Monthly Archives: December 2010

by | December 29, 2010 · 4:47 pm

High Unemployment Bad for Stocks, Right?

We regularly receive great comments from clients regarding our views on the economy and the markets.  Often, they are challenging… and in as difficult an environment as we’ve been in for the last 2 1/2 years, rightfully so.  I recently had a client question how we can continue to be bullish on stocks in lieu of our poor economy, particularly our high unemployment rate – which (agreeably) seems destined to stay that way for some time.

Ironically, the chart below indicates that the stock market has done much better when the employment rate was high (13.6% gain per annum when the unemployment rate was above 6.0%) than low (2.1% gain when unemployment 4.3% or below). 

Again, we remain secular bears.  But for now, our research lends us to a mildly bullish posture.

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by | December 28, 2010 · 4:44 pm

Managing Investment Risk

Managing Investment Risk

Whenever an individual takes cash and puts it to work in any form of investment, he or she does so with the anticipation of receiving a return on the money. At some future point in time, the investor expects to get back both the principal amount and something extra as well. The possibility that an investment will return less than expected is known as “investment risk.”

Risk vs. Reward

One of the great truths of the investment world is that risk and reward go hand in hand. The greater the risk an investor is willing to undertake, the greater the potential reward. If an investor is willing to assume only a small amount of risk, the potential reward is also low. In an ideal world, there would be no risk to any investment. Unfortunately, such a risk-free investment does not exist.

There is also more than one type of risk. An investor must understand each type of risk, and use that knowledge to create a portfolio of investments that balances the level of risk assumed, with the desired investment return.

Market Risk

In simple terms, market risk can be defined as the possibility that downward changes in the market price of an investment will result in a loss of principal for an investor. For many, market risk is most closely associated with the ups and downs of the stock market.

Market risk exists for other investments as well. For example, the market price of bonds and other debt investments will move up and down in response to changes in the general level of interest rates. If interest rates rise, bond prices generally fall. If interest rates decline, bond prices generally rise. Tangible assets such as real estate and gold, or collectibles such as art or stamps, also face market risk.

Over time, a number of strategies have been developed to help reduce market risk.

  • Invest only dollars that are not required to meet current needs. This helps avoid having to sell an asset when the market may be down.
  • Develop a long-term approach. A longer time horizon allows an investor to ride out market ups and downs.
  • Diversify your investments over a number of asset categories, such as stocks, bonds, or cash, and tangible investments such as real estate. Holding assets in different investment categories reduces the possibility that all investments will be down at the same time.

Inflation Risk

For many individuals, safety of principal is the primary goal when deciding where to place investment funds. Such investors frequently put much of their money in bank savings accounts, CDs or T-Bills. While such investments can provide protection from market risk, they do not provide much protection from inflation risk. An investor may hold the same number of dollars; over time, however, those dollars buy less and less.

While there are ways to shield your portfolio from inflation risk, most involve a higher level of market risk:

  • Consider placing a portion of your assets in the stock market.
  • Historically, tangible assets such as real estate or gold have tended to do well in periods of inflation.

Other Common Risk Types

In addition to market and inflation risk, there are a number of other common types of risk that each investor must be aware of:

Credit risk: This is also known as “default risk.” The chance that the issuer of a bond or other debt-type instrument will not be able to carry out its contractual obligations. Keeping maturities short, diversifying investments among various companies, and investing in institutions and issues of the highest credit rating are common methods used to help control this type of risk.

Liquidity risk: This risk is the possibility that an investor will not be able to sell or liquidate an asset, without losing a part of the principal, because there is an imbalance between the number of buyers and sellers, or because an asset is not traded very often. Choosing investments traded on an active market, and limiting investments to funds not needed for current expenses are approaches used to help lessen this risk.

