. The current low interest rate environment appears to be in place through 2014. Foreign markets appear to be stabilizing and US stocks are still reasonably priced. The threats that are still looming are Europe reversing course, US politicians not formulating a plan to address fiscal responsibility, and China’s growth falling faster than expected. We build our portfolios on a five-year outlook. We are prepared for volatility in 2013 and are willing to give up some growth for protection to the downside.

JL: Which asset classes are you overweight? Which are you underweight?

CS: We do not manage portfolios using a sector rotation strategy, or change assets class weightings frequently. Analyzing our core models we do currently have a value tilt in US and foreign large caps. This is because of our deployment of low volatility and dividend based exchange traded funds to complement the core ETFs.

JL: To which index or fund – if any – do you benchmark your performance? Has this changed recently, and if so, why?

CS: Our clients see the S&P 500’s performance on their statements as a default benchmark, as well as the Bar Cap US Aggregate Bond Index. If your investment has 30% exposure to equities then you would look at the same percentage of the S&P 500’s return to give you a very general risk adjusted comparison.

Internally when constructing portfolios we will use S&P’s risk based models. These models are available on the S&P website but also are the indexes tracked by the iShares risk based allocation ETFs. Those tickers are AOK, AOM, AOR and AOA. These are great portfolios to compare your own portfolio to. We have used this approach for many years, and I do not foresee any changes.

JL: What is your highest conviction pick heading into the new year?

CS: I like low volatility funds, such as PowerShares S&P 500 Low Volatility Portfolio ETF (SPLV) and iShares MSCI USA Minimum Volatility Index ETF (USMV), being added to portfolios to reduce volatility. These ETFs can complement a stock portfolio or simply be used to reduce core holdings in the S&P 500, MSCI Emerging Markets or MSCI Developed Europe. With the economic uncertainty around Europe and the US, I like adding these ETFs so that portfolios are still invested in equities and I do not have to add more to treasury bonds. The yields of theses ETFs are attractive as a secondary objective.

It should be noted that if the market has large gains these funds will not follow, but they have outperformed the market over the last ten years. Another pick that I chose two years ago was emerging market debt. Using an ETF like iShares JP Morgan USD Emerging Market Bond ETF (EMB) is still attractive. Emerging market debt has stock-like performance with bond yields.

JL: Speaking of yield, where have you been having retirees turn for income in this record low rate environment? How have potential changes to the tax code affected your assessment of interest-paying investments?

CS: In early 2011 we began adding dividend-focused ETFs such as iShares High Dividend Equity ETF (HDV) to complement our portfolios. Adding these funds has increased portfolio yield and kept the portfolio risk virtually the same. We did not want to move out of bonds into equities to chase yield, as our mandate from the clients was not to take on more risk.

In the past idle cash would sit in a brokerage account at a reasonable money market yield. We now will use CDs and ETFs like PIMCO Enhanced Short Maturity Strategy ETF (MINT) and Vanguard Short-Term Corporate Bond Index ETF (VCSH) to put a portion of that cash to work. We do not like any products involving insurance such as index annuities. The fine print of these products is rather disturbing.

ETFs are very tax efficient with only a few passing through capital gains this year. However, the dividends and interest that our clients receive could be taxed at a much higher rate. If this becomes a reality, we then will use more Muni bonds within our models for taxable accounts. Many of our clients are retired so we hope that there is an earned income component to the higher rates.

We have several clients who saved well during their working years who are now barely keeping up with their $6,500 per month nursing home bills paid for by interest and dividends. Only a politician needing money can explain how these people get labeled as “wealthy”. For our younger investors we will make sure that Roth IRA’s are being used effectively as part of their saving strategy.

JL: Turning to younger investors, what is the ideal asset allocation for someone with a long-term horizon (greater than a decade) and no need to touch their investments? Can investors continue to rely on stocks for the bulk of their capital appreciation?

CS: Historical data shows us that over the last 10 years equities have not paid off in relation to their risk compared to previous time periods. This is assuming that you simply invested money ten years ago and then added no more.

However, this is generally not how young people save. Part of each paycheck goes into their 401k plan or other means of saving. The ability to purchase more stock in March of 2009 proved to be a very good investment. So, yes, stocks should be a very big part of a young person’s portfolio with the benefit of dollar cost averaging. The key for these investors is to have good investment behavior and keep the cost of investing as low as possible.

I like an aggressive portfolio to look as follows:

click to enlarge

JL: How bad is the current gridlock in Washington and the uncertainty it breeds for investors? How closely do you watch political developments when formulating an overall investing thesis/asset allocation mix?

CS: There is no doubt that news headlines are affected by politicians through their actions or inactions. The debt-ceiling debacle in 2011 and now the fiscal cliff headlines add volatility to the market. As the market falls it makes investors feel bad, thus they may not buy that car, house or take that trip right away which in turn hurts the economy. A falling market applies more pressure on Washington to compromise on their agenda and to take action. Investors, especially individual investors, have to avoid this noise and focus on long term healthy asset classes. Pulling money out of the portfolio using fear as the main driver only adds to more losses.

Certainly a change to current tax laws will drive how we invest. We are a full service firm offering tax preparation, portfolio management, financial planning, 401k plans and through our attorney partner, business and estate legal advice. We understand how all of this gets funneled down to an efficient portfolio for our client. We do not make any changes based on ‘noise’ events, such as the debt ceiling 2011 debates. Remember that much of the market’s short-term movements are based on emotions, not long-term valuations. Investors should focus on five years out. Anything you may require in less than five years should be in CDs.

