Six Simple Ways to Value a Stock

Six quick and easy ways to determine stock values

Investors are always searching for methods to help them determine whether a company is worth investing in. There are many means of stock valuation, some simple, some more complex.1

Why is stock valuation so important? If the market price of the company’s stock is greater than the company’s intrinsic value, an investor might choose to stay away. If the market price of the company’s stock is less than the company’s intrinsic value, the investor may choose to buy the stock.

Here are six key valuation methods:

• Price-to-Earnings Ratio (P/E)

The price-to-earnings ratio (P/E) is a valuation method used to compare a company’s current share price with its per-share earnings. Its formula is calculated by dividing its market value per share by its earnings per share. The P/E is one of the most widely used ratios, and it is used to compare the financial performance of different companies, industries, and markets. The company’s forecast P/E (its P/E for the upcoming year) is generally considered more important than its historical P/E.

• Price-to-Earnings Growth Ratio (PEG)

The P/E ratio is a snapshot of where a company is, and the PEG ratio is a graph plotting where it has been. The PEG ratio incorporates the historical growth rate of the company’s earnings. This ratio also tells you how your stock stacks up against another stock. The PEG ratio is calculated by taking the P/E ratio of a company and dividing it by the year-over-year growth rate of its earnings.

• Price-to-Book Ratio (P/B)

The price-to-book ratio measures a company’s market price in relation to its book value. Its formula is calculated by dividing the company’s stock by its book value per share. Book value can be found in the company’s balance sheet, usually listed as “stockholder equity.” It represents the value of a company’s total assets subtracted by its total liabilities. The P/B does not consider the actual value of the assets, only the nondepreciated portion of the assets. Like most ratios, it’s best to compare P/B ratios within industries. For example, tech stocks often trade above book value, while financial stocks often trade below book value.

• Price-to-Sales Ratio (P/S)

The price-to-sales ratio helps determine a stock’s relative valuation. Its formula is calculated by dividing the company’s price per share by its annual net sales per share. Price-to-sales ratio is considered a relative valuation measure because it’s only useful when it’s compared with the P/S ratio of other firms. The P/S ratio varies dramatically by industry, so when comparing P/S ratios, make sure the firms are within the same industry.

• Return on Equity (ROE)

The ROE is calculated by dividing a company’s earnings per share by its book values per share. The ROE is a measure of how well the company is utilizing its assets to make money. Understanding the trend of ROE is important because it indicates whether the company is improving its financial position or not.

• Dividend Payout Ratio

This ratio is calculated by dividing the dividends paid by a company by its earnings. The dividend payout ratio can also be calculated as dividends per share divided by earnings per share. A high dividend payout ratio indicates that the company is returning a large percentage of company profits back to the shareholders. A low dividend payout ratio indicates that the company is retaining most of its profits for internal growth.

Looking for Income? Consider REITs

Income from REITs is still quite attractive

Income from REITs is still quite attractive

For most Americans, an investment in real estate begins and ends with the purchase of a home. Yet investments in commercial real estate — including shopping centers, office buildings, and hotels — may be available to investors.
Real estate investment trusts (REITs) allow individuals to invest in large-scale, income-producing real estate. REIT performance has varied historically, with a total annualized return of 11.78% over the past 10 years, and a 19.70% return in 2012

Types of REITs

There are more than 100 publicly traded REITs, according to the National Association of REITs (NAREIT).
•   Equity REITs, which directly own real estate assets, make up most of the market.
•   Mortgage REITs loan money to real estate owners or invest in existing mortgages or mortgage-backed securities.
•   Hybrid REITs combine the investing strategies of both equity and mortgage REITs.

REITs resemble closed-end mutual funds, with a fixed number of shares outstanding. REITs are also traded like closed-end funds, offering a price per share. Unlike a closed-end fund, however, REITs measure performance by funds from operations (FFO) rather than by net asset value. FFO is defined as net income plus depreciation and amortization, excluding gains or losses from debt restructurings and from sales of properties. REITs’ growth benchmark is FFO growth, while valuation is reflected in an FFO multiple (share price divided by FFO) rather than in a price-to-earnings ratio.

The REIT Appeal

REITs offer a number of potential advantages, including the following.
•    Diversification: REITs can help to diversify an equity portfolio weighted to stocks in other industries. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a nondiversified portfolio. Diversification does not ensure against market risk.
•     Built-in management: Each REIT has a management team, sparing investors the effort of researching each property’s management team.
•    Liquidity: Because REIT shares are traded on the major stock exchanges, they are more readily converted into cash than direct investments in properties. Like direct property investments, REITs may lose value.
•    Tax advantages: REITs pay no federal corporate income tax and are legally required to distribute at least 90% of their annual taxable income as dividends, eliminating double taxation of income. Investors can also treat a portion of REIT dividends as a return of capital, although those classified as dividends are taxed at ordinary rates.

Weighing the REIT Risks

As with all investments, REITs have specific risks that are worth considering.
•    Lack of industry diversification. Some REITs limit diversification even further by focusing specifically on niche developments such as golf courses or medical offices.
•    Potential changes in the value of underlying holdings. These changes can potentially be influenced by cash flow of real estate assets, occupancy rates, zoning, and other issues.
•    Concern about performance metrics. Critics contend that FFO could be misleading because it adds depreciation back into net income. NAREIT counters that real estate values fluctuate with the market rather than depreciate steadily over time, making FFO a realistic performance measure. Also, REITs may average the rent they will receive over a lease’s lifetime rather than report actual rent received, which critics say can further cloud performance figures.
•    Interest rate sensitivity. If rates and borrowing costs rise, construction projects with marginal funding may be shelved, potentially driving down prices across the REIT industry.
•    Environmental liability. Companies in the real estate industry are subject to environmental and hazardous waste laws, which could negatively affect their value.

