Rate Hike Hype

December 15, 2015 — Sam H. Fawaz

While I’m still a tad skeptical, we will almost surely see the U.S. Federal Reserve Board (Fed) start the long process of ending its intrusion into the interest rate markets, by allowing short-term rates to rise starting on Wednesday. It will be the first time the Fed has raised rates since 2006, and for some it will mark the beginning of the final chapter of the Great Recession.

Since 2008, as most of us know, returns on short-term bonds have been at or near zero percent, which is a consequence of the Fed keeping the Federal Funds rate—the rate at which it will lend banks virtually unlimited amounts of money, short-term—at 0.125%. The average Fed Funds rate has historically been 3.5% to 4.0%, so this is a considerable amount of stimulus.

At the same time, the Fed has purchased more than $3.5 trillion worth of Treasury securities and home mortgage pools as part of its quantitative easing (QE) programs, bidding aggressively against much smaller buyers, which is another way of saying: forcing the rates on these bonds down closer to zero.

Pulling back out of these interventions is going to be tricky, in part because shifts in interest rates have a direct impact on a still-fragile U.S. economy (higher rates mean higher borrowing costs, potentially less corporate investment and lower profits), and even trickier because we don’t know how investors will react. In the past, the markets have panicked at the mere mention of a cutback in Fed involvement, and (more recently) have also risen on the same news, presumably because people drew encouragement from the confidence the Fed was showing in the strength and resilience of the U.S. economy.

There are also some tricky mechanical problems. The central bank will try to control the extent that short-term rates rise and fall by raising the interest it pays to banks for the reserves held at the Fed, and also cautiously raising the amount it pays money market funds for short-term trades known as “reverse repurchase agreements.” The mechanics are highly technical and complicated—and still unproven, although there are reports that the Fed has been conducting tests for the past two years.

As the markets react, either upwards or downwards, there are a few things to keep in mind. First, despite the headlines soon to be blaring from every financial section of every newspaper in the country, the rate is expected to move very modestly from .125% to .375%—clearly a small first step in a long journey toward the long-term average. After each step—prominently including this one—the Fed will evaluate the consequences before deciding to make future changes. If the economy slows, or if there are signs that inflation is falling below the Fed’s 2% annual target, it could delay the next move by months or even years. That caution greatly reduces the danger of any kind of serious economic pullback.

It’s also worth noting that the Fed has announced no plans to sell the nearly $4.2 trillion worth of various bonds—including the aforementioned Treasuries and mortgages—that it owns. At the moment, the bank is simply rolling over the portfolio, meaning it reinvests $21 billion a month as bonds mature. Eventually, most observers expect the reinvestment to stop and the Fed to allow the huge bond holdings to mature and fall off of its balance sheet. The fact that this is not being done currently reflects the exquisite degree of caution among Fed policymakers, who don’t want to rock the boat too fast or too hard.

Finally, some have wondered about the future of mortgage interest rates as the Fed begins a cautious exit from the bond markets. Interestingly, recent history shows that mortgages haven’t been especially influenced by changes in the benchmark rate. The last time we saw extremely low interest rates, after the tech bubble burst in the early 2000’s, the Fed brought its Fed funds rate down to 1%. It began raising rates by 0.25% a quarter starting in the summer of 2004, but over the next four months, the 30-year fixed-rate mortgage actually fell from 6.3% to 5.58%. By the time of the last increase in the summer of 2006, mortgage rates were running at 6.68%, just a half-percent higher than they had been at the previous Fed funds rate low.

Nobody knows exactly what to expect when the announcement comes on Wednesday, but you can look for the investment markets to bounce around a bit more than usual, and economists—including the teams employed by the Fed—to examine every scrap of data about the impact on the economy over the next quarter. At that time, Fed policymakers will face another decision, and there is no reason to expect them to be less cautious than they have been recently. For many of us, the rate rise should be reason for celebration, a sign that the long recession and period of economic uncertainty is finally starting—carefully—to be put in our rear view mirror.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

https://www.washingtonpost.com/news/where-we-live/wp/2015/12/14/what-a-fed-rate-hike-could-mean-to-mortgage-borrowers/

https://www.washingtonpost.com/news/wonk/wp/2015/12/14/the-federal-reserve-will-likely-raise-interest-rates-this-week-this-is-what-happens-next/

http://www.usatoday.com/story/money/2015/12/14/this-week-december-13/77155714/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Posted in American Economy, Financial Planning, General, investing, retirement planning, Stock Market. Tags: , , , . Leave a Comment »

A Better Stock-ing Stuffer

November 30, 2015 — Sam H. Fawaz

What’s a better gift for a young person than a savings bond or a gift card?

When you talk with people who have made a lifelong habit of saving and investing, often you’ll hear them say that somebody—often a grandparent—gave them a few shares of stock at a young age. Following the stock, learning about the company and seeing the dividends reinvested got them interested in a whole new mysterious economic realm that many people never learn about.

The problem, of course, is that it’s not always easy, in this day and age, to give a few shares of stock. Instead of printed shares, we have electronic ownership, which is why websites like giveashare.com and uniquestockgift.com can charge twice as much for a stock and a printed certificate as you would pay for the same share if you went online through a discount brokerage firm. Buying a share directly means creating a new custodial account for the young child, and then executing a brokerage transfer or creating an UGMA account.

Recently, the idea of giving a share or two of stock has gotten a lot easier, with a website called SparkGift. You click on the site, and over the next two minutes, you select a recipient, provide an email address and Social Security number, select an investment—it could be Disney, Tesla, a Vanguard index fund or any ETF, anything that is publicly traded—and a dollar amount. The person on the other end of the email opens the message and creates the account. At that point, your payment executes the trade, and the securities end up in an account in the child’s name. You can use a credit card to make the purchase.