JL: Which global issue is most likely to adversely affect U.S. markets in the coming year? Issues which feature prominently in our minds at present include continued Eurozone contagion risks; the Iranian nuclear threat/potential disruption to global energy markets; a Chinese economic slowdown; and accelerated climate change and weather-related events.

CS: The most negative impact on the US Markets is either an unknown event or a known event taking a turn for the worse. Investors cannot control any of this; they simply have to build portfolios with some down-side risk protection. While US treasuries are not appealing in yield, they are good at hedging risk.

JL: Do you believe gold and other precious metals are a genuine hedge in uncertain markets? If so, how much exposure do you have? If not, where are you turning for potential downside diversification?

CS: There is no doubt that when investors are fearful that gold is on their purchase list. Purchasing gold in the past certainly has produced a good return and in this environment it could move higher. However, the majority of our clients are retired and in this low yield environment I have a hard time investing in something that does not have any yield.

When gold became very popular to add to portfolios, we researched adding it to our mix. The big concern at the time was a falling dollar. We found that gold was not a perfect hedge against a falling dollar. Instead we found purchasing foreign treasuries in their local currencies was a much better investment. Using an ETF such as iShares S&P/Citigroup International Treasury ETF (IGOV) gave us this capability. IGOV at the time had a .95% negative correlation with the US Dollar index and paid a 3.3% yield. Gold did not pay us and was more speculative in nature.

We do own gold through our commodity funds, iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP) and PowerShares DB Commodity Index Tracking ETF (DBC). Downside market protection or reduced volatility as we look at it is done through short term treasuries iShares Barclays 1-3 Year Treasury Bond ETF (SHY) and corporate bonds, via the previously mentioned Vanguard Short-Term Corporate Bond Index ETF (VCSH).

JL: Finally, what advice would you give to a ‘do-it-yourself’ investor in the present investing environment?

CS: This certainly depends on their objectives. All investors should stay away from product salespeople that refer to themselves as financial advisors. They are financial sales people that work under inferior standards compared to fiduciary standard, fee-only advisors. This advice will help with keeping your portfolio cost low. Every penny you pay in fees is less money that you have in your pocket.

Also, investors today must think long term and ignore the noise of the daily markets. Fear is not an investment strategy. Build a portfolio not based on feeling but rather on analysis of long-term healthy asset classes. Consider using ETFs that actually hold real assets. These ETFs are designed under the 1940 act, and while considered plan vanilla, offer investors more protection and are simpler to understand. If you are managing your portfolio yourself and doing it in a active manor, meaning moving in and out of stocks on a regular basis, statistically you are set up for failure. Very few professional managers beat the S&P 500 over a long time horizon.

To read other pieces from Seeking Alpha’s Positioning for 2013 series,click here.

Disclosure: Casey Smith is long AOK, AOM, AOR, AOA, USMV, SPLV, MINT, VCSH, HDV, RWO, IGOV, SHY and DJP in either client or personal accounts (or both).

If you just looked at your portfolio return since the November 2 election, you might think that nothing has really happened. From November 2 to December 10, 2012, the S&P 500 has returned 0.31%. While long-term investors really should avoid short-term noise, major media’s Fiscal Cliff countdown makes even the best behaved investor think twice about their current strategy. Just in case you missed it, looking at daily pricing we see that the post election low for the S&P 500 was on November 15, which put the S&P 500 down 4.3% from November 2. After that, the market rebounded.  It seems that market volatility is a given as the 2012 year end approaches.

So what is an investor to do? Moving to cash means that you earn -2% on your money (0.2% from a savings account less 2% inflation). Adding new money to bonds seems a bit risky with treasuries potentially forming a bubble, muni’s dropping in yield and quality, and TIPS priced rather high. Gold has done fairly well since the election, up 1.5%, but that does not generate income that you can live on today.

The first thing that we often tell our clients is that fear is not an investment strategy. Fear makes you do crazy things that ultimately have a negative impact on your portfolio. If you continually sell at the bottom and buy at the top, your portfolio will eventually check you into the poor house.  You say that you just want to stop the losses. I ask, was your portfolio built right in the first place?

In any market, your portfolio should be constructed to meet your risk tolerance. But what does this really mean? Advisors should know the historical volatility of their portfolios; many on the selling side of this business don’t have a clue, they just want to sell you a product. For the individual investor there are tools to measure portfolio volatility. Morningstar.com is a great resource.

Portfolio volatility is most often measured by standard deviation. If you remember back to math class, standard deviation is the variation from the average. If the S&P 500 averaged 4% over the last 10 years with a standard deviation of 21, this simply means that on average your rate of return could vary between 21%  above (for a total of 25%) or 21% below (for a total of -17%) the average 4% return.

Each investment will have its own historical standard deviation, or risk. Mixing bonds and stocks from different asset classes will create an overall portfolio rate of return and risk. Stocks will have a historically higher standard deviation than most bonds. I believe that your portfolio allocation should be set for the best of times as well as the surprises that seem to bring about the worst of times. Rather than try to time the market, you should hold on to your risk allocation that was built correctly from the start. It is better to ride out the storm at times vs. jumping out and testing new strategies in volatile markets. There are copious amounts of research showing how bad behavior and feel-good active portfolio strategies fail to work.

Building your own risk profile is fairly straight forward, especially using index funds such as Exchange Traded Funds (ETFs).  S&P Dow Jones Indices offers risk-based models.  These simple models are put to work in the iShares product line under the tickers AOK, AOM, AOR and AOA. These are great portfolios for small accounts that need to be properly allocated. For the do-it-yourself investors, these are very basic risk based allocations that can be used as a benchmark in regards to allocation vs. risk.

