January 20th, 2011
There are different methods to save for college. 529 plans are one method. There are some specific issues which everybody should be aware of:
a) Fees: not all investment management fees for 529 plans are created equal. There are Vanguard type based plans and broker based plans. Broker based plans have higher fees and potentially laden with commissions. Review the 529 plan fees to make sure they are compatible with your goals and philosophy.
b) 5 – Year election: Parents, grandparents, aunts/uncles etc. can contribute up to 5x the annual gift exclusion amount ($13k in 2011). This contribution can be treated as if they were made pro rata over 5 years. However, the donor has to file a gift tax return. This election is not automatic. The donor should consult with their tax adviser on the how this should be done.
c) Investment changes: Investors can change the investment choices normally on an annual basis or when there is a beneficiary change. The owner of a 529 plan, normally the donor, should consult the specifics of the 529 plan being considered.
d) Rollovers: When changing a 529 plan, the following needs to be followed to avoid tax consequences: don’t change beneficiaries if they are not a member of the same family; and don’t rollover a 529 plan for a beneficiary change if another 529 plan for the same beneficiary was rolled over within the last 12 months. If rollovers are done incorrectly, the IRS can assess a 10% penatly and impose a tax – on the earnings within the 529 plan itself.
e) Timing of distributions: 529 distributions are exempt from federal income tax if it is used to pay for qualified higher education costs in the the same calendar year.
f) Definition of higher education costs: The IRS defines higher educations costs as tuition, fees, books, supplies and equipment required for enrollment or attendance at an eligible educational institution. Keep documents of all costs paid by 529 distributions.
g) Don’t over fund a 529 plan: Non-qualified distributions will have a 10% penalty assessed and earnings are subject to ordinary income taxes.
For more information on the rules of 529 plans, visit this IRS site on 529 plans.
Bottom line: Discuss with your adviser how these issues need to need to be addressed into your financial plan. Ask if a zero-municipal or zero-Treasury bond with the same maturity date as the child’s college entrance date should be considered as an alternative to a 529 plan.
Always Asking, Never Assuming™
Christopher Holtby
Tags: 529 distributions, 529 penalties, 529 plans, college planning, dallas, fee-only advisor, financial planning, fort worth, investment advisor, north texas, wealth management
Posted in College Planning | No Comments »
November 26th, 2010
The markets are giving investors a lot of mixed signals right now that can be confusing or even frustrating on a day-to-day basis. Example: Gold recently climbed to a new record. Normally, strong gold prices indicate that investors are worried about currency devaluation and inflation, which is bearish for bonds. But bonds were actually stronger, which normally means that investors are worried about deflation and reducing their overall risk. But stocks were stronger as well, which normally indicates that investors are eager to take on more risk in search of correspondingly greater returns. Commodities prices — a key component of inflation — were soaring. But the dollar, which normally trades weaker in an inflationary scenario, was firm.
How can all these conflicting signals coexist in the same market system? Believe it or not, it happens all the time. Historic economic transitions like the Argentine debt default or the Canadian bank crisis teach us that when investors are adjusting their portfolios to reflect shifting probabilities, this kind of confusion is normal until the market corrects past excesses. Until that happens, we will probably see investments seesaw in ways that seem odd or even illogical. We may even see exotic scenarios like inflation-protected Treasury bonds paying negative yields — in effect, charging investors for the right to lend the U.S. government money. But markets do not always predict the future correctly or even unanimously. Investors who learn the benefits of diversification know that even if some investments go down, others will go up and their long-term rewards will remain intact.
Bottom line: No matter how much short-term noise the market generates, staying tuned to that clear signal is crucial.
Always Asking, Never Assuming™
Christopher Holtby
Tags: bonds, currency woes, dallas, deflation, fee-only, financial planning, fort worth, gold, inflation, investment advisor, stocks, texas, wealth management
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November 15th, 2010
In the 1990′s, Canada and Sweden experienced a bank crisis and relatively severe currency problems. Fast forward 20 years, both countries have emerged from the US credit crisis intact, stable and growing. Although, there are signs of an overheating Canadian residential real estate market causing the Bank of Canada to raise rates by 1% in 2010.
In the 1990′s, the beginning and end to Canada’s and Sweden’s bank crisis took roughly the same path: Stage 1: Bank crisis; Stage 2: Corporations react by cutting expenses and strengthening their balance sheets; Intermission; Stage 3: Households cut back on spending, increase savings, and pay down their debt; Time passes; Stage 4: Government makes structural, painful adjustments for the economic recovery. Sound somewhat familiar?
