Kevin Kroskey's Money & Mind

What Beneficiaries Need to Know

2012-01-09T16:39:00.000-05:00

What do you do when an account owner passes away?

If your loved ones have invested, saved or insured themselves to any degree, you may be named as a beneficiary to one or more of their accounts, policies or assets in the event of their deaths. While we all hope “that day” never comes, we do need to know what to do financially if and when it does.

Legally, just who is a “beneficiary”? IRAs, annuities, life insurance policies and qualified retirement plans such as 401(k)s and 403(b)s are set up so that the accounts, policies or assets are payable or transferable on the death of the owner to a beneficiary, usually an individual named on a contractual document that is filled out when the account or policy is first created.

In addition to the primary beneficiary, the account or policy owner is asked to name a contingent (secondary) beneficiary. The contingent beneficiary will receive the asset if the primary beneficiary is deceased.

Some retirement accounts and policies may have multiple beneficiaries. Charities, schools and nonprofits are also occasionally named as beneficiaries. If you have individually listed one (or more) of your kids or grandkids as designated beneficiaries of your 401(k) or IRA, that designation should override a charitable bequest you have stated in a trust or will.¹

A will is NOT a beneficiary form. When it comes to 401(k)s and IRAs, beneficiary designations are commonly considered first and wills second. If you willed your IRA assets to your son in 2008 but named the man who is now your ex-husband as the beneficiary of your IRA back in 1996, those IRA assets are set up to transfer to your ex-husband in the event of your death. Sometimes beneficiary forms are revised; often they are never revised.¹

If a retirement account owner passes away, what steps need to be taken? First, the beneficiary form must be found, either with the IRA or retirement plan custodian (the financial firm overseeing the account) or within the financial records of the person deceased. Beyond that, the financial institution holding the IRA or retirement plan assets should also ask you to supply:

· A certified copy of the account owner's death certificate

· A notarized affidavit of domicile (a document certifying his or her place of residence at the time of death)

If the named beneficiary is a minor, a birth certificate for that person will be requested. If the beneficiary is a trust, the custodian will want to see a W-9 form and a copy of the trust agreement.^2,3,4

If you are named as the primary beneficiary, you usually have four options regardless of what kind of retirement savings account you have inherited:

1) Open an inherited IRA and transfer or roll over the funds into it.

2) Roll over or transfer the assets to your own, existing IRA (spouse only).

3) Withdraw the assets as a lump sum (liquidate the account, get a check).

4) Disclaim as much as 100% of the assets, thereby permitting some or all of them to be inherited by a contingent beneficiary

However, these options may be influenced or limited by four factors:

1) The kind of retirement plan you have inherited.

2) Whether the named beneficiary is a spouse, non-spouse, trust or estate.

3) The age at which the account owner passed away.

4) The resulting tax consequences.

Before you make ANY choice, you should welcome the input of a tax advisor.^3,5

What if you are a spousal beneficiary? If that is the case, you may elect to:

· Roll over or transfer assets from a traditional IRA, Roth IRA, SEP-IRA or SIMPLE IRA into your own traditional or Roth IRA, or an inherited traditional or Roth IRA

· Withdraw the assets as a lump sum

· Roll over or transfer qualified retirement plan assets from a 401(k), 403(b), etc. into your own retirement account, or take them as a lump sum

· Disclaim up to 100% of the assets within 9 months of the original account owner’s death^3,5,8

What if you are a non-spousal beneficiary? If this is so, you may elect to:

· Roll over or transfer assets from a traditional IRA, Roth IRA, SEP-IRA, SIMPLE IRA or qualified retirement plan into an Inherited IRA

· Withdraw the assets as a lump sum

· Disclaim up to 100% of the assets within 9 months of the original account owner’s death

· Leave the assets in the plan (sometimes permissible with qualified retirement plans)^3,5

What if a trust, estate or charity is named as the beneficiary? If that is the circumstance, there are three choices:

· Transfer assets from a traditional IRA, Roth IRA, SEP-IRA, SIMPLE IRA or qualified retirement plan into an Inherited IRA

· Withdraw the assets as a lump sum

· Disclaim up to 100% of the assets within 9 months of the original account owner’s death^3,5

The next calendar year will be very important. Inheritors of retirement accounts have until September 30 of the year following the original account owner’s death to review and remove beneficiaries, and until December 31 of that year to divide the IRA assets among multiple beneficiaries. Usually, December 31 of the year after the original retirement plan owner’s passing is the deadline for the first RMD (Required Minimum Distribution) from an inherited traditional or Roth IRA.⁶

Now, how about U.S. Savings Bonds? If you are named as the primary beneficiary of a U.S. Treasury Bond, you have three options:

· Redeem it at a financial institution (you will need your personal I.D. for this).

· Get the security reissued in your name or the names of multiple beneficiaries. You do this via Treasury Department Form 4000, which you must sign before a certifying officer at a bank (not a notary). Then you send that signed form and a certified copy of the death certificate to a Savings Bond Processing Site.

· Do nothing at all, as the primary beneficiary automatically becomes the bond owner when the original bond owner passes away.⁷

What about savings & checking accounts? Bank accounts are often payable-on-death (POD) assets or “Totten trusts.” All a beneficiary needs to claim the assets is his or her personal identification and a certified copy of the death certificate of the original account holder. There is no need for probate. (Some states limit charities and non-profits from being POD beneficiaries of bank accounts.)⁷

How about real estate? Lastly, it is worth noting that about a dozen states use transfer-on-death (TOD) deeds for real property, including Ohio. If you live in such a state, you have to go to the county recorder or registrar, usually with a certified copy of the death certificate and a notarized affidavit which informs the recorder or registrar that ownership of the property has changed. If the deed names multiple beneficiaries and some are dead, the surviving beneficiaries must present the recorder or registrar with certified copies of the death certificates of the deceased beneficiaries.

Best Regards,

Kevin Kroskey

Citations.

1 - www.cbsnews.com/8301-505146_162-37941197/ira-beneficiary-forms-may-be-more-important-than-your-will/ [6/10/09]
2 www.ehow.com/info_12081482_ira-beneficiary-require-death-certificate.html [9/20/11]
3 - www.schwab.com/cms/P-1625576.3/CS13416-02_MKT13598-10_FINAL_118091.pdf?cmsid=P-1625576&cv0 [12/10]
4 - personal.fidelity.com/accounts/pdf/InheritedNonRetirementIntro.pdf [12/16/11]
5 - www.fidelity.com/ira/inherited-ira [12/16/11]
6 - www.sfgate.com/cgi-bin/article.cgi?f=/g/a/2011/12/14/investopedia6585.DTL [12/14/11]
7 - www.nolo.com/legal-encyclopedia/claim-payable-on-death-assets-32436.html[12/16/11]
8 - http://www.montoyaregistry.com/Financial-Market.aspx?financial-market=who-should-inherit-your-ira-andor-401k&category=22 [12/16/11]

Hire an Advisor or Go it Alone?

2011-12-05T14:18:00.000-05:00

Walter Updegrave, in addition to being an award-winning journalist, speaker, author and senior editor of MONEY is a professional who truly understands the world of retail investing and communicates his thoughts in a manner meaningful to his readers. As an example, below is an excerpt from a recent CNN Money release based on a readers question “Should I hire a financial adviser to manage my retirement portfolio, and can I afford to?”

“The answer depends largely on how comfortable you are going it alone -- and how good a job you think you could do overseeing your finances without help from a pro.

Let's start with one key aspect of retirement planning: investing. As long as you're familiar with the concept of asset allocation and you're comfortable picking funds, you shouldn't have trouble building a diversified portfolio on your own.

And you can get plenty of assistance short of hiring an adviser: These days most 401(k) plans provide tools to help you assess your investing options and assemble an appropriate lineup for your age and risk tolerance.

You can also find plenty of guidance online.” ….

“The problem is, if you screw up, you can end up losing a lot more than you might save. In a recent study, benefit consultant Aon Hewitt and advice firm Financial Engines looked at the 401(k) returns of more than 425,000 savers from 2006 through 2010.

The findings: The median annual return of those who got professional help was almost three percentage points higher than the return for those who invested on their own, even after taking fees into account.

One reason for that performance gap is that the investors who flew solo were far more likely to be too aggressive or too conservative. Emotions also played a role: Do-it-yourselfers were more apt to cash out of stocks in the 2008 crash. As a result, their returns lagged substantially when the market rebounded in 2009.” …

“While you're saving for retirement, you have plenty of free tools to guide you, plus low-cost access to professional help through target-date funds. But as you near the end of your career, the stakes go up.”

Good advisors will do much more than just help with investment advice but also with distribution planning, tax planning, estate planning, and insurance planning to name a few. The benefit received from the advisor has to be greater than the cost paid. Just don't be penny wise but pound foolish.

Check out the full story at http://finance.yahoo.com/news/should-i-hire-a-financial-adviser-or-go-it-alone-.html

The Euro's Troubles

2011-11-03T12:25:00.003-04:00

The excerpt below is from a keynote address gave in 2000 by "Uncle Milt" (or Milton Friedman as he's more commonly known). With all that is going on in Europe currently, it's not likely the question of whether the Euro is long-term sustainable will go away.

---

"The euro is one of the few really new things we’ve had in the world in recent years. Never in history, to my knowledge, has there been a similar case in which you have a single central bank controlling politically independent countries.

The gold standard was one in which individual countries adhered to a particular commodity—gold—and they were always free to break or to leave it, or to change the rate. Under the euro, that possibility is not there. For a country to break, it really has to break. It has to introduce a brand new currency of its own.

I think the euro is in its honeymoon phase. I hope it succeeds, but I have very low expectations for it. I think that differences are going to accumulate among the various countries and that non-synchronous shocks are going to affect them. Right now, Ireland is a very different state; it needs a very different monetary policy from that of Spain or Italy.

On purely theoretical grounds, it’s hard to believe that it’s going to be a stable system for a long time. On the other hand, new things happen and new developments arise. The one additional factor that has come out that leads me to raise a question about this is the evidence that a single currency—currency unification—tends to very sharply increase the trade among the various political units. If international trade goes up enough, it may reduce some of the harm that comes from the inability of individual countries to adjust to asynchronous shocks. But that’s just a potential scenario.

You know, the various countries in the euro are not a natural currency trading group. They are not a currency area. There is very little mobility of people among the countries. They have extensive controls and regulations and rules, and so they need some kind of an adjustment mechanism to adjust to asynchronous shocks—and the floating exchange rate gave them one. They have no mechanism now.

If we look back at recent history, they’ve tried in the past to have rigid exchange rates, and each time it has broken down. 1992, 1993, you had the crises. Before that, Europe had the snake, and then it broke down into something else. So the verdict isn’t in on the euro. It’s only a year old. Give it time to develop its troubles."

—
Milton Friedman. Keynote address at "Revisiting the Case for Flexible Exchange Rates" Conference organized by the Bank of Canada, November 2000.
Available at http://www.bankofcanada.ca/wp-content/uploads/2010/08/keynote.pdf.

Interest Rate Curve Balls

2011-10-17T12:03:00.001-04:00

Predicting interest rate movements correctly is hard. Predicting them for a living is harder still. But getting it wrong is nowhere near as painful as the experience of those who lose their own money based on someone's forecast.

A year ago, the Reuters news agency polled a group of people closer than just about any other community to those who actually decide rate movements. These were 16 money market dealers who do business directly with the US Federal Reserve.¹ The so-called primary dealers — banks or broker-dealers — are market makers for government securities. They consult directly with the US central bank and Treasury about funding the budget deficit and implementing monetary policy. So if you wanted an informed view about the interest rate outlook, these might be the people you would call on first, which is what Reuters did when it asked the dealers for their forecasts for Treasury bond yields three, six and 12 months ahead.

Back in late September 2010, the dealers came up with a consensus forecast for US 10-year Treasury note yields rising from 2.50 per cent to 2.70 per cent in three months, 2.80 per cent in six months and to 3.20 per cent by September 2011. So how did those forecasts turn out? Well, after three months, the yields had already surpassed the 12-month forecast at around 3.3 per cent. Another three months on, yields had topped 3.4 per cent, again well above forecasts. But then they started coming down again and by September 2011, were close to 2 per cent.

So the expert panel misjudged the trajectory for bond yields in terms of the magnitude of the increase in the first six months and then completely got the direction itself wrong in the subsequent six months.

