Savvy Mutual Fund Tax Moves

Year-end is always hectic, but it’s well worth taking the time to consider a few investment moves that could have positive tax ramifications.

First, think about tax-loss harvesting, or selling some of your losing positions at a loss in order to offset capital gains elsewhere in your portfolio. Also you need to manage mutual fund distributions. Remember, mutual funds must pay out at least 90% of their net capital gains and income to shareholders every year. Therefore, funds typically issue shareholder distributions toward the end of the year. If you’ve registered a loss in a fund that’s set to make a distribution, you might consider selling it before the distribution is issued. Not only can you use the loss to offset other gains, but you avoid taxes on the distribution.

Similarly, you might consider putting off until next year the purchase of a new fund poised to make a distribution. That is, if you buy the fund now, you will owe taxes on any distributions you receive by the end of year even though you did not participate in the fund’s growth over the course to the year.

You might think that the market’s negative performance this year would mean a lack of gains to distribute. However, it’s always worth checking to be sure. Your fund company's website should have estimates for year-end distributions.

However, if you own mutual funds in your 401(k), IRA or other tax-advantaged retirement account, you don't have to worry about these fund distributions because they will not be taxed until you begin withdrawing your money in retirement.

Feeling Squeezed?

Call it the middle-class squeeze. According to Paul Taylor, executive vice president of the Pew Research Center, income is shifting to the top tier of American households, especially those in the top 5% who earn more than $181,000 annually.

Just how much of American income has shifted to the top wage earners? The Pew Research Center found that in 2010, the top 20% of U.S. households collected 50.3% of the nation's income, up from 49.9% in 2006. The lowest-earning one-fifth of households collected just 3.3% of the nation's income, down from 3.4% in 2006. Three-fifths of households, or 60% collected just 46.3% of the income last year, down from 46.7% in 2006.

These increases for top tier households and decreases for the middle class may seem relatively minor, a percentage point here and there. However, according to Heidi Shierholz, an economist with the Economic Policy Institute, in the 1970s, 53% of the nation's income went to the middle class. She notes that middle class households began losing significant ground in the early 2000s and that the downward trend has been exacerbated by the recent recession and our difficult employment market.

With record unemployment, a struggling housing market, and continued market volatility, it is unlikely the middle class squeeze will cease anytime soon. That makes it that more crucial than ever to tend to your financial plan. Now’s a great time for an annual review to construct your balance sheet, evaluate your goals and ensure that your investment strategy properly aligns with your short- and long-term goals and your risk tolerance.

CDO Chief Daddy Officer

Many of you know that Bernhardt Wealth Managment has two traditions during the Holiday Season.  One is that we make contributions to charities in honor of our clients and the other is that we send our clients and strategic relationships a book.  This year is the 14th year we have sent a book, and we were pleased to send CDO Chief Daddy Officer: The Business of Fatherhood by Christos Efessiou.

Chris told me about the book when I first met him last year. As soon as he described the premise of CDO, I knew it would be an outstanding candidate for our gift book. My instincts proved correct when I had the opportunity to read a draft this summer.

I recommend this book to business owners, executives and employees; parents and grandparents; and teenagers, college students and recent graduates. There are lessons that every reader can apply to his or her life. One lesson we can apply is to leverage our business skills to the business of life.

Chris signing books in my office

One reason I like the book so much is that it confirms the reason I started my own independent, fee-only firm to give objective, conflict-free advice to our clients. My passion is to touch each client’s life in a way that allows them to lead the life they want to lead. For some clients hiring us as their personal chief financial officer means they have more time to spend with their family. For others it means they have more time to focus on their business/profession. And for others it means they have more time to give back to their communities or charities that are important to them.

Money is a tool. Peace and contentment do not increase as our net worth increases. Peace and contentment are the byproducts of realizing what is important to you and spending more energy on those things. I don’t think Chris will look back at any point in his life and say “I wish I spent less time with my daughter and more time day trading.”

Chris signing books in my office

I encourage you to get his book (if you don't already have it) and hope you find it inspirational and motivational.  I also invite you to contact me to let me know what you liked about the book.  And finally, I hope you consider writing a review of the book on Amazon.