Regarding the US, the wild card is how the speed and strength of household adjustments can occur when Washington keeps giving the electorate short-term candy reforms. Reforms which would promote long-term growth require pain of some type. Post World War II recessions were not caused by an over-leveraged economic system. For example, no post WWII recession had households paying down debt by such large amounts as today (i.e. household debt decreased $374 billion since 2Q2008). The four pillars of a typical post WWII recovery had one of the following: consumer spending, employment gains, revival in residential construction, and ending of inventory liquidation.
Bottom line: The Federal Reserve cannot solve our current problems with monetary solutions if the Legislative and Executive branches of the US government do not make structural sound reforms. The history of Canada and Sweden in the 1990′s gives the investor a sense of what is necessary.
Always Asking, Never Assuming™
Christopher Holtby
Tags: bank crisis, dallas, devaluation, fee-only, finanicial planning, fort worth, household, texas, wealth management
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November 3rd, 2010
Over the last decade US stock returns have returned slightly less than 0%, on average (iShares S&P500 Index ETF as of 10/29/10). Investors have been re-allocating money to bonds and income producing investments. Real estate, such as Real Estate Investment Trusts (known as REITs) are an example of an income producing investment.
In 2009, roughly $400 million was invested in REITs. Through July 31 of this year, 4x that amount has been invested in REITs (source: Morningstar).
Since REITs are required to payout 90% of their net income, using the traditional P/E ratio metric is not really useful. Instead, the real estate industry uses something called, Funds From Operations (FFO). The FFO provides investors a measuring stick to show how much cash flow a REIT generates. A REIT FFO can paint a rosier picture than might actually exist. For example, divide the REIT stock price by it’s FFO and you will get a better idea of how the market is valuing that REIT, much like a P/E ratio. Morningstar looked a the top 15 holdings of four top rated REIT mutual funds and found the average FFO multiple (REIT stock price/FFO), was 19.1. Looking back over the last decade, that is a high number compared to the average of 15 (source: Morningstar).
The current yield on REIT mutual funds average around 2 – 3%, compared to a 10 Year US Treasury bond, which depending on the day, has a current yield of around 2.5%. The REIT dividend yield relative to the yield of a 10 Year US Treasury bond is hovering below the 20 year average (source: Morningstar). This means you taking more risk (owning a REIT mutual fund) and getting less yield than owning a 10 Year US Treasury bond. The National Association of REITs studied the period from 1992 to 2010. It showed that when the dividend was 4-5% the next 5 years annualized nominal return was 0%. When the dividend yield was 6-7%, the next 5 years annualized nominal return was 12%. This means the returns investors receive on REIT mutual funds, based on historical analysis, depends on the current dividend yield at the time of purchase. Valuation matters.
Bottom line: Managing expectations is a key to success in investing and causes less disappointment in what the future actually delivers.
Always Asking, Never Assuming™
Christopher Holtby
Tags: current yield, dallas, dividend yield, fee-only, FFO, financial planning, fort worth, investment advice, investment services, REIT, texas, US Treasury bonds, wealth managment
Posted in Investments, Wealth Management | No Comments »
October 30th, 2010
One of the oddest parts of the American tax system was that the IRS relied on taxpayers to correctly report their realized investment gains. The fear driving taxpayers to correctly report those gains was the threat of an IRS audit. There was no automatic process for the IRS to confirm whether the reported cost basis on the taxpayers tax return (Form 1040, Schedule D) was correct. The Emergency Economic Stabilization Act of 2008 requires for investments such as stocks and mutual funds, that brokerage firms, banks and mutual fund companies report to the IRS the actual costs basis. IRAs and trusts, if I interpreted the IRS guidelines correctly, are exempted. When the taxpayer sells a portion or all of the investment, the IRS can match the taxpayer’s reported cost basis against that of the brokerage firm’s etc reported cost basis. Those firms will be providing IRS Form 1099-B to taxpayers in a more detailed fashion.
When an investment is purchased, one tax lot is created with purchase date and cost. When that investment pays a dividend or interest (for mutual funds), whose proceeds are re-invested in the investment that creates another tax lot changing that investments costs. Taxpayers will need to decide on what type of tax lot reporting they want. There are a few choices: First in First Out, Last in First Out, high cost, low cost or average cost. Each have different tax implications. The custodian of your investments are likely to have default tax lot report settings for those taxpayers not deciding which method they prefer.