Interest rate risk: This is defined as the risk that an increase in the general level of interest rates will cause the market value of existing investments to fall. Generally this risk applies to bonds and other debt-type instruments, which move opposite to interest rates. As interest rates rise, bond prices tend to fall, and vice versa. One approach to reducing this risk is to stagger or ladder the maturities in the portfolio so that a portion of the portfolio matures periodically, rather than all at the same time. Holding a security until maturity, at which time it is redeemable at full value, is also useful.

Tax risk: This refers to the possibility that a change in tax law, at either the federal, state or local level, will change the tax characteristics of an investment. After such a legislative change, an investment may no longer meet an individual’s needs. In some cases, new legislation has included a grandfather clause allowing current investors to continue under the old rules.

Making an investment because it’s a good investment, rather than focusing on the tax benefits, is an excellent way to help reduce this risk.

Managing Risk

Fortunately, investment risk can be managed such that surprises are minimized and worst-case scenarios planned for. The key is to know why you are investing, and when you are likely to need the funds from your investment.

David W. Russell, CFP

Sr. Vice President

Pinnacle Trust

Disclaimer: This report is intended to serve as a basis for further discussion with your professional advisors. Although great effort has been taken to provide accurate numbers and explanations, the information in this report should not be relied upon for preparing tax returns, legal documents, or making investment decisions. If investment returns are included with this report, the assumed rates of return are not in any way to be taken as guaranteed projections of actual returns from any investment opportunity. The actual application of some of these concepts may be the practice of law and is the proper responsibility of your attorney.

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by | December 27, 2010 · 4:36 pm

2010 Tax Laws Summary

2010 Tax Laws Summary

On December 16, 2010 Congress passed and the President signed the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (H.R. 4853), which finalizes the controversial tax agreement reached between President Obama and Republican congressional leaders to extend the Bush-era tax cuts. The legislation contains several important tax provisions. The following is a briefing of the most noteworthy items affecting individuals included in the Act.

Income Tax Provisions

Prior to this legislation, the 2010 individual income tax rates of 10%, 15%, 25%, 28%, 33%, and 35% were scheduled to increase to 15%, 28%, 31%, 36%, and 39.6% in 2011. The new legislation contains a two-year extension of the current rates through December 31, 2012.

Enhanced opportunity: With the prior uncertainty of tax rates in years beyond 2010, individuals may have been hesitant to do a Roth conversion in 2010 in order to take advantage of the automatic two-year spread of the resulting tax liability to 2011 and 2012 (half the income is reported in 2011 and the other half is reported in 2012 at the tax rates applicable for those years). Individuals may instead elect to have all the income reported in 2010. Now, with the knowledge that the tax rates for 2011 and 2012 will be unchanged, individuals may wish to do a Roth conversion before year-end to take advantage of this unique tax postponement opportunity. It must be recognized that no matter what year or years it will be reported, individuals may be subject to estimated tax penalties for failing to pre-pay the correct amounts.

Long-term capital gains are generally taxed at 15% (0% for those taxpayers in the 10% and 15% income tax brackets). The current 15% capital gains rate was scheduled to rise to 20% in 2011. The new legislation extends the 15% rate for two years, through December 31, 2012. Qualified dividends are currently taxed at 15% as well (0% for those taxpayers in the 10% and 15% income tax brackets) but were scheduled to be taxed at an individual’s ordinary income tax rate. The current legislation extends the current 15% rate on qualified dividends for two years, through December 31, 2012.

The limit on itemized deductions for higher-income individuals was repealed for 2010 but scheduled to return in 2011. The repeal of the limit on itemized deductions is extended for two more years, through December 31, 2012.

The personal exemption phase-out for higher-income individuals was repealed for 2010 but scheduled return in 2011. The personal exemption phase-out is also extended for two years, through December 31, 2012.

In 2010 the marriage penalty is partially eliminated meaning that:

1.)   the standard deduction for a married couple filing a joint return is equal to twice the standard deduction for a single individual, and

2.)   the size of the 15% tax bracket had been expanded for married couples filing jointly to help mitigate the marriage penalty.

The full marriage penalty was scheduled to return in 2011, but the 2010 partial elimination of the marriage penalty has been extended for two more years, through December 31, 2012.

