Highlights & Summary of the Tax Relief Act of 2010

December 17, 2010 — Sam H. Fawaz

I promised to keep you updated on the tax bill that was before congress which essentially extends the Bush era tax cuts for two years. Here are the highlights and full summary with more details to come in the next couple of weeks:

On Thursday December 16, 2010, Congress passed the Tax Relief, Unemployment Insurance Re-authorization and Job Creation Act of 2010. President Obama just signed the bill this afternoon Friday December 17, 2010.  This legislation, negotiated by the White House and select members of the House and Senate, provides for a short-term extension of Bush era tax cuts made in 2001.  It also addresses the Alternative Minimum Tax (AMT) and Estate, Gift and Generation-skipping Transfer taxes.

The following summary will provide you with key information and highlights from the bill with help from the Financial Planning Association. If you have any additional questions, please do not hesitate to contact me at (734) 447-5305 or at hf@ydfs.com. I hope that you find this summary useful for your personal and business affairs.

HIGHLIGHTS

Two-year extension of all current tax rates through 2012

  • Rates remain 10, 25, 28, 33, and 35 percent
  • 2-year extension of reduced 0 or 15 percent rate for capital gains & dividends
  • 2-year continued repeal of Personal Exemption Phase-out (PEP) & itemized deduction limitation

Temporary modification of Estate, Gift and Generation-Skipping Transfer Tax for 2010, 2011, 2012

  • Reunification of estate and gift taxes
  • 35% top rate and $5 million exemption for estate, gift and GST
  • Alternatively, taxpayer may choose modified carryover basis for 2010
  • Unused exemption may be transferred to spouse
  • Exemption amount indexed for inflation in 2012

AMT Patch for 2010 and 2011

  • Increases the exemption amounts for 2010 to $47,450 ($72,450 married filing jointly) and for 2011 to $48,450 ($74,450 married filing jointly).  It also allows the nonrefundable personal credits against the AMT.

Extension of “tax extenders” for 2010 and 2011, including:

  • Tax-free distributions of up to $100,000 from individual retirement plans for charitable purposes
  • Above-the-line deduction for qualified tuition and related expenses
  • Expanded Coverdell Accounts and definition of education expenses
  • American Opportunity Tax Credit for tuition expenses of up to $2,500
  • Deduction of state and local general sales taxes
  • 30-percent credit for energy-efficiency improvements to the home
  • Exclusion of qualified small business capital gains

Temporary Employee Payroll Tax Cut

  • Provides a payroll tax holiday during 2011 of two percentage points. Employees will pay only 4.2 percent on wages and self-employed individuals will pay only 10.4 percent on self-employment income up to $106,800.

FULL SUMMARY

Reductions in Individual Income Tax Rates through 2012

  • Income brackets remain 10, 25, 28, 33, and 35 percent
  • Capital gains and dividend rates remain at 0 or 15 percent
  • Repeal of the Personal Exemption Phase-out (PEP)
  • Repeal of the itemized deduction limitation (Pease limitation)
  • Marriage penalty relief
  • Expanded dependent care credit
  • Child Tax Credit
  • Earned income tax credit

Education Incentives Extended Through 2012

  • Expanded Coverdell accounts and definition of education expenses
  • Expanded exclusion for employer-provided educational assistance of up to $5,250
  • Expanded student loan interest deduction
  • Exclusion from income of amounts received under certain scholarship programs
  • American Opportunity Tax Credit of up to $2,500 for tuition expenses

Extension of Certain Expiring Provision for Individuals through 2011

  • Above-the-line deduction for qualified tuition and related expenses
  • Tax-free distributions of up to $100,000 from individual retirement plans for charitable purposes.  Donors may treat donations made in January 2001 as if made in 2010.
  • 30-percent credit for energy-efficiency improvements to the home
  • Deduction of state and local general sales taxes
  • Parity for employer-provided mass transit benefits
  • Contributions of capital gain real property for conservation purposes
  • Deductibility of mortgage insurance premiums for qualified residence
  • Estate tax look-through of certain Regulated Investment Company (RIC) stock held by nonresidents for decedents dying before January 1, 2012
  • Above-the-line deduction for certain expenses of elementary and secondary school teachers

Alternative Minimum Tax (AMT) Relief

  • The legislation increases the exemption amounts for 2010 to $47,450 (individuals) and $72,450 (married filing jointly) and for 2011 to $48,450 (individuals) and $74,450 (married filing jointly).  It also allows the nonrefundable personal credits against the AMT.

Temporary Estate Tax Relief and Modification of Gift and Generation-skipping Transfer Taxes

  • Higher exemption, lower rate. The legislation sets the exemption at $5 million per person and $10 million per couple and a top tax rate of 35 percent for the estate, gift, and generation skipping transfer taxes for two years, through 2012. The exemption amount is indexed beginning in 2012. The proposal is effective January 1, 2010, but allows an election to choose no estate tax and modified carryover basis for estates arising on or after January 1, 2010 and before January 1, 2011. The proposal sets a $5 million generation-skipping transfer tax exemption and zero percent rate for the 2010 year.
  • Portability of unused exemption. Under current law, couples have to do complicated estate planning to claim their entire exemption.  The proposal allows the executor of a deceased spouse’s estate to transfer any unused exemption to the surviving spouse without such planning. The proposal is effective for estates of decedents dying after December 31, 2010.
  • Reunification of estate and gift taxes. Prior to the 2001 tax cuts, the estate and gift taxes were unified, creating a single graduated rate schedule for both. That single lifetime exemption could be used for gifts and/or bequests. The proposal reunifies the estate and gift taxes. The proposal is effective for gifts made after December 31, 2010.
  • As noted above. the look-through of RIC stock held by non-resident decedents is extended through 2011

Temporary Extension of Investment Incentives

  • Extension of bonus depreciation for taxable years 2011 and 2012
  • Small Business Expensing: increase in the maximum amount and phase-out threshold under section 179. Sets the maximum amount and phase-out threshold for taxable years 2012 at $125,000 and $500,000 respectively, indexed for inflation.  (Previously-passed legislation raised the 2010 and 2011 max amount and phase-out at $500,000 and $2,000,000 respectively.)