Other revered market participants also misjudged the market. In February, the world's biggest bond fund PIMCO announced it had reduced its US government-related debt holdings from 22 per cent in December 2010 to just 12 per cent in January 2011, the lowest in two years. In March, PIMCO announced it had eliminated government related debt entirely from its flagship fund, saying that bond yields had reached unsustainably low levels given the scale of government debt obligations and the chance of a correction when the Federal Reserve ended its quantitative easing program.

But by August, PIMCO manager Bill Gross admitted he had made a mistake, telling the UK Financial Times that he felt like "crying in his beer", so badly had he misjudged the movement in bonds in 2011. "Do I wish I had more Treasuries? Yeah, that’s pretty obvious," Mr Gross told the FT.

None of this is to impugn Mr Gross' logic earlier this year in saying that the term risk of investing in government bonds was not worth the meager return. But as tends to happen with forecasts, events intervene and those who maintained an exposure to Treasuries in 2011 have enjoyed solid returns in the intervening months.

The chart above compares the relative yields of US Treasuries at various maturities in January this year versus more recently in September. You can see that the curve was relatively steeper earlier this year than it is now. The yield spread between the 10-year bond and the 1-year bonds was just over three percentage points in January. By September, this term premium had contracted to two percentage points. The change reflects news in the intervening period. Sentiment about the US economy has deteriorated in that time and investors have become more averse to taking term risk.

Put another way, when yields fall, prices rise. So those whose net exposure was relatively longer earlier in the year have enjoyed a capital gain that was not available to those who took a bet against Treasuries early this year.

Research has shown there is a reliable relationship between current term spreads and future term premiums. So wider yield spreads predict larger term premiums, while narrower yield spreads predict smaller term premiums. This is why a variable maturity approach, varying the allocation towards short-term and intermediate bonds depending on the shape of the yield curve, is warranted.

The advantage of this approach is that only information available in the market at the present time is used. There is no need for forecasts, which can come undone as events and circumstances change.

The bad news is that financial markets have a tendency of sending even the most well informed and respected forecasters a curve ball. The good news is that you don’t have to take those sorts of risks if you don’t want to.

Best Regards,

Kevin Kroskey, CFP, MBA

1. POLL: Rising Bond Yields Constrained by QE, Reuters survey, Sept 28, 2011

Assessing the American Jobs Act

2011-09-15T08:10:00.004-04:00

Will Congress pass it? What difference could it potentially make?

On September 8, President Obama announced a new plan to improve the economy – the $447 billion American Jobs Act, a sequel of sorts to his past economic stimulus proposals. His announced goal: job creation without new taxation.

What’s in this bill? The AJA would try to boost the economy through seven different tactics – extensions and expansions of tax breaks, and infusions of federal dollars.

The current payroll tax holiday would be extended through the end of 2012.
The payroll tax would fall to 3.1% - not only for workers, but also for businesses with payrolls of $5 million or less.
Companies could get a tax credit as large as $4,000 for hiring the long-term unemployed (people who have been out of work for at least 6 months).
Long-term jobless benefits would again be extended.
$80 billion of federal money would be assigned to new infrastructure projects (highways, bridges and schools).
Businesses could expense 100% of their investments in 2012, just as they have been able to do in 2011.
Additional federal money would be given to struggling state and local governments to help them avoid layoffs of first responders and teachers.^2,3

How could this all be funded without new taxes? President Obama claims the effort can be paid for as a byproduct of his plan to reduce the federal deficit (a plan he will discuss in greater detail in a September 19 speech).^1,4

The bill isn’t set in stone yet. Though the House Republican leadership likes the essence of the plan, it may seek major alterations.

In a jointly authored statement issued on September 9, House Speaker John Boehner (R-OH), House Majority Leader Eric Cantor (R-VA), Majority Whip Kevin McCarthy (R-CA) and Conference Chairman Jeb Hensarling (R-TX) said the plan “merits consideration”, but they also hoped that the President’s ideas were not offered “as an all-or-nothing proposition, but rather in anticipation that the Congress may also have equally as effective proposals to offer for consideration.”⁴

Indeed, Republicans have had an alternative plan in the works for a while - the so-called Plan for America’s Job Creators - which centers on tax reduction, decreased non-defense discretionary spending and less costly industry regulations to stimulate private-sector job growth. There isn’t much support for it among Democrats.

What do economists think the AJA could accomplish? Some think the economy would get some short-term relief if it became law. While of course others see an upcoming object lesson in failed Keynesian economics.

Moody’s Analytics chief economist Mark Zandi is big on the bill – he believes it could add 2% to GDP, cut 1% off the jobless rate, and create 1.9 million jobs in an economy “on the edge of recession”.
University of Pennsylvania Wharton School of Business professor Susan Wachter thinks the payroll tax reductions alone could generate 1 million jobs and expand the economy by 1%.
At Pimco, Mohamed El-Erian calls it a “credible program that is focused on the right structural areas.”
Unicredit’s Harm Bandholz thinks the AJA could “add up to 2 percentage points to growth in the coming year.”
“Bottom line: not a lot of bang for the buck here,” states Tom Porcelli of RBC Capital Markets, who feels that the economic impact of the infrastructure investments will likely be “fairly modest … the red tape and politics involved in allocating these funds makes the implementation a long and drawn-out process.”
The Heritage Foundation’s J.D. Foster sees “a bunch of retread policy ideas that two years after they were first tried managed to create an arithmetic novelty – exactly zero job growth in August. In total, the President is calling for more new spending on proven policies that are proven failures.”^5,6

As the economy is in such a low gear, you may see Democrats and Republicans support the bill with newfound unity or at least tolerance. While America can’t reach across the Atlantic and fix the Eurozone crisis hampering world stocks, this envisioned stimulus could help our economy make some strides.

Regards,

Kevin Kroskey, CFP, MBA

Citations.

1 - advisorone.com/2011/09/09/obama-chides-congress-as-he-urges-passage-of-jobs [9/9/11]
2 - montoyaregistry.com/Financial-Market.aspx?financial-market=maxxing-out-your-ira&category=1 [9/9/11]
3 - money.msn.com/business-news/article.aspx?feed=AP&date=20110909&id=14243169 [9/9/11]
4 - latimes.com/news/politics/la-pn-house-jobs-plan-20110909,0,2297315.story [9/9/11]
5 - usatoday.com/money/economy/story/2011-09-09/obama-jobs-plan-economists/50336434/1 [9/9/11]
6 - blogs.wsj.com/economics/2011/09/09/more-economists-react-gauging-impact-of-obama-jobs-proposal/ [9/9/11]
7 - blogs.wsj.com/economics/2011/09/09/more-economists-react-gauging-impact-of-obama-jobs-proposal/ [9/9/11]

This material was prepared in conjunction with MarketingLibrary.Net Inc., and does not necessarily represent the views of the presenting party, nor their affiliates. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy. Please note - investing involves risk, and past performance is no guarantee of future results. The publisher is not engaged in rendering legal, accounting or other professional services. If assistance is needed, the reader is advised to engage the services of a competent professional. This information should not be construed as investment, tax or legal advice and may not be relied on for the purpose of avoiding any Federal tax penalty.

Social Security: Common Mistakes and Misperceptions

2011-09-08T20:24:00.000-04:00

I find that retirees often have erroneous beliefs of Social Security and are blind to planning opportunities in claiming their benefits. Elaine Floyd, CFP is one of the foremost experts on Social Security planning within the financial planning community. In a recent newsletter she listed common mistakes both retirees and advisors make in addition to common misperceptions. These are posted below.

3 of the most common mistakes RETIREES make:

Thinking of 62 as being "Social Security age" without realizing the penalties they pay by claiming early benefits.
Filing for benefits without understanding all the ramifications as to spousal benefits, survivor benefits, the earnings test, etc.
Failing to consider the lifetime value of Social Security over a long life expectancy and how it provides longevity insurance in the event of a very long life.

3 of the most common mistakes ADVISORS make:

Focusing too much on the breakeven age without considering the importance of income at advanced ages, especially for surviving spouses.
Letting clients justify early filing at 62 for irrational reasons ("Social Security could go broke; I want my money now").
Failing to fully understand all the rules for spousal and survivor benefits—that is, who can do what and when; knowing just enough to be dangerous.

3 of the most common "misperceptions" regarding Social Security planning:

That you can do it without a calculator. People try to develop rules of thumb, but there are too many permutations of spouses' ages and benefit amounts to try to guess who should do what and when.
That people can get all the help they need from SSA personnel. SSA workers look at what benefits people are entitled to right now. They do not do long-range planning.
That Social Security exists in a vacuum. You have to consider all the other aspects of a client's financial plan, including IRAs, pensions, taxes, etc.

Will Apple Be the World's Largest Stock?

2011-07-19T14:25:00.000-04:00

Stock prices slumped around the world yesterday [Monday, July 18], but shares of Apple Inc. shrugged off worries about a Greek government bond default and record gold prices and surged to an all-time high of $373.80. With a market value of over $344 billion, Apple has already shouldered aside Microsoft to become the world's largest technology firm measured by market capitalization and is now second only to energy giant ExxonMobil among US stocks. It has all happened so quickly that despite its heavyweight stature in the US stock market, Apple shares are still conspicuously absent from the Dow Jones Industrial Average.

Apple's innovative products are the gold standard for personal communication and entertainment gadgets, and the company's fresh approach to store design generates sales-per-square-foot numbers other retailers can only dream about. As the company goes from strength to strength and the billions pile up on the balance sheet, it's worth recalling how uninspiring the future for the company looked not so long ago.

Apple historical share price adjusted for splits to faciliate comparison with current $373 price.

$39: "Lately hitting a new high above 77, stock in Apple is not just high-priced—37 times this year's estimated profit—but high-fashion. … Apple doesn't tempt me." Robert Barker, "Apple: It May Be Too Late to Take a Bite," BusinessWeek, February 14, 2005.

$12: "But behind the hype and buzz surrounding the iPod and Jobs, there are problems stewing at Apple. Its core computer business, which still accounts for 70 percent of the company's sales, is withering. … What's more, despite their soaring sales, iPods are depressing profitability because of their lower profit margin." Stephen Gandel, "Why iPod Can't Save Apple," Money, March 24, 2004.
$12: "I give them two years before they're turning out the lights on a very painful and expensive mistake." Quotation attributed to David Goldstein, Channel Marketing Corp. Cliff Edwards, "Sorry, Steve: Here's Why Apple Stores Won't Work," BusinessWeek, May 21, 2001.

$11: "Our conclusion is that Apple has started down a path that will lead to its demise as a serious player in the PC market. … Further, we do not believe Apple will survive its next downturn, which will presage the company spiraling into insignificance as it loses any advantage of scale." Excerpt from Dataquest company report. "Dataquest Sounds Death Knell for Apple," Reuters, September 23, 1997.

$4 "Apple has attracted a growing crowd of short-sellers, professional speculators who bet against a company by selling borrowed shares they hope to replace later at a profit if the stock falls. The short-sellers, in fact, now hold the equivalent of 10 percent of Apple's shares." Steve Lohr and John Markoff. "The Incredible Shrinking Apple Computer" New York Times, January 26, 1997.

$6: "Apple may have few options other than to shrink the company or to eventually sell out to a deep-pocketed partner." E.S Browning and Jim Carlton, "Apple Still Hobbled Despite Write-Down," Wall Street Journal, March 29, 1996.

Over its thirty-plus years as a public company, Apple has turned out to be a very rewarding investment. One hundred shares purchased at the initial offering price of $22 in December 1980 have multiplied to 800 shares after four stock splits with a current market value in excess of $299,000. Over the same period, $2,200 invested in the S&P 500 with dividends reinvested grew to approximately $49,000. But how many investors would have had the patience to wait nearly three decades for their investment to bear such abundant fruit? At year-end 1985, for example, Apple shares were still stuck at $22, and by year-end 2002, they had appreciated at an annual rate of only 4.4%—well below one-month Treasury bills for a twenty-two-year period. How many of us could have stuck it out, especially with industry "experts" telling us at the time that Apple's best days were behind it?

Some will study the ups and downs of Apple over the years and conclude that the roller coaster aspect of its business and its share price illustrates why clever timing is essential to successful investing. Predicting the future is difficult and forecasting success or failure in the fast-changing world of technology is harder still. A tiny number of stocks available for trading today will produce sensational results in the years ahead. Owning a broadly diversified strategy can provide exposure to the market's most spectacular—and unexpected—winners.

Jerry Useem, "Simply Irresistible: Why Apple Is the Best Retailer in America," Fortune, March 19, 2007.
Past performance is no guarantee of future results.

