Archive for the ‘Retirement Planning’ Category

Are junk bonds still a good option?

Friday, June 17th, 2011

Wall Street does not like the term “junk bonds;” they prefer to refer to them as ”high yield bonds.”  Junk bonds are debt securities rated below Investment Grade by the three  major rating agencies (defined as a Nationally Recognized Statistical Rating Organization such as S&P).  Over the last 20 months investors have been investing a significant amount of money into junk bonds in search of yield.   With Treasury and corporate bonds experiencing abnormally low yields, investors are getting desperate and greedy for more income.

Below is a table from Oaktree Capital Management, L.P. on the history of junk bond yields and the differences over US Treasury bonds ( 100 basis points is 1%, so 1773 basis points is 17.73%).    What is noteworthy is how investor yields  are declining and the yield difference compared to US Treasury bonds is also shrinking.  This means that junk bond investors are currently taking on more risk and receiving less return. 

  Yield to Maturity Spread vs. Treasurys
“Normal” – Dec 31, 2003 8.2% 443 b.p.
Bubble peak – June 30, 2007 7.6% 242
Panic trough – Dec 31, 2008 19.6% 1773
Recovered – March 31, 2010 9.0% 666
Shrinking again – April 30, 2011 7.5% 492

Junk bonds swing from greatly overvalued to undervalued.  The middle ground does not last a long time.   From 2005 to 2007, investors in junk bonds focused on the risk of missing opportunities rather than analyzing the junk bond as offering a good balance of risk vs. reward.   Then came the financial crisis.   Today investors can see evidence of some of the excesses from the bubble years creeping back – payment-in-kind bonds, covenant-lite debt, rising leverage ratios of completed buy-out deals and more leveraged buy-out activity.   Although the irrational exuberance exemplified in the financial markets between 2005 and 2007 is not representative of today, in a low interest rate environment investors should be careful not to make “handcuffed” investment decisions (people making decisions on the belief they have no choice.)  Investors always have a choice.   Additionally, many of the companies that were responsible for leveraged buy-out deals occurring in the 2005-2007 time frame are re-issuing their junk bonds, and these junk bonds are not necessarily being issued on “investor-friendly” terms.   Consequently, those deals also find their way into junk bond funds.  

Bottom line:  Junk bonds are no-longer a “cheap” investment .    Investors allocating money into junk bonds in today’s low interest rate environment should be cognisant of what is occurring with private equity restructurings and deals in the leveraged buy-out space.

Always Asking, Never Assuming™

Christopher Holtby

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Posted in Investments, Retirement Planning, Wealth Management | No Comments »

Do Commodities Belong in a Diversified Portfolio?

Thursday, June 9th, 2011

Investors basically have two choices when investing in commodities: 1) companies that mine, extract or farm commodities and/or 2) the price of the commodity itself in the futures markets.  Both have advantages and disadvantages.

The futures markets allow investors or speculators to make or lose money based on the direction of a commodity.  The term commodity in the futures markets can vary from US Treasury interest rates or currency rates to oil, corn, iron ore, etc.  For purposes of this discussion, commodities will relate to non-financial commodities.   Commodities trade on today’s price and prices on various dates in the future.   Those prices in the future are sometimes lower or higher than today’s price.  When it is higher, anybody invested in a passive commodity ETF  can lose money even if today’s price is rising consistently.   That is because the commodity ETF investments mature at $100 for example and the commodity has to invest into the future at a higher price of $103, let’s say,  thus losing $3 from day one.  This occurs even while today’s price is rising everyday.   When the future prices are declining the ETF does not have this problem.  However, don’t investors invest in commodity ETFs to make money when commodity prices are rising?   There are active commodity ETFs which use blackbox strategies to solve this problem but investing with blackbox strategies creates a new set of problems.   Hedge fund managers take advantage of the manadatory investments made by passive commodity ETFs each month, manipulating commodity prices to their benefit, which can be detrimental to the passive commodity ETF investor.

Companies who produce, farm, and extract commodities are generally publicly-traded companies where investors purchase their stock.   Generally, if the current price of the commodity is increasing, the stock price will increase.   However, there are other factors impacting the stock price such as the quality of earnings, the difference between the extraction/production price of the commodity versus the current price of the commodity, and the general interest in commodity companies.   The risk for investors is that a 100% correlation does not exist between the increase in the value of the commodity and the increase in the price of the stock.

Since the late 1990′s large pension funds have been investing in passive commodity indices.   This was due to a study by Goldman Sachs showing uncorrelated movements between commodity prices and stocks-the great diversifier( source:  Index Investment and Financialization of Commodities; Ke Tang and Wei Xiong).   Well, 20 years later everybody is doing this type of investing.   The commodity futures markets are now being influenced by the “passive indexers.”   Stock and commodity prices are now moving closer together.  This is a bad diversifier.

Bottom line: Warren Buffet said investing in an investment that does not produce earnings or cashflow is speculative.   Speculation is the hope somebody will pay more tomorrow for the same investment you purchased today without considering earnings or cash flow.   Although commodities can provide value in a portfolio, as with any other type of investment, it is important to understand the level of risk involved.

Always Asking, Never Assuming™

Christopher Holtby

Posted in Hedge Funds, Investments, Retirement Planning, Risk Management, Wealth Management | No Comments »

How good is Do-It-Yourself estate planning?

Thursday, June 2nd, 2011

Clients have asked me why they should pay an estate planning attorney $2,000 to $4,000 or some similar amount to get their estate plans in order when Legalzoom.com offers a basic Will for $69.  What services is an estate planning attorney providing that Legalzoom.com cannot?  How complicated is a Will?