For more advanced asset allocations, we considered seven ETFs designed to lower portfolio volatility on the equity side of your portfolio. Adding low volatility stocks to a portfolio is not a new concept. What is relatively new is the low volatility concept wrapped into an ETF. These ETFs could be core holdings, or added to an actively managed portfolio during times of anticipated volatility while still keeping the portfolio invested.

From the list above an investor can add a low volatility strategy in the asset classes of US large cap (SPLV), US all cap (USMV), foreign developed markets (EFAV & IDLV) as well as emerging markets (EEMV & EELV). ACWV covers the developed US, Europe and emerging markets. The expenses related to holding these funds are very reasonable.

As with any ETF, you must understand the methodology of the index that it tracks. There are two ways to construct a low volatility index. The MSCI indexes use a mean-variance optimized approach, meaning they construct the index by accessing an individual stocks volatility compared to the broad market and other stocks within the index. This approach appears to diversify the portfolio a bit more vs. the S&P approach. Using the comparison tool on ETFbd.com we can see the sector allocation differences between the SPLV and USMV. Consumer defensive and utilities make up half of the SPLV allocation.

The S&P low volatility construction is built on dividing a universe of stocks (say the S&P 500, 400 or 600) into quartiles by a measure of volatility using beta or standard deviation.  This approach is more transparent and simpler to calculate than the MSCI approach. There is also academic research supporting that the S&P approach is equally as effective at reducing volatility. SPLV is the largest player in the ETF low volatility category, which holds the 100 least volatile stocks within the S&P 500 for the last year. The fund rebalances annually.

Of the three low volatility asset classes, the emerging market low volatility caught my eye first. In many portfolio allocations, emerging markets are looked to as inflation beaters. The rapid growth of this asset class is worth the occasional fallouts, right? To test this assumption we took the allocation for AOM, the iShares S&P moderate risk allocation, and ran four scenarios – AOM with its 5- and 10-year traditional allocation, and AOM using the S&P Emerging Market Low Volatility Index as a substitute over the same two time periods. AOM holds a 3% allocation to emerging markets. Some of the ETFs within the AOM allocation have not been around for ten years, so we substituted the ETF with its assigned index when necessary.

What we are seeing here is that by substituting classic emerging market exposure with EM low volatility, in this case the S&P based EELV, we find that over a 5- and 10-year time period, we get a respective 2.6% and 3.2% reduction in volatility with an increase in overall portfolio return for both time periods. This is what we all want, right?  Less risk and higher returns? However, this brings up a new question – does taking more portfolio risk pay off? The answer is not necessarily, at least within emerging markets using these data sets.

Next we reset our portfolio back to the traditional AOM allocation and looked at the effect of replacing the S&P 500 with the MSCI US Minimum Volatility Index. There is a noticeable reduction in portfolio volatility. Over the 5- and 10-year periods, we see a 10% reduction. Portfolio returns were up in both cases.

In the next back-tested portfolio, we substituted foreign developed with its low volatility option. In this portfolio we used the MSCI based index for EFAV. As you can see below, this substitution has the same effect as the emerging market and large cap US low volatility indexes.

The next obvious question is what if an entire portfolio was built around low volatility indexes as core holdings? As you see below volatility was reduced by a large 20%.  The rate of return increased as well.

This whole exercise certainly shows that using low volatility strategies over 5- and 10-year periods has historically worked well using either the S&P or the MSCI based indexes. It should be noted that during large market upswings these low volatility strategies have not participated with the same gains as in the core index. It is in a volatile sideways, down or even slightly up markets that we see the best results from this strategy.

Choosing which ETF to deploy has a lot to do with what sectors are used within the asset class that you are looking for. Low volatility stock often pay a respectable dividend, thus the ETF that you choose might be focused on yield. What ever your take is on low volatility, remember that data mining easily generates perfect portfolios for the past. The future may be very different, but certainly since 2002, a low volatility strategy would have worked well for you.

Low Vol ETF Returns as of 12/12/12 (etfdb.com)

Low Vol ETF Dividends (etfdb.com)

Low Vol ETF Holdings (etfdb.com)

There are some notable differences between how the indexes represent certain markets. In the case of emerging markets, it is how certain countries are classified. These classifications can in some cases exclude certain countries from an index. FTSE does not consider South Korea an emerging country where MSCI does. The chart below has a full break down of where the indexes differ in their classifications.

The performance of FTSE and MSCI indices are very similar, but the MSCI index has the better one year results, probably do to the inclusion of South Korea in the index.

Inv 1 = FTSE

Inv 2 = MSCI

If VWO and the 21 other Vanguard funds are cheaper with similar performance, the investor wins. These changes will not take place overnight. Vanguard said in its press release that changes will take place over five months at the beginning of 2013.

More about the switch from Routers, Index Universe.

Recently Charles Schwab entered the ETF business offering Schwab branded ETFs with low pricing. On September 21, 2012 the company announced that they are lowering prices even further.

What does this mean for investors? For Schwab investors, this is great news as they now have access to low cost ETFs that also trade at no commission on the Schwab trading platform. For investors holding accounts with other brokers like TD Ameritrade, E-Trade or Fidelity, this drop in pricing does not necessarily matter as they would have to pay a trading commission to purchase the Schwab ETFs, negating the cost benefit unless the ETF is held for a long period of time.

I believe that Charles Schwab understands that assets invested in ETFs are on the rise versus assets invested with active mutual fund managers who, as a whole, have been underperforming their benchmarks for decades. By lowering the price of their commission free ETFs and launching an all ETF 401k plan, Schwab is embracing the future of investing. Through this process Schwab is looking to remain king of the hill in terms of assets under management. Perhaps their ETF offerings will also convince independent advisors to move their investors to the Schwab Institutional platform.

