No Free Lunch – But Maybe a Free Capital Gain?

fThe financial and investment profession is full of acronyms, jargon, and common phrases such as “buy low – sell high” and is “there’s no free lunch when it comes to investing”.  Believe it or not, some things are free in personal finance (and our role is to help you find them) such as the 0% capital gain rate for many taxpayers.  Yes…..0%....and hopefully we don’t have to argue that that is a good rate! 

Single taxpayers with taxable incomes of less than $34,500 and married couples filing jointly with taxable incomes below $69,000 are considered to be in the 10% or 15% marginal bracket.  One of the luxuries of being in the 10% or 15% marginal tax brackets is a 0% capital gain rate through the end of 2012. Those in marginal brackets higher than the 10% and 15% currently are subject to a 15% capital gain rate.   

Here are a few examples of who might benefit from such a rate: 

• Those holding appreciated securities that have been hesitant to sell because of the tax implications.
• Those interested in selling an appreciated security in order to reset the cost basis. (Don’t forget to avoid the wash sale rules)
• Those in higher tax brackets looking to make gifts to relatives that are in lower brackets (say a child that has moved back into their high school bedroom). 

Example:   John and Mary’s son Steven recently graduate and is finding full time employment illusive.  John and Mary expect to help Steven out with expenses for the near future.  John and Mary are in the 28% marginal bracket and Steven (with little income) is in the 10% marginal bracket.  John and Mary can gift Steven appreciated securities….Steven can then sell them and take advantage of the 0% capital gain rate. 

As always, work with your professional advisors before implementing any tax strategies….and possibly enjoy a free lunch thanks to a free capital gain.

Note: Changes in tax laws may occur at any time and could have a substantial impact upon each person’s situation.  While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters.  You should discuss tax or legal matters with the appropriate professional.

Deck the Halls with Tactical Allocation

One of my favorite things during the Christmas season is to decorate my house.  When driving down the street, my house tends to be the eye-catching one... think the Griswold house. As we string lights, hum Christmas tunes, and watch my husband crawl around on the roof with his staple gun, we really get into the holiday spirit. 

Now, let's put my slightly over-the-top "ode to the holidays" in investment terms. I recently explained that strategic investing, when you pick the mix of stocks, bonds and cash to make up your portfolio, serves as the foundation of your house. Well, I like to think of Tactical Allocation as decorating or changing for the season.  Of course, it shouldn’t be as drastic of a transformation as the Griswold’s (we don't want to blow a fuse or catch the tree on fire). Rather, a Tactical Allocation approach provides for overweighting or underweighting asset classes as perceived market opportunities arise. In yard decorating terms, you're not leaving the inflatable Santa out in the yard all year, that would be the traditional investing “buy and hold on for dear life” approach. You're watching conditions and judging when it's the opportune time to deflate old Saint Nick,  pack him away and move on to the next holiday. The goal of Tactical Allocation is to reduce risk, increase returns or both. 

While we believe that the relationship of valuation between markets over long periods will be efficient and will correspond to fundamentals, we also acknowledge that over shorter periods, some markets may become overvalued, while other asset classes will become undervalued. This is where Tactical Allocation can be considered. A somewhat modified asset allocation can potentially offer better returns and less risk when executed correctly.[1]

A tactical asset allocation strategy can be either flexible or systematic.  In a flexible approach an investor modifies his portfolio based on valuations of different markets or sectors (i.e. stock vs. bond markets).  Systemic strategies are less discretionary and more model based methods of uncovering market anomalies.  Examples of these are trend following or relative strength models. 

All of these methods require knowledge, discipline and dedication to execute successfully; it's not like throwing a single strand of lights over a tree branch and calling it festive. And with Tactical Allocation, less can be more, which is an approach I sometimes wonder if I should apply to my Christmas decorations. So, talk to your Financial Planner to determine what may be appropriate to incorporate into your portfolio.

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[1] Keep in mind that all investing involves risk, and there is no assurance that this or any strategy will be profitable nor protect against loss.

Building Your Foundation

Contributed by: Angela Palacios, CFP®

Asset allocation is like the foundation of your house. It is the most important structural part of your investment process. Without it, your home or your financial plans could become extremely unstable. 

Many investors either become paralyzed and unable to make decisions, or make decisions by constantly chasing the recent past and, thus, earning dismal returns.  To avoid those mistakes, one of the first and most important steps in investing is determining your Asset Allocation. 

An Asset Allocation Model is usually the outcome of the financial plan you complete with your investment professional. Its goals are normally to identify the mix of assets that best balances an investor’s desire for return with the desire not to take undue risk.  Studies have shown that asset allocation decisions account for a significant amount of the variation of total returns, while security selection accounts for a relatively small portion of the variability of total returns.  The most notable study was done in 1986 by Brinson, Hood and Beebower.  The researchers found that the asset allocation policy explained 93.6% of the average funds’ variation over time. 

In its simplest form, Asset Allocation is the percent of stocks, bonds, and cash you would own in a world of normal valuations.  Generally, allocations with more stocks than bonds would be in the “High Risk/High Return” area of the line on the “Efficient Frontier” chart below.

