Enlightened Financial Planning

Good News For a Change      December 15th, 2014

One leading candidate for the “most under-reported story” of 2014 is the remarkable drop in the U.S. government’s budget shortfall.  The final numbers announced by the U.S. Treasury for fiscal 2014 (ending September 30) shows a $483 billion deficit.  That’s about $1 trillion lower than the record $1.4 trillion deficit recorded in 2009.  As a percentage of the U.S. Gross Domestic Product, the deficit came in at 2.8%–below the average of the last 40 years.

Digging into the numbers a bit, the government collected just over $3 trillion in the past 12 months, which comes to 17.5% of America’s total GDP.  That’s up from $2.8 trillion last year, largely the result of a stronger economy, but also reflecting higher tax rates on higher-income Americans.  Meanwhile, spending was essentially flat; rising from $3.45 trillion to $3.50 trillion, reflecting decreased defense spending and cuts in the unemployment insurance program, flood insurance and disaster relief, crop insurance, the Supplemental Nutrition Assistance Program and a variety of housing programs.

If there is bad news in this picture, it’s that Social Security, Medicare and Medicaid are taking over an ever-larger share of the budget, and these costs have been rising much faster than inflation. “Entitlement” expenses are not discretionary; they are basically written contracts with the American people.  Medicaid in particular is worrisome; while discretionary expenditures are down almost totally across the board, Medicaid spending growth came in at 10.2% in 2014, and is projected to rise 14.3% next fiscal year.

How does all this affect you?  Notice that the partisan budget bickering has quietly faded away.  Congress has extended government funding several times without fanfare, and is expected to do so again during the lame duck session after the elections.  This might induce the rating agencies to give American bonds back their A+ credit rating.

We may see a tax reform bill sometime next year, which will certainly lower the U.S. corporate tax rate, and may address America’s tangled individual tax code.  Earlier this year, a House bill proposed to repeal dozens of tax credits, deductions and tax preferences, including the mortgage interest exemption and deductions for charitable contributions.  The legislation would create two individual income tax brackets at 10% and 25%. Another proposal would replace most current federal taxes with a 23% national retail sales tax.

And you may hear more about reforming Social Security, Medicare and Medicaid.  The Social Security fix is relatively straightforward; for persons under the age of 50 today, full benefits would be deferred a year or two, to reflect the fact that people are living (and capable of working) longer.  Medicare proposals have ranged from giving total discretionary control to states, to creating a voucher system that would cap benefits for each participant.

Finally, all of us who are recommending Roth conversions have to pause when we see proposals that would replace income taxes with a sales tax.  The premise of a Roth conversion is that you are paying, today, equal or lower taxes on the converted retirement dollars than you would be paying in the future.  If future marginal tax rates go down to zero, and all government revenues are shifted to a sales tax, that dramatically changes the Roth equation.  Yes, this is unlikely, but even the unlikely contingencies have to be factored into today’s financial decisions.  After all, who thought the budget deficits would fall below 3% of GDP so quickly?

By Bob Veres, publisher of Inside Information – the premier publication of financial industry trends and information for leading practitioners in the financial planning profession.


Volatility Is Up. So What?      December 4th, 2014

Professional investors know something that most people find impossible to believe: that the threat of scary ups and downs in the markets is by far the best friend of the long-term investor. Why? Because over the long term, stocks have provided returns far higher than bonds or cash.  If it weren’t for the occasional dizzying gyrations, any rational investor would put his or her money where the highest returns have been.  Right?

This appears to be one of those times–a time when non-professional investors are reminded of the reasons why they have this lingering fear of the stock market.  Since the end of September, the S&P 500 index has done something regularly that it normally does infrequently: moved more than a full percent up or down in a single day.  Consider the recent pattern this month:

Oct. 1 -1.3%

Oct. 4 +0.05%

Oct. 5 +1.1%

Oct. 6 -0.2%

Oct. 7 -1.5%

Oct. 8 +1.8%

Oct. 9 -2.1%

Oct. 10 -1.1%

Oct. 13 -1.65%

Contrast this to the calm before the storm: earlier this year, the markets experienced 42 consecutive days without a single 1% price move, and the accompanying chart shows that this is far from the record.

The question we should be asking ourselves is: why are we paying such close attention to daily market movements?  Why are we allowing ourselves to fall for the trap of getting anxious over short-term swings in stock prices?

The second chart shows the growth of a dollar invested in the S&P 500 at the beginning of 1950, with dividends reinvested, compared with a variety of alternative investments which have not provided the same returns. (Note that small cap stocks, which are more volatile, have done even better.)  The chart also shows all the scary headlines that the markets managed to sail through on the way to their current levels–all of which are scarier than the things we’re reading about today.