Extension of Certain Expiring Provisions for Businesses through 2011

  • Enhanced charitable deduction for corporate contributions of computer equipment for educational purposes
  • Enhanced charitable deduction for contributions of food inventory
  • Enhanced charitable deduction for contributions of book inventories to public schools
  • Special rule for S corporations making charitable contributions of property
  • 15-year straight-line cost recovery for qualified leasehold improvements
  • Employer wage credit for activated military reservists
  • Tax benefits for certain real estate developments
  • Extension of expensing of environmental remediation costs
  • Treatment of interest-related dividends and short term capital gain dividends of Regulated Investment Companies (RICs)
  • Work opportunity tax credit (WOTC)
  • 100% Exclusion of qualified small business capital gains held for more than 5 years
  • Research credit
  • Qualified Zone Academy bonds

Extension of Unemployment Insurance

  • The unemployment insurance proposal provides a one-year re-authorization of federal UI benefits.

Temporary Employee Payroll Tax Cut

  • The legislation creates a payroll/self-employment tax holiday during 2011 of two percentage points. The employer’s share of the payroll tax remains unchanged.  This means employees will pay only 4.2 percent on wages and self-employed individuals will pay only 10.4 percent on self-employment income up to $106,800.  The social security trust fund is made whole by transfers from the general fund.

Please check out my January-February 2010 Money Magazine Portfolio Makeover-Can I retire Early? http://bit.ly/5aGwIO

Have a small business?  Don’t miss out on these business tax deductions http://bit.ly/a49I1K

6 Ways To Gift Money to Family http://bit.ly/aDG90W

Follow me on Twitter at http://twitter.com/TheMoneyGeek for relevant personal finance advice and tips on great deals.

Read our blog: http://themoneygeek.com

YDream Financial Services, Inc. is providing this information as a service to its subscribers. While this information deals with tax and legal issues, it does not constitute tax or legal advice and cannot be relied upon as such for avoidance of penalties in matters before the IRS. If you have specific questions related to this information, you are encouraged to consult us, a tax professional or an attorney who can investigate the particular circumstances of your situation.

Sources: U.S. Senate Committee on Finance; U.S. Congress Joint Committee on Taxation

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner (CFP®), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP® and the Financial Planning Association(of which Sam is a member) and is provided by YDream Financial Services, Inc.

Posted in Taxes. Tags: , , , , , . Leave a Comment »

Happy Thanksgiving and a Quick Market Update

November 26, 2010 — Sam H. Fawaz

I just wanted to post a quick note to wish you and yours a very Happy Thanksgiving Holiday.  Here’s hoping that you are celebrating it in good health surrounded by family and friends.  Without both, life would be such a drag.

I am thankful for my family and friends, good health and the best clients and readers in the world.  I can’t imagine myself doing anything else that I would enjoy more in life than what I’m doing now.  I hope that you feel the same way about what you do, and if not, I hope you’ll take steps in your life to move closer to the activities that bring you joy and happiness.  It’s really about getting what you need and want out of the day rather than getting through the day.

A Quick Stock Market Update

The last few weeks have been quite volatile in the stock markets, and to be honest with you, it was really all my fault.  Right after I sent out my last newsletter update about the Federal Reserve pumping up the markets, we entered into a long overdue correction (a decline in prices).  As I had mentioned, the markets had gone straight up during September, October and early November, so it was no surprise that a correction was coming. We have swung up and down and sideways without much upside and thankfully without much downside either.

In some cases, I took advantage of this correction to “prune” (sell) certain client positions to lock in profits or avoid losses.  This past Tuesday, a day when everything was trending downward and things looked like they were about to fall apart (a day where about 90% of all asset classes were down) due to the events in Europe and South Korea, I took 95% of our available cash and invested it at the lows of the recent market range.  We were immediately rewarded yesterday as all the markets were up “big” to kick off what I hope to be a great year-end Santa Claus rally.  Seasonally, this period of the year tends to be the strongest for gains in the markets.  While we are technically still in a correction phase, I expect the uptrend to resume soon (but my crystal ball is still in the shop).  Recent economic news has been very positive, some much better than expected, and first time unemployment claims this week surprised nicely to the downside.

I still remain optimistic about a positive finish to the year and the rally continuing into 2011 as the economy recovers.  I believe that this is the best time to be invested in the markets as Uncle Sam has told us that he wants the markets higher. Consider taking advantage of this recent market correction to dip your toes into the market.  I like that most are pessimistic about the markets since that tends to propel them higher.  Yes, we have economic worries, future inflation, high unemployment and a moribund housing market, but those problems didn’t develop overnight, so they won’t be solved overnight either.  We are making progress, and that’s what really counts.

Later in December, I will send out my 2011 market and economic outlook newsletter.  In the meantime, year-end tax planning is in full swing and hopefully you’ve benefitted from my year-end tax planning newsletter and tips.  Remember, if you’re thinking about an IRA to Roth conversion in 2010, you only have about five weeks to complete it.  Don’t hesitate to contact us to discuss whether this option is appropriate for you. I am also available to help with your year-end financial or tax planning.

Enjoy your holiday weekend and please let me know if I can be of any help.  And remember: 50%+ off sales are great, but the best sales are those that save you more than 100% (that is, when you save and invest the money instead..sorry I couldn’t resist).  By the way, I was recently quoted in another online financial story-see the link below about Six Ways to Gift Money to Family.

New: 6 Ways To Gift Money to Family http://bit.ly/aDG90W

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner (CFP®), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP and is provided by YDream Financial Services, Inc.

Posted in General, investing, markets, retirement. Tags: , , , . Leave a Comment »

What’s Going On With Gold Part 2

July 5, 2010 — Sam H. Fawaz

Back on November 18, 2009, I wrote for the first time about what’s going on with gold as an investment.  Since that date, gold has appreciated 8.4% while the S&P 500 index (a proxy for stocks) has declined 7.1%.  All indications are that the price of gold will continue to rise.