REITs can be a way to add total return potential to a diversified, long-term portfolio. Your financial advisor can help you decide whether an allocation to a REIT could help you pursue your financial goals.

The information in this communication is not intended to be financial or tax advice and should not be treated as such. Each individual’s situation is different. You should contact your financial and/or tax professionals to discuss your personal situation.

Custodial Accounts: A Way to Transfer Wealth

story from A1A Wealth Management.

A custodial account invloves giving money to minors.

Setting up a custodial account can be a savvy move for adults who want to gift their assets and help their children become financially independent. They are simpler to set up than trusts. But there are many considerations — and consequences — to weigh before opening an account. Here are some key points to keep in mind.


The two types of custodial accounts you can use to gift assets to your youngster are called a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). Which one you use will depend on your state of residence. Most states — with the exception of Vermont and South Carolina — have phased out UGMA accounts and now only offer UTMA accounts. UTMA accounts allow the donor to gift most security types, including bank deposits, individual securities, and real estate. UGMA accounts limit gifts to bank deposits, individual securities, and insurance policies.
•    There are no contribution limits. Parents, grandparents, other relatives, and even non-related adults can contribute any amount to an UGMA/UTMA at any time. Note that the annual federal gift tax exclusion is currently $14,000 per year ($28,000 for married couples). Gifts up to this limit do not reduce the $1 million federal gift tax exemption.

•    The assets gifted are irrevocable. Once you establish an UGMA or UTMA, the assets you gift cannot be retrieved. Parents can set themselves up as the account’s custodian(s), but any money they take from the account can only be used for the benefit of the custodial child. Note that basic “parental obligations,” such as food, clothing, shelter, and medical care cannot be considered as viable expenses to be deducted from the account.

•    Taxes are due — potentially for both you and your child. Some parents may initially find custodial accounts appealing to help them reduce their tax burden. But it’s not that simple. The first $1,000 of unearned income is tax exempt from the minor child. The second $1,000 of unearned income is taxable at the child’s tax rate, which could trigger the need for you to file a separate tax return for your child. Any amounts over $2,000 are taxable at either the child’s or the adult’s tax rate, whichever is higher. Note that state income taxes are also due, where applicable.

•    Your child will eventually gain complete control. Once your child reaches the age of trust termination recognized by your state of residence (usually 18 or 21), he or she will have full access to the funds in the account. Be warned that your child could have different priorities for the assets in the account than you do. Money that parents had earmarked as paying for college tuition could instead be used to purchase a sports car or fund a suspect business venture.

Financial Aid Considerations

For financial aid purposes, custodial assets are considered the assets of the student. If the assets in the account could jeopardize your child’s chances of receiving financial aid, speak to your tax and/or financial professional. One of your options could involve liquidating the UGMA/UTMA and establishing a 529 account.
Before making any decisions about establishing a custodial account, be sure to talk to your tax and financial professionals.

This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. You should contact your tax professional to discuss your personal situation.

The Tax-efficient Retirement

Planning a tax-efficient Retirement

Planning a tax-efficient Retirement

Why would anybody pay taxes when they really don’t have to?
This is a question that financial advisors are hearing from their retired clients, who are taking their living expenses out of taxable and tax-deferred accounts like IRAs.

The whole idea of tax planning during retirement is a relatively new one in financial planning circles, and it has created some debates.  No doubt you’ve heard the conventional wisdom from magazines and online web commentators: when you retire, take money out of your taxable accounts first, which allows the money in your conventional IRA and Roth IRA to compound on a tax-free basis for the longest possible time.

When the taxable account finally runs out, start taking money out of your conventional IRA, which will cause you to pay ordinary income taxes, and let the money compound in the Roth IRA.  If there’s any money left over, the Roth IRA is the best vehicle to pass investment assets on to heirs, since the money won’t be taxed when it is taken in distributions that can be deferred over their lifetime.

The conventional wisdom, alas, is much better in theory than in actual practice.

If you take all your income out of taxable accounts, you might end up in a 10% (less than $8,925 in taxable income) or 15% (less than $36,250) marginal tax bracket.  What’s wrong with that?  Retirees who have a significant amount of money in their IRA–and who are growing that pool of assets during the first decade of retirement–will have to start taking mandatory distributions at age 70 1/2, even if they don’t need the income.  Those distributions could push them into significantly higher tax brackets.  And the tax brackets in the future might possibly be higher than they are today.

Raise your hand if you think tax rates are going to go down in the next 10-15 years.  That question was recently posed by an industry speaker to an audience of tax experts and senior financial advisors, and very few hands went up.

Another problem is that retirees who are working with a financial advisor will have very different investments inside and outside their IRA accounts.  Depleting the taxable account first means, for them, selling their stocks first, leaving them with a portfolio comprised mainly of real estate investment trusts, bond funds and commodities futures funds during their later years–which basically means they will fail to get the full benefits of diversification and rebalancing.

A better approach is to gradually let some of the air out of the IRA in the years before mandatory distributions come due–at the lowest possible tax rates.  That might mean taking out enough IRA money to offset your standard deduction and personal exemption and fill up the 15% tax bracket, meanwhile taking the rest of your living expenses from the taxable account.  Paying at a 15% rate today could mean not paying at a 28% or 33%–or higher, depending on the whims of Congress–rate in the future.

