Family Businesses: Make Lemonade out of Lemons

According to the Small Business Administration, 90% of the 21 million US businesses are family owned. Amazingly, less than one third of these companies will transfer successfully to the second generation, and only 15 percent will survive by the third. Why the low survival rate? Most of these businesses lack a succession plan, or an exit plan.

Exit planning is the process of ensuring the future success and continuity of your business after you retire. Your exit plan should address business, personal, financial, legal, and tax questions and includes contingencies for illness, burnout, divorce, and even your death. Ideally, your exit plan should maximize the value of your business at the time of exit, minimize the taxes paid, and position you and your family to achieve your future goals.

In one of the most compelling opportunities found in the down market, low valuations makes this an ideal time for family business owners interested in moving assets out of their estate to transfer ownership of their business to their heirs. For example, if your business was worth $8 million five years ago, but revenues are down 50 percent, consider selling 25 percent to a child. You could even provide financing for the transaction via an interfamily loan. Ten years from now when you are that much closer to retirement and the 25 percent you sold could well be back to being worth $2 million, you will be pleased with your foresight. Of course, you could also gift stock that has plummeted in value to your heirs. Advantageously, the tax consequences of your gift will be figured based on the fair market value of your company stock at the time you gift it.

Especially in today’s uncertain market and increasingly crowded marketplace, there is no substitute for getting a head start on your exit plan.

CAUTION: Long-Term Care Insurance through Your Employer!

Long-term care insurance (LTC) pays for the things Medicare does not--assisted living, in-home care, adult daycare and nursing homes. One of the biggest trends in LTC insurance is group coverage sold through your employer, an association you’re a member of, or even through your bank or credit union. We’ve heard from clients who have asked us if they should buy group long-term care insurance.

First things first

The first step in LTC Planning is just that--planning! Bernhardt Wealth Management has retained the services of a nationally recognized expert in LTC, Allen Hamm and his company Superior LTC, to help our clients with planning for long-term care. There’s no additional charge to our clients for this service. Allen is the author of the book “Long-term Care Planning: Assuring Choice, Independence & Financial Security” which is available at Amazon online.

Allen uses a seven step LTC planning process and insurance may or may not be the best option for you. He starts by assisting you with understanding the implications of relying on each available option to pay for long-term care, not just insurance.

But let’s say that you’ve gone through this process and it’s been determined that LTC insurance is the best option for your particular situation. Is Group LTC insurance a good value for you? The answer is: Usually not, but there may be an exception.

Adverse Selection

Unlike most types of group insurance, LTC is usually more expensive than individually issued coverage. This is because group LTC insurance is normally issued on a guaranteed or modified guaranteed issue basis. This means that unhealthy individuals, who would not otherwise pass the underwriting requirements of the insurance company, can obtain coverage through the group. This causes “adverse selection”: a disproportionate number of people buying coverage through the group who are in poor health and likely to have early claims, resulting in higher premiums for everyone.

In future years, adverse selection can also cause premium rates to be raised more frequently and more dramatically than premiums for individually issued coverage. Rates on some older group policies have been raised to the point where people have been forced to cancel the coverage.

The consequences of adverse selection are particularly negative if you’re healthy. By purchasing group coverage, you’ll heavily subsidize higher premiums for those in poor health, and will continue to subsidize increasingly higher premium rates in the future.

“But the Premium Seems so Low!”

Group LTC coverage has the appearance of a lower premium than individually issued coverage, which is why it’s common for people to automatically jump to the conclusion that they should buy it. But when comparing the details and benefits apples to apples, group LTC coverage premiums are higher than individually issued coverage.

The initial appearance of lower premiums for group coverage has to do with the fact that group coverage does NOT include the automatic inflation protection benefit as a component of the base policy. Yes, you may be able to purchase additional coverage later through the policy’s Guaranteed Purchase Option, but the new benefits will charge a premium at your new attained age rate. Based on Mr. Hamm’s experience in auditing older group policies for clients, people normally don’t exercise the option to increase their coverage, due to the increasing higher premium. In fact, people rarely revisit the group LTC insurance decision until several years later, after premiums have gone up dramatically.

Is Group LTC Coverage Ever a Good Value?

If you’re not in good health and you’re unable to qualify for individually issued LTC insurance, group coverage may be a viable alternative for you. But when people are educated about the higher premiums, the likelihood of increasingly higher premiums in future years, and the limited coverage options available through group coverage, they usually choose an option other than insurance as their plan for long-term care. The rare exception is if you have a strong desire to obtain coverage due to health conditions that make the odds of you needing long-term care very high.

Summary

Planning for long-term care can be confusing. If you haven’t yet developed a plan for long-term care or if you’re being offered group LTC insurance, please contact your independent advisor to begin the planning process . LTC insurance may not be the best option for you and your family - so paying for it, even at low cost, is a bad investment.

What the new Congress means for you?

What does the new Congress--with a Republican controlled House and Democratic controlled Senate--mean for your investments?