To date, I have personally not been able to bring myself to invest any of my own money in gold, and I remain a bit skeptical of it as an investable asset class.  However, as I’ve said before, I cannot ignore the fact that the uptrend that started in March 2009 has continued and has every indication that it will continue until the trend is broken.

In the past, the price of gold has appreciated while inflation was a threat or was marching upward (an inflation hedge.)  The price of gold usually continues to increase up until the point when the Federal Reserve raises interest rates enough to no longer make gold an attractive alternative; that is, until the actual interest rate paid on money market funds is something greater than the current 0.01%.  But today, we are facing the opposite environment: a potential deflationary environment in light of high unemployment, plenty of available factory capacity and low consumer demand.  Gold is not supposed to go up in this type of environment, but with governments around the world running sky high deficits and debasing their currencies (through either printing money or deficit spending), gold seems to have become a de facto currency in of itself.  Several legendary hedge fund managers and institutional investors have invested significant sums of money in gold and countries and central banks around the world continue to accumulate it.

Here’s what a fellow trusted investment writer and money manager Jon D. Markman wrote about a recent Credit Suisse report on gold:

Investment banker Credit Suisse (CS) recently increased its long-range forecast, arguing in a new report that gold should remain near current levels for at least the next four years. CS analysts’ 2014 target is now $1,300, vs. their previous forecast of $1,120, as investors have become more supportive of the yellow metal.  That may not seem like a very brave forecast since gold is already trading at $1,242, or less than $60 under the long-term forecast, but it’s likely that the estimate will go further up.

The rationale for the change: Credit Suisse believes there is an 80% chance of a renewal of quantitative easing — or money printing — due either to a full-blown sovereign debt crisis or a new recession. This enthusiastic and inflationary activity would rev up the safe haven buying that has pushed gold prices up over the past few years. The feeling is that companies and government officials may cheat and lie, but gold is steady as a rock as an irrefutable, trusted source of value.

Also, the ultra-low interest rate policy of the world’s central banks will keep gold prices on the move. Historically, gold prices tend to rise when short-term interest rates are below 2%. This relationship has been particularly strong over the last few years. With the Fed likely to stay on hold through 2012, and the potential for inflation-adjusted interest rates to move further into negative territory with another round of quantitative easing, there’s little reason to think gold’s run higher will end anytime soon.

Complicating matters has been the decline in new gold production. Global gold production has been falling since 2001 at an average rate of 1.3% per year. Increased demand and less supply equals higher prices. Credit Suisse research in 2003 and 2005 indicated that the decline was being caused by a reduction in exploration targets and exploration efficiency. In other words, it was becoming harder and more expensive to find new untapped sources of gold.

While a number of new projects are about to get started, the long-term picture looks tight. From 2013 onward, CS predicts global production to fall at an annual rate of 2.5%. Gold has always had its allure based on scarcity value. Well folks, it’s about to get a heck of a lot scarcer.

Now gold doesn’t pay any dividends or generate any income, has limited industrial uses, has not kept up with inflation, and garners unfavorable ordinary income tax (not capital gain) treatment outside of retirement accounts.  You’ve probably seen and heard the ads on TV and radio of companies trying to sell you gold coins or buy your unwanted gold jewelry (you can safely ignore them.)  In some countries, you can now buy gold bars from a vending machine, and right here in the “good ole’ U.S. of A”, department stores are hocking gold bars like perfume and cologne.  Normally this would indicate a top in the price of gold, but all evidence to date indicates that the buyers of gold have been mostly institutional, not retail (consumer) buyers.  Of course, like any other investment, gold has the potential to go parabolic and become a bubble (and it likely will), but we’re not there yet.  My worst fear about gold would be to wake up one morning and find out that the price has dropped $200-$400 an ounce overnight.

Fun gold fact: Just last week, a 200 pound Canadian collectible leaf gold coin (face value $1 million) was auctioned off for $4 million at exactly, you guessed it, the spot price of gold at the time of sale. http://news.bbc.co.uk/2/hi/world/europe/10425194.stm

If you are interested in investing in gold, I would look into the price of the SPDR Gold Trust GS (Ticker symbol: GLD) and invest on any weakness like we saw last week, and I would keep it on a “tight leash.”  I would say to invest no more than 2-10% of your investable portfolio in this commodity and be prepared for wide price swings (volatility).  It’s possible to use options to hedge the position to mitigate the risk of a sudden sharp decline or a mass exodus.  With weakness in the price of gold last week, you may be able to take advantage of a good entry price, but this article is by no means a suggestion, recommendation or an advisory to buy gold.  Some believe that the unwinding of Euro currency short interests that were invested in gold may have caused last week’s weakness (i.e., investors bought back borrowed Euro’s with the gold that they sold last week to cover their short interests).

I would appreciate your thoughts, feedback and inclination to invest in this commodity.

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions.
Posted in General, investing. Tags: , , , , . Leave a Comment »

What’s Going On With The Markets?

June 29, 2010 — Sam H. Fawaz

Well that was quick!

I’m referring of course to the short uptrend from the stock market correction that had seen a bottom on June 8. As of today, the S&P 500 index undercut the lows of the last correction and has put us back into another market correction. With all the overhang from worldwide events and mounting evidence of a slowing recovery, investor, consumer and institutional sentiment are at their lows.

In last week’s statement from the Federal Reserve, where it continued to hold interest rates at 0-0.25% for an extended period, the “Fed” acknowledged a softening recovery and lackluster employment growth. Hints of another fiscal stimulus or monetary easing emanated from Washington to help avoid a possible double-dip recession. Now you may have heard about the G-20 Summit meeting this past weekend in Toronto where the United States was the lone voice in encouraging a coordinated effort of more fiscal stimulus to heed off a global recession; instead, most European nations were insistent that austerity measures and tax increases were the way to go to bring their fiscal houses in order. While I’m totally in favor of balanced budgets and fiscal conservatism, simultaneously cutting spending and raising taxes are the surest way to plunge your country into recession or worse, depression (history has demonstrated this time and time again.) At a time when the recovery is so fragile, doing one of the two is risky; doing both is simply economic suicide.