This is not to say that the markets won’t go lower in the coming days, weeks or months; in fact, we are still awaiting that correction of at least 10% which the markets delivery with some regularity on their way to new highs, which has been long-delayed in this current bull market.  The thing to remember is that the daily price of your stock holdings are determined by mood swings of skittish investors whose fears are stoked by pundits and commentators in the press, who know that the best way to get and hold your attention is to scare the heck out of you.  What they don’t say, because it’s boring, is that the value of your stock holdings are determined by the effectiveness of millions of workers who go to work every day in offices and factories, farms, warehouses, power plants and research facilities, who slowly, incrementally, with their daily labor, build up the value of the businesses they work for.

The last time we checked, that incremental progress hasn’t stopped.  The economy is still growing.  You won’t get a daily report on the value of the stocks you own; only the daily, changing opinions of skittish investors.  But if you take a second look at the growth of an investment in stocks over the long-term, you get a better idea of how that value is built over time, no matter what the markets will do tomorrow.


By Bob Veres, publisher of ”Inside Information” – the premier publication of financial industry trends for financial professionals


2014 Tax Planning Tips      November 24th, 2014

As tax season approaches, we offer a few common sense tips for taxpayers in a variety of taxable income levels. Please keep in mind that federal tax rules continue to become more rather than less complex. Our most important tip – consider consulting with a qualified tax or financial advisor before the end of 2014 to take advantage of your unique planning opportunities.


Pay all MN income taxes by December 31 – If you make quarterly estimated income tax payments, make sure the fourth quarter MN estimated payment is made before December 31 in order to claim the payment as a 2014 federal itemized deduction.


Taxability of Social Security income – For joint returns, if adjusted gross income (AGI which is total income listed on the bottom line of Form 1040’s first page) minus half of social security is less than $32,000, then none of your social security benefit is taxable. Between $32,000 and $44,000, 50% of the benefit is taxable and over $44,000, 85% of social security is taxable. Each year, you should evaluate if you can reduce the taxability of social security income by avoiding or taking only your minimum required taxable IRA withdrawal. You might be able to take a Roth IRA withdrawal which is tax free or take a larger than necessary taxable withdrawal every other year.


Remember your federal taxable income is taxed in layers at ever increasing tax rates. For joint returns, the largest increase in federal tax rate occurs once taxable income exceeds $73,800 (up to a maximum of $148,850) causing rates to increase from 15% to 25%. Tax rates keep rising until the top rate of 39.6% is reached (taxable income over $457,600). To avoid jumping into a higher tax bracket, consider ways to increase deductions (or delay income if possible). Examples include:

o     Investment interest expense can offset investment income. Investment management fees over 2% of adjusted gross income (AGI) are deductible.

o     Maximize deductible work retirement contributions and work health savings contributions. Current year maximum 401k contribution limit is $17,500 ($23,000 for those 50 or older).

o     Bunch several years of expenses into one year

       Charitable gifts

       Medical expenses – in order to exceed the 10% of AGI floor (7.5% for age 65 or older), consider doing all elective procedures in one year. Remember, long term care costs are                                  qualified deductible medical expenses.


A Net Investment Income surcharge of 3.8% applies to joint filers with adjusted gross income over $250,000. Net investment income includes dividends, interest income and capital gains (and a few other less common items). The 3.8% surcharge applies to lesser of 1) current year net investment income or 2) the excess of AGI over the $250,000 threshold ($200,000 if filing Single).

Suggestions for minimizing the surcharge include:

o     Using municipal bonds for much of your taxable account bond allocation since municipal bond interest is exempt from the 3.8% surcharge.

o     Take capital losses before year end to reduce capital gain exposure.

o     When possible, delay income, to reduce the amount of AGI over the $250,000 threshold. A few examples include delaying a bonus to next year or delaying exercising stock options.

o     Certain expenses reduce AGI such as self-employed health premiums, health savings contributions, moving costs and payment of taxable alimony.

o     For large capital gains, say from the sale of investment property, consider using the installment method of reporting to stretch the gain over a number of years.


Charitable Gifting – first, be aware that certain limitations exist on the amount of deductible charitable contributions you can make in one year.

o     To leverage the value of your gift, consider using an appreciated security.  Assume you wish to make a large one time gift of $30,000 and have a mutual fund valued at $30,000 with cost basis of $10,000. By directly gifting the mutual fund, you avoid paying federal and MN taxes on the $20,000 gain that would result from the sale of the mutual fund. For folks in higher tax brackets, gifting the appreciated mutual fund could save up to $7,000 in taxes.

o     Charitable IRA transfer – watch to see if Congress once again extends to this year, the provision allowing taxpayers age 70.5 or older to make direct transfers to charities of up to $100,000 from their IRA. The charitable transfer also qualifies as your minimum required distribution for the year.

Why Do Losses Really Matter      November 11th, 2014

Everybody who told us that the steep market drops earlier last month wouldn’t last can rightly claim they’re right.  When the S&P 500 was down 7.4% during a two-week selloff, there was no way to know whether we’d have to endure more of the same.  Staying the course turned out to be exactly the right strategy, but that doesn’t mean that we shouldn’t be concerned about downside risk.  In fact, during the downturn, all of us should have been working hard to keep our portfolios from falling as far and as fast as the American indices.