According to the site, the average gift size is $75 to $100, and the giver will be charged $2.95 plus 3% of the gift size, equivalent to the transaction costs at a discount brokerage firm. Some children have gone so far as to establish their own gift registry, specifying the stocks they’re interested in—like Disney, Mattel, Apple or Electronic Arts—which encourages them to research the companies behind the brands they like.

Rather than a gift card that will be spent immediately, the stocks will demonstrate investment appreciation over time—and might even help your kids or grandkids with retirement planning someday.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://time.com/money/4067454/giving-shares-stock-sparkgift/?xid=tcoshare

https://www.sparkgift.com/#

http://thereformedbroker.com/2015/10/12/the-greatest-gift-you-can-give-a-young-person/

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

 

Posted in Financial Planning, General, retirement planning. Tags: , . Leave a Comment »

2015 Year-End Tax Planning Tips

November 21, 2015 — Sam H. Fawaz

As the end of the year approaches, it’s a good time to think of planning moves that will help lower your tax bill for this year and possibly the next. Factors that compound the challenge include turbulence in the stock market, overall economic uncertainty, and Congress’s failure to act on a number of important tax breaks that expired at the end of 2014. Some of these tax breaks ultimately may be retroactively reinstated and extended, as they were last year, but Congress may not decide the fate of these tax breaks until the very end of 2015 (or later).

These not yet extended breaks include for individuals: the option to deduct state and local sales and use taxes instead of state and local income taxes; the above-the-line-deduction for qualified higher education expenses; tax-free IRA distributions for charitable purposes by those age 70-1/2 or older; and the exclusion for up-to-$2 million of mortgage debt forgiveness on a principal residence. For businesses: tax breaks that expired at the end of last year and may be retroactively reinstated and extended including 50% bonus first-year depreciation for most new machinery, equipment and software; the $500,000 annual expensing limitation; the research tax credit; and the 15-year write-off for qualified leasehold improvements, qualified restaurant buildings and improvements, as well as qualified retail improvements.

Year-end tax planning is included on a complimentary basis for financial planning clients of our firm. Accordingly, clients will be receiving a separate e-mail from us requesting certain 2015 tax information so we can review and assess tax planning opportunities available to them.

Higher Income Earners

Higher-income earners have unique concerns to address when mapping out year-end plans. They must be wary of the 3.8% surtax on certain unearned income, and the additional 0.9% Medicare (hospital insurance, or HI) tax. The latter tax applies to individuals for whom the sum of their wages received with respect to employment and their self-employment income is in excess of an unindexed threshold amount ($250,000 for joint filers, $125,000 for married couples filing separately, and $200,000 in any other case).

The surtax is 3.8% of the lesser of: (1) net investment income (NII), or (2) the excess of modified adjusted gross income (MAGI) over an unindexed threshold amount ($250,000 for joint filers or surviving spouses, $125,000 for a married individual filing a separate return, and $200,000 in any other case). As year-end nears, a taxpayer’s approach to minimizing or eliminating the 3.8% surtax will depend on his estimated MAGI and NII for the year. Some taxpayers should consider ways to minimize (e.g., through deferral) additional NII for the balance of the year; others should try to see if they can reduce MAGI other than NII; and other individuals will need to consider ways to minimize both NII and other types of MAGI.

The 0.9% additional Medicare tax also may require year-end actions. Employers must withhold the additional Medicare tax from wages in excess of $200,000 regardless of filing status or other income. Self-employed persons must take it into account in figuring estimated tax. There could be situations where an employee may need to have more withheld toward the end of the year to cover the tax. For example, if an individual earns $200,000 from one employer during the first half of the year and a like amount from another employer during the balance of the year, he would owe the additional Medicare tax, but there would be no withholding by either employer for the additional Medicare tax since wages from each employer don’t exceed $200,000. Also, in determining whether they may need to make adjustments to avoid a penalty for underpayment of estimated tax, individuals also should be mindful that the additional Medicare tax may be over-withheld. This could occur, for example, where only one of two married spouses works and reaches the threshold for the employer to withhold, but the couple’s combined income won’t be high enough to actually cause the tax to be owed.

We have compiled a checklist of additional actions based on current tax rules that may help you save tax dollars if you act before year-end. Not all actions will apply in your particular situation, but you (or a family member or your business) will likely benefit from many of them. We can narrow down the specific actions that you can take once we discuss with you a particular plan. In the meantime, please review the following list and contact us at your earliest convenience so that we can advise you on which tax-saving moves to make.