The Conference Board reported a sharp drop in Consumer Confidence today which caught Wall Street completely off guard. However, today’s figures are in sharp contrast to last Friday when the University of Michigan reported its Consumer Sentiment gauge at the highest level in two years. Although the 9.8 point drop in the Conference Board numbers was higher than expected, keep in mind that Consumer Confidence fell over 10 points in February just before the last stock market rally. These numbers really don’t mean a whole lot to the markets, so I’d caution against reading too much into today’s report or market reaction.

As I’ve written before, the stock markets hate uncertainty. With the BP Gulf disaster getting worse, the European Union is still arguing who should pay for whom and how much, financial regulation passage still uncertain, new job creation largely absent, and slowing growth in China, we have the makings of a “bad news salad.” Even though yields on money markets and Treasuries are at their lows, it seems that there is no appetite for risk or conviction in the markets by both the bulls and the bears. With poor May retail sales, jobs, and housing numbers, the bulls haven’t had much to hang their hat on lately. But keep in mind that one month does not make a trend.

So we find ourselves once again at a critical level in the markets today. At a closing level of 1,041 in the S&P 500, the bulls must come in and rescue this uptrend or risk dropping another 6% from here to about 980. I must admit that I believe that our only short-term hope of averting this drop is a very favorable June jobs number on Friday (on the order of 100,000 new jobs created.) Tomorrow (Wednesday), ADP will release their preliminary estimate of the jobs number (of mostly private employment; it does not include government jobs) and it is widely expected to show 60,000 new jobs created. The ADP report is widely anticipated as an indicator of the main jobs report, but it has been known to be way off. However, many institutions and traders treat it as a preview of Friday’s number. Let’s hope that the Labor Department has a nice 4th of July weekend send-off for us.

So much bad news, negative sentiment and consecutive down days are built into the market that a bounce is overdue and may come tomorrow (Wednesday) if the ADP jobs report is favorable. For our portfolios, I will be closely watching the 1,041 level on the S&P 500 index for support. If that support line is definitively broken, I will look to reinstate the portfolio hedges that have served us well in the past. Even at these market levels, we are still considered to be in a correction, not another bear market. By technical definition, a bear market is a 20% decline from a market high, which was 1,220 in the S&P 500 index. That gives us running room to 976 to avoid descending into another bear market.

I personally believe that with an undoubtedly positive 2nd quarter earnings season coming up and a good jobs report, we can avert the drop to bear market levels. I am not in the camp that believes that a double-dip recession or depression is in our near-term future. Short-term, a negative jobs report and poor earnings guidance combined with severe austerity measures around Europe will likely mean bad news for stocks. My broken crystal ball predicts however that we will pull out of this malaise and that the recovery, albeit tepid, will carry the markets upward through the rest of the year. However, if the markets insist on going lower into bear market territory, I will look to liquidate a portion of equity portfolios and increase our hedges. Recall that earlier in the spring I mentioned that the summer months would be both volatile and bumpy…and here we are.

I am working on my 2nd half 2010 market and economic outlook and will send it out to everyone later this week. I wish I had better news for you right now. Nonetheless, I hope this update helps you understand a little more of what’s going on with the markets. Please feel free to forward this message to anyone who might benefit from reading it. If you have any questions or comments, please don’t hesitate to contact me. If you or someone in your family or circle of friends is considering hiring a financial planner, please visit our website or consider a complimentary financial roadmap via the link below. Your first consultation with us is complimentary and there is no pressure to make any decisions.

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner (CFP®), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.
All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP and is provided by YDream Financial Services, Inc.
Posted in investing, markets, retirement. Tags: , , , , . Leave a Comment »

Market Update for May 20 2010

May 20, 2010 — Sam H. Fawaz

Today marked the 9th day out of the last twelve where the market sold off in a clear message that world governments need to get their acts together and control their fiscal, spending and regulatory policies.  With the Euro currency at historic lows, demonstrations in Greece, an environmental offshore oil catastrophe, German bans on naked short selling, higher than expected weekly job claims, and financial regulatory reform debates going on, we’ve had the perfect storm to extend this market correction.  Stock markets don’t like uncertainty and wishy-washy policy making, so they express their dismay by selling off risky assets.  As of today, the major indices have given back all their 2010 year-to-date gains and then some.  Nonetheless, the long term stock market uptrend remains intact, though as I’ve indicated before (May 6), we’re in for some bumpy times in the market for the summer.

I wish I could say that my crystal ball knew when this short-term pain to the downside would be over.  However, all technical indications is that this move downward is a bit overdone, though admittedly the move to the upside was also overdone in the short-term.  I believe that we’ll see a short or intermediate-term bounce in the next couple of days as value investors and bargain hunters swarm the markets.   We will do the same as the waters calm down.

Indications from Washington are that we may get a vote on the financial reform bill (being debated) tonight and perhaps remove some of the uncertainty in the markets.  I’m not sure what the Obama Administration will tackle next (immigration reform, tax reform, ban on sovereign bailouts, take your pick), but you can bet that it will also rattle the markets when it gets underway.  The European Union appears to be working on a few measures to further restore confidence to the markets and those measures may come to light over the weekend or early next week.  Longer term, we will have to contend with overseas currency and economic weakness, further sovereign debt issues, huge budget deficits, and a stubbornly high unemployment rate.  For the time being though, we have an improving fundamental economic picture, ultra low interest rates, excellent corporate earnings, and plenty of unspent stimulus to keep the market uptrend going for awhile.

Because I felt that it was more likely than not that the majority of the short-term move downward was over today, I decided to lift about 50% of the contra-position hedge that I held on client accounts.  This will allow portfolios to more fully benefit when the uptrend resumes. Leaving 50% of the position “on” allows me to be at least half-right in case there is more downside to come.  This is just prudent hedging.  Should the markets show signs of continuing their downward trend, then it’s just as easy to put the position back on and perhaps add to it.  As of this moment, I see no negative longer term indicators in the markets that tell me that I should be liquidating equity positions and moving to a higher cash position.