Isn’t this a contradiction?  There is no contradiction between holding on during market downturns and building portfolios that are unlikely to keep pace with a bear market free-fall.  You hold on because no living person knows when the stock markets will recover, but history tells us that they always do seem to recover and eventually deliver returns that are higher, on average, than the returns you get when the money is safely stored under your mattress. 


But you also pay attention to downturns because the further your portfolio falls, the harder it is to recover.  There’s actually a rational reason why you tend to fear losses more than you enjoy your gains.


The mathematics show the asymmetrical effect of losses vs. gains.  If your $1 million portfolio loses 10%, falling to $900,000, then it requires an 11.11% gain to get you back where you started.  It doesn’t seem fair, but that’s how it is.  A 20% loss requires a 25% gain, and if your portfolio were to drop 40%, you’d need a subsequent 66.67% gain to climb back to your original $1 million nest egg.


Chances are, you know how we fortify portfolios against losses: we include a variety of different types of assets–including bonds which, against every single market prediction at the start of the year, are actually delivering positive returns almost all the way across the maturity spectrum.   We include foreign stocks, which haven’t exactly been knocking the lights out this year, but which will, someday, offer strong gains when the U.S. markets are weakening.  All of these different movements tend to have a calming effect on the portfolio’s returns, not always in every circumstance, but fairly reliably over time.


The result?  A smoother ride puts more money in your pocket.  If an investor experienced returns of +20% and -10% in alternate years over the next 20 years, a $100,000 portfolio would grow to just under $216,000.  If a more diversified investor experienced a smoother ride of 10% a year, her portfolio would grow to just under $673,000.  The power of steady compounding is a marvelous thing to see.  The drag of losses can be debilitating to a portfolio’s growth.


You won’t experience either of those trajectories, of course.  But if you can somehow soften the worst of the market’s falls, even if it means never beating the market during the up-cycles, you raise your chances of long-term success.  If you can do this and remain invested through a lot of uncertainty, like we experienced earlier this month, chances are you’ll enjoy better long-term returns than a lot of the “experts” you see screaming at you to buy or sell on the cable finance channels.


Oh, and that 7.4% drop?  The S&P 500 did go up as of the end of last month more than the required 7.99% to recover the ground it lost in that two-week sell-off period.


Making Sense of Employment Statistics      October 30th, 2014

We are deluged with numbers like how many jobs were created this month and last month, or the ever-fluctuating number of jobless claims, or number of people who may or may not have stopped looking for work. The most recent Bureau of Labor Statistics report says that U.S. employers had 4.635 million job openings in May, which is up from 4.464 million in April. The Labor Department recently released its latest reporting, telling us that non-farm employers hired a “seasonally-adjusted” 288,000 workers in June, and we are told that the unemployment rate now stands at 6.1%.

But what does that tell people who are actually looking for work? What does that tell us about the real economy? Is there a better way to make sense of today’s job picture?

The accompanying chart puts the current and historical U.S. labor situation into much clearer perspective. It shows the number of unemployed persons per job opening as of last week, and the same number going back to 2001. Back before the “tech wreck” bubble burst, there was approximately one job seeker per job opening. That doesn’t mean that everybody was trained or suitable for every job, but it does indicate that finding work was probably not impossible for able-bodied and skilled individuals.

During the Great Recession, that number jumped up to an average of roughly 7 job seekers for every opening. Today, after a long, slightly choppy improvement in the prospects of workers, there are 2.11 unemployed workers for every job opening, and the trend is the friend of the unemployed.

This chart shows, perhaps more clearly than other indicators, an improving economy and tightening labor markets, which usually signals more competitive pay packages as companies start doing something they haven’t been doing for years: actually competing for qualified workers. That, in turn, could cause the Federal Reserve Board–which watches unemployment numbers closely as it sets rates–to raise interest rates sooner than expected. It may also raise the cost of doing business for companies throughout the economy, raising the inflation rate as those extra employment costs are passed on to consumers.

In addition, as economist David E. Kelley has pointed out, more jobs at the tail end of a market expansion can add an unexpected boost to GDP growth by raising corporate capital spending. In a presentation in San Francisco, he recently said that when companies lay off people, and then eventually start hiring back to previous staffing levels, they really don’t need to buy anything new. They can give their new employees the cubicle, computer and desk of the fired workers.

But once they’ve replaced the jobs lost, the next hire needs new equipment. “What we’re seeing now is that the economy is going to need capital spending to go with the improvement in employment,” Kelley told the group, “and we are starting to see that in capital goods orders.”

For investors, higher inflation, higher interest rates, but more employment and higher GDP, is kind of a mixed bag. But at least the jobs situation can be better understood with this new chart, and more jobs and higher salaries are ultimately better for the American people as a whole.

By Bob Veres, publisher of Inside Information – the premier publication of financial industry trends and

information for leading practitioners in the financial planning profession.