The Child Tax Credit, Earned Income Credit, and American Opportunity Tax Credit have also been extended for two years, through December 31, 2012.

Several income tax incentives (collectively known as extenders) expired at the end of 2009. The following incentives were extended for 2010 and 2011:

  • Charitable contribution of IRA distributions for IRA owners over age 70 ½
  • State and local sales tax deduction
  • Higher education tuition deduction
  • Teacher’s classroom expense deduction

Note that the legislation does not extend the additional standard deduction for real property taxes that expired at the end of 2009.

In 2011, the maximum contribution amount to a Coverdell Education Savings Account was set to decrease from $2,000 to $500 and tax-free distributions for K-12 expenses were not to be permitted beginning in 2011. The new Act extends both the current $2,000 contribution amount and the ability to take tax-free distributions for qualified education expenses of students in grades K-12 for two years, through December 31, 2012.

Alternative Minimum Tax (AMT)

The new legislation includes an AMT patch for 2010 and 2011 to help prevent the AMT from affecting middle-income taxpayers. For 2010, the exemption amounts are increased to $47,450 for single filers and $72,450 for joint filers. For 2011, the amounts are $48,450 and $74,450 respectively.

Estate Tax Provisions

In 2010, the federal estate tax was repealed. A $1 million exclusion amount and a top rate of 55% were scheduled to occur in 2011. The new legislation contains a $5 million exclusion amount and top rate of 35% for 2011 and 2012.

In addition, the legislation allows for portability of the $5 million estate tax exclusion for married couples. In other words, a surviving spouse could elect to use the unused portion of the estate tax exclusion of the predeceased spouse, thus resulting in a larger exclusion amount for the surviving spouse.

Estates of decedents dying in 2010 now have the option to elect either a) an estate tax with the new 35% top rate and a $5 million exclusion with a step-up in basis allowed or b) no estate tax and the modified carryover basis that existed just before the Act was passed. In addition, these estates have an extended time (generally nine months) to file a Form 706 Estate Tax Return and make the necessary payment.

Gift Tax Provisions

The gift tax has remained in effect for 2010, with a top tax rate of 35% and a maximum applicable exclusion amount of $1 million. The new legislation provides for a top rate of 35% and a $5 million exclusion for two years, through December 31, 2012. Gift and estate taxes were decoupled in 2001, but the new legislation reunifies gift and estate taxes for gifts made after December 31, 2010.

Social Security Payroll Tax Relief

The new legislation contains a 2% reduction, from 6.2% to 4.2%, of the Social Security payroll tax in 2011 for all wage earners regardless of income. Individuals earning at or above the Social Security cap of $106,800 will receive a $2,136 tax benefit in 2011. The employer’s share of the Social Security tax will remain at 6.2%.

Naturally, it can be anticipated the IRS, over time, will be issuing further interpretative regulations involving more specifics of the implementation of these provisions. Although advisors cannot provide tax or legal advice, the above information should assist you in the financial planning you do for clients.

© 2010 Cetera Financial Group 10-0267 03/10

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by | December 22, 2010 · 2:22 pm

It's Official: No Double Dip for Economy

The ECRI (Economic Cycle Research Institute) produces a U.S. Weekly Leading Index to aid in forecasting the direction of the economy.  Sharp declines in the index over the summer led many to believe (not us) that we were headed for a double-dip recession.  Our research has been consistent in showing that sometimes these signals indicate slowdowns, not recessions (points-in-case 1981 and 2002).  WLI is now indicating expansion, just in case you’re still worried. 

Although I continue to have secular concerns, price and trends look positive for stocks, and seasonal and cyclical tendencies are bullish.  Hope you and your family have a wonderful holiday season.