Year-End Tax Planning Moves for Individuals

  • Recognize capital losses on stocks or funds while substantially preserving your investment position. There are several ways this can be done. For example, you can sell the original holding, then buy back the same securities at least 31 days later, or buy a similar security. It may be advisable for us to meet to discuss year-end trades you should consider making.
  • Postpone income until 2016, and accelerate deductions into 2015 to lower your 2015 tax bill. This strategy may enable you to claim larger deductions, credits, and other tax breaks for 2015 that are phased out over varying levels of adjusted gross income (AGI). These include child tax credits, higher education tax credits, and deductions for student loan interest. Postponing income also is desirable for those taxpayers who anticipate being in a lower tax bracket next year due to changed financial circumstances. Note, however, that in some cases, it may pay to actually accelerate income into 2015. For example, this may be the case where a person’s marginal tax rate is much lower this year than it will be next year, or where lower income in 2016 will result in a higher tax credit for an individual who plans to purchase health insurance on a health exchange and is eligible for a premium assistance credit. Being subject to the alternative minimum tax (AMT) may also change this recommendation, so it’s best to “run the numbers”.
  • If you believe that a tax-free Roth IRA is better than a traditional IRA, consider converting traditional-IRA money invested in beaten-down stocks (or mutual/exchange traded funds) into a Roth IRA if eligible to do so. Keep in mind, however, that such a conversion will increase your adjusted gross income for 2015.
  • If you converted assets in a traditional IRA to a Roth IRA earlier in the year, and the assets in the Roth IRA account have declined in value, you could wind up paying a higher tax than is necessary if you leave things as is. You can back out of the transaction by re-characterizing the conversion—that is, by transferring the converted amount (plus earnings, or minus losses) from the Roth IRA back to a traditional IRA via a trustee-to-trustee transfer. You can later re-convert to a Roth IRA.
  • It may be advantageous to try to arrange with your employer to defer, until 2016, a bonus that may be coming your way.
  • Consider using a credit card to pay deductible expenses before the end of the year. Doing so will increase your 2015 deductions even if you don’t pay your credit card bill until after the end of the year. Again, if the AMT applies to you, this strategy may not work.
  • If you expect to owe state and local income taxes when you file your return next year, consider asking your employer to increase withholding of state and local taxes (or pay estimated tax payments of state and local taxes) before year-end to pull the deduction of those taxes into 2015 if you won’t be subject to the AMT in 2015.
  • Consider taking an eligible rollover distribution from a qualified retirement plan before the end of 2015 if you are facing a penalty for underpayment of estimated tax, and having your employer increase your withholding is unavailable or won’t sufficiently address the problem. Income tax will be withheld from the distribution and will be applied toward the taxes owed for 2015. You can then timely roll over the gross amount of the distribution, i.e., the net amount you received plus the amount of withheld tax, to a traditional IRA. No part of the distribution will be includible in income for 2015, but the withheld tax will be applied pro rata over the full 2015 tax year to reduce previous quarterly underpayments of estimated tax.
  • Estimate the effect of any year-end planning moves on the AMT for 2015, keeping in mind that many tax breaks allowed for purposes of calculating regular taxes are disallowed for AMT purposes. These include the deduction for state property taxes on your residence, state income taxes, miscellaneous itemized deductions, and personal exemptions. Other deductions, such as for medical expenses of a taxpayer who is at least age 65, or whose spouse is at least 65 as of the close of the tax year, are calculated in a more restrictive way for AMT purposes than for regular tax purposes. If you are subject to the AMT for 2015, or suspect you might be, these types of deductions should not be accelerated.
  • You may be able to save taxes this year and next by applying a bunching strategy to “miscellaneous” itemized deductions, medical expenses and other itemized deductions. Check to see if deferring the payment of 2015 deductions until 2016 provides more benefit.
  • You may want to pay contested taxes to be able to deduct them this year while continuing to contest them next year. Check with your tax accountant before doing this.
  • You may want to settle an insurance or damage claim in order to maximize your casualty loss deduction this year.
  • Be sure to take required minimum distributions (RMDs) from your IRA or 401(k) plan (or other employer-sponsored retirement plan). RMDs from IRAs must begin by April 1 of the year following the year you reach age 70- 1/2. That start date also applies to company plans, but non-5% company owners who continue working may defer RMDs until April 1 following the year they retire. Failure to take a required withdrawal can result in a penalty of 50% of the amount of the RMD not withdrawn. If you turned age 70- 1/2 in 2015, you can delay the first required distribution to 2016, but if you do, you will have to take a double distribution in 2016—the amount required for 2015 plus the amount required for 2016. Think twice before delaying 2015 distributions to 2016, as bunching income into 2016 might push you into a higher tax bracket or have a detrimental impact on various income tax deductions that are reduced at higher income levels. However, it could be beneficial to take both distributions in 2016 if you will be in a substantially lower bracket in that year.
  • Increase the amount you set aside for next year in your employer’s health flexible spending account (FSA) if you set aside too little for this year. Estimate your expenses carefully since this is a “use it or lose it” type of deduction.
  • If you are, or can make yourself eligible to make health savings account (HSA) contributions by Dec. 1, 2015, you can make a full year’s worth of deductible HSA contributions for 2015.
  • Make gifts sheltered by the annual gift tax exclusion before the end of the year and thereby save gift and estate taxes. The exclusion applies to gifts of up to $14,000 made in 2015 to each of an unlimited number of individuals. Your spouse can give the same person up to $14,000 as well. Consider gifting appreciated stock or mutual/exchange traded funds to individuals with a lower tax bracket than you. You can’t carry over unused annual gift tax exclusions from one year to the next. The transfers also may save family income taxes where income-earning property is given to family members in lower income tax brackets (who are not subject to the kiddie tax.)