TD Ameritrade currently offers 100 transaction fee free ETFs chosen by Morningstar. The list includes ETF offerings from various providers such as Vanguard, State Street, iShares and Powershares. Fidelity also offers some iShares ETFs for no trading commission as well.

One thing is clear, the cost of investing is going down, which is a great benefit to long term investors. Investor education on understanding how to trade ETFs seems to be the next frontier in truly lowering ETF investors total cost.

With the onset of the European debt crisis, Eurozone nations pose a significant risk due to political uncertainty.  Political leaders continue to avoid solutions aimed at root causes, making future investing in Eurozone companies unsuitable.

So what choices do investors have with this bleak outlook? European investment risk may be reduced by investing away from European Union nations, or by remaining invested but hedging currency exposure.

Featured below are two strategies that highlight solutions for investing passively in European and international markets, while protecting portfolios against the increased systematic risks of the European continent and falling currencies.

Strategy One – Separating Asset Classes

In market environments when a falling US Dollar is the main concern, investing as broadly as possible into the international market is rewarded when lower correlations lower the risk. However, in an environment when a rising dollar becomes a main concern, there are benefits to separating international investments so that each can be studied for its effect against a rising dollar. In this current environment we can also diversify political risk by allocating a larger percentage of our international allocation to non-european countries.

Which ETFs?

For the European space, which accounts for about 25% of the world’s market capitalization, the iShares S&P Europe 350 Index, IEV, is a solid choice. The fund has 50% non-eurozone investments; 37% and 14% of the ETF are invested in British and Swiss companies, respectively. Morningstar reports that currency has given the US investor the main boost in returns over the last 10 years – 6% versus 2% in local currency returns. Morningstar also reports that this ETF has had a 91% correlation to the S&P 500 over the last 10 years.

A comparable fund is the cheaper Vanguard MSCI Europe ETF, VGK, with an expense ratio of 0.14% compared to iShare’s IEV’s 0.60%.  Also, Morningstar reports that VGK has a yield of 4%, but 20-30% of those dividends are not considered qualified, potentially causing the ETF extra tax expenses. IEV, however, has had 100% qualified dividends over the last two years with a yield of 3%.

The Non-Europe Asset Class

To represent the asset class of non-european, international developed countries (which are mainly Asian markets), the Vanguard MSCI Pacific ETF, VPL, is a preferred choice with limited competition in the ETF space. Over the last 10 years, according to Morningstar, VPL has had a 70% correlation to the S&P 500, though it is mainly caused by its 60% holding in Japanese companies (Japan has its own economic concerns and major national debt issues). Over the last 3 years, currency has given this fund a 10% annualized boost for US investors against local currency investors. Yields are around 3% according to Morningstar.

Strategy Two – Hedging Against The Euro

The WisdomTree International Hedged Equity Fund, HEDJ, is an ETF giving an alternative perspective on International markets. Through hedging the foreign currencies against the US Dollar, HEDJ, gives investment access to international developed markets while neutralizing currency fluctuations.

The ETF and index seek to give exposure to Europe, Australasia, and the Far East (EAFE) while aiming to minimize currency fluctuation in the ETF relative to the US dollar. This fund can be compared to a local currency investment, benefiting the US investor when the US dollar rises and hurting returns when the US dollar falls on a relative basis against foreign investments included in the ETF.

HEDJ appears to be a good match against iShares MSCI EAFE Index Fund (EFA) for a currency hedging strategy.

The above ETFs compare fairly closely to covering similar countries, though HEDJ seems to be slightly more diversified and carries less of the slow growth economy of Japan.

Rising Dollar

The chart below compares a Euro/USD index against EFA and HEDJ. As the Euro/USD began to sink in August 2011, both EFA and HEDJ dropped nearly 15% (signifying the start to the European Debt Crisis). But as the weakened Euro fell against the already weak dollar, HEDJ allowed for much more upswing during the bailout talks in the first quarter of 2012.

The above graph shows a perfect scenario where a currency hedged ETF works well. However, below, a March 2012 graph comparing the same ETFs and currency index shows that having a currency hedged fund does not protect in any way against loss in the underlying stocks.

An exchange-traded fund like HEDJ is extremely useful for a specific market outlook – a rising dollar against currencies represented in the index. Making long-term tactical decisions such as to limit currency exposure can be done as a conservative approach to international investing. Also, since this fund closely matches asset classes found in EFA, a simple adjustment can be made by switching between an MSCI EAFE Index and HEDJ, allowing portfolio allocations to the international developed asset class to be maintained.

Choosing Strategies

If you are not willing to make a currency play, simply reducing your Europe allocation would lower your political risk. Reallocating the reduced EFA can also be challenging. Perhaps taking the approach in Strategy One, reallocating to global real estate or incorporating a US large cap high dividend play would be good options. In the long term just holding Europe without a strategy does not seem like it will work out well.

*All data comes from Morningstar Advisor Workstation and charts have been taken from Yahoo Finance. All opinions are the analyst’s unless stated otherwise. Kyle Waller, Research Analyst and Mitchell Williams, Intern Research Analyst, for Wiser Wealth Management put the data together for this article. 

Historically, REITs have been structured to include investments mostly here in the US.  However, over the last decade the structure has expanded to include REITs in a total of 21 countries, making a global REIT allocation possible in your portfolio. According to Cohen and Steers, from 1990 to 2010 the number of global publicly traded REITs increased from 33 to 250 companies.