The Best of Times, the Worst of Times

2011-07-08T11:35:00.000-04:00

Below is a brief article from Weston Wellington of Dimensional Fund Advisors, reviewing the markets over the last year and concurrent headlines from the media. It always helps to keep things in perspective and not get caught up in the financial pornography that is put upon us.

-Kevin Kroskey

---------

For the twelve-month period ending May 31, 2011, equity investors around the world enjoyed the equivalent of blue skies and bright sunshine while the economic news was partly cloudy at best. Among forty-five developed and emerging-country stock markets tracked by MSCI, all but four had double-digit total returns (in US dollar terms), and twenty-six had returns of 30% or more.

If someone had told us a year ago that global markets would stage such a broad-based rally, we would have been inclined to think that trends in employment, housing, and financial distress were about to take a pronounced turn for the better. It seems hard to argue they have done anything of the sort. Somehow, despite gloomy financial page news that keeps repeating itself, equity prices marched substantially higher.

The moral of the story? Investors should be skeptical of their ability to predict future events and even more skeptical of their ability to predict how other investors will react to them.

Last Year's Headlines	This Year's Headlines
"Europe Crisis Deepens as Chaos Grips Greece" Sebastian Moffett and Alkman Granitsas. Wall Street Journal, May 6, 2010	"Greek Woes Fuel Fresh Fears" Marcus Walker and Hannah Benjamin. Wall Street Journal, May 10, 2011
"Fearful Investors Are Pulling Out" Adam Shell. USA Today, May 20, 2010	"Fear Wins: Stocks Resume Long Slide" Adam Shell. USA Today, June 16, 2011
"Housing Prices Remain Weak" Sara Murray. Wall Street Journal, May 26, 2010	"Home Market Takes a Tumble" Nick Timiraos and Dawn Wotapka. Wall Street Journal, May 9, 2011
"Fear Returns—How to Avoid a Double-Dip Recession" Cover story. Economist, May 29, 2010	"The World Economy—Sticky Patch or Meltdown?" Cover story. Economist, June 18, 2011
"Spill Tops Valdez Disaster—Deep Trouble: There Was 'Nobody in Charge'" J. Weisman, G. Chazan and S. Power. Wall Street Journal, May 28, 2010	"Japanese Nuclear Crisis Is Ranked at the Level of Chernobyl" Mitsuru Obe.Wall Street Journal, April 12, 2011
"Discouraging Job Growth Batters Stocks" Don Lee. Los Angeles Times, June 5, 2010	"Jobs Data Stoke US Recovery Fears" Robin Harding, S. Bond and M. Mackenzie. Financial Times, June 4, 2011
"Economic Outlook Darkens" Jonathan Cheng and Justin Lahart. Wall Street Journal, June 2, 2010	"Stocks Plunge Amid Fears That Global Economy is Slowing" Christina Hauser. New York Times, June 11, 2011
"Bond Fund Managers See Signs of a Bubble" Sam Mamudi. Wall Street Journal, June 8, 2010	"Why Are Investors Still Lining Up for Bonds?" Jeff Sommer. New York Times, May 29, 2011
"Rapid Declines Rattle Even Optimists" E.S. Browning. Wall Street Journal, June 14, 2010	"Investors Shaken by the Fear Factor" James Mackintosh. Financial Times, June 18, 2011

Tax Update: Mileage Rates Changed for 2011

2011-06-23T15:09:00.001-04:00

The IRS has enhanced mileage reimbursement rates for the second half of 2011 to 55.5 cents for business and 23.5 cents for medical and moving per mile. This is an increase from the first half rate of 51 cents for business and 19 cents for medical and moving per mile.

The full announcement is below. It's nice to get a little help from our friends at the IRS.

To Your Prosperity,

Kevin Kroskey, CFP

======

Optional Standard Mileage Rates
Announcement 2011-40

This announcement informs taxpayers that the Internal Revenue Service is modifying Notice 2010-88, 2010-51 I.R.B. 882, by revising the optional standard mileage rates for computing the deductible costs of operating an automobile for business, medical, or moving expense purposes and for determining the reimbursed amount of these expenses that is deemed substantiated. This modification results from recent increases in the price of fuel.

The revised standard mileage rates are:
(1) Business = 55.5 cents per mile
(2) Medical and moving = 23.5 cents per mil

The mileage rate that applies to the deduction for charitable contributions is fixed under § 170(i) of the Internal Revenue Code at 14 cents per mile. The revised standard mileage rates set forth in this announcement apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes on or after July 1, 2011, and to mileage allowances that are paid both (1) to an employee on or after July 1, 2011, and (2) for transportation expenses paid or incurred by the employee on or after July 1, 2011.
The standard mileage rates set forth in Notice 2010-88 continue to apply to deductible transportation expenses paid or incurred for business, medical, or moving expense purposes before July 1, 2011, and to mileage allowances paid (1) to an employee before July 1, 2011, or 2 (2) with respect to transportation expenses paid or incurred by the employee before July 1, 2011. All other provisions of Notice 2010-88 remain in effect.

Should retirees limit spending to interest and dividends?

2011-06-07T17:02:00.002-04:00

Limiting spending to interest or dividends received is a common idea that many retirees have about managing spending in retirement. This idea causes some retirees to reach for yield in both stock and bond investments. In an annual report for Berkshire Hathway, Warren Buffett wrote, "More money has been lost reaching for yield than at the point of a gun."

Pursuing an interest-and-dividend-only strategy is sub-optimal for a multitude of reasons, man of which I'll be explaining in an upcoming article to be posted at the Money & Mind blog. Meanwhile, click on the video below to listen to Ken French of Dartmouth College answer the question whether retirees should limit their spending to interest and dividends.

Deconstructing Berkshire Hathaway and Warren Buffett

2011-04-26T11:10:00.001-04:00

Weston Wellington of Dimensional Fund Advisors often displays an ability to make unique observations and simplify complex concepts not unlike Warren Buffet. Below Wellington looks through Berkshire Hathaway's annual report and Buffett's letter to shareholders and makes some unique observations about the Berkshire portfolio and underlying investment principles that the every-day investor can learn from.

To Your Prosperity,

Kevin Kroskey, CFP, MBA

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Berkshire Hathaway released its 2010 annual report last weekend, including the letter to shareholders from Chairman Warren Buffett that is always eagerly awaited by the investment community. We are gratified to find that Mr. Buffett's legendary ability to simplify complex issues remains undiminished and his trademark wit is as sharp as ever.

Financial journalists, eager for clues that might reveal Buffett's thoughts on where markets are headed, focused on Buffett's optimistic outlook for the future ("America's best days lie ahead") and his appetite to make further large acquisitions ("my trigger finger is itchy").

We prefer to focus on a number of issues touched on in the letter that offer investment wisdom that should be just as useful ten years from now as it is today.

As of year-end 2010, Berkshire held positions in excess of $1 billion in fourteen common stocks. Five of these were non-U.S. firms: BYD Company Ltd. (China), Munich Re (Germany), POSCO (South Korea), Sanofi-Aventis (France), and Tesco plc (UK). Five years ago a similar list of twelve companies contained just one non-U.S. firm, and ten years ago there were none. In his comments about the future of America, Mr. Buffett remarked that "human potential is far from exhausted" and that, despite many setbacks, the American system "has worked wonders for over two centuries." Judging by Berkshire's portfolio, it appears this notion applies with equal force throughout the world.

Berkshire has willingly shouldered some unusual risks over the years. It acquired building products maker Johns Manville in 2000 despite the stigma of asbestos-related liabilities, invested over $15 billion in various financial firms in the tumultuous weeks following the Lehman Brothers bankruptcy in 2008, and once insured an internet firm against the possibility of awarding a $1 billion prize associated with a marketing promotion. Many investors might assume that such adventurous and unconventional thinking in equity assets would be matched by an equally unorthodox approach in fixed income. On the contrary, Buffett's strategy for investing Berkshire's cash ($38 billion at year-end) is so conservative that some might accuse him of excessive caution. We suspect any institutional money manager with a balanced account mandate who maintained most of the fixed income assets in Treasury bills despite yields approaching zero would be fired for lack of imagination. Such an approach only makes sense if the role of fixed income is to preserve liquidity and limit the potential damage associated with riskier equities, rather than to generate satisfying returns. Mr. Buffett cites an observation from financial writer Raymond DeVoe that "more money has been lost reaching for yield than at the point of a gun."

For those who ponder why it is that stocks are expected to provide a positive rate of return even if they pay no current dividend, one number cited in the letter offers a clue: $1 billion. That is the approximate amount of cash that shows up in Berkshire's mailbox each month from its collection of seventy-six businesses. Mr. Buffett's job is to invest that cash in new projects that carry an attractive rate of return, and history shows that these may come in a variety of shapes and sizes. Last year, for example, Berkshire spent $50 million to buy Alabama's largest brick manufacturer and $22 billion to complete its acquisition of the nation's largest freight railroad. Mr. Buffett reports that the rail acquisition is working out "even better than I expected," and to the extent any chief executive can invest a firm's retained earnings more profitably than we can, dividends are not just unnecessary, they are undesirable.

Since taking control of a floundering Massachusetts textile mill in 1965, Warren Buffett has assembled an extraordinary record of business success. His oft-stated goal has been to grow Berkshire's book value at a faster rate than the total return of the S&P 500 Index, and he has certainly succeeded. While many have focused on his facility with numbers and his ability to identify attractive business opportunities, it seems to us there is a lot more to the story. Mr. Buffett may never forget a number you give him, but he also appears to be an astute judge of character and has a knack for quickly sizing up individuals whose business acumen and management style will make for a good fit within the Berkshire confederation.

What are the investment implications of this appealing story? Should we be confident that Berkshire shares will continue to outperform the market, at least as long as Mr. Buffett is at the helm?

To address this question, we should consider to what extent Mr. Buffett's skills are already reflected in Berkshire Hathaway's stock price and whether the S&P 500 Index is the most useful basis of comparison. Let us first acknowledge that Berkshire's long-run price performance relative to almost any benchmark is sensational—over the last 25 years it has compounded at 16.9% per year compared to 9.93% for the S&P 500 Index with reinvested dividends. The margin of superiority relative to the S&P 500 narrows for more recent time periods, however, and disappears altogether in comparison with broader-based equity strategies. Over the last fifteen years, for example, Berkshire shares have still outperformed the S&P 500 by 276 basis points per year, but fall a smidgen behind a globally diversified Dimensional Balanced Equity Index (16 basis points). Over the last ten years, Berkshire shares have underperformed the Balanced Index by an even larger amount: 295 basis points per year.

Some might be tempted to conclude from these results that Mr. Buffett's legendary skills are waning, but if markets are working properly the numbers should come as no surprise and are no reflection on Mr. Buffett's talents. Berkshire's book value has grown from $48 million in 1965 to $157 billion in 2010, making it larger, by this measure, than oil giant Exxon Mobil. Mr. Buffett has gone from piloting a speedboat to commanding an aircraft carrier; the ever-increasing amount of capital Berkshire oversees makes it difficult to earn above-average returns. Moreover, Berkshire Hathaway is not a mutual fund, but a public company with a share price that reflects expectations for the future. Now that Mr. Buffett's admirable qualities are understood and acknowledged by so many market participants, it seems likely that his perceived value is already reflected in Berkshire's stock price, just as Apple's current stock price reflects the genius of founder Steve Jobs.

We wish Mr. Buffett well and hope to be reading his letters for many years in the future. And investors who have a soft spot for Berkshire Hathaway shares can take comfort in the knowledge that if they own a truly diversified equity strategy, they own a piece of Berkshire.

Weston Wellington of Dimensional Fund Advisors

Berkshire Hathaway Inc. 2010, 2005, and 2000 shareholder letters. Available at http://www.berkshirehathaway.com (accessed February 27, 2011).
Dimensional Equity Balanced Index: Dimensional Fund Advisors.
Past performance is no guarantee of future results.

The Media: If It Bleeds It Leads

2011-03-27T07:24:00.003-04:00

With spring finally here, I have a bit of a spring in my step. With a bit of a light-hearted, spring-time flair, I thought I'd share a clip from Alonzo Bodden. Alonzo has a comedy special airing on Showtime.

The clip below talks about the 'Fear of Disease.' In today's world, there's always a crisis going on somewhere--financial crises included. At the potential cost of our peace of mind, they are usually showing up in our newspapers, television news, and other media outlets. Remember to keep things in perspective and don't get too caught up in the crises du jour.