In my mind it’s too early to answer that question. While we will almost certainly be dealing with some measure of the gridlock we are so accustomed to in D.C., I worry that gridlock will be paramount in the two month lame duck session before our newly elected representatives and Senators take their oaths. If so, we will wait for answers to our most pressing questions: Will the Bush tax cuts be extended? If so, for whom and for how long? Will the estate tax be allowed to be reinstated at pre-2009 levels? Trouble is, if our representatives fail to address these questions by the end of the year, taxes will increase for nearly everyone unless a retroactive provision is passed.

As for the election’s impact on the investment environment, market commentator Todd Schoenberger has noted that we are closer to the optimal formula for investment success of a Republican-controlled House; Republican-controlled Senate; and a Democrat in the White House. Going back to back to 1940, he says the RRD combination has provided investors with an average stock market return of 15.3% per year, whereas the DDD combination we’ve had for most of this year has lifted stocks only 5.0% on average.

Wall Street Journal writer Brett Arands reminds us, however, that the historical basis for this analysis--data since 1949 via the Stock Trader's Almanac--is meager. I agree with Arands’ observation: “You can't extrapolate universal rules from such a small amount of data. The results are too heavily skewed by the Reagan (1981-86) and Clinton (1995-2001) booms under divided governments."

Could it be we are falling into the behavioral trap of identifying pattern where none exists in order to help ourselves feel more in control? I certainly don’t blame anyone for desiring a measure of predictability in the wake of such recent volatile markets, but markets are just that–unpredictable.

Do Expense Ratios Matter?

Russell Kinnel, Morningstar’s director of mutual fund research, wrote an article on August 9, 2010, titled “How Expense Ratios and Star Ratings Predict Success.” It is a must read and can be found online at Morningstar by clicking on this link.

Morningstar examined five broad categories of mutual funds—domestic equity, international equity, balanced, taxable bond, and municipal bond—over multiple periods beginning in 2005, 2006, 2007 and 2008 and ending in March 2010. The funds were sorted into quintiles based on expenses and the performance of the cheapest funds was compared to that of the most expensive.

We have always preached that investors should focus on the things they can control—expense ratios, turnover (i.e., tax efficiency), diversification, and asset allocation. Therefore, it did not surprise me that Morningstar’s research showed that cheap funds outperformed their expensive cousins in every time period tested. Kinnel observed “if there’s anything in the whole world of mutual funds that you can take to the bank, it’s that expense ratios help you make a better decision.”

Among both domestic and international equity funds, total returns in every time period were higher for the cheapest funds compared to the 5-star funds. Kinnel concluded by saying that "investors should make expense ratios a primary test in fund selection. They are still the most dependable predictor of performance.”

All I can say is Amen!

IRA Assets Top $732.9 Billion

According to a new Employee Benefit Research Institute (EBRI) report based on the organization’s own data, total assets in IRAs are up 25% on average. At $732.9 billion, IRAs represent the bulk of the $13 trillion in 14.1 million retirement accounts across the United States.

According to EBRI, traditional IRAs, including rollover IRAs from employer-based retirement plans, account for 67% of all IRAs, whereas Roth IRAs, funded with after-tax dollars and where qualified withdrawals are treated as tax-free income, account for roughly a quarter of the market. The report also disclosed a host of other interesting statistics. For example, more than half of IRAs have a balance of at least $25,000. The average IRA owner has $68,498 invested in one or more accounts, with men (56.6%) being slightly more likely to own an IRA than women (43.4%). Along a similar vein, men ($91,063) tend to have higher average balances than women ($51,314).

Notably, most investors don’t make the maximum annual IRA contribution of $5,000 ($6,000 for those 50 and older). The average annual IRA contribution is $3,798 for traditional IRAs and $3,582 for Roth IRAs. What’s more, the volatile market seems to be taking its toll, with just 7.2% of traditional IRA owners adding to their accounts in 2008.

Remember that when you change jobs, you have the option to rollover your 401(k) or pension plan lump sum into an IRA.  And don't forget that you have until the end of the year to consider whether converting an IRA (fully or partially) to a Roth IRA is right for you.   You should consult your advisor with questions about Traditional IRAs, Roth IRAs, rolling over your 401(k) into your IRA, or converting an IRA to a Roth IRA.

Who Are You Going to Trust?

With trust in banks and the nation’s financial system at historic lows, new market research reveals that 86 percent of investors are thinking twice about their financial advisors.

If you don’t trust your financial advisor, get a financial second opinion. Above all, you want to work with a financial advisor who tells the truth. The best definition of truth is when the word and the deed are one. Find an advisor who truly looks out for your best interest--someone who isn’t just there to tell you what you want to hear, but someone who is there to tell you what you need to hear. An advisor who makes commissions from selling you a financial product has an inherent conflict of interest. Remember, an advisor who swears to act as a fiduciary bears a legal obligation to act in your best interest at all times.

An industry survey recently revealed how confused investors are about which financial professionals operate under a “fiduciary standard” that mandates putting their clients’ interests ahead of their own. Although most investors don’t understand that brokers and registered investment advisors work under different legal obligations, 97 percent of investors agree that “when you receive investment advice from a financial professional, the person providing the advice should put your interests ahead of theirs and should have to tell you upfront about any fees or commissions they earn and any conflicts of interest that potentially could influence that advice.”