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by | · 1:38 pm

Consumers Making Progress on Debt

Produced by the Federal Reserve Board, the Household Debt Service Ratio (DSR) is an estimate of the ratio of debt payments to disposable personal income.  Debt payments consist of estimated required payments on outstanding mortagage and consumer debt.  The Financial Obligations Ratio (FOR) adds automobile lease payments, rent payments, homeowners’ insurance and property tax.

As of September, FOR fell for the seventh consecutive quarter to its lowest level since the first quarter of 1995.  DSR also fell to its lowest level since the first quarter of 1999.

While these ratios continue to move in the right direction, we expect that both the FOR and DSR will need to test their early-1980′s or mid-1990′s lows before we are in position for a sustainable recovery in household spending.

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by | December 13, 2010 · 3:42 pm

Federal Government Posts More Deficits

The federal government posted a $150.4 billion budget deficit in November, its 26th straight shortfall, according to the Monthly Treasury Statement released last Friday. The deficit widened by $30.1 billion to $1.288 trillion on a 12-month total basis, representing 8.9% of nominal GDP. Federal receipts picked up $15.4 billion to $2.188 trillion, led by individual income, payroll, and corporate taxes, as the economic recovery progressed. On a y/y trend basis, individual income taxes have risen for the first time since August 2008, while corporate income taxes have gained at the fastest pace since November 2005.

Federal spending rose $45.5 billion to $3.476 trillion and is near even with a year ago. Net interest payments have trended upward for the past year, despite historically low interest rates, as government debt continued to rise. Data from the Flow of Funds report show that government spending as a share of GDP rose to a record 25.5% in Q3, while tax receipts rose to 16.4%, resulting at a near record gap between the two.

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by | December 8, 2010 · 9:00 am

Five Reasons You Might Need A Trust

First off, what is a trust? The simplest definition I can offer is that it is an agreement involving three parties – you, a trustee, and a beneficiary – where property is given by you to a trustee to manage on behalf of one or more beneficiaries. The agreement will have its own set of instructions for the trustee that direct the trustee how to manage the property and when to give property or income to the beneficiary. By law the trust must have an ending event – a future time when the property of the trust is distributed to the remaining beneficiaries. Until then, which can be one hundred years or more, the property is held under the control of the trustee who manages it according to your original wishes.

A few other basics: a trust can be created during your lifetime, in which case it’s called a “living” trust, or it can be created through your will, in which case it’s called a “testamentary” trust. In addition, a trust may be “revocable” meaning that you may change or revoke the trust during your lifetime; or the trust may be “irrevocable” which means that no one has the power to alter the terms of the trust once it’s written. A revocable trust will usually become irrevocable at your death, just like your will.

So, five reasons you might need a trust are:

1. You’re concerned about the expense and delay of probate. Probate is the legal proceeding involved in settling your affairs when you die. It can be expensive, and it can be time consuming, depending on the complexity of the estate. In this case a Revocable Living Trust that holds title to your assets may be an appropriate alternative to a traditional will. Under this arrangement, you can be the trustee and beneficiary of the trust during your life; therefore no control is lost over the trust assets. At death, no title changes are required since the trust already owns the assets, so no probate proceeding is necessary. A successor trustee, normally a corporate trustee or family member, carries on the trust and disburses the assets according to your written instructions.

2. You have more than $2.0 Million in total assets (or $4 Million if married). For 2006, individuals may die with an estate of less than $2.0 Million and pay no estate taxes. Married individuals may leave an unlimited amount to one another, but doing so my waste the first spouse’s $2.0M exemption. That’s because when the surviving spouse dies, the combined estate only has one remaining exemption. To preserve the exemption, use a credit shelter trust. At the first spouse’s death, an amount not exceeding the exemption is placed into the shelter trust. It is neither taxed at that time nor at the later death of the surviving spouse, even though it may appreciate greatly in value.