Bottom line: Taxpayers have to discuss with their CPA or research on their own which tax lot reporting method they should choose.
Always Asking, Never Assuming™
Christopher Holtby
Tags: 1099-B, average cost, cost basis, dallas, Estate Planning, fee-only, FIFO, financial planning, fort worth, high cost, investment advisor, LIFO, low cost, tax lot reporting, tax planning, tx, wealth management
Posted in Taxes | No Comments »
October 23rd, 2010
To paraphrase Warren Buffet, if you can’t handle a stock investment dropping in value by 50%, you shouldn’t own it in the first place. Stock investors, whether investing in a stock mutual fund or with a stock money manager, need to consider this concept when deciding on stock investments.
In the last decade, US stocks have returned slightly less than 0%, on average. Over the last 18 months, investors have withdrawn tens of billions of dollars from stock investments. This money has been re-invested in bonds or income producing investments. Whether this is strategically correct, depends on an investors specific goals and current situation. If you want or need to own stocks, here are a few concepts to consider:
a) High quality companies are not always high quality investments.
b) Stock investments are like infinite maturity bonds with potentially rising coupons.
c) Cheap stocks can get a lot cheaper but when expensive stocks go down, that money is lost forever.
d) Companies that cannot pass price increases with higher interest rates will have a declining net profit margin.
Bottom line: Considering the concepts above and Warren Buffet’s paraphrased comment, if your time horizon is less than 7 – 10 years, why would you risk owning stock investments?
Always Asking, Never Assuming™
Christopher Holtby
Tags: dallas, fee-only, financial planning, fort worth, fundamental valuations, income statement analysis, investment advice, p/e ratio, portfolio management, standard deviation, texas, valuation, wealth management
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October 12th, 2010
The US trade deficit rose from $42 billion in May to $50 billion in June (numbers not seen since summer of 2008). Trade deficits rise for two reasons: consumers are spending more or adjustments to the international trade imbalances between surplus and deficit countries via currency/interest rate differentials or manipulations.
Over the last 20 years the world has been separated into surplus and deficit countries. Japan, China and Germany are leading surplus countries. America, UK, and most of Europe are leading deficit countries. The surplus countries are dependent on these surpluses for economic and employment growth. The recent credit crisis stressed this relationship between surplus and deficit countries. Households in deficit countries are lowering their consumption, increasing their savings. This has forced surplus countries to use unconventional tools to maintain the status quo for their countries excess capacity to be purchased by the households of the deficit countries.
Germany has reported huge surplus numbers since the decline of the Euro. China has offset the rise of the Renminbi with cheap credit to the countries banks thus protecting China’s surplus numbers. Europe’s deficit countries have had a difficult time raising debt, making them a less relevant recipient of the surplus countries destination of their excess capacity. Global trade must balance. The US, with it’s flexible and open financial markets, will likely absorb the majority of this adjustment to balance the global trade equation.
For example, China has been buying Japanese Yen instead of US dollars as part of the goal to make Japanese exports relatively more expensive than Chinese exports (or least the Japanese components). Japan understanding the importance of exports to it’s economic model has been attempting to neutralize these effects.
Bottom line: US households are de-leveraging. The US deficit is increasing. Surplus countries, focused on their economic growth, believe the US Executive and Legislative branch will not make structural changes to disrupt their economic model of the US absorbing their excess capacity via currency manipulations (e.g. what they produce and export). Trade wars occur when one party believes their economic model is at risk. Whether we reach such point is unknown, but the risks are building.
Always Asking, Never Assuming™
Christopher Holtby
Tags: dallas, fee-only, financial advisor, financial planning, fort worth, protectionism, surplus countries, texas, trade deficit, trade imbalances, trade war, wealth management
Posted in International | No Comments »
October 8th, 2010
A common model to calculate the future value of a company’s stock price (represents the future value of the company’s market value), is the discounted value of the expected future cash flows to the shareholder. The discount rate (the denominator or number on the bottom) used in this model moves in the same direction as interest rates. If the US Treasury Bill or 3 month US LIBOR rate move up, the discount rate used in modeling future stock price values will also increase. The discount rate is currently a heavily influenced number. If it were to return to a non-artificially suppressed rate, that would severely impact the derived valuation from the discount cash flow model.