Think positively. Think Spring. Laugh a little.

To Your Prosperity,

Kevin Kroskey, CFP, MBA

Healthcare Reform Explained

2011-02-22T04:02:00.001-05:00

If you're like me, you find the 1000 page plus Heathcare Reform Act a bit confusing. This nine minute animated movie -- featuring the "YouToons" -- explains the problems with the current health care system, the changes that are happening now, and the big changes coming in 2014, produced by the Kaiser Family Foundation.

Kevin Kroskey, CFP, MBA

Don't File Your Taxes Too Soon

2011-02-14T09:32:00.003-05:00

I'd like to remind everyone to not be too anxious to file your taxes. Many taxpayers rush to file their tax returns as quickly as possible. Ordinarily, that’s fine. But if you own mutual funds, don’t file your tax return before March 1.

In past years, revised 1099s were often issued, reclassifying distributions and/or their amounts. This was a huge headache for the investors who had already filed tax returns based on the original documentation. These hapless consumers found themselves forced to redo their returns and file amended tax returns, adjusting the amount they owed or were due in refunds - and paying their tax preparer additional fees to do the extra work.

It looks like 2010 may be the same. Therefore, if you own mutual funds, do not file your tax return before March 1. By then, any amended IRS forms are likely to arrive, potentially helping you avoid the hassle and costs of filing an amended return.

Kevin Kroskey, CFP, MBA

Dodging the Size Premium

2011-02-01T15:52:00.000-05:00

Small cap stocks outperformed large cap stocks by a significant margin in most global markets last year but capturing the size premium required both patience and a willingness to ignore the advice from those claiming to identify the best-performing asset classes in advance. US small stocks got off to a strong start last year as the Russell 2000 Index jumped to a gain of 18.6% through April 23, more than double the return of the S&P 500®. But as stock prices wilted during the summer, small caps fell even faster and by August 24th both large cap and small cap indices were down roughly 5% for the year. A surprisingly strong rally during the remainder of the year drove the Russell 2000 up 31.5%, and for the year as a whole it was the best performance for US small stocks since 2003.

The strength in small cap stocks caught a number of financial pundits flat-footed. An article appearing in the Wall Street Journal in mid-November 2009 claimed “small caps aren’t looking that cheap anymore” and suggested that the stock market rally was in the midst of “an important change that has put the less-volatile large caps back in favor.”

In a similar vein, the 2010 Investor’s Guide issue of Money argued that “smaller and junkier” stocks often did best in the early stage of a rally but since the bull market appeared to be maturing, now was the time to switch gears: “Speculative frenzy eventually gives way to the fundamentals,” they said, “and that should bring your focus back to high quality blue-chip stocks this year.” Money identified ten stocks to capitalize on this trend, including stalwarts such as ExxonMobil and Johnson & Johnson. Investors following this advice not only missed out on the strong performance of small cap stocks, they failed to capture the market rate of return from large cap stocks as well: the ten stocks selected by Money had an average price-only return of 6.3% compared to 12.8% for the S&P 500® Index.

SmartMoney likewise emphasized large-cap stocks in their annual forecast issue, but for a different reason. They foresaw a good chance the U.S. would remain mired in recession and favored large multinationals such as Procter & Gamble and Coca-Cola that “sell goods worldwide and don’t need an economic rebound to make money.” Their twelve stock picks produced an average price-only gain of 7.5% for the year.

Fortune made little distinction between large cap and small cap stocks in their 2010 Investor’s Guide issue, and instead chose to repeat the familiar refrain that an uneven economic recovery would reward clever stock-picking: “Making judicious stock selections will be crucial in what is likely to be a topsy-turvy year.” It was indeed a topsy-turvy year for the markets, but even more so for Fortune’s ten stock selections. Among the combined 32 stocks selected by Fortune, Money and SmartMoney for 2010, Fortune had both the best performer for the year (Salesforce.com, up 78.9%) and the worst performer for the year (Amedisys, down 31.1%). Fortune finished last in this three-way magazine competition with an average price-only return for their picks of 1.75%.

To its credit, the same issue of Fortune included a useful article on the appeal of a simple index fund approach: “Stock picking, whether you do it yourself or pay a pro to do it for you, is a mug’s game”, they wrote. “You’re better off buying and holding a cheap, diversified, and consistent index fund, which passively invests in the stocks listed on a broad market benchmark.”

Good advice, but I suspect it won’t be long before catchy cover stories such as “Top Ten Stocks for the Year Ahead” are crowding the magazine racks once again. And last year’s results offer another example of how easy it can be to miss out on all the rewards the capital markets have to offer.

Kevin Kroskey, CFP®, MBA

Donna Kardos Yesalavich. “Large-Cap Stocks Are Back in Favor” Wall Street Journal November 12, 2009.
Pat Dorsey. “What’s Ahead for Stocks” Money January/February 2010
Reshma Kapadia and Russell Pearlman. “Where to Invest 2010” SmartMoney January 2010
Katie Benner, Scott Cendrowski, and Mina Kimes. “The Best Stocks in 2010” Fortune December 21, 2009
Thanks to Weston Wellington of Dimensional Fund Advisors for article content.
New York Stock Exchange/NASADAQ Trading Summary. Year-End Review: Markets & Finance 2010 . Wall Street Journal January 3, 2011

New Year's Investment Resolutions

2011-01-18T06:11:00.001-05:00

It's that time of year when many of us are thinking about the New Year's resolutions we set for ourselves. This often means committing to improving one's lifestyle by losing weight or exercising more. Some investors could probably benefit from resolutions targeting their financial health as well. Just as many individuals endanger their well-being with bad habits, numerous investors suffer from ill-advised practices that are detrimental to their wealth. Perhaps a set of New Year's investment resolutions will lead to a more prosperous future.

Everybody wants to be healthier, and many people want to be wealthier, but it's just not that easy. Most of us are creatures of habit and discover that making permanent changes in our behavior is surprisingly difficult. We need every possible mental crutch at our disposal to help us adhere to a new regimen; hence we establish mental road signs, such as New Year's resolutions, as behavioral aids.

So, for those who find making such promises useful, here are ten investment-related resolutions that will hopefully result in better long-term wealth:

1. I will not confuse entertainment with advice. I will acknowledge that the financial media is in the entertainment business and their message can compromise my long-term focus and discipline, leading me to make poor investment decisions. If necessary I will turn off CNBC and turn on ESPN.

2. I will stop searching for tomorrow's star money manager, as there are no gurus. Capitalism will be my guru because with capitalism there is a positive expected return on capital, and it is there for the taking. And for me to succeed, someone else doesn't have to fail.

3. I will keep my cost of investing reasonable.

4. I will keep a long-term perspective and appropriately consider my investment horizon (i.e., how long my portfolio is to be invested) when determining my performance horizon (i.e., the time frame I use to evaluate results).

5. I will continue to invest new capital and work my plan because it is time in the market—and not timing the market—that matters.

6. I will adhere to my plan and continue to rebalance (i.e., systematically buying more of what hasn't done well recently) rather than "unbalance" (i.e., buying more of what's hot).

7. I will not focus my portfolio in a few securities, or even a few asset classes, as diversification remains the closest thing to a free lunch.

8. I will ensure my portfolio is appropriate for my goals and objectives while only taking risks worth taking.

9. I will manage my emotions by learning about and acknowledging the biases and cognitive errors that influence my behavior.

10. I realize that just as successful athletes rely on coaches and trainers to help them achieve their goals, most investors can probably benefit from having a "financial coach" to keep them accountable, objective, and on track toward their life's goals.

Wishing you good health and good wealth in 2011.

Kevin Kroskey, CFP, MBA

1. Globally diversified portfolio represented by MSCI World Index performance. As of November 30, 2010, the ten-year annualized compound return (gross dividends) for the index was - 1.78%. MSCI data copyright MSCI 2010, all rights reserved.

Why Irish Eyes Aren't Smiling And What This Teaches Us About Risk Management

2010-12-08T10:19:00.000-05:00

The article below is a timely one from Dimensional Fund Advisor's (DFA) Jim Parker, VP of DFA Australia. Though Ireland is a country there are many lessons to be learned from Ireland's missteps by the individual investor.

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Reaching understanding on the right way to invest often starts with studying bad investment decisions. But the lessons are far less painful when they are built on others’ experiences.

Recent events in Europe provide case studies on what can go wrong when a wealth-building strategy is built on too much debt, too little diversification and too little awareness of risk.

Ireland in recent years, for whatever reason, became heavily dependent on a couple of industries – namely construction and banking. The IMF1 in a report this year described the causes of these imbalances as “rapid credit growth, inflated property prices and high wage and price levels”.

Now, an economy is clearly much more complex than any individual and the ability of governments to control the composition of growth is limited. But there still are lessons here for individuals if they fail to spread their wealth-building strategies across different asset classes and diversify within those asset classes.

Becoming more diversified leaves you less open to idiosyncratic risks that are related to one sector or one company or one asset class. And you can do this without significantly compromising your expected return.

Another lesson from Ireland is not to base your investment strategy only on what happens during the good times or only in the bad.

Real interest rates in Ireland were very low before the crisis, which encouraged people to load up on debt. That debt now has to be repaid in an environment of falling prices, higher real interest rates and sluggish growth. The problem was too much focus on return and not enough on risk.

For individuals, the take-out is that leverage, while increasing the potential upside in boom times, magnifies the downside in the bust. So people swing from greed to fear and back again.

A better approach is to have a realistic, measured and long-term approach to risk. This means that during rising markets, you don’t take on more risk than you originally intended. And it means that during falling markets, you don’t become more risk averse than you first planned.

A third lesson is the importance of liquidity. This means you can quickly turn your investments back into hard cash if you need to.

Ireland’s banks got into trouble because their loan portfolios were dominated by speculative property ventures. When the crisis hit, their recourse to short-term funding dried up and they were unable to call in loans because of the illiquid nature of the assets.

For individuals, the lesson is there is value in having portfolios with sufficient liquidity. That means publicly traded equity and fixed income securities that can be turned into cash if needed.

So Ireland has some lessons for all of us:

• Holding concentrated portfolios exposes you to risks you don’t need to take. Diversification is the answer, both across and within asset classes.

• Basing your strategy only on the good times means you can end up taking more risk than you intended. And grounding your strategy only on the bad times means you can miss real opportunity. A balanced approach to risk and return is the answer.

• Finally, staking everything on illiquid assets can leave you high and dry when you need quick access to cash. So keep a proportion of your portfolio in liquid investments.

• All these strategic decisions are ones you should make in consultation with an advisor who understands your risk appetite, personal situation and goals.

Just don’t count on the luck of the Irish.

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Kevin Kroskey CFP, MBA

The Economics of Fiscal Defecits

2010-11-02T12:27:00.000-04:00

It's quite difficult if not virtually impossible to have forecasting abilities to consistently predict future economic scenarios. Even if a prediction about what will happen to our economy is done accurately, an investor is not done yet. In order to capitalize upon an accurate economic prediction, the investor must still translate the economic prediction into a successful investment strategy and must also get the timing of it correct. No small feat indeed.

As we get through a political season where much in relation to our country's economics have been discussed or at least used in the negative political ads that seemingly permanently reside on my television, it's helpful to keep things in perspective and look at things objectively. Marlena Lee, Researcher with Dimensional Fund Advisors, examines historical data to test the relationships between fiscal deficits, interest rates, business activity, investment returns, and exchange rates in a video and/or podcast available by clicking the link below.

http://www.dfaus.com/2010/11/the-economics-of-fiscal-deficits.html

To summarize her findings, Marlena academically tested the following economic questions and their potential investment implications. The short answer to the question is shown bolded in ALL CAPS.

Economic Questions:

• Are deficits related to higher long-term interest rates? YES

• Do large deficits stifle long-run economic growth? YES

• Are fiscal deficits linked to current account deficits? INCONCLUSIVE

Investment Implications:

• Do interest rates efficiently incorporate information about fiscal policy? YES

• Do deficits predict bond or equity returns? NO

• Does low future economic growth imply low future equity returns? NO

• Do fiscal deficits and/or current account deficits predict short-term exchange rate movements? NO

Remember, in our era of the in-your-face, usually negative media, it's important to stay objective. The sky may not be falling after all.

Kevin Kroskey, CFP, MBA

Should You Make Extra Mortgage Principal Payments?