Disclosure:  The “Efficient Frontier” is a concept derived from Modern Portfolio Theory.  According to the theory, it is possible to construct an “efficient frontier” of optimal portfolios offering the maximum possible expected return for a given level of risk.

This chart can change greatly depending on the time period you use to draw it.  The following is how the above chart varies in actuality decade to decade.

© Dorsey Wright & Associates

In the 1960s, 1980s and 1990s stocks significantly outperformed bonds. While the 1970s and the 2000s show a much different story. Not only were stocks an underperforming asset, but the risks involved were very high using standard deviation as our risk scale. (The Weiss Report, Vol. 13)

While careful Asset Allocation can help make your investment portfolio structurally strong, unlike the foundation of your house, shifting investments can be a good thing. In practicality your Asset Allocation, rather than being static, can be changed tactically to reflect current market conditions as shown above.  Watch future posts to find out more about using asset allocation and other investment strategies. 

Angela Palacios, CFP® is the Director of Investments at Center for Financial Planning, Inc.® Angela specializes in Investment and Macro economic research. She is a frequent contributor The Center blog.

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Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Asset allocation does not ensure a profit or protect against a loss.

It's Just Math...

Let’s say Samantha invests $100,000 in the stock market and in a gigantic downturn, she loses half. Not great for Samantha, since she was planning on sending her son to college soon and now she has $50,000. Perhaps it’s time to pick a new school, but first let’s do the math. 

Quick question:  How much does she need to gain to get back to even? 

Did you guess 50%? 

Wrong! When you lose 50% and you then gain 50%, you end up at 75%. If Samantha gained 50% after her bad run of luck, she’d be up to $75,000 … not the 100-grand she invested from the get-go. 

To get back to where she started and get her son packed off to college, Samantha’s going to need a whopping 100% return! So remember, the greater the losses … the greater the needed rebound just to get back to even. 

                   If you lose …        You’ll break even with …

                   10%                      11%

                   20%                      25%  

                   50%                      100%

                   80%                      400%

The Bucket Strategy

If you are in retirement (or close to retirement), you are most certainly concerned about the recent market volatility.  You are likely wondering how your investment portfolio might be structured to provide the income you need without putting the portfolio in a vulnerable position. 

 The Bucket Strategy (not to be confused with the “Bucket List”) is another way to describe a cash distribution method to provide you with income from your nest egg during any kind of market cycle. 

Consider that we each have 4 buckets and that every investment within your portfolio fits into one of these buckets.  The idea is that this strategy can provide cash flow, even if equity markets drop or stay low for extended periods of time. 

Bucket 1:  The first bucket is labeled 1-year or less.  This is the cash and short term securities that mature in less than one year to support the cash flow needs for the client for the first 12 months. 

Bucket 2:  The second bucket would start generating cash flow in the 13 month – 36^th month or years 2 and 3.  This contains short-term bonds and fixed income type securities that have a small amount of volatility and are primarily for preservation of capital.  The holdings in this bucket do pass on interest income that flows into the first bucket. 

Bucket 3:  The third bucket is structured to generate cash flow needs in years 4 and 5 and primarily contains strategic income and higher yielding bonds (lower quality, longer maturing and international type bonds).  However, they do pass on interest income that flows into the first bucket. 

Bucket 4:  The fourth bucket is made up of equities (stock investments) and other assets that have higher volatility like gold, real estate, commodities etc.  Many of these assets produce dividends to help replenish the first bucket, if the dividends are set to pay in cash vs. reinvest. 

The bucket strategy is designed to provide enough cash flow to get through roughly a 6- or 7-year period without needing to liquidate the stock portion of the portfolio.  This should provide you with the confidence and consistent income needed to enjoy your retirement and work on your bucket list! 

Talk to your financial planner to see how the bucket strategy might work for you.

Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James. Investments mentioned may not be suitable for all investors. There is an inverse relationship between interest rate movements and bond prices. Generally, when interest rates rise, bond prices fall and when interest rates fall, bond prices generally rise. High-yield (below investment grade) bonds are not suitable for all investors. When appropriate, these bonds should only comprise a modest portion of your portfolio. Please note that international investing involves special risks, including currency fluctuations, differing financial accounting standards, and possible political and economic volatility. Gold is subject to the special risks associated with investing in precious metals, including but not limited to: price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated. Be advised that investments in real estate and in REITs have various risks, including possible lack of liquidity and devaluation based on adverse economic and regulatory changes. Commodities and currencies investing are generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising. Dividends are not guaranteed and must be authorized by the company’s board of directors. Every investor’s situation is unique and you should consider your investment goals, risk tolerance and time horizon before making any investment. Investing involves risk and you may incur a profit or loss regardless of strategy selected. The forgoing is not a recommendation to buy or sell any individual security or any combination of securities. Be sure to contact a qualified professional regarding your particular situation before making any investment decision.