Alternatively, for people who don’t need the income, you could make a partial conversion of assets from the IRA account to a Roth IRA–just enough to offset the various deductions and fill up that 15% bracket.  You pay taxes on some of those converted assets at 15% today in order to avoid any future taxation on them down the road.  Since Roth IRAs don’t have any mandatory distributions for the original owner, you’re free to take the money out tax-free or not as you desire in the later retirement years–or leave that money to your heirs.

An advisor who looks at the retiree’s total tax picture might also use your lower tax bracket to sell some stocks that have significant appreciation, taking the capital gains at a 10% rate, and avoiding a 20% or 23.8% (if the Medicare tax is applicable) tax rate if the asset were sold when mandatory distributions are pushing you into the upper brackets.

So the answer to the question: “Why would anybody pay taxes when they don’t have to?” is simple: When they can pay at a lower rate today than they would have to pay in the future, or when they can pay at a low rate today and avoid all future taxation on those assets altogether. Every situation is different, every year is different for every situation, and many professional advisors are beginning to realize that planning for a tax-efficient retirement is more complicated than most of us realized.  But careful planning can also be more beneficial for people who want to get the most value out of their retirement assets.

Asset Location: Handle With Care

Is a Piggy Bank a good asset location

Smart Asset Location Plan

An old question has resurfaced lately.  You have tax-deferred accounts like IRAs and Roth IRAs, and you have accounts that pay taxes every year on the income they receive.  Where do you put different types of assets?

The answer is that you want to put the most tax-inefficient investments inside the tax-deferred accounts.

The most notoriously tax-inefficient investments, historically, have been bond funds, commodities futures funds and real estate investment trusts (REITs), which all generate ordinary income that can be taxed at 39.6% plus the 3.8% Medicare tax for higher-income taxpayers.  The Roth IRA, which shelters all future returns from taxes of any sort, can be a great place for mutual funds that invest in small cap stocks, since they tend to have high turnover and historically have provided the highest gains.

In taxable accounts, you might put growth stocks which, if you hold them for more than a year, will have their price appreciation taxed at a maximum rate of 20% (or 23.8% with the Medicare surtax).  Of course, you can choose to hold individual securities for much longer periods, which gives you tax deferral on its own–and, if the stocks are held until death, the heirs get a step-up in basis, which basically means any rise in value is never taxed.  Municipal bonds which qualify for an exemption from federal taxes are also good candidates for the taxable portion of your investment accounts.

What makes this Asset Location debate new again?

Higher ordinary income tax rates, and potentially higher capital gains tax rates (up from 15% to 23.8% for tax filers who have to pay the new Medicare surtax) have introduced some gray areas, as have the historically low rates on bonds.  When bonds were delivering upwards of 10% on the investment dollar, putting them in an IRA was a no-brainer.  But what if you’re cautious about rising rates, and you’ve shortened maturities in a yield-starved market, finding your return now to be closer to 1%?   Suddenly, these funds are no longer a huge tax concern.

At the same time, REITs offer tax benefits like depreciation, which becomes more valuable at higher ordinary income rates.  And persons in retirement may see their tax rates fall from above 39% down to 15%, which decreases the benefits of astute asset location, and might raise the value of rebalancing each year across all accounts.

Another consideration for retirees is the mandatory withdrawals they have to take from their IRA account after they reach age 70 1/2.  If the IRA is holding all the income-generating investments, then systematically liquidating those holdings means creating a higher exposure to stocks and a generally more volatile portfolio as you age–which may be the opposite of what is desired.

Saving taxes through asset location strategies is one of those rare opportunities to get additional dollars without taking additional risk–but a mindless focus on taxes without looking at the bigger picture can result in unintended consequences.  The rules of thumb need to be informed by your tax bracket and other aspects of your individual circumstances–with an eye on the ever-changing tax and interest rates that Congress and the markets throw at us.

Official Inflation Rates Keep Falling: How Long Can it Last?

When the metal in a coin values higher than the purchasing power

Economists and market watchers have been warning investors about the prospect of increased inflation since the housing bubble burst in 2007. But the inflation rate keeps going lower, not higher.
As of April 30, 2013, the Official Consumer Price Index (CPI) as published by the government stood at a paltry 1.1%, under the Federal Reserve’s target of 2% annually.

Why is low inflation troubling?

For a number of reasons:
•    When companies don’t have any leeway to raise prices, they’re more apt to cut costs, which could mean a cutback in hiring.
•    When inflation is low, it doesn’t offer a large buffer against deflation if an economic shock occurs. Deflation — when prices fall — often freezes up spending. Why would you buy an item now if you expect it to be cheaper in a few months?
And it’s not just the United States that is dealing with lower inflation — or even deflation — rates. Many of the world’s top industrialized nations are in the same boat.