The entire Bernhardt Wealth Management team and I wish you a happy, safe and rewarding Holiday Season! Please let us know if we can leverage our skills and knowledge to help you or someone you know achieve and pursue what is important to you or them.

Chris and me holding one of the books he signed

If It Sounds too Good to Be True, You Can Bet That It Is

A recent article in the Washington Post, “Children’s Charity Victim of Ponzi Scheme,” caught my eye. Looking to protect its endowment in 2008’s difficult market, the DC-based Hillcrest Children’s Center invested in what Garfield Taylor of Gibraltar Asset Management Group described as a “can’t lose” investment strategy. By mid 2009, the $8 million Hillcrest invested had evaporated in a Ponzi scheme, severely compromising their ability to help orphans and families in need.

Stephen L. Cohen, an SEC official, notes in the piece that this sad story should serve as a reminder to investors. “There really isn’t any such thing as an investment that has zero risk with a high reward,” Cohen said. I wrote an article “A Tragic Case of Misplaced Trust” in the wake of Bernie Madoff’s crimes that outlines steps investors should take to protect themselves. Briefly, investors should choose to work with an independent Registered Investment Advisor who is bound by a fiduciary duty to clients and who uses an independent custodian. Also, it’s crucial not to put all your eggs in one basket and to understand what you invest in.

Above all, however, question the impossible. When an investment manager claims to always beat the market, be skeptical. Simply, when evaluating potential investments, remember the old adage: “If it sounds too good to be true, it probably is.”

Sports Illustrated: In My Tribe

Most of the people who know me know that I love college football and, more specifically, the Nebraska Cornhuskers.  I never attended the University of Nebraska but I grew up on a farm in Nebraska.  There was always work to be done on the farm but on a Fall Saturday I would never be far away from a radio so I could hear the radio broadcast of my beloved Nebraska Cornhuskers and the opponent I hoped they would defeat that day.

My pride for my Nebraska Cornhuskers is about to come forth and I wanted to share with you the first paragraph and last section of an article, In My Tribe, written by Terry McDonell in the November 28, 2011, issue of Sports Illustrated.

First Paragraph:  In the fall of 1980, when SI senior writer Lars Anderson was nine years old and living in Lincoln, his father took him to the Florida State-Nebraska game. With less than a minute left in the fourth quarter, the highly favored Cornhuskers had the ball on the Seminoles' three-yard line, trailing 18-14. That's when heartbreak visited Nebraska: Quarterback Jeff Quinn fumbled. Florida State recovered. Game over. Then, as Seminoles coach Bobby Bowden and his team walked off the field, the crowd rose to its feet in appreciation of the underdogs' hard-fought victory. At first it was just polite clapping, the kind you hear at a golf tournament, but then fans started cheering for Bowden and his players, building to one of the loudest roars of the day. Tears of disappointment ran down Lars's cheeks as his father put his arm around him, pointed to the red-clad fans in full throat and said, "Lars, this is as good as sports gets."

Last Section:  The rearview mirror has always been the best oracle when it comes to sports. More than 30 years after Lars Anderson saw that Florida State-Nebraska game with his father, he was reporting a story about the history of spring football and had lunch with Coach Bowden in Birmingham. Near the end of the conversation, Anderson mentioned that he was from Lincoln. The coach's eyes lit up. Without prompting, he recalled that day three decades earlier when the fans of Nebraska cheered him off the field.

"What a moment," Bowden said, a grin spreading over his face. "Wow."

And then these two men, two generations apart, just looked at each other until Bowden spoke again.

"The classiest thing I ever experienced."

Thanks for indulging me for a few moments to share my love of Nebraska football.  Go Huskers!  Go Big Red!

Could Black Friday Spark a Rally?

Black Friday sales may be the harbinger of a significant surge in consumer confidence that could fuel our economic recovery. According to the National Retail Federation (NRF), Black Friday retail sales were up 16% over last year. The NRF notes that 226 million shoppers hit the stores and online sales over Thanksgiving weekend and spent $52.4 billion.