Please check out my January-February 2010 Money Magazine Portfolio Makeover-Can I retire Early? http://bit.ly/5aGwIO

Have a small business?  Don’t miss out on these business tax deductions http://bit.ly/a49I1K

Follow me on Twitter at http://twitter.com/TheMoneyGeek for relevant personal finance advice and tips on great deals.

Read our blog: http://themoneygeek.com

Reach Your Goals with a Complimentary Financial Roadmap: http://www.boulevardr.com/welcome/SamFawaz

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP and is provided by YDream Financial Services, Inc.

My no-nonsense no-spam policy: If you’d prefer not to receive future updates, just reply and let me know by typing “unsubscribe” in the subject (please don’t hit the spam button-it just puts me on a universal spammer’s list which is tough to get off of.)I’ll take you off my list immediately and permanently.  I will never sell, share, rent or give away your e-mail address to anyone.  Period.

Posted in General, investing, markets. Tags: , , , , , , . 1 Comment »

Market Update-Week Ended March 27, 2010

March 28, 2010 — Sam H. Fawaz

The stock markets have been enjoying several weeks of continued gains after a market correction that ended around mid-February.  Corporate earnings have been stellar, mostly on a net income basis, but many have also enjoyed sales growth as well, albeit from a low (2009) base.

We’ve had stock market indices that have run up to 18 month highs and we came within 100 points of 11,000 on the Dow Jones Industrial Average this week.  Down days in the market have been only very mildly down as investors enjoy more confidence that the economy is slowly improving and that the possibility of a double-dip recession this year is nil.  This has all happened despite bad news from Europe relating to Greece’s possible default on their sovereign debt, Fitch’s downgrade of Portugal’s sovereign debt, passage of “Obama Care”, poor sales of U.S. Treasury bills, record federal deficits, and still dismal (though improving) unemployment figures.  The news that a South Korean Navy ship experienced an explosion yesterday barely made the markets blink.  High inflation is currently nowhere in sight, though it’s a certainty that it will be here before we know it.

With any long string of stock market gains (with only minor down days) comes the inevitable correction in the market. During the latter part of this week, days that were up for the most part suffered downside reversals and profit-taking towards the end of the day.  This could be a sign of another correction coming (perhaps in the range of 5-10%), portfolio managers adjusting their quarter-end books, or just traders preparing for a week or so off for the Easter holiday.  Dwindling stock market volume certainly would indicate that many are planning some time off.  A correction would be healthy for the market, and would give those still sitting on the sidelines or mostly invested in bonds an opportunity to jump back into the stock market at a lower price.  Stories are abound about $3 trillion still on the sidelines in money market accounts earning less than 1-2% interest or invested in low-risk short-term bond funds.  I personally still believe that we will enjoy returns this year in the low to mid-teens while gross domestic product (GDP) growth will be in the 3-4% range, which is historically low.

Next Friday April 2nd, while the stock markets are closed (the bond markets are open), unemployment figures for March 2010 will be reported and they’re expected to show actual job growth for the first time since early to mid-2008.  The boost will be partially attributable to the hiring of census workers, though employers, who are enjoying record productivity levels, have been increasingly hiring temporary workers and will have no choice but to make permanent hires soon, as the existing workforce grows exhausted from one person doing the work previously done by two people.  Even General Motors announced this week that it is recalling 700 workers to its plant in Ontario Canada and plans to hire 60-70 new workers.  The employment trend is definitely in the up direction, but the speed is still at a snail’s pace.  For the unemployed, the pace is understandably far too slow.

For those taking some time off for spring break and the Easter holiday week (post or pre), I hope you enjoy your time off and have good weather wherever you go.   To all who have to work, enjoy a great holiday nonetheless.

I welcome your comments and feedback. If you have any questions, please feel free to get in touch with me and be sure to share this post with your friends and colleagues.  And please be sure to let them know about me if you think that they might benefit from my services.  As a CFP® and NAPFA registered investment advisor, we have a fiduciary responsibility to always put your interest ahead of ours and avoid conflicts of interest.  Most brokers and advisors cannot say this nor do they adhere to this very high standard of care.

A summary of the week’s market results :

Market Update For Week Ending 3/26/2010

Index Close Net Change % Change YTD YTD %
DJIA 10,850.36 +108.38 1.01 +422.31 4.05
NASDAQ 2,395.13 +20.72 0.87 +125.98 5.55
S&P500 1,166.59 +6.69 0.58 +51.49 4.62
Russell 2000 678.97 +5.08 0.75 +53.58 8.57
International 1,572.26 +0.17 0.01 -8.53 -0.54
10-year bond 3.86% +0.17% +0.05%
30-year T-bond 4.75% +0.17% +0.06%

International index is MSCI EAFE index. Bond data reflect net change in yield, not price. Indices are unmanaged and you cannot directly invest in an index.

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. Sam is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families.

All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions.  Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions. This message was authored by Sam H. Fawaz CPA, CFP and is provided by YDream Financial Services, Inc.

Posted in General, investing, markets. Tags: , , . Leave a Comment »

Should College Freshman Start A Roth IRA?

September 3, 2009 — Sam H. Fawaz

At no time since the Great Depression have college students worried more about money.  Tuition continues to rise, financing sources continue to contract.  So why should a student worry about finding money for, of all things, retirement?

Because even a few dollars a week put toward a Roth IRA can reap enormous benefits over the 40-50 years of a career lifetime that today’s average college student will complete after graduation.  Take the example of an 18-year-old who contributes $5,000 each year of school until she graduates.  Assume that $20,000 grows at 7.5 percent a year until age 65.  That would mean more than a half-million dollars from that initial four-year investment without adding another dime.

Consider what would happen if she added more.

There are a few considerations before a student starts to accumulate funds for the IRA.  First, students should try and avoid or extinguish as much debt – particularly high-rate credit card debt – as possible.  Then, it’s time to establish an emergency fund of 3-6 months of living expenses to make sure that a student can continue to afford the basics at school if an unexpected problem occurs.

To contribute to an IRA, you must have earned income; that is, income earned from a job or self-employment.  Even working in the family business is allowable if you get a form W-2 or 1099 for your earnings.  Contributions from savings, investment income or other sources is not allowed.