Inflation Rates Around the World (as of April 30, 2013)

China    2.40%
France    1.00%
Germany    1.15%
Italy    1.10%
Japan    0.90%
South Korea    1.20%
Spain    1.40%
United Kingdom    2.80%
United States    1.10%

Stay Diversified

For investors, whether inflation continues to remain low or starts to rise, a well-rounded portfolio may be your best weapon. The key is to consider your time frame, your anticipated income needs, and how much volatility you are willing to accept, and then construct a portfolio with the mix of investments with which you are comfortable.
•    CDs and Other Cash Instruments — The Fed is still keeping a tight lid on interest rates, forcing investors who hope to keep pace with inflation by investing in cash instruments face a harsh reality. Average rates on a 1-year CD are hovering around 0.25%, while a 5-year CD is yielding an average of 0.78% nationwide, according to Money market accounts are averaging a microscopic 0.11%.3
•    Bonds — Historically, investors have turned to shorter-term corporate and high-yield bonds for protection in rising-rate environments.4 There are two types of bonds that receive a lot of investor interest when inflation starts to rise: Treasury Inflation-Protected Securities (TIPS) and I Savings Bonds. Both TIPS and I bonds are types of fixed-interest rate bonds whose value rises as inflation rates rise.
•    Domestic Stocks — Although past performance is no guarantee of future returns, historically, stocks have provided the best potential for long-term returns that exceed inflation.5 An analysis of holding periods between 1926 and December 31, 2012, found that the annualized return for a portfolio composed exclusively of stocks in the S&P 500® index was 9.90% — well above the average inflation rate of 2.98% for the same period. The results are almost as good over the short term as well. For the 10 years ended December 31, 2012, the S&P 500 returned an average of 7.10%, compared with an average inflation rate of 2.41%.6
•    International Stocks — During the same 10-year span that ended December 31, 2012, the Morgan Stanley Capital International (MSCI) EAFE, which is composed of established economies such as Germany and Japan, outpaced the S&P 500 with an average return of 8.70%. The MSCI Emerging Markets index — which tracks developing world economies such as Brazil and China, and is even more risky than MSCI EAFE — was even more stellar, returning an average of 16.89%.8

Remember, diversification does not ensure a profit or protect against a loss. Consult a financial professional to discuss your specific needs and options.

A Long-Awaited European Recovery?

Is Euro enjoying an economic recovery

Is Euro enjoying an economic recovery?

You may be enjoying this long respite from reading about the European debt problems, which just a year ago still scared many observers into thinking that the world was on the edge of a deep economic malaise.  The last time Europe made headlines, Greece was going bankrupt, France had its pristine AAA credit rating downgraded, Spain was wrestling with unemployment north of 20%, Italy was insolvent and everybody south of Germany was mired deep in economic recession.

So where are we now?  The Financial Times of London recently took a hard look at the current situation in Europe, and found that the reports of Europe’s demise may have been exaggerated.  In fact, it says that when the Eurozone’s gross domestic product data are released in the coming week, we will see positive figures after 18 months of gloomy negative growth rates.

Among the hopeful signs: manufacturers in the 17 countries that use the euro currency have reported their biggest increase in output since 2011, and Greece, the epicenter of the original crisis, has qualified for its next batch of rescue loans totaling 5.8 billion euros as it sells off (or privatizes) government-owned corporations to pay its debtors.  Spain’s unemployment rate has recently fallen for the first time in two years and even troubled Portugal, where political opposition to austerity threatened its ability to receive a global bailout, now seems to be back on the tracks of economic reform.  Perhaps the best news is that France’s finance minister recently announced the end of recession in the Eurozone’s second-largest economy, with second quarter 2013 growth of 0.2%.

Of course, there are still problems that could derail this still-fragile recovery.  Perhaps the biggest is the continent’s banking industry, where banks are still avoiding having to fess up to their losses on sovereign debt, still cleaning up their balance sheets and are slow to make much-needed loans to regional businesses.  Greece and Spain are still burdened with 27% jobless rates, and Italy is still mired in recession after a 2.4% GDP decline in 2012.

Those of us who have read more about the Greek economy can finally dare hope that the break from scary headlines continues.  Interestingly, most of the reports that talk about rays of hope in Europe also mention, in passing, that the U.S. economy has been the sole engine of growth in an otherwise troubled global economy.  That, in itself, is something to cheer about.

Six Tips on How to Manage an Inheritance Well

Six Tips to Manage an Inheritance

A sizeable inheritance can represent a life-changing opportunity. Here are six tips to help you prudently manage your windfall.

Tip 1: Consult With a Financial Professional and Tax Professional
Depending on the type of inheritance (e.g., investments, life insurance, retirement account), you could be dealing with substantial federal and/or state inheritance taxes. Working with a financial advisor and/or a tax professional could help you plan the sale of any assets and deal with the tax implications. For example:

•    If your inheritance was from your spouse, there may be no taxes due.
•    Life insurance proceeds are usually tax free.
•    Non-retirement assets are taxed when sold, and those assets typically receive a “step up” in cost basis. That means that any capital gains tax you owe will be based on the asset’s fair market value at the date of death of the benefactor.

If you inherit an annuity or traditional workplace retirement account or IRA, you will have to pay taxes on the distributions. Be very careful when taking your distributions. For example, if you cash out your uncle’s IRA and roll the money over into your own IRA, the entire amount of the rollover will be subject to ordinary income taxes.

Note too that there are considerations for spouses rolling over their deceased spouse’s retirement account.

Tip 2: Park the Cash
Before you make any plans or major purchases, stop. Deposit the inheritance or investments in a bank or brokerage account. If you are married, you need to determine whether to put the account solely in your name or jointly with your spouse. Note that inheritances are considered separate property, in case of divorce. However, once they are commingled in a joint account, those assets lose that protection.

Tip 3: Cut Down/Eliminate Your Debt
Your inheritance may allow you the ability to pay off your debt, including your mortgage. But first consider paying off those loans with higher interest rates, such as credit cards, personal loans, and car loans. Then consider paying off your mortgage. Also fund an emergency account with at least six months’ worth of living expenses.