Existing studies (FAMA/Schwert 1977) found stock returns move in the opposite direction as interest rates. Nissim/Penman (2003) found that interest rates and operating income move in the same direction (remember: free cash flows are included in the operating income calculation which makes up the numerator or number found on top of the discounted cash flow model). Their studies found that interest rates affect both the numerator and denominator in the discounted cash flow model calculation, but the denominator (discount rates) were affected more by interest rate moves. Davis (2010) studied the interest rate changes against large and small stock returns. His focus was on what type of stocks, small, large, value and/or growth have a higher correlation to interest rate changes. The research showed small and value stocks are more sensitive to interest rate changes. A portfolio manager or investor would need to decide what type of interest rate should be applied to the discount rate. In Davis (2010) study, AAA corporate bond yields, 1 Month US Treasury bills, and 10 Year US Treasury bond yields were used as discount rates. Each provided varying degrees of predictive power and explanation of stock returns.
Bottom line: Stocks do not have a fixed maturity. Bonds do have a fixed maturity. Using the discounted cash flow model to determine a stock’s future value is sensitive to the type of discount rate used. This is another example that stock analysis is not a science.
Always Asking, Never Assuming™
Christopher Holtby
Tags: correlation, dallas, Davis 2010, discounted cash flow, Fama/Schwert 1977, fee-only, financial planning, fort worth, interest rates, investment advisor, Nissim/Penman 2003, operating income, p/e ratios, stock analysis, stock returns, texas, wealth management
Posted in Investments | No Comments »
September 28th, 2010
Not since the 1930′s has the world seen developed and developing countries either blatantly devaluing their currencies (Switzerland 2009, Japan 2010) or attempting to debase their currencies (US and UK 2010). There is more to this story than most people expect, which I will explore in latter postings.
In the 1930′s, the major countries of the world, based the value of it’s currency against a fixed exchange price to gold. The effect of this policy, in a period of decreasing private demand (another term for a recession or depression), magnified the effects of deflation as the government could not ”print money” due to the gold/currency fixed rate (the central bank could not print money that is linked to a corresponding value of gold). Beginning with Spain (1927) and ending with France (1937), countries de-linked their currencies to gold, allowing the central bank to devalue their currency (i.e. print money). In the US, this allowed the Roosevelt administration to “pump” money into the system as the household and corporate sector demand evaporated. The 1930′s showed that when all countries de-value at once, little was gained in relative international trade competitiveness. The only real result was political tension and foreign-exchange rate uncertainty.
Fast forward 70 years. Today, the daily foreign exchange market of roughly $4 trillion makes moving foreign exchange markets more difficult. Printing money to devalue one’s currency needs to be done in massive amounts. Switzerland gave up the attempt to de-value it’s currency last year after the intervention involved 40% of it’s GDP. There is a struggle between the surplus countries keeping their currencies artificially low and deficit countries choosing to rectify their deficit positions.
Bottom line: Every country cannot have a surplus account because for every net exporting country there has to be an offsetting net importing country. A currency cold war, of sorts, has begun between the surplus and deficit countries.
Always Asking, Never Assuming™
Christopher Holtby
Tags: currency, dallas, deflation, devaluation, fee-only, financial planning, fort worth, government involvement, inflation, texas, wealth management
Posted in International, Wealth Management | No Comments »
September 3rd, 2010
A depressed asset (e.g. stock, partnership, real estate, private company) provides an opportunity to transfer (characterized as a gift) the value to the next generation. This strategy is successful when the asset’s value appreciates and is worth more in the future.
From the Chief Counsel Advice (CCA 201024059: Consequences of Gift Not “Adequately Disclosed”), per the IRS, gifts that are not “adequately disclosed” on a gift tax return provide the IRS the opportunity to assess the gift tax any time. The IRS is not barred by the three year statute of limitations. In a particular case, a taxpayer made a taxable gift of stock in a closely-held company. Per the IRS, the gift tax return did not disclose “(1) any information with respect to the method used to determine the Fair Market Value of the stock; and (2) any description of the discounts used to value the stock that were in fact used to value the stock.” The IRS differentiated between “adequately disclosed” and “adequately shown.” There are numerous Internal Revenue Code and Treasury Regulations dealing with these differences. If a gift tax can be assessed a long period of time after the actual gift has been made, penalties and interest can be added. There are more moving parts, but that is the general gist of this issue.
Bottom line: If you are planning to transfer assets with temporarily depressed values, have your CPA and estate attorney understand the nuances found in Chief Counsel Advise 201024059.
Always Asking, Never Assuming™
Christopher Holtby
Tags: CCA 201024059, dallas, fee-only, financial planning, gift tax, investment management, IRC, north texas, transfer planning, Treasury Regulations, wealth managmeent
Posted in Legacy Planning | No Comments »