The Dodd-Frank Act gives the SEC the chance to craft a pro-investor policy that requires all financial professionals to operate under the fiduciary standard. The investing public deserves nothing less.

You Can be Excellent at Anything

In The Way We're Working Isn't Working, Tony Schwartz lays out a guide, grounded in the science of high performance, promising he can “systematically build your capacity physically, emotionally, mentally, and spiritually.”

Says Schwartz, “It's possible to build any given skill or capacity in the same systematic way we do a muscle: push past your comfort zone, and then rest.” There is something wonderful about his observation. It suggests that hard work, not innate talent, plays the biggest role in determining our successes. Keep that in mind as you set your financial goals and as you pursue your chosen career – or your golf game!

Here are the six keys to achieving excellence that Schwartz has found most effective in helping his clients reach their goals:

1. Pursue what you love.
2. Do the hardest work first.
3. Practice intensely
4. Seek expert feedback, in intermittent doses.
5. Take regular renewal breaks.
6. Ritualize practice.

He also recommends additional books on this subject:

     Talent is Overrated by Geoffrey Colvin
     The Talent Code by Daniel Coyle
     Outliers by Malcolm Gladwell
     The Genius in All of Us by David Schenk.
     Bounce by Mathew Syed

The Recession is Officially Over

On September 20, 2010, the Business Cycle Dating Committee of the National Bureau of Economic Research (NBER), a non-profit group based in Cambridge, Massachusetts and the arbiter of when U.S. recessions begin and end, officially declared that the recession ended in June 2009 when a trough in business activity occurred in the U.S. economy. The trough marks the end of the recession that began in December 2007 and lasted 18 months, making it the longest of any recession since World War II. Previously, the longest postwar recessions were those of 1973-75 and 1981-82. Both of those recessions lasted 16 months.

While economic indicators now make a double-dip recession seem unlikely, NBER states that it will categorize any potential future economic downturn as a new recession, not a continuation of the recession that began in 2007.

Notably, however, the Committee did not conclude that our economy has returned to normal capacity. We are simply on what may be a long and winding road to a recovery that likely will require multiple quarters to achieve.

As an aside, NBER defines a recession as a “significant decline in economic activity spread across the economy, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and wholesale-retail sales.” Absent from that definition is the commonly-held public opinion that a recession is marked by two consecutive quarters of decline in real GDP.

The Art of Getting Along

I had a meeting with a gentleman last week.  He shared a personal story about a high school graduation gift that his grandfather gave him.  It was a print of "The Art of Getting Along."  The gift was not appreciated at the time; but today it is one of his prized possessions and is displayed prominently in his office.  I liked his story so much that I wanted to share this and share the words of "The Art of Getting Along."  Thank you for sharing your story with me, Chris!

THE ART OF GETTING ALONG

Sooner or later a man, if he is wise, discovers that life is a mixture of good days and bad, victory and defeat, give and take.

He learns that a man's size is often measured by the size of the thing it takes to get his goat...that the conquest of petty irritations is vital to success.

He learns that he who loses his temper usually loses.

He learns that carrying a chip on his shoulder is the quickest way to get into a fight.

He learns that buck-passing acts as a boomerang.

He learns that carrying tales and gossip about others is the easiest way to become unpopular.

He learns that everyone is human and that he can help to make the day happier for others by smiling and saying, "Good morning!"

He learns that giving others a mental lift by showing appreciation and praise is the best way to lift his own spirits.

He learns that the world will not end when he fails or makes an error; that there is always another day and another chance.

He learns that listening is frequently more important than talking, and that he can make a friend by letting the other fellow tell HIS troubles.

He learns that all men have burnt toast for breakfast now and then and that he shouldn't let their grumbling get him down.

He learns that people are not any more difficult to get along with in one place than another and that "getting along" depends about ninety-eight percent on his own behaviour.

--Wilferd Peterson

Who Do You Trust?

Trust in banks and the financial system in general is at historic lows. The Dow Jones Industrial Average dropped 700 points in just ten minutes on May 10, 2010. Since the Great Recession started in mid 2007, over two trillion dollars of wealth has evaporated. According to the Conference Board, consumer confidence in 2009 plunged to an all-time 41-year low. Market research into the continuing turmoil has discovered that 86 percent of investors are thinking twice about their financial advisors.

If you are looking for advice in today’s uncertain market, look for an advisor who is a fiduciary. What does it mean to be a fiduciary? When you are a fiduciary, you put the needs of your clients ahead of your own--in all cases.

According to Professor Steven Blum, a business ethics professor at the Wharton School, acting as a fiduciary encompasses both a “duty of care and a duty of loyalty.” He insists that our industry embrace a new definition of a professional, noting, “A true professional uses his or her ability and power solely to advance the best interests of the client. When the professional's interests diverge from those of the client, the professional always follows only the client's interests.” That’s a definition, I have embraced since day one in the business and one I hope will soon be more widely practiced. The investing American public deserves nothing less.

If you want to read more on this topic, read my article titled "Defining My Fiduciary Standard" by clicking on the title.