Tip 4: Think About Your Other Goals
Identifying your financial goals can help you determine what types of investments to make or other types of accounts to open. These goals could include:
•    Contributing to charity
•    Setting up a trust or foundation
•    Paying for a family member’s education
•    Helping out loved ones
•    Adding to your retirement savings

Tip 5: Review Your Insurance and Estate Planning Needs
If you’ve inherited a significant sum, it may be wise to increase the liability limits on your homeowners and automotive policies. If you inherited jewelry, artwork, or real estate, you may need to increase your property and casualty coverage. Consider an umbrella policy. Does the inheritance inflate the size of your estate so that it will be subject to estate taxes? Are you thinking about setting up a trust to provide for family or charity?

Tip 6: Do Something Nice for Yourself
Set aside a small percentage — no more than 5% to 10% — of your inheritance for “splurges.” Take a trip. Buy a new car. Just be sure to keep it small. After all, inheritances don’t grow on trees.

This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. You should contact your tax professional to discuss your personal situation.

Dividends: A Bird in the Hand

A Bird in the Hand is certainty

A Bird in the Hand Spells Certainty, or does it?

There’s a lot of focus on the dividend component of investment returns these days–for a variety of reasons.  First, dividends represent money in hand, which is more of a sure thing than stock price appreciation.  Many investors still have a wary eye on the 2008 meltdown, and are having trouble convincing themselves that today’s record stock values represent real money in their portfolios.  As the old saying goes, a bird in the hand is worth two in the bush.

On the other hand, there are taxes to consider.  Since the passage of the new tax law last January, higher-income taxpayers (those in the 39.6% tax bracket) have to pay 20% on the money that is paid out by the corporations in our taxable accounts–up from 15% for tax years 2003 to 2012.  The new Medicare tax will pile on an additional 3.8% tax burden for people with more than $200,000 (individuals) or $250,000 (joint) of taxable income.  You can forestall the tax bite by putting dividend-paying stocks in your IRA, but in doing so, you eliminate another tax-saving measure: the ability to harvest capital losses whenever any of your stock holdings decline in value, share the pain with Uncle Sam and shelter some of your gains.

As recently as last year, dividend investing strategies were considered to be something of a fad, as mutual funds and ETFs that invested in stocks paying the highest dividend percentages were raking in record investor inflows.  But naively investing in companies giving the most money back to their shareholders has not proven to be the ideal strategy.  For one thing, because these rates are calculated as the dividend divided by the share price, the highest dividend payers are sometimes companies that have recently experienced the highest drop in share value.  If a stock valued at $100 is paying a 4% dividend before it plummets to $67, the dividend is suddenly up to 6% of the share price–and becomes a screaming buy at a time when you might worry about the health of the company.  Meanwhile, companies whose dividend rates look low may have recently experienced a surge in their stock value.  Buying simply based on dividend rates may result in a portfolio that resembles a kennel.

In addition, some stocks, like utilities, act more like bonds than stocks; that is, they are built more for income than growth.  Buying the highest dividend stocks could lead to lower overall growth in share value.

Finally, it should be remembered that the dividend rate is never guaranteed, and in fact is paid at the whim of the company’s board of directors.  In 2012, after suffering through an earnings decline, the J.C. Penney company stopped paying its 4% dividend altogether.  Looking in the other direction, late in 2012, anticipating higher taxes on dividends, more than 175 companies made the list of highest dividend payers when they sent “special dividends” out to their shareholders–which were to be paid out of future earnings this year.

When you sort out all the various issues, the best lesson is not to ignore dividends–they have, after all, provided 34% of the monthly total return on the S&P 500 since the beginning of 1927–but not to get carried away by them either.  You’re probably being paid to hold the stocks you own regardless of your strategy.  Just over 82% of the stocks in the S&P 500 are now paying some form of dividends to their shareholders, which is the highest rate since September of 1999.

Instead of looking for the highest dividend yields, a more workable strategy is to identify funds or ETFs that invest in stocks that have a track record of growing their dividends consistently over time, and which are only paying out a portion of their earnings in the form of dividends–what is called the “dividend cover ratio.”  The historical average of earnings paid out as dividends is 52%, but that may go up in the months and years ahead.  Companies are sitting on record amounts of cash–an estimated $1.1 trillion in the 500 stocks making up the S&P 500–and are still reporting record earnings.  That money has to go somewhere, and some of it will eventually find its way into the pockets of patient investors.

Is Gold a New Asset Class?

Gold is a safe nest egg if diversified properly

Gold can be a very safe nest egg if diversified properly.

Should gold be considered as a new asset class or as an instrument of financial speculation? Down from its 2011 high of $1,920.30, Gold sits at $1,333 per ounce today, a $60 jump from $1,277.80 an ounce two Friday’s ago. Many investors view gold these days as an essential part of their portfolio. And a trending obsession for this metal has brought new ideas as well as challenges to the financial planning table. While some advisors refuse to enter the conversation, others are beginning to engage their clients.

With so many opinions on the matter, what is a serious investor to do? Steve Forbes, publishing magnate and chief executive officer of Forbes Magazine said, “The fact that gold is now seen as an investment vehicle reflects the poor state of the U.S. global economy.” He added that only jewelers and gold miners should be buying gold. “When [gold] has to be bought as an asset class it tells you that the politicians are making a hash of things, central bankers are making a mess,” he said.