Year-End Tax-Planning Moves for Businesses & Business Owners

  • Businesses should buy machinery and equipment before year end and, under the generally applicable “half-year convention,” thereby secure a half-year’s worth of depreciation deductions in 2015. Be careful: a “mid-quarter convention” applies when the total depreciable basis of property that was placed in service during the last three months of the tax year is more than 40% of the total depreciable basis of all property that was placed in service throughout the entire year.
  • Although the business property expensing option is greatly reduced in 2015 (unless retroactively changed by legislation), making expenditures that qualify for this option can still get you thousands of dollars of current deductions that you wouldn’t otherwise get. For tax years beginning in 2015, the expensing limit is $25,000, and the investment-based reduction in the dollar limitation starts to take effect when property placed in service in the tax year exceeds $200,000.
  • Businesses may be able to take advantage of the “de-minimis safe harbor election” (also known as the book-tax conformity election) to expense the costs of inexpensive assets, materials and supplies, assuming the costs don’t have to be capitalized under the Code Sec. 263A uniform capitalization (UNICAP) rules. To qualify for the election, the cost of a unit of property can’t exceed $5,000 if the taxpayer has an applicable financial statement (AFS; e.g., a certified audited financial statement along with an independent CPA’s report). If there’s no AFS, the cost of a unit of property can’t exceed $500. Where the UNICAP rules aren’t an issue, purchase such qualifying items before the end of 2015.
  • A corporation should consider accelerating income from 2016 to 2015 if it will be in a higher bracket next year. Conversely, it should consider deferring income until 2016 if it will be in a higher bracket this year.
  • A corporation should consider deferring income until next year if doing so will preserve the corporation’s qualification for the small corporation AMT exemption for 2015. Note that there is never a reason to accelerate income for purposes of the small corporation AMT exemption because if a corporation doesn’t qualify for the exemption for any given tax year, it will not qualify for the exemption for any later tax year.
  • A corporation (other than a “large” corporation) that anticipates a small net operating loss (NOL) for 2015 (and substantial net income in 2016) may find it worthwhile to accelerate just enough of its 2016 income (or to defer just enough of its 2015 deductions) to create a small amount of net income for 2015. This will permit the corporation to base its 2016 estimated tax installments on the relatively small amount of income shown on its 2015 return, rather than having to pay estimated taxes based on 100% of its much larger 2016 taxable income.
  • If your business qualifies for the domestic production activities deduction (DPAD) for its 2015 tax year, consider whether the 50%-of-W-2 wages limitation on that deduction applies. If it does, consider ways to increase 2015 W-2 income, e.g., by bonuses to owner-shareholders whose compensation is allocable to domestic production gross receipts. Note that the limitation applies to amounts paid with respect to employment in calendar year 2015, even if the business has a fiscal year.
  • To reduce 2015 taxable income, if you are a debtor, consider deferring a debt-cancellation event until 2016.
  • To reduce 2015 taxable income, consider disposing of a passive activity in 2015 if doing so will allow you to deduct suspended passive activity losses.
  • If you own an interest in a partnership or S corporation, consider whether you need to increase your cost basis in the entity so you can deduct a loss from it for this year.

These are just some of the year-end steps that can be taken to save taxes. Again, by contacting us, we can tailor a particular plan that will work best for you. We also will need to stay in close touch in the event that Congress revives expired tax breaks to assure that you don’t miss out on any resuscitated tax-saving opportunities.

If you’d like to know more about tax planning or want to discuss other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.

Posted in Financial Planning, retirement planning, tax planning. Tags: , , , . Leave a Comment »

The Paris Attacks

November 16, 2015 — Sam H. Fawaz

Most of us watched news coverage of the multiple terrorist acts against the city of Paris, France, with a mixture of horror and dread. The horror was our usual response to terrorism, the feeling that arises when we ask ourselves: how can people think this way? And when we realize that, somehow, there ARE people who think that way, which is so far from our own reality, that the realization triggers deep emotions somewhere far on the opposite end of the spectrum from inspirational.

The dread, of course, comes from the realization that these attacks could have, and might still, happen here—that is, wherever we happen to be sitting, whatever concert venue or restaurant we might be planning to visit.

Hard on these emotions comes outrage, and that helps illustrate something that is seldom realized about terrorism. In a recently published book entitled The Better Angels of Our Nature, author Steven Pinker points out that terrorism is far from a new phenomenon. After the Roman conquest, resistance fighters in Judea—who called themselves zealots—would stab unguarded Roman officials whenever the opportunity arose. In the 11th century, Shia muslims launched furtive assassinations on officials who practiced a different version of their belief system. For 200 years, a cult in India strangled tens of thousands of people traveling through their country. The assassination of President William McKinley was executed by a particularly ugly breed of terrorist known at the time as anarchists. Most of us remember days when London and Belfast were routinely rocked by Irish Republican Army terror strikes, and in the U.S., the Weather Underground of the 1960s had a terrible habit of setting off explosives in public places.

The book lists many other instances of terrorist organizations, but all of them prove a point: eventually, each of these groups will go too far, provoke the consciousness of the general public in the wrong way, and turn sympathy to their cause into outrage. Pinker cites statistics that show that virtually zero terrorist organizations ever accomplish their aims, and they tend to die out after their most visible credibility-destroying “success.” One has only to think of the fate of Al Qaeda after 9/11 as an example of a terrorist organization whose relevance declined to near zero in the messy aftermath.

No doubt, the ISIS leaders who planned the attacks on Paris believed that this bloodletting would cause all Western nations to recoil in fear, and back off of their military efforts to contain the new caliphate so it wouldn’t strike again. You and I know that this is pure nonsense. The inevitable outcome will be a new resolve, a hardening, a coming-together of the Western nations in a display of solidarity with France. Countries that were inclined not to get involved in the Middle Eastern messiness are now motivated to sign on for an international military campaign that will contain and perhaps completely destroy ISIS. Leaders who feared that their citizens would revolt at the thought of military intervention can now count on the support of their outraged voters. The next year or two will almost certainly reveal the ISIS attacks on Paris to have been a fatal mistake for those who dream of an Islamic, Sharia-governed caliphate in Syria and Iraq.

Today, you will see the world’s investment markets open lower, and probably close lower, as the horror of the events in Paris are translated into uncertainty about the world we live in—and, therefore, the safety of our assets, reflected in our stocks. The markets always respond reflexively and negatively to threats to our safety.

But as the year proceeds through its last few weeks, the smart money always tells us that these downturns are temporary. Fears that global enterprises are somehow worth less because blood was spilled overseas will prove to be overblown. More importantly, after the events in Paris, the object of our horror and fear—the terrorist organization known as ISIS—is about to confront an opponent more powerful than its leaders have the ability to imagine: the resolve of the Western nations. At the same time, it will have to endure the disgust and repudiation of moderate members of the muslim faith, in the Middle East and elsewhere.