2010-10-26T06:41:00.001-04:00

I was recently interviewed for an article done by Betty-Lin Fisher, Business Writer with the Akron Beacon Journal, about whether bi-weekly payment plans and mortgage prepayments in general are a good thing. She wrote:

Claytor and Kevin Kroskey, a certified financial planner and owner of True Wealth Design in Fairlawn, both agreed with McBride that paying off other high debt and funding other accounts should come before prepaying a mortgage.

Another option is to do a little more each month. Claytor and Kroskey said they both round up their mortgage payments to add a little extra to their principal.

''By and large, paying down the house is a good idea,'' said Kroskey.

But there is a caveat, he said, where he sees people making mistakes. Often, as people are getting closer to retirement and if they haven't done a really good job of saving, they might think, ''I have to pay off this mortgage before I get into retirement. It's what Americans are supposed to do,'' said Kroskey.

''If they're aggressively paying down that mortgage while they're forsaking the 401k,'' that's not good, he said.

As with virtually all aspects of personal financial planning, whether something is good or bad can usually be answered with 'it depends.' It depends upon the unique circumstances of each client. Virtually nothing is axiomatic.

Some clients should pay down their debt while others have a strategic choice to use today's low interest rates and the tax favorability of mortgage and/or investment interest and incorporate these tools into their overall plan. They key is to have a plan and evaluate the pros and cons of the decision in the context of your plan. Otherwise, it's easy to have tunnel vision and rely upon rules of thumb that may not be properly suited or optimal for your situation.

You can read the full article here.

Kevin Kroskey, CFP, MBA

The Lost Decade for Family Income

2010-09-21T16:18:00.000-04:00

"The inflation-adjusted income of the median household—smack in the middle of the populace—fell 4.8% between 2000 and 2009, even worse than the 1970s, when median income rose 1.9% despite high unemployment and inflation. Between 2007 and 2009, incomes fell 4.2%."

The above paragraph is from a Wall Street Journal article describing the pain the American middle class has experienced over the "lost decade." The media has generally referred to the "lost decade" for the lack-luster results of the S&P 500 from 2000-2009. While I disagree that this time period was a lost decade for a well-allocated investor, I do agree with the author of this article that it was a lost decade in terms of real or inflation-adjusted income.

In his autobiography, Alan Greenspan describes this phenomenon and says how the mass influx of labor from China and India kept prices and inflation relatively low world-wide for an extended period of time. The good news, he says, is that as these economies are continually developed and experience a rising middle class, world-wide wages, including those in America, will rise. The question always seems to come back to when.

As we wait, it's quite likely that the disparity between the 'haves' and the 'have nots' will continue to increase, as described in the article. If this trend continues, the societal and political implications may be great.

To Your Prosperity,

Kevin Kroskey, CFP, MBA

Is a Double-Dip Imminent?

2010-08-24T08:12:00.002-04:00

Consumer sentiment is down. Unemployment is not. Housings starts are terrible. A double dip is on the lips of many. Since this is an election year, each side of the aisle has reasons to portray the future as gloomy.

There is an alternative view. Markets on average recover greatly. Yes, maybe this time is different, but then again, probably not. I like to say that 'this time is different' are the four most costly words an investor can utter.

If this market recovery is average, then there is substantial market appreciation from today's valuation over the coming years. Moreover, alternative strategies-chiefly lending your money to the U.S. government is fraught with low interests and ultimately high probability in principal decline, if individual bonds are not owned and held to maturity.

This is not a prediction, but we need to keep things in perspective. It's difficult to be objective when 'you're in it.'

Kevin Kroskey, CFP, MBA

“Rates Can Only Go Higher”

2010-07-16T06:28:00.001-04:00

It seemed so obvious. With the economy slowly recovering last year from the worst recession in decades and the federal government seeking to tap the credit markets for over $2 trillion to fund an ambitious spending program, both laymen and experts alike seemed to agree that interest rates had nowhere to go but up. The yield on the ten-year U.S. Treasury note as of June 30, 2009 was 3.52%, down from 5.25% in June 2007 but well above the 2.09% level registered amidst the depths of the credit crisis the previous December. With retail sales and housing activity showing signs of gradual improvement, the only question appeared to be how much higher interest rates would go.

Among fifty economic forecasters surveyed by the Wall Street Journal in June 2009, forty-three expected the ten-year U.S. Treasury note yield to move higher over the year ahead, with an average estimate of 4.13%. Seven expected a rate of 5.00% or higher while only two predicted rates to fall below 3.00%. The result? The ten-year Treasury yield slumped to 2.95% on June 30, 2010 and rates on 30-year mortgages fell to their lowest level since Fannie Mae began tracking them in 1971. How many of us would have expected this during a period when gold prices soared over 33% to a record high?

Some observers may be tempted to poke fun at these hapless “experts”, implying they are incompetent or poorly informed. This interpretation is flawed since it suggests that a better team of experts would achieve a more accurate result. A more useful explanation is that even the most talented analysts are unlikely to make reliable predictions and the poor showing by this particular group is simply what we would expect to see, just as often as not, if markets are working freely and fairly. Today’s bond prices already reflect expectations for tomorrow’s business conditions and inflation and these expectations can change quickly in response to new information. However tempting it may be to believe that we can predict the future better than other market participants through careful study, the results of the Wall Street Journal survey as well as numerous other efforts suggest this confidence is misplaced.

What is the message for investors? Predicting interest rates and bond prices is no easier than predicting stock prices, and making decisions based on what appear to be certain outcomes at the time can often prove costly. Many investors reconfigured their portfolios in anticipation of higher interest rates and have penalized their results while they are waiting.

Instead of seeking to predict the unpredictable, investors are much more likely to enhance their results by focusing on the elements they can control – risk exposure, diversification and minimizing costs and taxes.

Kevin Kroskey

Yahoo! Finance www.yahoo.com accessed July 7, 2010. Wall Street Journal Forecasting Survey www.wsj.com accessed July 7, 2010. Prabha Natarajan and Matt Phillips. “Stocks Drop; So Do Mortgage Rates” Wall Street Journal, June 25, 2010.
This article was prepared by Wes Wellington of Dimensional Fund Advisors.
Mark Gongloff. “Two Treasury Forecasts: a Grand Canyon-Sized Gap” Wall Street Journal, April 10, 2010.
Tom Petruno. “Gold Hits Record as Investors Seek Haven” Los Angeles Times, June 9, 2010.

Recent Market Volatility in Perspective

2010-05-04T10:08:00.027-04:00

Recent Market Volatility in Perspective

The US stock market has taken investors on a bumpy ride in recent years. This volatility has tested investor discipline and prompted some people to question their commitment to equities. While no one knows the future, looking at the past may help you gain a better view of long-term market performance and put the recent market volatility in perspective.

The above chart shows the historical distribution of US market returns since 1926. The performance years are stacked in ascending order by return range. This chart illustrates that:

• Market performance over the past two years has been extreme by historical standards. In 2008, US stocks experienced their second-worst calendar return in eighty-four years. Then, in 2009, stocks rebounded strongly to deliver a return in the top quartile of the historical distribution.

• Over the long term, the market’s positive return years have outnumbered the negative return years. Since 1926, the market has experienced a positive return in almost three-quarters of the calendar years.

• Not only are the positive years more numerous, the chart shows a larger concentration of performance in the higher ranges of returns.

• The sequence of calendar returns appears random, suggesting that accurately predicting future performance is a difficult task for any investor or professional manager.

Over time, the market has rewarded investors who can bear the risk of stocks and stay committed through various periods of performance.

"Rebalancing Act"

2010-03-18T05:16:00.001-04:00

Global diversification gives investors a valuable tool for managing risk and volatility in a portfolio. But smart diversification has an important side effect. It requires maintenance.

In a given period, asset classes experience divergent performance. This is inevitable and, in fact, desirable. A portfolio that holds assets that do not perform similarly (i.e., with low return correlation) will experience less overall volatility. That results in a smoother ride over time. However, dissimilar performance also changes the integrity of your asset mix, or allocation—a condition known as “asset drift.” As some assets appreciate in value and others lose value, your portfolio’s allocation changes, which affects its risk and return qualities. If you let the allocation drift far enough away from your original target, you end up with a different portfolio.

Once you form a portfolio to match your current investment goals and risk tolerance, you should preserve its structural integrity since asset allocation accounts for most of a portfolio’s return. This is a strategic priority, like portfolio design or investment manager selection. To efficiently pursue investment goals, you must manage asset drift.

Rebalancing is the remedy. To rebalance, you sell assets that have risen in value and buy more assets that have dropped in value. The purpose of rebalancing is to move a portfolio back to its original target allocation. This restores strategic structure in the portfolio and puts you back on track to pursue long-term goals.

Why rebalance?

At first glance, rebalancing seems counter-productive. Why sell a portion of outperforming asset groups and acquire a larger share of underperforming ones? Intuition might suggest that selling previous winners may hinder returns in the future. This logic is flawed, however, since past performance may not continue in the future—and there’s no reliable way to predict future returns.

Equally important, remember that you chose your original asset allocation to reflect your risk and return preferences. Rebalancing realigns your portfolio to these priorities by using structure, not recent performance, to drive investment decisions. Periodic rebalancing also encourages dispassionate decision making—an essential quality during times of market volatility. Moreover, if and when your overall financial goals or risk tolerance change, you have a foundation for making adjustments. In the absence of a plan, adjustments are a matter of guesswork.

Challenges and decision factors.

In the real world, portfolio allocations are usually complex, incorporating not only fixed income and equity, but also the multiple asset groups within equity investing. The more complex a portfolio’s allocation, the greater is the need for maintenance. Determining when and how to effectively rebalance requires careful monitoring of performance and awareness of your tax status, cash flow, financial goals, and risk tolerance. Rebalancing also incurs transaction fees and potential capital gains in taxable accounts. Thus, while there are good reasons to rebalance, the benefits must outweigh the costs.

Given these challenges, a practical rebalancing approach will establish asset drift triggering points while leaving enough flexibility to manage costs effectively.

Defining triggering points helps investors decide when to rebalance. Most experts recommend rebalancing when asset group weightings move outside a specified range of their target allocations. This may be widely defined according to stock-bond mix, or more appropriately, according to a percentage drift away from target weightings for categories like small cap stocks, international stocks, and the like.

While rebalancing costs are unavoidable, several strategies can help minimize the impact:

• Rebalance with new cash. Rather than selling over-weighted assets that have appreciated, use new cash to buy more under-weighted assets. This reduces transaction costs and the tax consequences of selling assets.
• Whenever possible, rebalance in the tax-deferred or tax-exempt accounts where capital gains are not realized.
• Incorporate tax management within taxable accounts, such as cost basis management, strategic loss harvesting, dividend management, gain/loss matching, and similar considerations.
• Implement an integrated portfolio strategy. Rather than maintaining rigid barriers between component asset classes and accounts, manage the
portfolio as a whole.

Rebalancing incurs real costs that can detract from returns. Investors should define ranges within which investment components can acceptably drift, and adopt cost-saving strategies during rebalancing, paying particular attention to tax-sensitive transactions. And of course all of this needs to be aligned with a structured plan that remains flexible to each individual’s unique blend of goals, risk tolerances, cash flow, and tax status.

No one knows where the capital markets will go—and that’s the point. In an uncertain world, investors should have a well-defined, globally diversified strategy and manage their portfolio to implement it over time. Rebalancing is a crucial tool in this effort.

To Your Prosperity ~ Kevin Kroskey

Endnotes
1 Gilbert L. Beebower , Gary P. Brinson, and L. Randolph Hood, “Determinants of Portfolio Performance ,” Financial Analysts Journal 42, no. 4 (July/August 1986): 15-29. Gilbert L. Beebower, Gary P. Brinson, and Brian D. Singer, “Determinants of Portfolio Performance II: An Update,” Financial Analysts Journal 47, no. 3 (May/June 1991): 40.

Disclosures
Although investors may form their expectations from the past, there is no assurance that future investment results will model historical performance. Indexes are not available for direct investment. Their performance does not reflect the expenses associated with the management of an actual portfolio. Past performance is not a guarantee of future results. Stocks offer a higher potential return as compensation for bearing higher risk. However, this premium is not a certainty, and investors should not expect to consistently receive higher returns from stocks. In fact, market history shows extended periods when stocks did not outperform bonds. Diversification neither assures a profit nor guarantees against loss in a declining market. A bond portfolio designed for income also carries significant risks, including default and term risk, call risk, and purchasing power (inflation) risk. Foreign securities also are exposed to currency movements. The information presented above was prepared by Dimensional Fund Advisors, a non-affiliated third party.