There are currently 18 domestic, 7 foreign and 3 global REIT Exchange Traded Funds (ETFs) to choose from. During our search for real estate ETFs, we found it interesting that the highest Morningstar rankings went to the global REIT category. While four and five star rankings are only indicators of good past performance and reflect nothing into the future, it still sparked a bit of curiosity on our part as to the inner workings within the three global ETF choices.

To understand the difference, a domestic REIT will invest in real estate companies within the US. A foreign REIT will invest in real estate companies outside the US; these funds often have ex-US in their title. A global REIT will invest in companies all over the world, including the US.

The three choices for a global REIT ETF are as follows:

• First Trust FTSE EN Developed Markets Real Estate (FFR)
• Cohen and Steers Global Realty Majors (GRI)
• SPDR Dow Jones Global Real Estate (RWO)

METHODOLOGY

The most important research into any ETF is knowing the methodology of the index that the ETF tracks. The methodology will explain the fund’s performance, turnover and allocation.

First Trust FTSE EN Developed Markets Real Estate (FFR) tracks the FTSE EPRA NAREIT Global Real Estate Index. This index is managed by committee and reviewed quarterly. The index is made up of developed and emerging market real estate holdings. The real estate companies represented within this index will get 75% of earnings (before interest, taxes, depreciation and amortization) from real estate activities. Companies that finance real estate, construct homes or hold infrastructure assets are excluded from the index. Companies that sell residential homes are only considered within emerging markets. The index holdings are tested for liquidity on an annual basis.

Cohen and Steers Global Realty Majors (GRI) tracks the Cohen and Steers Global Reality Index. The index is managed by a committee and tracks the top 75 companies that in the committee’s analysis are leading the securitization of real estate globally. Companies must meet minimum size and liquidity requirements, as well as final determining factors such as market position, financial strength and asset quality. Positions are limited to 4% of the index while also trying to maintain geographical proportional representation. The index is reviewed and rebalanced quarterly.

SPDR Dow Jones Global Real Estate (RWO) tracks the same index as its name. To be included in this index, a company must be both an equity owner and an operator of commercial or residential real estate, as well as have its revenue derived from the ownership and operation of these assets. The company must have a minimum market cap of USD 200 million. Some companies, such as real estate finance companies and home builders, are excluded from the index. The index is float adjusted based on market capitalization. Index daily pricing data is available back to December 31, 2004. This index is reviewed and rebalanced quarterly.

The listing shows that the funds’ top five stocks are very similar; only the weight in each security seems to be the differentiating factor. Looking deeper into this, we find that this is also the case for the top twenty-five holdings of the three ETFs. RWO and FFR have a similar number of holdings, at 213 and 286 respectively. GRI holds 75 securities and caps the weight at 4% as defined in the index methodology.

We can also break down the ETF holdings by market cap. The chart below shows that FFR and RWO hold more weight in mid caps while GRI holds more large/giant caps.

Breaking down the ETFs into their respective country weights, we see that for each ETF the top five weights are the same:  USA, Australia, Japan, Hong Kong and the UK (highlighted in yellow below). The slight variation in weight from one ETF to another can be explained by index methodology.

We can look to correlation to help show us how REITs have reacted to each other and major indices over the last few years. As you can see in the chart below, all three ETFs are highly correlated to each other, as expected given what we have observed in holdings and country exposure. We also note that we should expect the REIT ETFs to closely move with the S&P 500 and MSCI EAFE (developed Europe) indexes. The ETFs are negatively correlated with the US Dollar. The chart below shows correlation from 7/1/07 to 6/30/2012 with data provided by Morningstar.

Many investors deploy the use of REITs for the income that they generate. FFR has a 12-month yield of 2.35%, GRI’s yield is 2.31%, and RWO’s is 3.03%.

The fees associated with ETFs are usually much less than mutual funds. The expense fee for FFR is 60bps, GRI is 55bps, and RWO is 50bps. Unlike mutual funds, however, this is not the only expense. How you trade ETFs is also related to your expense. ETFs trade with a bid and ask just like stocks. Your purchase price if at a premium to the funds net asset value (NAV) would in theory add an “expense” to your investment. Of course, if you also sell the fund at a premium then you would recapture that cost.

Contrary to many articles on the internet, low trading volume or low fund assets do not mean that you cannot trade the ETF at or near NAV, you just have to have the right tools to make it work efficiently for you. Any ETF can be shut down, but a fund with less than 100 million in assets has a higher risk of being closed due to lack of interest. Fund closings have historically been done in an orderly fashion.

Currently FFR has 87 million in assets and an daily average trading volume of 18,800 shares. GRI has 64 million in assets and a 9,700 average daily trading volume. RWO has 461 million in assets with a 91,000 average daily trading volume. The tradability ranking would go to RWO in this analysis, based on its relative high volume and assets under management. We also note that RWO trades free of transaction charges at TD Ameritrade.

The historical performance of these funds differ somewhat, however volatility looks to be very similar. The unique strategy of GRI does not appear to have much of a performance difference between these funds. Because the ETFs have not been around for 10 years we note that the below chart uses the index data where ETF data is not available. The index for FFR is not available for 10 years.

Data Provided by Morningstar

Data Provided by MorningStar

FFR, GRI and RWO represent many of the same global REIT stocks but with different weightings. RWO looks to be the the leader in assets and ease of trading.  All three funds have similar performance. In the end, each of these ETFs are going to give you the global REIT exposure you are looking for. As to which one is best for you depends on which index methodology makes you more comfortable.

NOTES:

Mitchell Williams, Wiser Research Intern contributed to this article.