The world changed over the weekend, but not in a way that affects the value of your investments. The change will be felt most powerfully in the failed dreams of a caliphate whose leaders have made a grave and awful miscalculation, who are destined to pay dearly for their malicious stupidity.

TheMoneyGeek thanks guest writer Bob Veres for writing this post

Posted in General. Tags: . Leave a Comment »

Medicare Cost Increases

November 5, 2015 — Sam H. Fawaz

At the same time it was announcing that Social Security recipients wouldn’t receive any increases in their benefits, the government was announcing that certain Medicare participants would be paying dramatically higher premiums for Medicare Part B, the highest price jump in the program’s history. In general, the higher premiums will affect new enrollees in 2016, enrollees who don’t yet collect Social Security checks, enrollees with incomes above $85,000 (single) or $170,000 (married), and dual Medicare-Medicaid beneficiaries. In all, that represents 30% of 2016 Medicare beneficiaries—roughly 7 million Americans.

This jump in some recipients’ costs is, ironically, tied to a relative bargain for others. Under something called the “hold harmless” clause in Social Security, in years when there is no cost of living increase in Social Security payments, the government also has to keep Medicare Plan B the same for those receiving Social Security payments. Under current law, the government has to collect 25% of all expected Part B costs from recipients each year. As a result, this relative bargain for many retirees had to be paid for by others—meaning: those NOT receiving Social Security checks.

Medicare recipients who are not taking Social Security checks, who fall below the income thresholds, will see their monthly premiums go up from $104.90 to $123. Those whose income is above the threshold could see increases of $223 a month up to $509.80 a month for individuals whose family income exceeds $428,000 a year.

So next year will see some retirees make out better than expected on their Medicare costs, while others will lose big. There are proposals in Congress to fix this situation, but you shouldn’t expect any big reform in an election year. Should you take matters into your own hands and start collecting Social Security benefits—putting you in the protected class of Medicare recipients? Probably not. First, for those under age 70, it means locking in lower Social Security benefits. And second, if your income is above the $85,000 (single)/$170,000 (joint) thresholds, you will pay higher premiums anyway.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://www.aarp.org/health/medicare-insurance/info-2015/medicare-part-b-premiums-could-spike.html?intcmp=HP-FLXSLDR-SLIDE1-MAIN

https://www.medicare.gov/your-medicare-costs/part-b-costs/part-b-costs.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

Posted in Financial Planning, retirement planning. Tags: , , . Leave a Comment »

No Social Security Benefit Increase This Year

October 25, 2015 — Sam H. Fawaz

You’ve probably heard by now that the 2016 cost of living (COLA) adjustment for Social Security benefits is zero—the third time this has happened in the last seven years. (2010 and 2011 were the other recent years.) In fact, Social Security benefit increases have stalled since the Great Recession; only once since 2008 have they risen by more than 2%.

For many retirees, this was surprising news. Anybody who has visited the grocery store lately knows that the price of food is rising. Every day, the papers tell us that housing costs are increasing and medical care costs are also rising.

You will undoubtedly see websites which blame the Obama Administration or Democrats generally for trying to balance the federal budget on the backs of people who have paid into the Social Security system, but in fact the annual COLA calculation is automatic and set by formula.

The formula is something called the Consumer Price Index for All Urban Wage Earners and Clerical Workers, known to economists as CPI-W, calculated by the government’s Bureau of Labor Statistics in an effort to make the purchasing power of Social Security as close as possible to the same each year. The CPI-W was attached to Social Security payments in 1972 and has never been replaced. There are many components, and indeed most of them rose in 2015. Food was calculated to be 1.6% more expensive than it was last year; shelter costs rose 3.2% and medical costs were up 2.4%. Ironically, the falling price of gasoline was the factor which drove the CPI-W back to zero; the index tells us that energy prices declined 18.4% this year.

Is this a fair way to calculate actual costs of living? Many believe it is not, for several reasons. First, the CPI-W is a weighted formula, based on the costs of urban workers, not retirees. Therefore, it presupposes, in the weightings, a very different lifestyle than most Social Security recipients are living. The price of gasoline, for example, is assumed to represent 20.1% of a retiree’s total expenditures, which may be true for somebody who commutes to work every day in one of America’s major cities, but doesn’t reflect the normal lifestyle of a retiree. Medical care is assumed to be 5.1% of a retiree’s annual expenditures. For a young office worker, that may be a slight overstatement. For a retiree over age 70, it is almost certainly a gross understatement.

Recreation is assumed to be 5.4% of expenditures, which again sounds about right for the office worker who brings home work on the weekends. But a retiree almost certainly spends more on travel and greens fees. (Amusingly, college tuition is assumed to be 1% of the average CPI-W person’s expenditures.)

Is there a way to fix the formula so it more accurately reflects the actual costs of living in retirement? The Bureau of Labor Statistics actually calculates, each year, something called the Consumer Price Index for the Elderly. In that index, transportation costs are assumed to make up a more realistic 14% of yearly expenditures, and medical care counts double the CPI-W figure: 10.9% of assumed expenditures. Curiously, the index assumes that retirees spend less money on recreation (4.4%) and food away from home (4.6%, compared with 6.4% for that urban worker). The Social Security Administration has calculated that if it had been using the CPI-E COLA each year, rather than the CPI-W, the result would have been significantly higher Social Security benefits, more than 15% higher than today’s payments.

So is it time to push for a switch? Alas, the proposals currently in Congress have nothing to do with the CPI-E. Our elected representatives want to switch the index tied to Social Security benefits to something called the “chain-weighted CPI,” which annually comes up with lower COLA figures—and would, indeed, help balance the budget on the backs of seniors. Instead of complaining, should we celebrate the fact that the cost of living calculation wasn’t negative for next year?