Managing a High-Income Roth IRA Conversion

2010-02-11T10:34:00.001-05:00

There is a lot of hoopla surrounding the ability to convert pre-tax IRA (or 401k) dollars into tax-free Roth IRA dollars. Much of this hoopla is deserved and much is not. As with most anything, the devil is in the details. How this strategy may apply to you could be vastly different when compared to someone else.

The article from Money Magazine linked to below does a good job of discussing some background information on the Roth conversion and considerations for determining whether or not to convert; and if so how much. If this strategy seems to be something for you to investigate, I'd recommend obtaining professional help from a good CFP or CPA. This is one area that can easily trip you up as effectively implementing a conversion strategy can get quite complex.

http://money.cnn.com/2010/01/25/pf/expert/roth_iras.moneymag/index.htm

To Your Prosperity ~ Kevin Kroskey

Notable Gaffes from a Decade Now Gone

2010-01-19T05:37:00.001-05:00

Investors are often confronted with unexpected developments, and the last decade offers an abundance of examples. Ten years ago, for example, Brazil was on the verge of a currency collapse, and General Electric was among the largest and most admired firms on the planet. Who would have thought that Brazilian stocks would soar sevenfold during the subsequent ten-year period, while GE shares fell 70%?

A lucky few may be able to exploit such extreme outcomes to enhance their investment results. But history offers compelling evidence that shows that those making concentrated bets on companies or countries are more likely to get blind-sided by unpredictable events. Markets have 101 ways to teach us the virtues of diversification.

While sifting through our stacks of news clippings in preparation for our customary review of the year's events, we came across a number of tidbits from the more distant past that offer some lessons. These quotes turned out to be oopses by those who spoke or wrote them. And unfortunately for them, we noticed.

"It's the only company in the S&P 500 with sales of more than $30 billion that has double-digit sales growth. 'WorldCom is the must-own large-cap growth stock,' says Salomon Smith Barney analyst Jack Grubman." Pablo Galarza, and Peter Keating, "The Twelve Best Investments for 1999." Money, January 1999.

WorldCom filed for bankruptcy on July 21, 2002—the largest in US history at that time. Chief executive Bernard Ebbers was convicted of conspiracy and securities fraud on March 15, 2005 and is currently serving a twenty-five-year prison term. In 2002, Grubman agreed to a settlement with regulators that included a lifetime ban from the securities industry. Black and white strip oops.

"On May 19 [2001], Apple will open a swanky new retail store—the first of as many as 110 nationwide—at Tyson's Corner Galleria mall outside Washington. . . . Since PC retailing gross margins are normally 10% or less, Apple would have to sell $12 million a year per store to pay for the space. 'I give them two years before they're turning out the lights on a very painful and expensive mistake.'" Quotation attributed to David A. Goldstein, president Channel Marketing Corp. Cliff Edwards, 'Sorry, Steve: Here's Why Apple Stores Won't Work" Business Week, May 21, 2001

"Apple, all in all, should sell nearly one billion dollars' worth of iPods this year. . . . Its shares have risen 51% in the past year to a recent $23. . . . But behind the hype and buzz surrounding the iPod and Jobs, there are problems stewing at Apple. Its core computer business is withering. Apple sold just 3 million computers in its last fiscal year, which ended in September—900,000 less than it sold in 1996. . . . Job's other strategy to boost market share is Apple retail outlets . . . but, so far, the stores have done little to increase market share and could be bleeding red ink.' Apple will remain a company that is neat from a product and consumer standpoint but c--- from an investor standpoint.'" Quotation attributed to Chris Bonavico, portfolio manager, Transamerica. Stephen Gandel, "Why iPod Can't Save Apple." Money, April 2004.

For the first time, Apple Inc. ranked #1 in Fortune magazine's annual "Most Admired Companies" survey published on March 17, 2008. A Fortune cover story appearing November 23, 2009 celebrated Apple chief executive Steve Jobs as "CEO of the Decade." Adjusted for splits, Apple shares that sold for $23 in April 2004 closed at $390.86 on December 18, 2009. Oops.

"Stick with storage . . long term, this simple fact is true: A company can postpone buying new PCs or upgrading its network, but it can't stop producing digital data. The stuff must be put somewhere, and it increasingly gets stored in many places. . . Buy EMC Corp. at $44 per share...Amazon.com is the exact opposite [of eBay]; it faces—and has yet to solve—all the problems of offline retailers. Sell Amazon at $12 per share." Stephanie N. Mehta, "Ten Tech Trends to Bet On." Fortune, March 19, 2001.

EMC shares closed at $17.34 on December 18, 2009, down 60%, while Amazon shares closed at $128.48, up 907%. Darn trends. Oops.

"Federal Reserve Chairman Alan Greenspan said the central bank is already developing plans for a world without Treasury securities and gave members of the bond industry something of a nudge to begin their own planning. . . . Mr. Greenspan expressed confidence that worker-productivity gains will continue, enabling the nation's debts to be paid off relatively soon." Gregory Zuckerman, "Greenspan Encourages Bond-Market Professionals to Prepare for World Without Government Debt." Wall Street Journal, April 30, 2001.

No explanation required as to whether or not our nation's debts have been paid off. Itsy-bitsy oops.

"Sandy Weill has built Citigroup into a financial services empire. Is his formula for success a blueprint for the rest of the industry? . . . Despite gale-force winds battering the financial service industry—bear market, recession, Sept. 11, Enron, Argentina—Citi has grown earnings at a 17% annual clip over the past three years. Washington Mutual's back-to-basics banking—and customer service—attracts the average Joe and leaves rivals in the dust. . . . That focus has served Washington Mutual and its shareholders well." Jon Birger, "Leader of the Pack." Money, July 2002.

Washington Mutual was seized by federal regulators on September 25, 2008. The closing price for Citigroup shares was $38.49 on July 1, 2002 and $3.40 on December 18, 2009. Double oops.

These are just a select few notable gaffes that show the folly of forecasting. Big bets on the future that may be life-changing events for some market participants often amount to little more than rounding error for diversified investors. You don't need predictions to be a successful investor. To borrow from a brilliant nobel laureaute: diversification is your buddy.

To Your Prosperity ~ Kevin Kroskey

More Mutual Funds 'Time' Market

2009-12-12T07:17:00.000-05:00

Through my experience as a Certified Financial Planner(r) in counseling clients and in staying abreast of changes of the financial product companies, it has become quite evident time and again that it is a lot easier to sell consumers what they think they want rather than to educate them on what they need. From insurance carriers and financial sales people selling 'guaranteed products' at exorbitant costs to mutual fund companies seeding multiple new funds and then promoting the ones that do well while silently closing the unsuccessful funds before they receive their Morningstar ratings, consumers are preyed upon and have to side step a mine field of damaging advice and products if they're to be successful and reach their life's goals.

The Wall Street machine certainly isn't slowing down. Rather than educating consumers on market history, so they can learn why the negative returns from The Great Recession--while not pleasant nor frequent--are in fact a part of investing, Wall Street is instead now more actively pushing products that prey upon consumers' recent and deep fears. Mutual funds that are aggressively trying to get in and out of the market, called market timing, are the new fad. A recent article from the Wall Street Journal, entitled More Mutual Funds 'Time' Market, describes why this is such a risky strategy.

"But academic research raises doubts that the typical fund manager can successfully time the market over the long haul. Anders Ekholm, adjunct professor at Hanken School of Economics in Helsinki, recently analyzed more than 4,000 U.S. stock funds' returns between 2000 and 2007. Managers helped their performance through stock-picking, he found, but hurt their returns by market-timing.

There are a couple of reasons why the deck is stacked against market-timers, Mr. Ekholm says. Market-timing requires more trading, and transaction costs hurt performance. What's more, while a manager may relatively easily dig up some unique information that gives him an edge in selecting an individual stock, it's difficult to get such superior information about the overall market."

In my opinion the article is somewhat more favorable to market timing and stock picking than it should be, given the overwhelming academic evidence against them. There will always be money managers that get lucky and outperform, especially in the short run. However, to consistently guess right on both the prediction made and the timing involved in executing the investment strategy is virtually impossible to do.

Here's a prediction: looking back five years from today, a majority of the market-timing funds in existence today will underperform their benchmark--much more so than what one would expect from blind, random luck. A small minority of the funds will outperform their benchmark--much less than what one would expect from blind, random luck. Yet these darlings will be touted in the financial media and will receive large inflows from investors chasing returns.

Then over the subsequent five year period, these investors will be disappointed as their chosen guru no long has the 'gu' or the 'ru' (aka 'luck') that enabled them previously outperform. This is the continual dance that Wall Street does with consumers and the consumers are consistently dazzled by Wall Street darlings only later to find the emperor has no clothes.

If investors truly realized there were no silver bullet and took the harder road of educating themselves or working with a financial planner that can guide them, I have no doubt they would be in better financial shape and have much greater peace of mind.

Click here to read the full Wall Street Journal article.

Why Smart People Make Dumb and Costly Mistakes With Money

2009-11-02T19:01:00.004-05:00

"I can calculate the motion of heavenly bodies, but not the madness of people."

Sir Isaac Newton, Response to the 1720 collapse of the "South Sea Bubble"

Isaac Newton not only invented Calculus and discovered his Three Laws of Motion. Isaac Newton also lost a majority of his wealth in the South Sea Bubble, falling victim to behavioral mistakes investors make. Research indicates that humans are not naturally wired for prudent, long-term investing. And if a genious like Isaac Newton falls victim, what are ordinary investors supposed to do?

In the video accessible through the link below Scott Bosworth of Dimensional Fund Advisors describes common forms of behavioral bias and discusses how these biases influence investment decision making. He also explains how knowledge and discipline can help investors control their instincts for a better investment outcome.

Click here to watch the video. (Approximate run time is 20 minutes.)

"Hell Week, One Year On" by Nick Murray

2009-10-04T05:38:00.004-04:00

We recently observed the first anniversary of the most shocking and terrifying week in most of our financial lives: the economic cataclysm of September 15-19, 2008.

Even the greatest one-day stock market crash in history on October 19, 1987 did not shake us the way this Hell Week did, inasmuch as it was almost entirely contained in the equity market: the economy, the banking system, and the world at large, aided by a tsunami of liquidity from the Federal Reserve, rolled merrily along. The epicenter of the earthquake - at the corner of Broad and Wall Streets - turned out to be the whole earthquake.

And the terrorist atrocities of September 11, 2001, even as they forced us to confront a whole new global geopolitics - and our position in the world as the target of an unfathomable crypto-religious hatred - had, after the initial shock, no lasting economic effect.

But Hell Week 2008 shook the global financial system to its foundations. The previous week, the federal government had taken over the two government-sponsored mortgage enterprises Fannie Mae and Freddie Mac as they teetered on the edge of the abyss. On Monday, September 15, Lehman Brothers failed. It was (and remains) the largest corporate bankruptcy in American history, but on that day, this datum seemed almost beside the point. The issue was how much damage Lehman's failure would do to financial institutions all over the world which were exposed to Lehman through complex derivatives - in the jargon, Lehman's counterparty risk. No one seemed to be able to get a handle on this, and that uncertainty struck terror in the heart of the financial system. That same day, Merrill Lynch - one of the last great, independent investment banking and brokerage houses - was forced to merge with Bank of America in order to stave off its own imminent failure.

The next day, the government had to bail out one of the world's largest insurance companies, AIG, whose counterparty risk threatened to be even greater than Lehman's. And indeed, on that day - having written off its exposure to Lehman - the Reserve Primary Fund, a $62 billion money market fund, "broke the buck." That is, its net asset value fell below a dollar a share. Suddenly, no one knew what three trillion dollars of nominal money market fund assets were really worth, and panic liquidation set in on a hitherto unimaginable scale.

And so the week went on, with the government desperately injecting unprecedented amounts of liquidity into the financial system, in an attempt to prevent the credit markets from going into anaphylactic shock. All in vain: by week's end, it was becoming clear that the global market for credit was shutting down. And as it did, the world economy - to which credit functions as oxygen does to the human body - would fall off a cliff. Never in our lifetimes has economic activity in our country fallen so far so fast as it did in the fourth quarter of 2008 and the early months of 2009. Hell Week had been the detonator of a global thermonuclear financial implosion.