Index Methodology

GRI http://etf.capitallink.com/files/global0911.pdf

FFR http://www.ftse.com/Indices/FTSE_EPRA_NAREIT_Global_Real_Estate_Index_Series/Downloads/EPRA_NAREIT_Index_Rules.pdf

RWO http://www.djindexes.com/mdsidx/downloads/fact_info/Dow_Jones_Global_Select_Real_Estate_Indexes_Fact_Sheet.pdf

I found a website the other day that promises to teach you about indexed annuities in seven free lessons on “strategies the rich use to buy indexed annuities.”  (Notice they don’t say “benefit”.)  The lessons cover the basics of fixed indexed annuities, so-called safety nets, strategies and concepts, planning tools, and a demo on how to choose the right mix of annuities.

The lessons aren’t openly available – you have to register with your name, phone number, email, age, state, goals and concerns before you have access to the lessons.  The site is geared toward retirees looking for income, growth and preservation of principal.  The single page of this website also includes testimonials from three retirees who implemented the suggested strategy.  Without registering for the site, I can’t tell you for sure whether or not the company who gives this training for free then conveniently has products to sell you to fulfill your strategy.  Perhaps this .com company is providing this information simply out of the kindness of its heart.  Hmm.

What is an Indexed Annuity, Anyway?

An indexed annuity is a variation of the fixed annuity.  Fixed annuities pay interest on the principal.  The minimum rate of interest is stated in the contract, but depending on market conditions to fund the interest payments and the interest rate needed to be competitive in the marketplace, the interest rate can be higher than the minimum.  Usually not by much, though.

Indexed annuities are more complicated and generally imply you have the opportunity to receive a higher interest rate than with a traditional fixed annuity.  Fixed indexed annuities also pay interest.  But the rate is tied to the performance of an index, such as the S&P 500.  The sales pitch for an indexed annuity says that you can participate in market upswings with no downside risk.  Sounds like heaven, doesn’t it.

You often have multiple indexes to choose from, and sometimes can even choose to use more than one index, and can assign different percentages of the principal to each index chosen.  For simplicity, let’s choose one index, the S&P 500 index I mentioned before.

The interest credited to your account is actually determined by participation rates, caps and calculated values.  The participation rate is the percentage of growth that is actually used in the calculation.  A 75% participation rate means that with a 20% return on the S&P 500, only 15% would be used in the calculation of interest.  If the S&P returned 4%, only 3% would be used in the calculation.

But that’s not all.  You will also be subject to a cap.  The cap is the maximum amount of interest that can be credited to your account.  Say you have a 7% cap.  When the return on the index is below the cap rate, only the participation rate applies.  So if the S&P returned 4%, with the 75% rate, you’d receive a 3% interest credit.

What if the S&P returned 20%, our other example?   Again, with the 75% participation rate, the applicable interest rate drops to 15%. Then the cap kicks in, dropping the rate to the 7% cap.  So even though the S&P 500 did 20%, you only see a 7% return in your annuity account.   That’s 13% you lost out on.

What happens if the return of the S&P 500 was negative?  Then you receive nothing.  This is because indexed annuities have a zero floor – zero interest is paid when the return of the index is negative.

That’s not all.  You also have to choose the option of how the return of the index is calculated.  No, it isn’t what CNBC reports.  CNBC may say that the S&P 500 index rose by 20% in the last year.  However, the index annuity calculates the return based on one of three methods – point to point, averaging, or monthly sum.  You have to choose one, just like you choose the index.

In the point to point method, the indexed annuity looks at the value of the index chosen on a given day, usually the contract date, and then compares it to the value on a future date, usually one year later.  In the averaging method, the annuity looks at the value every day and takes the average value for that year, and then compares it to the average value from the previous year.  In the monthly sum method, monthly values are added then divided by 12, then compared year over year.  Values also are usually subject to caps.

Protection from Downside Risk

But wait, oh Wiser advisor, I don’t see any downside risk.  If the market tanks, I don’t lose any money, because I have guarantee of principal.  Yes.  This is a great selling point for the indexed annuity provider and seller.  However, you pay for this privilege.  You will be subject to surrender charges, sometimes upwards of 10%, for a period of upwards of 10 years.  If your desire is to not lose money, and even earn a little, you’d be better off with a 5-year CD paying a guaranteed rate of interest for a smaller lock-in period.

Why We Don’t Like Indexed Annuities

Indexed annuities are complicated.  I’m a financial advisor.  I even used to sell indexed annuities for another firm before I wised up.  And still every time I run across a client who has an indexed annuity and is wondering what he can do with it, I have to study the darn thing extensively to fully understand it.  And virtually every time, we can’t do anything with it until the surrender charge period is over.

Indexed annuities are also not fair to you.  The indexed annuity seller makes a whole lot of money off of you when you purchase it.  In return you get limited upside potential, and even zero growth potential in negative years.   And you can’t get out of it for a significant period of time without negative impacts.  The lack of downside risk is not worth what you pay for it.

The Moral of the Story

Don’t buy an indexed annuity.  Just don’t.  You’ll regret it.

Can you fill in the Blanks?

I need to save ___% of my paycheck to reach my financial independence goal to make working optional at age___. My retirement nest egg needs to be built to $_____ to achieve this goal. 

Financial Security
Most Americans will not be retiring with pensions or family trusts, thus placing the burden of our future financial security squarely on ourselves. For those in their 20′s filling in the blanks above would be easier than someone just starting in their 50′s, however knowing the answers is important for everyone of all ages. 