History Lessons in the Fourth Quarter

Many investors were ready to say goodbye to the 2011’s third quarter with extreme volatility demanding attention and negative returns for many types of investments.  Indeed, when you review the chart below, the fate of most investors was grim from June 30th to September 30, 2011.

 *Source: JPMorgan Asset Managment

News from the Europe has been dismal.  Questions linger about the growth prospects for US and global markets.  Whether we’re experiencing a new or double-dip recession or just very slow growth, the economic picture does not feel rosy.  

While emphasizing that past performance does not predict future returns, the fourth quarter has historically been the best return environment for stocks.  While the third quarter has been the worst performing quarter for the S&P 500 on average (going back to 1928), the fourth quarter has been the best.  Interestingly, this trend has been even more distinct over the last 20 years. 

 *Source: Bespoke Investment Group

Many people will be watching third quarter earnings as they are announced as an important gauge of trends in our economy.  Greece and the Eurozone’s issues are far from resolved.  Don’t get too distracted by these headlines to lose the lessons of the history of returns.

[1] All indexes are unmanaged.  MSCI EME represents emerging market equities.  Russell 2000 is an index of 2,000 smaller U.S. companies.  MSCI EAFE is an index of large companies in developed countries outside the US.  REITS is composed of the NAREIT Equity REIT index composed of US Real Estate Investment Trust equities.  The S&P 500 is an index of 500 widely held stocks that’s generally considered representative of the U.S. stock market.  DJ UBS Cmdty is compiled by Dow Jones and represents the price of a basket of commodities.  Market Neutral is CS/Tremont Equity Market Neutral index with long and short exposure to stocks.  Barclay’s Agg is an index of US bonds representing a variety of investment grade bond assets and weighted by outstanding composition.  Inclusion of these indexes is for illustrative purposes only.  Individuals cannot invest directly in any index, and individual results will vary.

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material.  Any opinions are those of Melissa Joy and not necessarily those of RJFS or Raymond James.  Expressions of opinion are as of October 14, 2011 and are subject to change without notice.

Gold Sparkles, But For How Long?

There has been much interest in the media over the past year regarding gold as the bullion price per ounce has gained nearly 30% this year.  As a result, investor interest in gold has increased as a diversifier to portfolios because many view this as a "safe haven." Gold is a “fear” asset class, and uncertainty in almost every risk asset class has intensified gold’s price increase.  Much of the gains this year can be attributed to growing uncertainty surrounding U.S. Treasuries and European Sovereign debt.  Investor demand has also increased because the asset class has become more accessible through new products such as ETF’s (Exchange Traded Funds). 

In the past gold has shown itself to be a good hedging instrument against inflation and a weakening dollar and tends to have almost no correlation to stock and bonds.  Other investments also serve as a potential hedge against inflation and a weakening US dollar such as TIPS (Treasury Inflation-Protected Security), commodities, and foreign currency bond funds.  Naturally, gold has been part of our research efforts on this front.  The run up in the price of gold over the last few years is a concern to us (see chart below). 

The cost to extract gold from the ground is roughly $740 per ounce.  With gold trading over $1,882 per ounce as of 9/2/11 that is a $1142 premium.  This could indicate a supply and demand imbalance and perhaps, panic or speculative buying.  Gold’s price has often been driven more by speculation or its role as investment portfolio “insurance” than by fundamentals.  As a result, gold is subject to market risk. 

Sources:

No-Load Fund Analyst July 2009

Geoff Considine Ph.D., Advisor Perspectives, Sept. 2010

The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation.  Any opinions are those of Center for Financial Planning, Inc., and are not necessarily those of RJFS or Raymond James.  Investments mentioned may not be suitable for all investors.  Past performance may not be indicative of future results.  Gold is subject to the special risks associated with investing in precious metals, including but not limited to:  price may be subject to wide fluctuation; the market is relatively limited; the sources are concentrated in countries that have the potential for instability; and the market is unregulated.

Investing Against Human Nature

“The loser is the trend-chasing, comfort-seeking investor. The market doesn’t reward comfort. It rewards discomfort.”  Rob Arnott

The above quote brings to mind a book I read recently, The Little Book of Behavioral Investing by James Montier. It attempts to describe in detail why we are our own worst enemies in investing. 

Human evolution has dictated much of our decision making process and emotions.  In modern society we don’t have to play the predator/prey game of survival on a daily basis.  Yet much of our instincts are based on this survivalist mentality developed hundreds even thousands of years ago. 

Contrary to when it was safer to go with the herd, a safety in numbers mentality can be detrimental when applied to modern investing.  Enter the discomfort.  Going against the grain when it comes to investing can be very scary, for example funding your Investment accounts when you’d rather throw a brick through your financial advisor’s window; however, it is generally where the best investment returns come from. 

Having a sound investment process in place to identify opportunities and maybe more importantly to avoid “knee-jerk” reactions is critical in investing.    Process, in an uncertain world, is one of the few things we can control.  Just as important as the process, is the time that must also be taken to reflect on your process when you are most successful and not necessarily when you are making the most mistakes. 

Investing involves risk and you may incur a profit or loss regardless of strategy selected.  Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.