In more good news, an NRF pre-holiday poll found that shoppers are more optimistic this year than they were last year. Based on that survey, the NRF forecasted that total holiday sales would be up 2.8% to $465.6 billion. However, the wildly successful Black Friday may result in sales beating that estimate. Interestingly, over the last ten years, we’ve seen a 2.6% annual average increase in holiday spending. However, over the course of the previous decade, the average annual increase was 3.4%.

Retailers have a huge incentive to get you to shop until you drop this season. As the NRF notes, about 20% of their sales occur in the less than 30 days between Black Friday and Christmas. For some retailers, such as jewelers, that percentage could be as high as 40%. To resist the holiday message to spend, spend, spend, think of other economies that stress the merits of saving. Over the past three decades, Germany, France, Austria, Belgium, and Sweden have maintained household saving rates between 10 and 13 percent. Conversely, saving rates in the United States dropped to nearly zero in 2005 before inching up to 5% during the credit crisis of 2008. Most recently, our savings rate has fallen to less than 4%, far less than half of what many Europeans save. Think about that as you head to the mall….

Think Twice About an Indexed Annuity

We all enjoy playing a game we can’t lose, but investing in the stock market is not one of them. However, the promise of “guaranteed returns” led shell-shocked investors to pour nearly $30 billion into index annuities in 2009, even as they pulled $9 billion out of U.S. stock funds.

Index annuities are a close cousin of a traditional deferred fixed annuity, an investment vehicle in which an insurance company invests your money in bonds during an "accumulation period" of seven years and then converts your account into a steady stream of guaranteed income payments. An index annuity has the additional twist of tying those guaranteed payments to the performance of a stock market index, such as the S&P 500.

Guarantees are tempting in the wake of the Great Recession and continued market turbulence, but dangers lurk in the indexed annuity’s structure and fine print. In my view, the top three stumbling blocks are:

• High commissions, up to 9 percent in some cases, that can tempt the selling agents to act against your best interests.
• Steep surrender fees, as high as 20 percent, that can be imposed if you cash out before 10 years.
• Product complexity that makes it tough to know what you are buying.

Beyond those concerns, according to William Reichenstein, an investment management professor at Baylor University, over the long term a very conservative portfolio easily beats an index annuity. Why do indexed annuities almost always underperform? The issuing insurance company caps your return and can adjust the cap each year. A common cap for an annuity tied to the S&P 500 is 4.5 percent. And, according to the research firm Advantage Compendium, for the five years ended in September, the average index annuity paid an annualized 3.89 percent, just slightly better than the 3.81% you would have earned in a five-year CD and less than the 5.1 percent from taxable bond funds.

Finally, please be aware that fixed annuities are often marketed at “informational lunches” that are really over aggressive, high pressure sales pitches. Remember, the old adage “There is no such thing as a free lunch” applies to the market as well.

In Praise of Rebalancing

If buying low and selling high is the secret to investing success, should you buy every time the market drops significantly? Jason Zweig argues convincingly in a Wall Street Journal article that investing during the market’s equivalent of retails’ Black Friday is not a simple path to increased returns. Sure, buying low helps, but how low does the market have to go before you buy? Also, you have to correctly identify how high is high enough to sell.

Zweig correctly identifies rebalancing—selling one asset that has gone up in price to buy another that has gone down—as the key to improving returns over time. Rebalancing works as your portfolio’s GPS. That is, you set your course with your initial asset allocation, but when you encounter roadblocks or the unexpected along your route, the GPS re-calculates your driving directions, or rebalances, to keep you on course to reach your destination.

Zweig quotes research from Francis Kinniry Jr., an investment-strategy analyst at Vanguard Group, that found that, over the past decade, regular rebalancing between stocks and bonds would have added about 0.3 percent in average annual return to a strategy of buying on dips of 2 percent or more. Further, he shares the finding that an investor with 40 percent in U.S. stocks, 20 percent in international stocks and 40 percent in U.S. bonds who rebalanced at year end over the last decade would have earned 5.6 percent annually —versus 4.9 percent for someone who merely bought and held.