Wiser Financial Planning
Wiser Wealth Management, Inc in Marietta, GA, offers retirement planning to help you fill in the blanks. Based on the information and goals you provide, we create a retirement plan unique to your needs and situation. Our planning process determines your probability of success as well as gives you a list of action items to implement to help you achieve your financial independence goal.
 
Probability of Success Calculation
The probability of having enough money to fund a full retirement is determined by the Monte Carlo simulations completed by our plan software. In the Monte Carlo simulations, the software uses 500 individual hypothetical scenarios of market performance over time to come up with an average probability of success.  These hypothetical scenarios include very good performance, very poor performance, and everything in between.  Performance scenarios used in the computation do not reflect actual current returns and are no guarantee of future returns.

Take Action
Wiser Wealth charges a flat fee for our retirement planning session. To schedule your retirement planning session please contact Casey Smith or Sonja Gonzalez. 678.905.4450 Ext 1 or 4. 

casey@wiserinvestor.com
sonja@wiserinvestor.com

You are not eligible to to contribute to a 401k and a traditional IRAk however you could contribute to a Roth IRA. The 5K limit is for your total IRA contribution, not per IRA.

The purpose of an estate plan is multi-faceted.  It helps you direct your assets to the people you want to have them, when you want them to have them.  It minimizes taxes, administration costs, and probate hassles and expenses.  It provides protection for yourself and your beneficiaries.  And finally, a will can allow you to have control even after you die.

According to Michael Burnett, estate planning attorney, “A will is absolutely essential for anyone with minor children, as it will allow you to designate who will care for your children if both parents die.  Without a will, a court is left to decide who should care for your children, without guidance from you.”

I admit, at first glance it would look like current transfer laws are set up for the fairly wealthy, at least in terms of minimization of taxes.  2012 laws allow you exclude up to $5,120,000 of estate assets from transfer taxation.  However, the laws benefit those with less than that amount, because it allows you to not pay any transfer tax.  Pretty cool, huh?  Those with over $5,120,000 in assets, however, will pay some transfer tax – sometimes a lot of it – if they don’t plan carefully.

What is transfer taxation, you ask?  It’s the tax you pay for the privilege of leaving someone else your money and personal possessions.  You can thank Thomas Paine for this idea.  Sure, us patriots value his most famous work, Common Sense, where he states that “all hereditary government is in its nature tyranny.”  His lesser known works, however, include The Rights of Man and Agrarian Justice, where he expanded his hereditary tyranny concept to include economic power.  He pushed an inheritance tax to balance out what he considered to be the unfair distribution of property among the landed elite.

So…. $5,120,000.  Seems like a lot.  But guess what?  That amount only lasts for 2012. Starting in 2013, if Congress does nothing, the exclusion amount will revert back to previous levels.  That pivot point is $1 million.  If you have a good-paying job that allows you to save adequately for retirement and have a nice house, you could easily go over that limit.  So if you’d rather have the higher limit, die this year.

What Can You Do?

I assume you’d rather not die this year.  There are steps you can take to protect your assets.  The first step is to work with an attorney to create a will.

A will allows you to distribute your property how you want to.  If you die without a will, called dying intestate, the state will decide how to distribute your property.

A will can be useful for other things besides distribution of property.  It names someone to settle your estate. It establishes domicile – your state of residency.  It names guardians for your minor or incapacitated children. It establishes the order of death in case of a common accident.  You can also use a will to create trusts.

A will goes through probate.  Probate is a process under state law for settling an estate.  Some states have an onerous probate process, which increases expenses.  Some property, such as real estate and tangible (touchable, like art) personal property need to be probated in the state where it is located.  So if you live in Georgia, and have a mountain cabin in North Carolina, you’ll be probating in two states, making things more expensive.

Some things don’t transfer through a will.  Jointly owned property (such as property owned as joint tenants with right of survivorship or tenants by entirety) will transfer outside of a will by operation of law because joint owners are on the title.  Other property, such as life insurance proceeds or annuities, will transfer by contract, because beneficiaries are named on the contract.

A will is also a public document.  Notice will be published to allow creditors to make claims against the estate.  The documents filed with the courts are a matter of public record, meaning anyone can go look them up.  This can get dicey if you plan on disinheriting a person who thinks they should get something from you, or if you plan to distribute unequally.  (Although, there are some laws that prevent the complete disinheritance of, or less than minimal distribution to, spouse and children.)

Again, What Can You Do?

You can work with your attorney to add a trust to your estate plan.  A trust does not negate the need for a will.  But a trust and a will need to be complementary and work together.

A trust is an arrangement where a trustee is appointed to take title to property and manage it for the benefit of one or more beneficiaries as guided by the trust document.  Trusts can be in one of two forms – revocable and irrevocable.

The benefits of a revocable trust are to provide professional management of assets during the grantor’s lifetime (the person who set up the trust and put the assets in it); to provide management of assets in the event of incapacity; to avoid the probate process; to avoid ancillary administration (the two state example); and to maintain privacy (no notice or court documents).

The benefits of an irrevocable trust include removing assets from the taxable estate (because the grantor relinquishes right to the assets); to remove assets from probate (just like revocables); and to protect from creditors (useful for spendthrift beneficiaries).  The decision of whether to use revocable or irrevocable trusts depends on what your goals are.

Trusts are also defined by when they are created.  Living trusts are created while the grantor is still alive.  Testamentary trusts are created by the will.  Note that the testamentary trust does not avoid probate, since the assets to fund the trust come from probate-able assets.

If the probate process in your state is simple and quick, if your heirs/beneficiaries are smart about managing money, if you don’t care if strangers know how you distributed your assets, then maybe a will is all you need.  You should work with an attorney to create both wills and trusts, which will cost money; however, the benefits of creating a trust often outweigh the additional legal costs it entails.