Wondering if this statement is fueled by political aspirations, one should question if Mr. Forbes stands alone in this belief? Turns out that he is not. For the last decade investors have participated in one of the biggest “buy-ups” in recent history. Mostly prompted by fear, this action has driven up prices and handed some a nice return. The question remains, is it sustainable, and if so, for how long? I’m not sure that anyone can reasonably answer that question so I would approach Gold like any other investment, with much consideration.  One consideration is this. Even though heralded as Gold’s all-time high, the September 2011 high was not its true peak. Adjusted for inflation, Jan. 21, 1980, remains gold’s highest level. At one point in trading on the New York Commodity Exchange, gold touched an intraday level of $875 per ounce, which would be the equivalent of $2,438 in 2012 dollars.

When it comes to the markets, there are some principal strategies that have proven favorable for the investor. First, you should talk to your advisor about your goals. Next, examine your time horizon. In other words, how long do you need this money to work for you? Then you should talk about suitability.  Ask him or her, “Does this investment really make sense for me?” Some advisors are even proponents of Asset Allocation. And by all means, diversify. A reasonable percentage of your portfolio in precious metals is a hedge against long term inflation risks.

Whatever your choice of strategy, understand, there are no guarantees. And as a general rule, when everyone is running in one direction, caution would tell you to consider the other direction.

¹ July 12, 2013 -“Steve Forbes Talks Gold on Kitco News” by Neils Christensen and Daniela Cambone of Kitco News
By Ronnie Stoots
Ronnie Stoots is the President of Amelia Wealth Management.

The Roller Coaster Effect

The Wall Street Roller Coaster is at it again

The Wall Street Roller Coaster is at it again

The impact of a roller coaster period in the markets  is, on the long run at least, usually negligible; but on the short term it can be exhilaratingly devastating…to some. There are two kinds of investors in this world.  One type pays close attention to the daily (and sometimes hourly) flood of information, looking for a reason (any reason) to jump in or out of the markets.  The other kind of investor is in for the long haul, and recognizes that the markets are going to experience dips and turns.  If these people are particularly wise, they know that the dips and turns are the best friend of the steady, long-term investor, because as you put money into the markets, as you rebalance your portfolio, you gain a little extra return from the occasional opportunities to buy at bargain prices.

Last week, the investment markets made an unusually sharp turn on the roller coaster, and showed us once again the sometimes-comical fallacy of quick trading.  See if you can follow the logic of the events that led to last week’s selloff.  Federal Reserve Board Chairman Ben Bernanke and the Federal Open Market Committee issued a statement saying that the U.S. economy is improving faster than the Fed’s economists expected.  Therefore (the statement went on to say) if there was continued improvement, the Fed would scale back its QE3 program of buying Treasury and mortgage-backed securities on the open market, and ease back on stimulating the economy and keeping interest rates low.

Everybody knows that the Fed will eventually have to phase out its QE3 market interventions, and that this would be based on the strength of the economy, so this announcement should not have stunned the investing public.  Nothing in the statement suggested that the Fed had any immediate plans to stop buying altogether; only ease it back as it became less necessary.  The statement said that this hypothetical easing might possibly take place as early as this Fall, and only if the unemployment rate falls faster than expected.  At the same time, the Fed’s economists issued an economic forecast that was more optimistic than the previous one.

The result?  There was panic in the streets–or, at least, on Wall Street, where this bullish economic report seems to have caused the S&P 500 to lose 1.4% of its value on Thursday and another 2.5% on Friday.

In addition–and here’s where it gets a little weird–stocks also fell sharply in Shanghai and across Europe, and oil futures fell dramatically.  How, exactly, are these investments impacted by QE3?

The only explanation for last week’s panic selloff is that thousands of media junkie investors must have listened to “we plan to ease back on QE3 when we believe the economy is back on its feet again,” and heard: “the Fed is about to end its QE3 stimulus!”

It’s possible that the investors who sold everything they owned on Thursday and Friday will pile back in this week, but it’s just as likely that the panic will feed on itself for a while until sanity is restored.  If stocks were valued daily based on pure logic, on the real underlying value of the enterprises they represent, then the trajectory of the markets would be a long smooth upward slope for decades, as businesses, in aggregate, expanded, moved into new markets, and slowly, over time, boosted sales and profits.  The rollercoaster effect that we actually experience is created by the emotions of the market participants, who value their stocks at one price on Wednesday, and very different prices on Thursday and Friday.

The long-term investor has to ask: did any individual company in my investment portfolio become suddenly less valuable in two days?  Did ALL of their enterprise values in aggregate become less valuable within 48 hours–and at the same time, did Chinese and European stocks and oil also suddenly become less valuable?  Phrased this way, the only possible answer is: no.  And if that’s your answer, then you have to assume that eventually, people will be willing to pay the real underlying value of the stocks in the market, and the last couple of days will be just one more exciting example of meaningless white noise.

Bitcoins and Tulips

If you want a little excitement in your investing life, consider this market capitalization graph.  It shows the remarkable growth in price, and then the remarkable fluctuation (mostly down in recent weeks), not of a hot internet startup, or a bond issued by Zimbabwe’s central bank, or a mutual fund, but a kind of currency.  As you can see from the chart, the cumulative value rose from essentially zero to over $2.5 billion, and then lost more than half its value in a few trading days.

Welcome to the strange world of bitcoins, the alternative currency that exists on the web, favored by a small number of techno-geeks, libertarians, drug dealers and the occasional legitimate business.