Here’s another analogy to underscore the value of rebalancing. It feels great to buy a new car far below the sticker price, but you need to regularly maintain your vehicle for it to serve you well over the long-term. Rebalancing is required maintenance for your portfolio. As I look back on the technology bubble that burst, 9/11 and the financial crisis/Great Recession, our disciplined rebalancing is one of the major reasons our clients have had a better investment experience.

Don't Let Fear Thwart Your Investment Strategies

With Paranormal Activity 3 setting records at the box office, it’s a good time to talk about how fear can impede sound investment decisions. Certainly, the acute market volatility we’ve experienced over the last few years has sparked a growing fear among investors of incurring additional losses. How does this attitude impact your portfolio? Interestingly, a Fidelity survey of participants in workplace retirement plans during the turbulent 18-month period from October 2008 to March 2010 quantifies just how much letting yourself fall into fear’s grips can hurt.

Fidelity found retirement investors who kept contributing to their plan and who maintained some exposure to equities throughout the period were better off throughout the market’s roller coaster ride than those who moved in and out of the market in an attempt to avoid losses. Specifically, the 81,400 who sold all stocks in 2008 had an average return of -6.8 percent over the period. On the other hand, the 7,332,000 who sat tight and kept investing in equities earned an average 21.8 percent over the 18 months.

We tend to retreat during market turbulence because, as behavioral finance pioneers Daniel Kahneman and Amos Tversky have shown, human beings have a stronger preference for avoiding losses than for registering gains.

Recognizing and adjusting for this innate bias may help prevent you from making fear-driven decisions during dark days in the market. Think about your own behavior during past downturns. Did you make any fearful decisions that you now regret? With volatility looking like it’s here to stay, has your risk tolerance changed? If so, it may be necessary to make adjustments to your portfolio. Otherwise, the best advice to keep short-term volatility from prompting emotional fear-based decisions that can negatively impact your portfolio is to stay focused on your long-term goals.

As Benjamin Graham, a pioneer in security analysis said, “Individuals who cannot master their emotions are ill-suited to profit from the investment process.” As our clients' trusted advisor, it’s our job to help minimize the impact of inescapable emotional swings and maintain disciplined investing.

Stick with Stocks

Many investors believe step one in dialing down their portfolio’s risk should be reducing equity exposure. Yes, stocks are riskier than bonds, but that’s an oversimplification that can result in some misguided moves. First, stocks provide a greater return than bonds over the long term According to Standard & Poor’s, the S&P 500 Index has had an average annual return of 9.9 percent annually from 1926 to 2010. Over the past 50 years, it’s returned 9.8 percent, and over the past 25 years, the return has been 9.9 percent. According to Ibbotson Associates, long-term government bonds have averaged 5.5 percent, 7.1 percent, and 8.9 percent during these same three time periods.

Stocks are also a better hedge against inflation. On an inflation-adjusted basis, the S&P 500 Index has provided average annual returns of 6.7 percent from 1926 to 2010, 5.4 percent over the past 50 years, and 6.9 percent over the past 25 years. There were a total of 10 rolling-year periods when the S&P 500 Index did not keep up with inflation. While long-term government bonds provided inflation-adjusted returns of 2.4 percent, 2.9 percent, and 5.9 percent over those same three periods, there were 33 rolling-year periods when long-term government bonds did not keep up with inflation. One factor influencing the gap between stocks and bonds is that, even in difficult markets, companies can increase their prices to remain competitive.

If you want another reason to invest in equities, consider this prediction by Professor Sylla, a financial historian at New York University's Stern School of Business who has studied market behavior all the way back to 1790. A recent Wall Street Journal article--A Long-Term Case for Stocks--reported his view that if the market sticks to its long-term pattern, the Dow Jones Industrial Average could climb to 20250 by the end of 2020, up 84% from its recent 10992. Additionally, he says the Standard & Poor's 500-stock index might hit 2300, up 99% from its recent close of 1154.23.

Using 10-year averages of annual market returns, including dividends and adjusting for inflation, Prof. Sylla found when 10-year-average annual returns drop below 5% as they did in 2008 and 2009, markets tend to transition to recovery.

Of course, we all know that past results cannot be used to guarantee future returns…

The real lesson in this research is that investors are best served when they take a long-term view of the market and think in terms of decades and years, not quarters.