Certainly $5,000 a year sounds like an enormous amount of outside money for today’s student to gather, but it’s not impossible.  Here’s some information about Roth IRAs and ideas for students to find the money to fund them.

The basics of Roth IRAs: I’ll start by describing the difference between a traditional IRA and a Roth IRA and why a Roth might be a better choice for the average student.   Traditional IRAs allow investors to save money tax-deferred with deductible contributions until they’re ready to begin withdrawals anytime between age 59 ½ and 70 ½.  After age 70 1/2, minimum withdrawals become mandatory.

Roth IRAs don’t allow a current tax-deductible contribution; instead they allow tax-free withdrawal of funds with no mandatory distribution age and allow these assets to pass to heirs tax-free as well.   If someone leaves their savings in the Roth for at least five years and waits until they’re 59 1/2 to take withdrawals, they’ll never pay taxes on the gains. That’s a good thing in light of expected increases in future tax rates.  For someone in their late teens and early 20s, that offers the potential for significant earnings over decades with great tax consequences later.  Also, after five years and before you turn age 59 1/2, you may withdraw your original contributions (not any accumulated earnings) without penalty.

Getting started is easy: Some banks, brokerages and mutual fund companies will let an investor open a Roth IRA for as little as $50 and $25 a month afterward. It’s a good idea to check around for the lowest minimum amounts that can get a student in the game so they can plan to increase those contributions as their income goes up over time.  Also, some institutions offer cash bonuses for starting an account.  Go with the best deal and start by putting that bonus right into the account.  Watch the fine print for annual fees or commissions and avoid them if possible.

It’s wise to get advice first: Every student’s financial situation is different. One of the best gifts a student can get is an early visit – accompanied by their parents – to a financial advisor such as a Certified Financial Planner™ professional.   A planner trained in working with students can certainly talk about this IRA idea, but also provide a broader viewpoint on a student’s overall goals and challenges.  While starting an early IRA is a great idea for everyone, students may also need to know how to find scholarships, grants and other smart ideas for borrowing to stay in school.  A good planner is a one-stop source of advice for all those issues unique to the student’s situation.

Plan to invest a set percentage from the student’s vacation, part-time or work/study paychecks: People who save in excess of 10 percent of their earnings are much better positioned for retirement than anyone else. Remarkably few people set that goal.  One of the benefits of the IRA idea is it gets students committing early to the 10 percent figure every time they deposit a paycheck. It’s a habit that will help them build a good life.  Better yet, set up an automatic withdrawal from your savings or checking account for the IRA contribution.

Get relatives to contribute: If a student regularly gets gifts of money from relatives, it might not be a bad idea to mention the IRA idea to those relatives.  Adults like to help kids who are smart with money, and if the student can commit to this savings plan rather than spending it at the mall, they might feel considerably better about the money they give away.  At a minimum, the student should earmark a set amount of “found” money like birthday and holiday gift money toward a Roth IRA in excess of the 10 percent figure.  Again, the IRA contributions cannot exceed the student’s earned income for the year.

Sam H. Fawaz is a Certified Financial Planner ( CFP ), Certified Public Accountant and registered member of the National Association of Personal Financial Advisors (NAPFA) fee-only financial planner group.  Sam has expertise in many areas of personal finance and wealth management and has always been fascinated with the role of money in society.  Helping others prosper and succeed has been Sam’s mission since he decided to dedicate his life to financial planning.  He specializes in entrepreneurs, professionals, company executives and their families. This column was co-authored by Sam H. Fawaz CPA, CFP and the Financial Planning Association, the membership organization for the financial planning community, and is provided by YDream Financial Services, Inc., a local member of FPA.

Posted in investing, retirement. Tags: , , , , , , . 2 Comments »

Market Update and A Caution For The Week Ending 5/29/2009

May 29, 2009 — Sam H. Fawaz

The markets ended up for the third month in a row with a late day rally on Friday, capping one of the best (albeit volatile) months in two years. With the exception of the Dow Jones Industrial Average (of 30 stocks), all indices are positive for the year.  GM traded below $1 a share today as bankruptcy is likely to occur on Monday.

Opinions about the markets’ direction run the gamut from “drunken bulls” to “raging bears”, with everyone taking each up or down day to prove their point.  But the solid fact is that the market is in a confirmed uptrend, and no opinion can argue with that.  But that’s all they are: opinions.

Economists predict that the recession will end by the 3rd quarter of this year, but the recovery will be slow.  For states like Michigan and California, recovery will likely begin in the 1st or 2nd quarter of 2010.  In the meantime, we still have to deal with waning consumer demand and higher unemployment.  Nonetheless, consumer confidence rankings jumped nicely in April, a bullish sign for the markets and the economy.  Remember, the stock market usually leads an economic recovery by 6-9 months.

Our investment approach remains a cautious, defensive one as we closely monitor the markets for signs of sell-offs.  Over the past few months, I’ve slowly increased clients’ allocations to equities and bonds to take advantage of the markets’ rallies.  However, I continue to maintain a healthy allocation to cash as a defensive move should the markets begin to move against us.  Any move this high, this fast, is a good reason to be cautious.  Fortunately, technical indicators confirm that the bullish sentiment is higher than bearish negativity and therefore give reason to be optimistic.  As billions of dollars of economic stimulus hits the streets, it can’t help but “lift all boats.”

Many prognosticators and so called experts predict that the low on March 9 was not the bottom, and that we’re merely experiencing a bear market rally.  Some even predict that we may have a severe 35-40% drop from here before the economic recovery and the “real bull market” kicks in later this year.  That drop could begin next week, next month, or next quarter—no one really knows.  I would be remiss if I didn’t warn you about this possibility. I don’t know if they’re right or not, but everyone should nonetheless be prepared for that possibility.

For my clients, I will continue to take advantage of the upside of the markets as long as it lasts and will not simply wait on the sidelines for the bears to arrive.  If or when the bears return, I am prepared to make the necessary tactical adjustments to minimize the effects on client portfolios and lock in as much of the recent gains as possible.  If the bears decide to stay for awhile, then we’ll take advantage of those conditions and attempt to profit from such bearish conditions.