With the federal reserve holding interest rates at zero percent, and now no COLA increase for social security recipients, our senior citizens continue to see an erosion of their buying power and no return on their low-risk savings which they worked a lifetime to accumulate. It certainly doesn’t seem very fair, and makes the case for careful financial planning very clear.

If you would like to exchange thoughts about your social security benefits or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://www.usatoday.com/story/money/personalfinance/2015/10/16/tips-social-security-recipients-worried-no-cola-2016/73993428/

http://www.nbcnews.com/business/retirement/social-security-benefits-remain-unchanged-next-year-n445066

http://www.socialsecurity.gov/policy/docs/ssb/v67n3/v67n3p73.html

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

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Searching for Yield in Today’s Market

October 11, 2015 — Sam H. Fawaz

Income-oriented investors have had a tough go of it for the past several years. Persistently low interest rates have curtailed traditional sources of yield. Yet, by broadening their search criteria, investors may uncover new ways to diversify their income portfolios with potentially more attractive options.

Consider Total Return

When evaluating income-generating opportunities investors need to consider total return — income plus price appreciation, while maintaining a consistent focus on risk reduction. When you think in these terms, certain asset classes can emerge as relatively more attractive. Given these parameters, here are a few equity and fixed-income investments to consider.

Equity real estate investment trusts (REITs) — Equity REITs are investments consisting of diversified portfolios of commercial real estate that are publicly traded on major exchanges.1 Because their focus tends to be on owning U.S.-based properties, equity REITs stand to benefit from improving economic conditions, such as the boost in U.S. job growth, which, in turn, could increase demand for commercial real estate. From a yield perspective, REITs are required to distribute 90% of their annual income to shareholders in the form of dividend payments.

When this income-generating capability is coupled with real estate’s potential to appreciate in value, equity REITs may be considered an attractive investment from a total return perspective. To manage risk, it is wise to maintain a portfolio that is broadly diversified by property type, location, and geographic area. In addition, even though equity REITs are considered equity investments, they historically have had a low correlation with stocks, which allows investors to benefit from the potential for enhanced returns while lowering their equity portfolio’s overall risk profile.

Global bonds — One of the key arguments for considering an allocation to global bonds is to add currency exposure to a portfolio.2 Although currency adds another level of volatility to a portfolio’s fixed-income allocation, it also provides investors with a natural hedge against the devaluation of the dollar, which traditional domestic fixed-income asset classes cannot offer. Another reason to consider adding global bonds is the prospect for higher economic growth rates outside the United States (see table below).2 As world economies grow more quickly, investors with an exposure to global bonds stand to benefit from this growth.

World Economic Growth Rates
2014 2015 — Projected
United States 2.4% 3.1%
Developed World (incl the USA) 1.8% 2.4%
Emerging/Developing Markets 4.6% 4.3%

Source: International Monetary Fund, World Economic Growth, April 2015.

When researching global bonds from an income perspective, it may be important to consider that many foreign countries typically run on different business/interest rate cycles than the United States. Therefore, when interest rates are higher abroad, global bond investors potentially may be able to take advantage of these varying cycles to earn higher yields.

Keep in mind that unlike international bond funds, which typically are bound by their investment policies to adhere to a non-U.S.-allocation mandate, managers of global bond funds have the flexibility to shift allocations out of foreign markets back into domestic securities (and vice versa) as conditions warrant. In this way, U.S. investors in global bonds may potentially gain protection on the downside while retaining the ability to participate on the upside.

Leveraged loans — When considering high yield, few investors tend to think of leveraged loans.3 Briefly, leveraged loans are floating rate loans that banks make to below-investment-grade companies, hence their high-yield status. Since they are adjustable rate instruments, tied to short-term interest rates, they can provide investors a hedge against interest rate risk — if interest rates rise, the coupon on the loan resets accordingly. This feature can potentially result in better performance relative to longer-term fixed income in a rising rate environment, as traditional fixed-income asset prices tend to move inversely with changes in interest rates.

One unique feature of leveraged loans that makes them potentially less risky than traditional high-yield bonds is their senior-secured status, meaning in case of a potential default, investors in leveraged loans may be more likely to get their money back.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Source/Disclaimer:

1The stock prices of companies in the real estate industry are typically sensitive to changes in real estate values; property taxes; interest rates; cash flow of underlying real estate assets; occupancy rates; government regulations affecting zoning, land use and rents; and the management skill and creditworthiness of the issuer. Companies in the real estate industry may also be subject to liabilities under environmental and hazardous waste laws which could negatively affect their value.

2Foreign bond investments involve greater risks than U.S. bond investments, including political and economic risks, the risk of currency fluctuations, as well as liquidity risks and may not be suitable for all investors.

3Lower-quality debt securities involve greater risk of default or price changes due to changes in the credit quality of the issuer. They may not be suitable for all investors.

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2015 Third Quarter Review

October 5, 2015 — Sam H. Fawaz

Many investors will be glad to finally see the end of the third quarter of 2015, and most of them will feel like their portfolios are worse off than they actually are. That whooshing sound you hear is not just air being let out of the markets; it’s also an end to that optimistic feeling that many people had been cautiously building during the long 6-year bull market that followed the Great Recession.

The past three months turned yearly gains into yearly losses almost completely across the board of the investment opportunity set. The Wilshire 5000–the broadest measure of U.S. stocks—fell 6.91% in the third quarter of 2015, posting a total return of -5.79% in the first half of the year. The comparable Russell 3000 index is down 5.45% so far this year.

The Wilshire U.S. Large Cap index dropped 6.44% of its value for the quarter, and is now down 5.15% for 2015. The Russell 1000 large-cap index is down 5.24% so far this year, while the widely-quoted S&P 500 index of large company stocks posted a loss of 6.94% in the third quarter, and is now down 6.75% for the year.