It is a minor irony of Hell Week that the stock market, as measured by the S&P 500, closed that Friday at its high for the week: 1255. The rally, such as it was, was propelled by the hope against hope that the government's apparent willingness to intervene without limit - to do, in Fed Chairman Bernanke's phrase, "whatever it takes" - would stem the tide. Reality would overtake us soon enough: driven relentlessly lower by massive home foreclosures, a cascade of bank failures, the bankruptcy of two of Detroit's Big Three and soaring unemployment, the equity market would in the next six months decline by nearly half from its Hell Week close, to 676 on March 9. (And this, of course, was the continuation of an already significant bear market which had begun when the market topped out at 1565 in October 2007.)

It was the nearest thing we had ever seen to the end of the world. Investors fled equities in a wave of panic which has few if any antecedents in our lifetimes. As 2009 began, deposits in passbook savings accounts and money market funds (the latter now guaranteed, in desperation, by the government) were greater than the market capitalization of the entire U.S. stock market, as denominated in the Wilshire 5000 stock index. Think of it, dear reader: for months on end - on any given day - the holders of cash equivalents earning less than one percent per year could have reached out and bought the American stock market in its entirety by nightfall. Yet they did not. And indeed, why would they? It was the end of the world. Everyone said so.

As I write, a year almost to the day since the end of Hell Week, the S&P 500 stands at 1070-about fifteen percent below its close on the Friday, and less than six percent below the week's low at 1134.

How can that be? Why, Hell Week was the beginning of the end of the world. Look what unfolded over the next six months: inarguably, the onset of the end of the world. Everyone said so.

Yet six months further on - the best six months in the American stock market since 1933, if anyone is counting - we're within a whisker of where we were in the middle of Hell Week. And will - sooner than later, if one may hazard a pure guess - surpass those levels. This eventuality will, when and if it happens, wipe out all the market's "losses" since the morning of Lehman's failure. Far more to the point of this essay, it will leave everyone who panicked out of the market during and after Hell Week - and who is still out - under water. Again: how can this be? What on earth can have happened?

What happened, dear reader, is that once again, seemingly against all reason and logic, the world did not end.

A detailed recitation of all the economic phenomena which have turned importantly positive - manufacturing (up eight months in a row), retail sales, productivity, the national savings rate, household net worth (the first uptick in two years), and even housing starts - is probably not necessary here. Indeed, even the last, lingering negative economic indicator, unemployment, seems to be in the process of topping out. The major banks have begun repaying their TARP money, and are recapitalizing. Merger and acquisition activity has restarted from a dead stop. And in a final irony, the Treasury just in the last few days quietly ended its guarantee program for money market funds, stating quite correctly that it was no longer necessary. We are by no means out of the economic woods - now, all that excess liquidity has to get mopped up before inflation ignites - but (a) we'll cross that bridge when we come to it, and (b) that's way beyond the scope of this essay.

One wishes simply to point out, here, that the world did not end - as indeed, historically, it has always failed to end in all the crises of yesteryear - and that everyone who predicated his portfolio on the end of the world has once again, at this writing, thrown snake-eyes. This is neither economic nor market commentary. Still less is it a prediction of the economy, nor of next year's market. It is purely an inquiry into the tragedy of panic.

Even more seductive than the siren song of a fad near its top - the Internet in 1999, real estate in 2005, oil in the spring of 2008 - is the hypnotic spell of catastrophism near a bottom. This is a psychological much more than it is an economic phenomenon, since it is well documented in the literature of behavioral finance that we fear loss far more acutely than we hope for gain. The peaceful and even blissful illusion of "the safety of cash" - bringing with it surcease from the pain of watching our investments lose value every day - becomes at such times well-nigh irresistible. And to justify giving in to the lure of cash, we latch on to whatever apocalyptic theory comes most readily to hand in the mainstream media.

And invariably - at least throughout history so far - we come bitterly to regret it.

This is, finally, the lesson of Hell Week one year on: that however horrific this particular turn of the cycle was, it was just that: a turn of the cycle. But that the cycle itself had not been repealed. And that if history was any guide-and it remains the only guide we have-however much the rubber band was stretched in one direction, even so would it snap back when released.

It was not necessary to know how or when the cycle would reassert itself, and in fact no one did, because no one consistently can. (And even if a lonely voice or two had spoken up for the imminence of the cyclical turn, the cacophony of catastrophism last winter would surely have drowned them out.) It was merely necessary to maintain one's faith that the cycle would turn. But that faith was and is much more a temperamental than an intellectual quality. And one nurtures it not by studying the economy at any given moment, but by studying history all the time.

The great documentary filmmaker Ken Burns has said, "History is medicine. It has nothing whatever to do with the past. It has everything to do with the present."A word to the wise: next time - and you may be sure there will be a next time - just keep taking your medicine.

© 2009 Nick Murray. All rights reserved. Used by permission.

I.O.U.S.A. Free Movie Showing During Financial Planning Week

2009-09-27T11:12:00.008-04:00

In support of Financial Planning Week which runs from October 5-11, 2009, the Financial Planning Association of Northeastern Ohio is pleased to announce a public showing of the movie I.O.U.S.A. (http://www.iousathemovie.com/) at the Cedar Lee Theater in Cleveland Heights, OH. One of the missions of the FPA is to raise awareness about the the importance of personal financial planning and offer guidance in making financial decisions. As a Board Member of the association I support and encourage this pro bono event in our community.

Tuesday, October 6, 2009 at 7pm
Free Admission (with a suggested donation of $3 to go towards Cleveland Saves)
Cedar Lee Theater
2163 Lee Road
Cleveland Hts., Ohio 44118

Seating is limited, so please register at http://tinyurl.com/ydq99lh. (You must register to attend.)

Although the movie is free, there is a suggested donation which will go towards Cleveland Saves, a local non-profit that encourages individuals and families to save money so that they can build wealth.

I.O.U.S.A. boldly examines the rapidly growing national debt and its consequences for the United States and its citizens. Burdened with an ever-expanding government and military, increased international competition, overextended entitlement programs, and debts to foreign countries that are becoming impossible to honor, America must mend its spendthrift ways or face an economic disaster of epic proportions.

Throughout history, the American government has found it nearly impossible to spend only what has been raised through taxes. Wielding candid interviews with both average American taxpayers and government officials, Sundance veteran Patrick Creadon (Wordplay) helps demystify the nation's financial practices and policies. The film follows former U.S. Comptroller General David Walker as he crisscrosses the country explaining America's unsustainable fiscal policies to its citizens.

With surgical precision, Creadon interweaves archival footage and economic data to paint a vivid and alarming profile of America's current economic situation. The ultimate power of I.O.U.S.A. is that the film moves beyond doomsday rhetoric to proffer potential financial scenarios and propose solutions about how we can recreate a fiscally sound nation for future generations.

Creadon uses candid interviews and his featured subjects include Warren Buffett, Alan Greenspan, Paul O'Neill, Robert Rubin, and Paul Volcker, along with the Peter G. Peterson Foundation's own David Walker and Bob Bixby of the Concord Coalition, a Foundation grantee.

Pointedly topical and consummately nonpartisan, I.O.U.S.A. drives home the message that the only time for America's financial future is now.

The Financial Planning Association® (FPA) is the leadership and advocacy organization connecting those who provide, support and benefit from professional financial planning. FPA demonstrates and supports a professional commitment to education and a client-centered financial planning process. Based in Denver, Colo., FPA has close to 100 chapters throughout the country representing more than 29,500 members involved in all facets of providing financial planning services. Working in alliance with academic leaders, legislative and regulatory bodies, financial services firms and consumer interest organizations, FPA is the community that fosters the value of financial planning and advances the financial planning profession. For more information about FPA, visit www.FPAnet.org or call 800.322.4237.

Cleveland Saves is a broad-based coalition of nonprofit, financial, corporate and government groups which encourages individuals and families to save money so that they can build wealth. Through the delivery of information, advice, and encouragement, Cleveland Saves assists individuals who wish to pay down debt, build an emergency fund, afford a home, education, investments, or retirement in order to improve their standard of living and most important, gain peace of mind.

The Deeper the Slump, the Zippier the Recovery

2009-09-19T07:39:00.005-04:00

(Below is an excerpt from a Wall Street Journal article, written by James Grant--an esteemed market observer and usual pessimist--published on 9/19/09. In my opinion this article represents a minority voice in public economic comment today and should be heard.)

From Bear to Bull: James Grant argues the latest gloomy forecasts ignore an important lesson of history: The deeper the slump, the zippier the recovery.

Americans are blessedly out of practice at bearing up under economic adversity. Individuals take their knocks, always, as do companies and communities. But it has been a generation since a business cycle downturn exacted the collective pain that this one has done. Knocked for a loop, we forget a truism. With regard to the recession that precedes the recovery, worse is subsequently better. The deeper the slump, the zippier the recovery. To quote a dissenter from the forecasting consensus, Michael T. Darda, chief economist of MKM Partners, Greenwich, Conn.: "[T]he most important determinant of the strength of an economy recovery is the depth of the downturn that preceded it. There are no exceptions to this rule, including the 1929-1939 period."

Click here to read the full article.

Reasons for Optimism Shouldn't be Shunned

2009-09-14T07:20:00.003-04:00

There was a good, short article in the Wall Street Journal this morning that I wanted to post. The article is entitled, "Reasons for Optimism Shouldn't be Shunned." Investors are emotional and find reasons to support the emotions they're feeling, ranging from overly pessimistic to overly optimistic. After 2008 most investors have been focusing on the negative and ignoring the positive.

"Even though stocks are up nearly 50% since early March, worries about valuations, the dollar, inflation and corporate profits permeate market chatter -- chatter so loud you can barely hear all the good news." Click here to read the entire article:

http://online.wsj.com/article/SB125287540315306843.html?mod=djemITP

Active vs. Passive: Man or the Market?

2009-09-11T08:06:00.009-04:00

Many academics consider the active-vs.-passive debate settled. Yet, despite the strong evidence supporting a passive, index-like approach, many investors still assume that skillful active management can increase returns, net of costs. The basis for a prescription of a passive investment strategy rests on scientific inquiry in the field of finance rather than on anecdotal evidence or 'good-sounding' stories told by the active mangers, media, supposed gurus, or others spouting investment pornography.

The tests have been done and they are well documented. Unfortunately for many investors, the subjects of these tests are not lab rats, but real people with real money! Below are some common questions that can help clarify this debate and hopefully help you not to fall victim to the higher costs and subpar performance of active managers.

Q: If an active manager can gather information and gain insight or knowledge through research into a company, shouldn't he be able to beat the market?

A: Not necessarily. You and I could have a different set of information or a different interpretation of the same information, while other investors may have no information at all. However, neither of us is at an advantage or disadvantage because the aggregate of all information is already contained in prices. So, rather than gaining insight or knowledge, the manager is simply gathering information the market has already digested.

One way to look at it is that in order to beat the market with skill rather than luck, you don't just need to have more information and insight than the "average" investor. You theoretically need to have more information and insight than all investors combined.

An active manager has only two arrows in his quiver—market timing and stock picking. All nuanced forms of active management ultimately boil down to some combination of these two elements. Both fundamentally rely on predicting the future, and the information presented in support of the forecast is typically quite compelling. Statements are made such as "we think the price of oil will rise because . . ." or "we think the economy will recover next year because. . . ." No matter how convincing the case may seem, however, you should always ask why this information that is readily available to the market would not already be reflected in prices.

Q: If market efficiency implies prices are right, then doesn't the fact that some stocks being 80%-90% below the level they were priced at a year ago challenge this fundamental premise? Which was the right price—today's price or the one a year ago?

A: The short answer is that both prices were probably wrong, but both prices were also your best estimate of the right price!

Market efficiency is not based on the premise of prices being "right" but on them being your best estimate of fair value. All prices may be wrong; but for markets to be inefficient, the errors would have to be systematic and identifiable. You, or your active manager, must also be able to identify these errors when other investors cannot, since your profit must be at someone else's expense. Not every investor can win in a zero sum game! However, the mistakes are mostly random rather than systematic (some prices are too high and others are too low), and there is little persistence in the ability of active investors to exploit these pricing errors.

Besides, the fact that prices can change dramatically is not a sign of market inefficiency. This is a reflection of how quickly prices can adjust to a new equilibrium based on the latest information.

Furthermore, there is a dilemma facing active investors who believe that pricing errors are identifiable for profit at the expense of someone else. If the price is wrong today, how can one be sure the market will eventually arrive at the "correct" price in the future? Is the market inefficient today but efficient tomorrow, or is there a chance an investor will go to his grave as the only one who knows the right price?

Q: How can you say active managers won't beat the market when I just read about XYZ Investment Company, which has outperformed for the last twenty years?