Let’s Get Back to Taxes

One of the reasons for creating a trust has to do with taxes.  There are two types of transfer taxes – estate taxes and gift taxes.  Let’s talk about estate taxes first.

The taxable estate is different from the probate estate.  Things that escape probate do not necessarily escape taxation.  For instance, the life insurance you own on yourself goes into your taxable estate, even though it escapes probate by issue of contract.

You may be tempted to give away some of your assets while you are still living, called lifetime gifts.  This can be a useful tool, if used wisely.   Lifetime gifts are subject to an exclusion limit, just like estate taxes.  Currently that exclusion limit is the same as estate taxes.

There is a unified schedule for estate and gift taxes.  While lifetime gift taxes are calculated at the time of the gift, in certain instances they get added back into the estate for estate tax calculation purposes.

Note that the exclusion amount is not what is used to calculate the actual tax owed.  Instead a tax credit is used.  I bet you’re wondering what the difference is between the exclusion amount and the tax credit.  The tax credit is the actual amount of tax saved on the exclusion amount.  Let’s see how this works.

Say your estate is worth $5,500,000, and you died in 2011.  (The exclusion amount and the credit amount for 2011 were $5,000,000 and $1,730,800, respectively.)  Estate taxes have a sliding scale based on amount of assets, with the percentage tax rate increasing as the estate value increases.   There are charts that outline this scale.  For the $5,500,000 estate, the base tax amount for $500,000 (the highest on the chart) is $155,800.  The balance of the estate over $500,000 (in this case, $5,000,000) is taxed at a rate of 35%, the maximum rate.  The result of the 35% calculation is added to the base of $155,800, to result in a total tentative tax of $1,905,800.  This is the tentative tax on the entire $5,500,000.  Here is where the tax credit comes in.  The tax credit of $1,730,800 is subtracted from the tentative tax to result in an actual tax due of $175,000.

Notice that the tax calculation is based on the total estate value, not the value less the exclusion amount.  This makes the estate taxes tax inclusive, meaning that the amount from the estate that will be used to pay estate taxes is included in the tax calculation, resulting in higher taxes.  (Sounds convoluted, but there is a form for that.)  If the exclusion was taken first, and then the tax calculated on the amount left over, it would result in a lower tax bill of $155,800, in our example.  Guess which one the IRS prefers?

Regarding 2013.  We’ve already noted that the 2013 exclusion amount will revert to $1,000,000 in 2013 if Congress does nothing.  That’s not the only thing that will happen.  The credit amount will reduce to $345,800 and the maximum tax rate will go up to 55%.

Portability will also go away.  Currently, a surviving spouse is able to “inherit” the unused portion of the exclusion not used by the deceased spouse.  Meaning that if the deceased spouse left an estate valued at $2,500,000, the surviving spouse upon his/her own death could apply his/her own exclusion amount of $5,000,000 to his/her own estate, plus the left over amount from the first deceased spouse – in this case, another $2,500,000.  In 2013, portability of the exclusion amount will no longer be available.

One of the benefits of doing lifetime gifts is that gift taxes are tax exclusive, meaning that the funds used to pay the gift tax is excluded from the taxable base.   (There’s a form for this calculation, too.  And don’t worry – your accountant will take care of all this.)  The way lifetime gift taxes are calculated results in a lower tax bill than if the amount was included in the estate.

“Lifetime and annual gift exclusions are a powerful planning tool and can often be used to fund irrevocable trusts in order to reduce your taxable estate.  One example would be to create an Irrevocable Life Insurance Trust (ILIT) and have the ILIT purchase life insurance on you.  You would then use your personal annual exclusion to gift the amount required each year to pay the life insurance premium.  This would keep the cash payout from the life insurance at your death out of your taxable estate,” Burnett says.  The 2011/2012 annual gift tax exclusion is $13,000.

Deciding whether to distribute your assets through lifetime gifts or through your estate depends on a number of factors.  If you gift and reduce the amount of your estate, you leave less in the estate for your heirs.  Another disadvantage of doing lifetime gifts is that you lose the ability to step up the basis in the asset.  For instance, if you bought a piece of real estate for $100,000, and at the time of the gift it was worth $1,000,000, the person who receives the gift will also have a basis of $100,000.  Which means when he goes to sell the property, he will be taxed on the capital gains of $900,000 – the difference between the current value and the basis (original value).

The advantages of doing lifetime gifts (beyond the tax advantages) may override the disadvantages.  Advantages include privacy; personal gratification watching the gift receiver enjoy the gift; ability to shift income the asset produces (i.e., rental income on real estate) from you in a higher tax bracket to your gift receiver in a lower tax bracket; achievement of personal objectives, such a child’s education; and trial run to see how well the gift receiver manages the asset received.

There are many more things that can be said about estate and/or gift taxation.  There is the unlimited marital deduction, the generation skipping transfer tax, gifts that are excluded from taxation, the process for valuating estate or gifted property, etc.   A good financial planner and an accountant can help you navigate these things.

All legal advice and documents, such as wills and trusts, are best provided by your estate planning attorney.

* Input provided by Michael S. Burnett, Esq.  www.msb-law.com

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. 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, Matt Hougan’s blog, and the iShares Response here:

Bogan & Conner Report

CNBC Report

Index Universe Response to Bogan & Conner Report

iShares Response to the Bogan & Conner Report

iShares Response to Bogan & Conner Followup 

iShares Blog on ETFs, Kauffman Report and the Flash Crash 

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.