Bitcoins are a digital currency that has been getting a lot of press coverage, especially recently, with that price spike and subsequent collapse, along with news that people in Cyprus are converting their savings into bitcoins to avoid government confiscation.  The actual coins are, of course, not coins at all; they are essentially records in a digital archive stored on servers throughout the web, in the form of digital signatures, timestamps and public keys, all created in open-source computer code in a way that is designed to foil hackers.  Because a Bitcoin transaction can be processed easily in any currency, anywhere in the world, without banking or transaction fees, some economists think that they represent an early version of what currencies will look like in the future.

Libertarians like bitcoins because they allow you to buy and sell (with those few business who will accept them in payment) totally anonymously, without the government being able to assess taxes or track your activities.  (This is also the attraction for drug dealers.)  People who are suspicious of central bank policies like them because bitcoins are not tied to any traditional banking system; no government can print more of them and debase the currency.

Hackers like them because once bitcoins are stolen, there is no way to recover your losses or trace the thieves.  It’s like stealing the money out of your wallet.

The phantom money received a measure of credibility when Forex, a financial news online portal, recently began offering minute-to-minute Bitcoin news to traders and investors.  However, some of the most astute commentators believe that it is inevitable that bitcoins will eventually wind up worthless.

Why?  First of all, there is nothing backing the bitcoins in your digital wallet.  Unlike dollars, pesos, euros or yen, no government guarantees that bitcoins will have value in the marketplace.  For bitcoins to become a stable reservoir of value, they would have to be accepted by the mainstream business community.

That can’t happen.  Under the protocol that established the digital currency, the global supply of bitcoins can never exceed 21 million.  At a recent (probably inflated) conversion value of $141 per bitcoin, that comes to just under $3 billion, which sounds like a lot until you realize that the foreign exchange markets routinely experience trading volumes of $4 trillion a day, and the global value of all commercial transactions is many times that amount.

Of course, you would solve this problem if the value of individual bitcoins could rise dramatically, to, say, $100,000 each (global value: $2.1 trillion), but this is where the economists point to a fatal flaw.  Suppose your $141 bitcoin suddenly started trading at $200, and then $500, and the value was growing as the need for bitcoins expanded to encompass a broader share of global trade.  That’s great for your paper wealth, but it represents massive deflation of the things you’ll be purchasing.  That iPhone you purchased with one bitcoin would soon be worth half a bitcoin, then a quarter of a bitcoin, and eventually less than a thousandth of a bitcoin–and just like consumers during the Great Depression, you (and millions of other bitcoin holders) would have no incentive to actually do any transactions with your precious hoard.  There’s a reason why currencies are not supposed to be terrific investments; you want them circulating into the economy, rather than hiding in the mattress or an encrypted digital wallet.

Nevertheless, as business (and, yes, people doing business with drug dealers online) learn how to navigate this new digital currency, economists and others say we’re learning how to construct a better global transaction system.  Bitcoins will be an interesting part of the future history of commerce.  They may also become one of the great financial cautionary tales, right alongside the Dutch tulip bulb mania as portrayed by 19th century British Charles Mackay in his book “Extraordinary Popular Delusions and the Madness of Crowds” , as people with thousands of bitcoins valued at millions suddenly find their digital wallets empty of value.

Federal Deficit Ballooning Out of Control – or Is It?

Federal deficits are shrinking says Goldman Sachs

Federal deficits are shrinking says Goldman Sachs

America’s budget deficit is ballooning out of control, right?

As it happens, while Congress and certain pundits scream that we need to cut government spending to the point where we can drown the executive branch in a bathtub, analysts are discovering something surprising: the U.S. government budget deficit this year and next appears to be shrinking.  The Wall Street firm Goldman Sachs has issued a report which lowered fiscal 2013’s estimated red ink from $900 billion to $775 billion, or about 4.8% of total U.S. economic output.

How did this happen? Spending is down as a result of the sequestration ($85 billion this year) and prior spending cuts, plus tax revenues are up 12% over last year, the report tells us.  It says that the deficit may come in even smaller than currently anticipated, due to the higher payroll taxes that are only now starting to be counted on the government’s balance sheet.  If the economy grows faster than expected, that, too, could bring in higher-than-anticipated revenues.  Goldman now projects the budget deficit to fall to just 2.7% of economic output by the 2015 fiscal year, which many economists believe is a sustainable level.

Interestingly, some global economists are not happy about this optimistic budget news.  Senior members of the International Monetary Fund are criticizing Washington policymakers for imposing too much budget austerity, too soon, arguing that it is preventing the unemployment rate from coming down more quickly.

Meanwhile, one of the most influential arguments for bringing the overall deficit down before it reaches 90% of American GDP has taken a serious hit to its credibility.  In an astonishing development, three professors from the University of Massachusetts have looked over spreadsheet data behind a highly influential book published by professors Carmen Reinhart and Ken Rogoff, which purports to show that throughout history, nations have typically foundered when their debt level reached certain thresholds.  The UMass professors found that in their calculations, Reinhart and Rogoff inadvertently omitted data for three countries: Australia (1946-1950), New Zealand (1946-1949) and Canada (1946-1950).  An embarrassing coding error in the spreadsheet also excluded other data from five countries: Australia, Austria, Belgium, Canada and Denmark.

When the missing information was correctly included, it painted a very different picture of the dangers of high government debt levels.  In the original report, whenever countries reached overall government levels of 90%, they experienced negative GDP growth–essentially, a recession–in aggregate over the countries studied.  With the new data, countries crossing that threshold, in aggregate, actually experienced 2.2% positive growth levels.