3. You have minor children. Minor beneficiaries of an estate cannot legally accept title to property or assets. Without a trust, the courts will create a guardianship for the assets. While designed to protect the estate of a minor, these guardianships may not accomplish your specific wishes. The courts may require the guardian to post bond and file an annual accounting. This is fine, unless the guardian is the surviving parent, in which case, these requirements can be overly burdensome. In addition, most guardianships are required to pay out their balance when the minor reaches the age of majority for the state they live in, which may be earlier than you’d like. As one father put it, “if my daughter were eighteen, and received a windfall of tens of thousands of dollars, I know exactly what she’d do with it. She’d buy a new car and spend the rest on clothes

4. You are concerned about the financial maturity of your adult heirs. A trust is the only instrument that gives its creator the ability to control property “from the grave.” Now if this sounds too controlling to you, consider the fact that the average inheritance is consumed within six months. Furthermore, 25% of those receiving inheritances of $150,000 or more totally drop out of the workforce (apparently only for about six months). Many parents are concerned about the impact that sudden wealth may have on their children’s lives. Trusts can preserve the estate for longer periods, and protect the assets from events such as divorce or bankruptcy.

5. You have children from a prior marriage. Children from a prior marriage may inadvertently be left out of their deceased parent’s estate if the parent has remarried and owns all of his assets in joint tenancy with the 2nd wife, or has only a simple will. In either case, the entire estate will pass to the surviving 2nd wife who is under no obligation to leave any part of the estate to the children of the first marriage. However, the surviving spouse may need the income from the assets. To address this situation, a QTIP trust may be established. The QTIP trust allows the creator to designate income to a surviving spouse for life, while retaining the right to name the persons who will ultimately receive the trust assets at the surviving spouse’s death. The QTIP also reduces the possibility of the estate passing to a subsequent marriage partner or “close friend” of the surviving spouse.

These are only five instances where a trust may provide control, tax, or protection benefits. There are a myriad of other situations where a trust may be warranted as well. Only a thorough analysis of your financial and personal goals can determine if a trust is a tool that can benefit you and your family. Perhaps these scenarios will encourage you to take the first step.

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by | December 7, 2010 · 1:35 pm

Republican Leaders Reach Deal with President Obama

Late Monday afternoon President Barack Obama announced that he and Republican leaders in Congress had reached a deal on taxes. The deal will extend the Bush-era income tax cuts, which were slated to expire at the end of this year, for two more years.  This agreement comes as no surprise.  Based on the November mid-term elections, the majority of the country’s population made it clear that they were not enthused about the direction the nation’s leaders were taking it.  What is shocking, however, is how far reaching the cuts extend.  

In the agreement, income, dividend, and capital gains tax cuts will remain in effect for all Americans.  Originally, the President had been pushing for the Bush tax cuts to expire for joint-filers with incomes above $250,000 per year.  A program that extends unemployment benefits for the long-term unemployed will be extended for another 13 months.  A payroll-tax cut would reduce Social Security taxes from 6.2% to 4.2% of worker’s wages for one year.

The deal will still reinstate the estate tax but on estates above $5,000,000 instead of estates above $1,000,000.  It will also be reinstated at 35% instead of 55%. 

Many Democrats are outraged over the agreement.  Rep. John Conyers (Democrat, Michigan) was quoted as saying, “I can tell with certainty that legislative blackmail of this kind by the Republicans will be vehemently opposed by many, if not most, Democrats.”  Without support from his left wing base, the President will rely heavily on Republicans and moderate Democrats to get this through Congress.

The proposed agreement should aid in stimulating the economy but at what cost?  Early estimates are that the proposal will cost the government approximately $1 trillion in revenue over the next two years.  Some of the revenue could be recouped by an increase in consumer spending as the cuts in Social Security taxes will put more money in the pockets of the middle class.  But the proposal will have a bloating effect on the federal deficit.     

The government’s focus is to first keep the economic expansion on track and then second address the federal deficit, once things have stabilized further.  With the deficit expected to go above the $15 trillion mark this fiscal year, time is running short. 

But for now this news supports Pinnacle Trust’s thesis that the economic recovery will continue and that the stock market will continue to climb into 2011.

Jeremy Nelson, CTFA
VP & Investment Officer

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