In any case, future annualized returns on equities and bonds are likely to be in the single digits for some time.  Nonetheless, there’s no substitute for regular saving and continuous financial planning.  That combination can help overcome any lower expected returns.  Remember, it’s never too late to start.

I welcome your comments and feedback and invite you to read the below articles.  If you have any questions, please feel free to get it touch with me and share this with your friends and colleagues.

http://www.ydfs.com

Market Update For Week Ending 5/29/2009
Index

Close

Net Change

% Change

YTD

YTD %
DJIA

8,500.33

+223.01

2.69

-276.06

-3.15
NASDAQ

1,774.33

+82.32

4.87

+197.30

12.51
S&P500

919.14

+32.14

3.62

+15.89

1.76
Russell 2000

501.58

+23.96

5.02

+2.13

0.43
International

1,317.31

+27.10

2.10

+79.89

6.46
10-year bond

3.47%

+0.02%

+1.22%
30-year T-bond

4.34%

-0.05%

+1.65%

International index is MSCI EAFE index. Bond data reflect net change in yield, not price. Indices are unmanaged and you cannot directly invest in an index.

Market Wrap
A volatile post-holiday week ended with the bulls back in control of Wall Street and most major equity indices in positive territory for both the week and the year to date. The Dow industrials continued to lag, held back by developments at component General Motors in particular, but other benchmarks gained 3% to 5%. Foreign shares also ended in the black, while bond markets were mixed. For more on recent trading activity, please read:
http://finance.yahoo.com/news/Stock-market-fluctuates-after-apf-15385078.html

Consumer Confidence Revives
The American public’s battered sense of the economy’s health revived somewhat in April. Analysts warn that while the light at the end of the recessionary tunnel may finally be in sight, it will take some time for a true recovery to begin. In fact, while the business environment seems to be improving in many parts of the country, conditions in the Midwest in particular appear to be getting worse as the auto industry lurches from crisis to crisis. For more on the latest economic indicators and what they mean for the economy, please read:
http://bloomberg.com/apps/news?pid=20601087&sid=aYRGnAW70og8

Is The Recession Nearing An End?
Some economists now say the longest and most savage economic contraction in six decades may finally be winding down. But while consumers are in relatively high spirits, both labor markets and home prices remain fragile at best as layoffs and foreclosures continue. Where are the “green shoots” that some see heralding a new cycle of economic growth? And where are the storm clouds ahead? For more, please read:
http://www.msnbc.msn.com/id/30979615/

Sam H. Fawaz CFP®, CPA is president of YDream Financial Services, Inc., a registered investment advisor. All material presented herein is believed to be reliable, but we cannot attest to its accuracy.  Investment recommendations may change and readers are urged to check with their investment advisors before making any investment decisions. Opinions expressed in this writing by Sam H. Fawaz are his own, may change without prior notice and should not be relied upon as a basis for making investment or planning decisions.  No person can accurately forecast or call a market top or bottom, so forward looking statements should be discounted and not relied upon as a basis for investing or trading decisions.

Posted in investing, markets. Tags: , , , , , , . 2 Comments »

Five Tips to Avoid Potential Investment Fraud

April 13, 2009 — Sam H. Fawaz

I recently wrote about avoiding investment fraud (How to Avoid Being Madoff’ed) but the subject keeps coming up.  In the most recent news from Wall Street, securities fraud has affected individual investors, pensions and charitable organizations.  At the risk of being a bit repetitive, here are five key safety tips that may help you prevent this from happening to you:

1. Know your advisor.

Most advisors (like me) are registered with government organizations. You can research registrations and review any past complaints with the Securities and Exchange Commission (www.sec.gov), or with the respective state regulatory agency.  If a firm is a Broker-Dealer, you can research it with the Financial Industry Regulatory Authority (www.finra.org).  You should also be aware of what you have authorized your advisor to do.  For example, if you have granted your advisor discretion over your investments, then you have given her permission to buy and sell investments to meet your stated objectives without your approval for each individual trade.  The authority you have granted your advisor should be stated in your client services agreement (you do have one, right?)

2. Know your investments.

Consider stocks, bonds, exchange traded funds (ETFs), and mutual funds that are publicly traded and listed on major exchanges like the New York Stock Exchange.   They are valued independently at least daily, if not minute by minute, when the exchange is open.  You can check their reported returns against your own portfolio.  If you can’t look up the prices and performance of what you own in the newspaper or on the Internet-that’s a red flag, so ask more questions.  If you choose to invest in complex securities like private placements, then you have much more additional homework to do.

3. Use an independent custodian.

By utilizing an independent custodian, there is objective, unbiased pricing of underlying securities.  Investment performance can look better if the prices reported to clients are manipulated, showing winning performance year after year despite the ups and downs of the market.  For example, our custodian, TD Ameritrade, receives security prices through well-known third-party pricing vendors or directly from issuers.  In many cases, prices are provided on a real-time basis for most securities.  We have no input on asset pricing or valuation.  Clients get statements directly from TD Ameritrade.  In addition, your advisor’s independent custodian should have a business continuity plan and a privacy policy to provide access to your investments in the event of a disaster and to protect your personal information.

4. Check on protection.

Your advisor’s custodian MUST be a member of the Securities Investor Protection Corporation (SIPC); if not, find one that is.  If it is, the securities in your account are protected up to $500,000, of which $100,000 may be applied to cash.  For additional information, please visit www.sipc.org and see the Account Protection Sheet.  Our custodian, TD Ameritrade, also provides additional coverage through London insurers of up to $149.5 million per customer of which $900,000 may be applied to cash (and an aggregate of $250 million for all customers).  Please see the Evidence of Excess SIPC Coverage for additional details.  SIPC protection and Excess SIPC insurance protect against losses from brokerage failure, not from market value decline.

For additional information, please see TD Ameritrade’s FAQ for Investors on Protection against Market Fraud.