A: We can't say there aren't any active managers who have beaten the market in the past, and we can't say there won't be any active managers who will beat the market in the future. What we can say is there haven't been, and likely won't be, any more than you would expect by chance. The problem isn't that there are managers who have beaten the market; it is that there are too few of them!

Let's assume there were 5,000 funds available for investment over this twenty-year period. The 95th percentile of the distribution of outcomes from this sample (i.e., the top 5%) would represent 250 managers with a twenty-year history of generating returns that are significantly above market. At that point, you may be thinking, "what more proof do I need than 250 managers over twenty years?!" What you need to consider, however, is that if you had 5,000 proverbial monkeys managing portfolios by throwing darts at stock pages, you might observe even more than 250 who would have generated returns that put them in the top 5% of manager returns net of fees.

The monkeys would have clearly been dismissed as just being lucky, even over a twenty-year period. However, many investors are unwilling to dismiss the superior returns of an even smaller number of managers as being largely due to luck over the same time frame. I can't say for sure that it is all luck, but what I can say is that the outcomes don't look much different than if there were no skill at all. For many investors, hope springs eternal, but in my opinion investment dollars shouldn't be invested based on hope but time-tested, scientific research.

As a result, your example of XYZ should only be viewed as anecdotal evidence, and we do not want to implement an investment strategy on that basis. Let's say you had a very serious illness for which a doctor was prescribing treatment. Would you be comfortable following a treatment plan if you asked the doctor for the basis of his diagnosis and he responded, "it worked for my last patient"? Probably not, as you likely want to hear about years of scientific tests examining the whole distribution of possible outcomes, both in and out of sample, as outlined in top-tier medical journals subject to intense scrutiny, refereeing, and peer review. Why expect anything less for your financial health?

Did You Do as Well as Your Mutual Fund?

2009-08-21T05:06:00.007-04:00

It's common practice to look at a fund's total return number for a snapshot of what performance to expect, but that won't give you the full picture. Morningstar studies have shown that investors' actual gains frequently pale in comparison to reported total return numbers. This phenomenon frequently plays out among funds that attract assets after streaks of hot performance, only to see some investors get skittish at the first signs of underperformance. After a moment's though, even a novice investor will realize that this behavior is just the opposite of the mantra -- buy low and sell high.

This practice can be more broadly attributed to bad behavior and lack of a plan or philosophy when it comes to investing. Investors are human and humans are emotional. As much as the logician in me would like to believe my left brain is working to drive my decision making, logic comes in after emotions are experienced to provide context for how we are feeling and not the other way around. To borrow from the existentialists, we as humans have limits to our rational ability.

It is these emotions that cause bad behaviors that then lead to poor investor returns. However, by being consciously aware of how we are feeling (emotions) and how these emotions relate to our thinking (logic), investors can empower themselves to make better decisions. The primary manifestations of investor bad behavior come in the form of market timing, picking stocks, and using past performance or a track record to pick investments that will (hopefully) provide superior performance in the future. These are topics for discussion on another day, but at least be aware of them for now.

Using past performance as a tool for investment selection simply doesn't work. This is counter intuitive for most people and in direct conflict with other areas of our life. For example, if an all-pro NFL quarterback leaves one team for another, it is not unreasonable to expect the quarterback will excel with his new team. Stated another way, the quarterback's performance will persist. However, this is not so in investing. In fact recent stellar past performance by a fund manager may be an indication that you don't want to own that fund.

There is no academic study that I am aware of that has shown that a manager's superior performance is likely to persist into the future. (There are mountains of studies that show just the opposite.) And more importantly, there is no reliable way for an investor to predict what fund manager will have future superior performance in advance or before the fund manager does outperform. Yet hindsight is always 20/20 and investors are emotional. It's a virtual spinning wheel investors tend to run on but one that can be gotten off of by being consciously aware of these behavioral traps.

Click here to read more about investor returns and to see some real life examples of how investors actually fared in funds with strong recent past performance.

To Your Prosperity ~ Kevin Kroskey

Bangladesh Butter Production Predicts U.S. Stock Returns

2009-08-10T07:14:00.007-04:00

After reading the title of this post, my hope is that a look of disbelief is cast on your face. Of course butter production in Bangladesh has nothing to do with prediction of US stock market returns. However, through data mining all sorts of 'relationships' can be demonstrated. Many mutual funds, ETFs, and trading strategies are built upon these data mining strategies--most often to the harm of investors that utilize them.

As Jason Zweig describes in a recent article in the Wall Street Journal, entitled Data Mining Isn't a Good Bet For Stock-Market Predictions, "The stock market generates such vast quantities of information that, if you plow through enough of it for long enough, you can always find some relationship that appears to generate spectacular returns -- by coincidence alone. This sham is known as data mining."

I recall in from my business statistics course in grad school, how I was able to show that ice cream consumption was correlated to the murder rate--the more ice cream that was consumed the more people were murdered. Should we therefore ban ice cream? On a completely object note, my stomach says, "Heck no!"

The thing I learned from the ice cream case is that correlation does not equal causation. Simply put, your idea should make sense on top of any evidence found in data. And then if the idea makes sense and data seems to support it, you must test and re-test to make sure you're still not data mining. This is the process of prudent research.

What History Can Tell Us

There are some things history can and cannot tell us, and it is often very difficult even for the trained eye to know the difference. However, it is critical to build a sound investing strategy and at least in part, utilize what history can tell us. So what can we learn from history?

Stocks generally will return more than bonds over time. This is called the 'equity premium.'
Value companies generally will return more than growth companies over time. This is called the 'value premium.'
Small companies generally will return more than large companies over time. This is called the 'small premium.'

All of these premiums have been well documented in the academic literature. Studies show these premiums persist over different time periods and in different countries, so they are not data-mined farces. These premiums can add higher rates of return to an investor's portfolio while also adding diversification benefits. An investor not building a portfolio utilizing these premiums is ignoring useful history and not the data-mined farces that harm many investors.

Bond Investors Misled by Wall Street Journal Article

2009-08-03T07:03:00.007-04:00

In an article published today in the Wall Street Journal, entitled "The New Bond Equation," the author attempts to educate readers about the potential risks involved in investing in bond mutual funds, given the current economic environment. He writes:

"As the financial crisis heads into its third year, investors in bond funds are facing some difficult choices. Investors usually turn to these funds for safety. But bond funds are facing a host of pressures that are driving down returns, raising long-term risk—and making it tougher to settle on the right investment strategy."

While I agree with the author's statement above, he makes some statements that mislead bond investors. (Click here to read the full article.) For example, he writes:

"....they’re buying vehicles that invest in intermediate-maturity bonds. These funds also typically hold a mix of government, mortgage and investment-grade corporate bonds, which spreads risk around. Even cautious intermediate-bond funds yield about 4%, handily beating rates available on money-market funds."

This quote above is comparing apples to oranges, as these investments have completely different risk levels. Of course an intermediate term bond fund will yield much more than a money market fund. Investors face the risk of rising interest rates when they hold longer term bonds. The more rates rise, the more their longer term bonds suffer price declines. For this additional risk money market investors don't face, intermediate bond investors expect a higher return over time.

Further, in the article the author initially talked about buying long-term treasuries as a very safe bet. He really misled readers about the risk and corresponding volatility involved, ignoring interest rate risk and price fluctuations. However, the author did later explain how these fluctuations occur and provided a good description of bond duration, which investors or their investment advisors need to understand. In an oversimplified explanation, think of duration as how long it takes to get your money back from the bond. The larger the duration the longer it takes to get your money back and thus the more interest rate risk inherent in the bond or bond fund.

To provide a real-life example, VUSTX (Vanguard Long Term Treasury) has a duration of 11.6 and a standard deviation of 12%, which a measurement of how volatile the investment is. Comparatively, VFISX (Vanguard Short Term Treasury) has a duration of 2.6 and a standard deviation of just more than 2%--a much less volatile and thus a 'safer' bet than it's long-term counterpart. As rates change, there is little lag with the short-term rate bond fund, so the volatility is much, much lower. Longer term rates aren't quick to change and thus their price fluctuates much more, causing increased standard deviation.

A reader posted a comment that makes an argument that individual investors should use individual bonds rather than bond mutual funds. However, investors must be careful in purchasing individual bonds. Transaction costs to purchase bonds on the secondary market are quite high for smaller denomination bonds, making a low cost mutual fund and its institutional purchasing power less costly net of fees. Further, most investors purchasing individual bonds will be resigned to treasuries and AAA-AA municipals, as they can't afford to purchase enough riskier bonds to gain adequate diversification of credit risk. The same isn't true for a low cost bond mutual fund.

In short, keep your bonds 'short and sweet', meaning short duration and high credit quality. A low cost bond fund with these characteristics will serve you just fine, but if you have substantial assets, you could purchase individual bonds and get a bit more control of your bond / income portfolio. However, a mutual fund may still be preferable because of the diversification, liquidity, and simplicity it yields for the investor.

To Your Prosperity ~ Kevin Kroskey

Are We All Socialists Now: Government Intervention and Stock Market Returns

2009-07-29T20:08:00.006-04:00

As a recent Newsweek cover asked, "Are We All Socialists Now?" And if so, should U.S. equity investors be alarmed by the prospect of greater government intervention in the economy? Historical data looking at this very question may be surprising to you.

Click the link below to watch a short 6 minute video, which provides some objective comparisons of stock market returns from the more free-market system in the U.S. compared to the returns from more interventionist governments from around the world. The evidence suggests that government intervention is just one factor among many affecting stock returns, and that an above-average degree of intervention is not necessarily associated with below-average returns.

https://admin.acrobat.com/_a772887163/governmentinterventionandstockreturns/

To Your Prosperity ~ Kevin Kroskey

Last Week Was Not One To Miss

2009-07-20T07:41:00.007-04:00

Last week the Dow rose 7.3% last week amid earnings reports from many companies, as reported in the Wall Street Journal (http://online.wsj.com/article/SB124782681174757379.html). For most companies, it's not like the reports were necessarily good. It was that the news was not as bad as expected. This rapid rise in the market occurred despite poor economic news, including rising unemployment now predicted to go north of 10%.

To many investors, this seems counter-intuitive: poor economic news and declining earnings reports compared to the same time last year yet the market goes up markedly. How come? It's quite simple actually. The market looks forward and reacts to new and unknowable information. So even though the news was bad, much of it was not as bad as expected. Thus the new information positively changed market expectations and prices adjusted upward.

Unless you can predict the future, as investors we must stay invested through good times and bad to ensure we experience the positive results the market historically provides. Several studies show how the market provides its returns in short-bursts, as it did last week. (Click here to see the impact of missing the 12 best months from 1979-2008 http://www.truewealthdesign.com/content.cfm?ContentID=1564).

Alternatively, some investors try a market timing approach. Market timing is an attempt to forecast the market’s direction, pulling money out in anticipation of a downturn and reinvesting when it seems likely that prices will move higher. The events that move markets are virtually unpredictable, so market timing is essentially trying to predict the future--crystal ball anyone?

While a market timer may get lucky in the short run, numerous academic studies have showed that market timers yield results significantly lower than a passive buy-and-hold type investor. The markets run up last week amid poor economic news is an example of how market timing can severely hurt investor's returns. Another example can be seen in investors who fled stocks in October after a painful eight-day, 23% slide in the S&P 500, because on October 13, these investors may have also missed a major 12% one-day gain. This illustrates the point that episodes of falling prices can be clustered with episodes of rising prices.

So while it may be unsettling to some to have to endure the downs to experience the ups, there is no other way to ensure that market returns will be realized. If an investor cannot maintain his or her allocation during negative markets, the portfolio should be adjusted more conservatively and done so permanently. Trying to get back in when the news is good will likely lead to disappointment and under performance.

For a short video to expand on this subject, click here to hear Professor Ken French discuss whether Stockholders Should Sit This One Out.

http://www.dimensional.com/famafrench/2009/07/should-stockholders-sit-this-one-out.html#more

To Your Prosperity ~ Kevin Kroskey

DISCLAIMER

2009-07-17T06:50:00.000-04:00

This blog and website are for informational, educational and discussion purposes only. Even though topics may be discussed on this blog that involve legal, tax, or investment issues, nothing on this blog shall be deemed to constitute the practice of law, legal advice, tax advice or investment advice. No reader should act in reliance on anything discussed in this blog without prior consultation with a licensed professional who is qualified to evaluate the reader’s individual facts and circumstances and offer an informed professional opinion with respect thereto.

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