Using words to express a thought or to follow instructions is an inexact science.   How many people feel Help Manuals are easy to understand?  An estate planning attorney has to combine all the goals, objectives and philosophies of a client with all relevant state and federal law, including all applicable state and federal tax law, to create one document. The drafting of the Will is the simple part.  Understanding the law and it’s subtleties with respect to the wishes of the client can be quite complicated.  However, the most difficult part is providing sound advice, which requires both knowledge and experience. 

Legalzoom.com or other do-it-yourself websites require users answer a string of questions using a “decision tree” form of logic.    These sites do not offer assistance on a question that would be considered legal in nature.   Their documents assume a mother and father with illiquid assets, no special needs children, and harmonious heirs is the same as a mother and father with liquid assets (stocks and bonds), a special needs child and a highly combative family.  These do-it-yourself website tools treat all families and situations alike. 

Bottom line: Why would anyone be “penny wise and dollar foolish” on an estate planning document?  Mistakes can cost hundreds of thousands of dollars or more if the documents are drafted poorly.  An estate planning attorney has the ability to tailor estate planning documents to adhere to  a client’s unique circumstances, whereas, do-it-yourself websites, such as Legalzoom.com, are unable to  provide this level of customization or advice.

Always Asking, Never Assuming™

Christopher Holtby

Posted in Estate Planning, Investments, Legacy Planning, Retirement Planning, Taxes, Wealth Management | No Comments »

IRA protection

Wednesday, October 1st, 2008

People are freaked out.  Normal reaction, actually.  Very few people are always wondering how things don’t work.  Here is a short piece on how FDIC insurance covers IRA and various derivatives of IRA account descriptions from Ed Slott, the IRA “guy.”

As we all know, clients with IRAs at a bank are federally insured up to $250,000 per bank. (Congress raised the limit from $100,000 in 2006.)  This limit applies to retirement accounts at banks and savings associations insured by the FDIC, as well as credit unions insured by the NCUA.   If you have traditional and ROTH IRAs, Simplified Employee Pension (SEP) IRAs, and Savings Incentive Match Plans for Employees (SIMPLE) IRAs, the coverage also falls under these limits.   In addition, the coverage also extends to self-directed Keogh accounts, 457 plan accounts for state government employees, and self-directed employer-sponsored defined contribution plans, including 401(k) and SIMPLE 401(k) accounts.

Under the FDIC/NCUA rules, all of an individual’s retirement accounts at the same insured bank are added together and insured up to $250,000.

EXAMPLE:

If the client has $200,000 in a traditional IRA and $100,000 in a Roth IRA at ABC Bank, federal deposit insurance would cover $250,000 of those accounts, leaving $50,000 uninsured.   If the individual has both his own IRA and an inherited IRA at the same bank, they are insured separately for $250,000 each (4000 – FDIC Advisory Opinions; FDIC–97—9; November 3, 1997).

Since some people have forgotten about the lumping and various types of IRA accounts as defined by the FDIC, I thought it would be interesting.

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Dead men can’t defend themselves

Saturday, August 9th, 2008

How many times has a husband left behind a VERY large tax-qualified asset (IRA etc.) without really considering the tax and wealth transfer impact?   A lot is the answer.   If he did not correctly ask the question, or if his advisors did not ask the right questions, a lot of money could be left on the table.

What are the issues?  Amount of assets in and out of the tax-qualified status, control issues, charitable issues, children relationships, income needs, requirement to fund a credit shelter trust, etc.   The answer of who the beneficiary of a qualified asset could be depends on these issues and many others.  It is VERY SITUATION SPECIFIC. 

After consulting with your wealth manager or financial planner on the goals, income needs, etc., it will become apparent whether the spouse should be the beneficiary solely, with children, grandchildren etc. as contingent beneficiaries, or whether a trust should be named as the contingent beneficiary.   The trust needs to be drafted correctly to allow receipt of and distribution of qualified assets so as not to trigger a full liquidation (estate attorney job).

Asking the questions avoids the living being angry at the dead (only regarding tax and wealth transfer efficiency topics).  Don’t forget, the weathy can use deferred compensation plans.

Christopher Holtby

Posted in Estate Planning, Retirement Planning | 4 Comments »

Retirement plans for UHNW

Wednesday, May 14th, 2008

I was lamenting with a friend of mine whose client mix is very heavily weighted to dentists about the lack of any meaningful retirement planning for the Ultra High Net Worth client.  For example, a client making $3 million, with a net worth of $15 million, is unlikely to implement a $45,000 a year Simple 401k or SEP retirement plan unless their employees demand it.  

DC plans (defined contribution plans like 401ks) have made everything rather staid for the UHNW client.  My friend mentioned that DB plans (defined benefits, where the employer is on the hook for funding the retirement account of the employees) are a real option.  

If a UHNW client has a small firm generating huge gross income, with a few relatively low paid employees, the opportunity might exist where the owner, our client, can contribute $2 million into the DB plan.  He (gender neutral for you PC purists out there) would save $650,000 in taxes.  Now, there are lots of gotchas and fine points which need to be checked and double-checked before embarking on a DB plan for the UHNW client.   The third-party administrator and lawyer need to be well versed in DB plans, and an actuary needs to review the age-based testing and contribution detail.  The availability exists for retirement plans for the UHNW. 

As I say, better to ask than to assume.

Christopher Holtby

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