The Wilshire U.S. Mid-Cap index lost 8.96% for the quarter, and is now off 4.86% as we head into the fourth quarter. The Russell Midcap Index has lost 8.58% so far this year.

Small company stocks, as measured by the Wilshire U.S. Small-Cap index, gave investors a 10.88% loss during the latest three months, which takes the index down 7.29% so far in 2015. The comparable Russell 2000 Small-Cap Index is down 7.73% in the first three-quarters of the year, while the technology-heavy Nasdaq Composite Index lost 7.35% for the quarter, and stands at a 2.45% loss for the first three quarters of the year.

Meanwhile, in the global markets, the broad-based EAFE index of companies in developed foreign economies lost 10.75% in dollar terms in the third quarter of the year, for a negative 7.35% return so far this year. In aggregate, European stocks lost 9.07%, and are down 7.33% for the year. Emerging markets stocks of less developed countries, as represented by the EAFE EM index, were down a whopping 18.53% for the quarter, and are down 17.18% for the year.

Looking over the other investment categories, real estate investments, as measured by the Wilshire U.S. REIT index, gained 2.88% for the third quarter, but is still standing at a 3.01% loss for the year. Commodities, as measured by the S&P GSCI index, lost 19.3% in the third quarter, largely due to a fall in oil prices that may be nearing its end. They are down 19.46% this year.

There were many contributors to the loss of confidence in the stock market, and they appear to have been mainly psychological. Analysts blame the Federal Reserve Board for not having raised rates as the so-called “smart money” seems to have expected in September. Why are low rates a bad thing? Because Fed economists seem to believe that the economy has not recovered sufficiently to warrant stopping the central bank’s long-running stimulus program. Who are we investors to argue with the Fed economists?

Except… The explanation for not raising rates had little to do with actual economic activity, which is finally moving ahead, as of the second quarter, at an annualized 3.9% growth rate for U.S. GDP. This is higher than the 3.7% estimate from the Bureau of Economic Analysis, and much higher than the 2% rate that the U.S. economy has experienced since 2009. At the same time, consumer income, wages and salaries, and spending are all increasing modestly, existing home sales are growing at a 6.2% rate over last year, and the unemployment rate, once higher than 10%, has finally dropped down to the 5% range.

The Fed explained that it was delaying its rate rise because the core inflation rate—currently 1.83%, is below the 2% target rate the Fed set back in June 2012. Some people believe low inflation is a GOOD thing, and speculate that’s the real reason.

And another reason why many investors are nervous about the markets—could be the slower growth of the Chinese economy, coupled with the recent unnerving drop in its stock market. Unfortunately, the Chinese government controls the economic statistics that come out of the world’s second largest economy, which makes it hard to know exactly how fast China is or isn’t growing. But it’s worth noting that Chinese stock prices, even after the drop, are still up 31.6% from where they were a year ago.

For the time being, investors will have to continue to accept interest rates at historically low levels. The Bloomberg U.S. Corporate Bond Index now has an effective yield of 3.42%. 30-year Treasuries are yielding 2.87%, down from 3.13% a quarter ago, and 10-year Treasuries currently yield 2.06%, down from 2.36% in June.

At the low end, the yield on 3-month U.S. T-bills remains at 0.01%. 6-month bills are only slightly more generous, at 0.08%. Long-term (30-year) municipal bonds are yielding 3.16%, more than comparable Treasuries, and you get the federal tax-exemption thrown in for good measure.

When you look at the decline year-to-date, you see relatively small losses. But many investors are remembering that they were 10-15% wealthier just a couple of months ago, measuring their pain from the high point of the various indices. It’s tough to watch your portfolio go down, but it’s also worth remembering that people have been predicting a significant downturn—erroneously—for the better part of six years. Now that the downturn has finally arrived, it hasn’t been terribly painful, mostly giving back gains that were posted in the first two quarters.

The third quarter could be a temporary drawdown that sets the market up for a push back into positive territory by the end of the year, which would give us a record seven years of positive market performance. Or we could see the year end in negative territory, perhaps even giving us the first true bear market (defined as a drop of 20% from the peak) since the Great Recession. We don’t know how the psychology of millions of investors will turn in the next few months, and neither do the smart money analysts who thought that interest rates would be nudged upward by our central bank last month.

We do, however, have confidence that the next bear market will be followed by yet another bullish period that will eventually take us back into record territory, and we’re pretty sure that the markets will punish anyone who tries to outguess their unpredictable behavior in the short term. If you know what the next quarter will bring, please tell us now. Meanwhile, perhaps we should celebrate the fact that we can buy many kinds of investments at cheaper prices than we could just three short months ago. It’s not much, but it’s something to feel good about.

In our client portfolios, our returns this quarter were buffered by a larger than normal cash position, investments in inverse funds, a focus on defensive sectors, and by selling call options against some of our positions. If the market chooses to launch a 4th quarter rally, we’ll be ready for it. It may even have already started. But if the market instead chooses to go the bear route, we’ll increase our defensiveness further.