This revisionist view is actually being confirmed in the real world.  Japan has the highest debt-to-GDP ratio in the world, well beyond the supposed collapse threshold, and its interest rates have remained stubbornly low (as, to be fair, has its economic growth).  Southern European countries that have embraced austerity–like Greece, Spain and Portugal–have endured multiple recessions, the opposite of what the original (flawed) Reinhart/Rogoff data suggested.  The United States, which opted for a stimulus approach to the 2008 meltdown, is recovering faster than any developed country in the world.

Getting the economy healthy accomplishes two things: it lowers the budget deficits by bringing in more tax revenues, and it further lowers the debt-to-GDP ratio by expanding the GDP number in the equation.  Nobody argues that America can’t keep piling up debt forever.  But it seems clear, from the data on the ground and from the corrected data in the influential report, that the stimulus efforts after the Great Recession weren’t quite the terrible decision that they are sometimes made out to be. What is not always so clear is how to cut through the political hyperbole – from both sides – and drill down to the facts of the matter.


Marriage & Money: A Balancing Act

Searchamelia financial commentary

Marriage has a lot of financial consequences

Marriage affects your finances in many ways, including your ability to save money, invest, prepare for retirement, manage your estate, or make decisions about tax and insurance-related benefits. If you are planning to get married or have recently tied the knot, here are some thoughts to consider.

Saving & investing –If both you and your spouse are employed, two incomes can be a considerable benefit toward saving money, investing, and building long-term wealth. For example, if both of you have access to employer-sponsored retirement plans, your joint contributions are double the individual maximums ($17,500 for 2013). Similarly, a working couple may be able to pay a mortgage more easily than a single person can, which may make it possible for a couple to apply a portion of their combined paychecks for family savings or investments.

Retirement benefits –Some (but not all) pensions provide benefits to surviving spouses following a pensioner’s death. When participating in an employer-sponsored retirement plan, married workers are required to name their spouse as beneficiary unless the spouse waives this right in writing. Qualifying widows or widowers may collect Social Security benefits up to 100% of the benefit earned by a deceased spouse.

Estate planning –Married couples may transfer real estate and personal property to a surviving spouse with no federal gift or estate tax consequences until the survivor dies. But surviving spouses do not automatically inherit all assets. Couples who desire to structure their estates in such a way that each spouse is the sole beneficiary of the other need to create wills or other estate planning documents to ensure that their wishes are realized. In the absence of a will, state laws governing disposition of an estate take effect. Also, certain types of trusts, such as QTIP trusts and marital deduction trusts, are restricted to married couples.

Tax planning –When filing federal income taxes, filing jointly typically results in lower tax payments when compared with filing separately.

Debt management –In certain circumstances, creditors may be able to attach marital or community property to satisfy the debts of one spouse. Couples wishing to guard against this practice may do so with a prenuptial agreement. Be sure to consult an attorney regarding legal documents and advice specific to your situation.

The opportunity to go through life with a loving partner may be the greatest benefit of a successful marriage. That said, there are financial and legal benefits that you may want to explore with your betrothed before you tie the knot and take the leap into the abyss of marital bliss.

The Strain and Drain of Hidden 401k Fees

What to do about 401K feesConcerned about the drain hidden fees in your 401(k) plan are extracting from your hard-earned retirement savings? Maybe you should be. Millions of Americans–and a lot of professional advisors–are talking about the hard-hitting Frontline exposé on retirement plans.  The PBS special, entitled “Retirement Gamble,” tells you a lot of things you already know: that corporations have offloaded the decision-making for retirement portfolios on their (not always financially sophisticated) employees, but provided virtually no guidance.  The 2008 market crash wiped out investors who had naively put their entire retirement savings in stocks and then sold out at the bottom in a panic.  Just 14% of Americans are confident that they have saved enough to live comfortably in retirement.

The special report includes a few details that are likely to be shocking to many non-experts, including the fact that 401(k) plans are not provided for free, as many participants believe, and some plans were set up by the mutual fund and brokerage companies who (no surprise here) populate it with their own funds and triple-dip, charging fees for managing the account, and more fees for managing the funds, plus commissions for selling the funds to those naive plan participants.  We learn what many professionals already know: that some people pay ten times more in fees drained out of their retirement plan than others.  Vanguard founder Jack Bogle, who is charming, telegenic, and a big believer in index funds is interviewed extensively.

Interestingly, the PBS report doesn’t mention that help may be on the way.  The U.S. Department of Labor, which sets the regulations for corporate retirement plans, has mandated that all retirement plans disclose, in writing, the various costs and fees that are being charged to plan participants.  These disclosures are now starting to show up in performance statements, and some believe that these rays of sunlight will eventually eliminate the self-dealing and high fees that were exposed in prime time.

The DOL is working on proposals that would require those who give investment advice to plan participants to act in the best interests of the future retirees, and the proposal is expected to ban sales commissions.  The requirement–known as a fiduciary standard, or putting the client’s interest first–would extend to the IRA accounts that receive the rollover funds from 401(k) and other retirement plans.

Nobody should be surprised that the brokerage industry is lobbying furiously against these proposals, which has caused several delays and at least one incident where the Department of Labor shelved a proposal for “further study” to explore the economic impact on brokerage firms and consumers.

Will the new rules ever be enacted?

Sales agents failed to stop the disclosure rules from passage, so their lobbying power is not unlimited.  And few unbiased parties would argue with the idea that people receiving advice should be given unconflicted advice, and that sales people should openly disclose the fact that they’re selling rather than advising.  The Frontline special, showing millions of people how much money has been siphoned out of their retirement accounts into the pockets of larger financial services firms, should help the Department of Labor resist the big moneyed opposition to its efforts to do the right thing for retirees.

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