5. If it Sounds Too Good…

One final thought: If it sounds too good to be true, it probably is.  Beware of consistent annual returns that are out of line with established benchmarks.  Remember, there is no return without risk, so never believe anyone who says that they can get you a high return with little or no risk.  There’s always a “gotcha” hiding somewhere (e.g., excessive fees, commissions, early termination penalties) when they tell you this, so you should be very suspicious.

If you or someone you know has been affected  by investment fraud, or if you have any questions, please comment below.

Posted in General, investing. Tags: , , , , , , , , , . 2 Comments »

Are Mutual Funds Becoming Obsolete?

April 1, 2009 — Sam H. Fawaz

The markets that we’ve seen during the past several months are unlike any others I’ve seen in my lifetime.  In fact, they’re probably unlike the markets most of us have ever seen.   This market upheaval has caused me to re-examine everything that I thought was “sacred” about investing and the markets. This in turn has led me to begin questioning many basic premises about how financial planners think about investing, proper diversification, and trading.  Specifically in this article, I’m looking at the future of saving and investing in mutual funds.

I’m by no means an expert in this area.  But I have taken to reading and researching as much as I can about what works and what doesn’t work while saving and investing for the long and short term.  Between listening to tons of podcasts, attending numerous webinars and conferences, reading books, newsletters, magazines and newspapers, I’ve become intimately familiar with the arguments advanced by “buy and hold” crowd and their counterparts, the “market timers.”  I’ve learned that both approaches have their merits, and each has its time and place in the right types of markets.  This article is not about those merits or which method is superior.

While re-examining and researching mutual funds in client and prospect portfolios, and seeing how much some of them suffered in this awful bear market, I keep asking myself if there is a better way to invest their money.  Even though most mutual funds were down 35-50% over the past twelve months, I shook my head in disbelief that many of the same funds, even as late as January 2009, were still ranked as four and five star funds by the investment rating firm Morningstar.  Really?  Four and five stars were given to funds ranked in the bottom 35% of their category?  Funds that had double-digit negative annualized returns for 1, 3, and 5 years still earned three or four stars?

Just to be clear, as an advisor, I don’t rely on Morningstar “Star” rankings to rate and choose funds for my clients and prospects.  I dig much deeper into the details and third party information for comparison, research and evaluation purposes.  But I know that many consumers do rely on star rankings.  And I have to wonder how much of a favor Morningstar is doing for consumers when managers who are paid handsomely to manage mutual funds missed the whole financial crisis and didn’t steer their funds away from the financial or the big oil stocks in the second half of 2008.

In a secular bear market like the one we’ve been in, buying and holding mutual funds (or any investment for that matter) can be a money losing proposition.  But mutual funds have a few characteristics that make them even riskier, if not downright inappropriate for certain market conditions.

One characteristic that makes mutual funds riskier is the once-a-day, end-of-day pricing; you can’t get intra-day pricing on a mutual fund like you can on a stock.  If the market is trending down, there’s no way to cut your losses when the writing’s on the wall and the market’s headed for a big daily loss.  Wouldn’t it have been nice, on an 8% down day, to cut your losses in half?  Well, sorry, you can’t; you have to ride it all the way down.  Of course, on an up day, you may benefit from the extra upside.  Exchange traded funds (ETFs), which trade just like stocks, don’t suffer from this disadvantage and can be bought and sold at intra-day prices.

Another risky characteristic of mutual funds in bear markets, closely related to the above characteristic, is the inability to put a stop-loss order on a mutual fund.  If the market is crashing, and you’re unable to monitor your investments every minute that the markets are open, you could lose big or give up a good chunk of your gains.  Stocks and ETFs don’t have this disadvantage; you can have a standing stop-loss order on them with your broker for up to 6 months.  As soon as the stock or ETF drops to the sell-stop price, a sell is triggered and voila, you’re in cash, protected from further downside.  This gives you time to assess market conditions and decide on your next investment.

The inability of most mutual funds to deviate from their stated investment objectives prevented many mutual funds from cashing out on money losing stocks (almost all of them in 2008) and being able to sit on the sidelines with significant amounts of cash.  Funds with more flexibility in their cash positions, and those with the ability to take inverse (e.g., short) positions fared better than most in this bear market.  To be fair, many ETFs are index-based and have the same problem.

Mutual funds also suffer from a lack of timely disclosure of their investment holdings.  While they all publish their stock and bond holdings, most holding lists are usually at least three months old.  Mutual fund managers don’t like to publish their holdings more frequently so they don’t have to tip their hand to the competition.  It’s important to know what investments your funds are holding so you don’t duplicate or overlap your holdings with funds carrying the same stocks or bonds.  And if your fund was still holding, say Washington Mutual when it was sold for pennies on the dollar to JP Morgan Chase, maybe you would have known better to avoid the fund.  ETFs are much more transparent and publish their holdings on a daily basis.

Many will argue that ETFs have commissions that must be paid to buy and sell them, thereby making them a more costly option than mutual funds. To that I say three things: 1) commissions at most big brokers are about $19.95 or less; 2) the potential higher-gain or lower-loss on an ETF may pay for the commission in multiples; and 3) many desirable mutual funds have transaction fees much higher than ETF commissions at many brokers.

So will the mutual fund industry eventually die? I don’t think so.  Mutual funds are so ingrained in institutional settings and retirement plans that they likely have a long future ahead of them.  But I have a feeling that the mutual fund industry is already trying to reinvent itself.  Many of the big mutual fund companies have gotten into the ETF business because of the net (negative) out-flows from mutual funds and the net (positive) in-flows to ETFs.  Perhaps mutual funds will get some of the nice advantages that ETFs have like intra-day pricing, sell-stops and timelier holdings disclosures.

What I also hope for is that more 401(k) and self-directed retirement plans embrace ETFs and give employees the option to invest in them.  That way, they’re not sitting ducks when the markets come crashing down.

Do you think that mutual funds are headed for extinction? Do you think that employees should have more choices (e.g., ETFs) when it comes to their 401(k) investment choices? Please let me know what you think.

Posted in investing. Tags: , , . 1 Comment »
« Older posts
Newer posts »