If you would like to review your current investment portfolio or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

Wilshire index data: http://www.wilshire.com/Indexes/calculator/

Russell index data: http://www.russell.com/indexes/data/daily_total_returns_us.asp

S&P index data: http://www.standardandpoors.com/indices/sp-500/en/us/?indexId=spusa-500-usduf–p-us-l–

http://www.tradingeconomics.com/united-states/unemployment-rate

Nasdaq index data: http://quicktake.morningstar.com/Index/IndexCharts.aspx?Symbol=COMP

International indices: http://www.mscibarra.com/products/indices/international_equity_indices/performance.html

Commodities index data: http://us.spindices.com/index-family/commodities/sp-gsci

Treasury market rates: http://www.bloomberg.com/markets/rates-bonds/government-bonds/us/

Aggregate corporate bond rates: https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

Aggregate corporate bond rates: http://www.bloomberg.com/markets/rates-bonds/corporate-bonds/

Muni rates: https://indices.barcap.com/show?url=Benchmark_Indices/Aggregate/Bond_Indices

http://www.bloomberg.com/news/articles/2015-07-01/global-equity-axis-tilts-east-even-as-china-takes-gloss-off-gain

http://money.cnn.com/2015/06/29/investing/china-stocks-bear-market/index.html

http://www.reuters.com/article/2015/10/01/us-usa-economy-idUSKCN0RV4I120151001

http://www.theguardian.com/business/2015/sep/28/us-stock-markets-fall-concerns-china-economy

http://www.usnews.com/news/business/articles/2015/10/01/asia-stocks-higher-china-manufacturing-index-ticks-higher

http://www.usnews.com/news/articles/2015/09/29/will-russias-move-ruin-erdogans-plan-for-syria?int=af8409

http://www.usnews.com/news/articles/2015/10/01/federal-reserve-stands-pat-on-interest-rates-as-an-anxious-world-waits?int=a6f909

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post.

Posted in Financial Planning, General, retirement planning. Tags: , . Leave a Comment »

Should You “Fix” Variable Rate Debt?

September 27, 2015 — Sam H. Fawaz

While investors are keeping a close watch on the Federal Reserve for indications of when it will start raising interest rates, the consensus among economists is that it will begin its credit-tightening cycle at some point this year.

Of course there are two sides to the interest rate coin: the investor and the borrower. Rising rates are generally good news for savers and investors, but they represent an expense for borrowers and increase the cost of taking out loans and mortgages.

In the current environment, individuals may be evaluating the potential benefits of converting variable-rate loans, including adjustable rate mortgages (ARMs), home equity lines of credit, and student loans, to a fixed rate.

Only One Way to Go

Interest rates are still at historic lows and are only likely to go up from here. Personal finance experts typically favor refinancing, when practical, to a fixed rate for the stability it provides the borrower. With a fixed-rate loan the borrower will not have to be concerned if there is a sudden spike in interest rates. What’s more, individuals with fixed-rate debt have much more control over their budget and can plan ahead with more confidence, as they have a clear, predictable picture of their monthly income and expenses.

While adjustable-rate loans may have lower initial interest rates than fixed-rate loans, the lower interest rate is only for a set period of time. At the end of the fixed period, the monthly loan amount “adjusts” based on the market rate or index. In this case, refinancing may be a smart choice if your ARM is adjusting to an interest rate that is higher than the current market rate.

How Low Are Rates?

Just how low are short-term rates now, historically speaking? Most lenders base their variable rates off a LIBOR rate, which stands for London Interbank Offered Rate and works as a benchmark rate for banks internationally.1 As the LIBOR changes, so does the variable rate. The LIBOR is low today, compared to its 10-year and 20-year averages (see table below), but once it begins to increase, borrowers holding adjustable rate loans will see an increase in their regular payments. While most variable rate loans will have an upper interest rate cap, it is important to know what that maximum rate is — and whether you could handle that potential debt load — before signing any documents.

LIBOR — Then and Now

10-year average 20-year average July 6, 2015
6-month LIBOR 1.95% 3.09% 0.44%
12-month LIBOR 2.17% 3.29% 0.76%

Source: Federal Reserve Economic Data (FRED). For the dates indicated. The 10-year and 20-year averages are for the period ended July 6, 2015.

Generally, a variable rate loan is a safe bet for individuals who plan to repay their loan quickly, or have a short time horizon for underlying property ownership. For example, if you plan to move within 3-5 years, refinancing to a fixed rate mortgage may not be worthwhile, when you take into account the cost of refinancing compared with your monthly potential payment (interest) savings. In general, you should be able to recoup your refinancing costs within two years to make it worthwhile in the short term.

While the Federal Reserve is expected to begin raising rates soon, it is likely to take a very measured, slow path, so there’s really no need to rush into a refinancing.

If you would like to review your current loans or discuss any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Source:

1 U.S. News.com, “Fixed or Variable: Which Interest Rate Should You Choose?” July 14, 2015

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Rent or Buy?

September 20, 2015 — Sam H. Fawaz

If you read articles that offer budgeting advice, you might see an item that says you shouldn’t spend more than 25% of your income on housing costs. These days, that advice doesn’t apply.

Why? According to the latest report from Zillow Group, which tracks rental housing affordability, the typical renter making the median income in the U.S. spent 30.2% of her income on a median-priced apartment. This is the highest rate since Zillow started keeping statistics in 1979. The average from 1985 to 1999 was 24.4%.

The rise appears to be driven by greater demand for apartments and rental units. In the second quarter of this year, due to strict lending standards, the U.S. homeownership rate fell to the lowest level in almost five decades, forcing a greater number of people into the rental market. However, those fortunate enough to obtain mortgage loans appear to be much better off than renters. With today’s low interest rates, homeowners are paying, on average, 15% of their income in mortgage payments, well below the historical average of 21%.

Zillow found that rents were least affordable in Los Angeles, where residents were paying 49 percent of monthly income. The share in San Francisco was 47 percent, 45 percent in Miami, and 41 percent in the New York metro area.

If you would like to discuss whether renting or buying makes more sense for you or talk about any other financial planning matters, please don’t hesitate to contact us or visit our website at http://www.ydfs.com. We are a fee-only fiduciary financial planning firm that always puts your interests first.  If you are not a client yet, an initial consultation is complimentary and there is never any pressure or hidden sales pitch.

Sources:

http://www.bloomberg.com/news/articles/2015-08-13/renting-in-america-has-never-been-this-expensive

The MoneyGeek thanks guest writer Bob Veres for his contribution to this post

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