Lost Decade for Stocks

Okay folks, I really, REALLY meant to restart blog posting with another article in the series entitled "Planning Basics" but I found this article at Econobrowser by Jim Hamilton such a good read I had to share it with you. In it Hamilton presents two superb graphs: one of total non-farm payrolls over the decade and the other of corporate (S&P 500 as proxy)earnings. Wonder why stocks have gone nowhere over that time period? The article contends these are highly suggestive of the answer. Here's a peek.



Pure carnage. Now for S&P 500 earnings:



(Click on either image for a larger view.)

The same. Of particular concern is the increase in earnings variability as the economy has become more geared to the financial sector (30% at one point). Since the sector profits through various types of "transactional taxes" if you will, I believe it would be a very good thing if we substantially decreased our reliance on this mechanism of "growth".

Merry Christmas

Peace on Earth and Good Will Toward All Men. Merry Christmas All!

Arrival

And a wintry white arrival it was.

Amid boxes, papers and general disarray, my family and I are "settled" in our new house in Wisconsin and occasionally venturing out to brave the colder winters here.

A Hiatus

I am moving my family back to the Midwest. I grew up there, as did my wife, and we have much family there. It will be nice to have family close.

We have enjoyed our time in New England. It was too short. I made some good friends here. All my family did. These friends will be missed.

I am taking a hiatus to coordinate the move. For about a week I will not have access to my usual tools. (I know, you CAN blog remotely, but that's not for me.) Then the holidays will be upon us. I'll pick this up again on the other end. Posting will be even lighter than normal.

Mark

Brighten Your Holiday Spirits with End of Year Tax Planning

If you didn't catch my earlier post on this when the topic was, well, a WEE BIT MORE TIMELY, it is here.

Speaking of timely, hopefully you are farther along in your gift shopping than I am.

Economist John Hussman: Stocks' Discounting Mechanism Broken

I have been a long time fan of the economist and money manager John Hussman's writings. In fact I own both of his mutual funds. A recent post of his in his Weekly Comment drew my particular attention because it hit upon a question that has been nagging me for years now. It goes like this: What if the change in the composition of the stock markets has affected them in some manner? What if the fact that hedge funds and proprietary trading desks now dominate the daily volumes on the exchanges means something for the individual investor other than it making it ever harder to "win" the investment game? What if the markets no longer function as a long term arbiter of value? Hussman has the same concern. Read it here.

Another Credit On Its Way: Cash for Appliances!

More stimulus is on its way from Washington:

In the coming months you may be eligible to receive rebates from your state or territory for the purchase of new ENERGY STAR-qualified appliances.

These rebates are being funded with $300 million from the American Recovery and Reinvestment Act of 2009. Under this program, eligible consumers can receive rebates to purchase new energy-efficient appliances when they replace used appliances.

......

Each state and U.S. territory was allowed to design its own rebate program, and all 56 have submitted plans to the U.S. Department of Energy (DOE).

The link to the Department of Energy's website announcing the program is here. A PDF of states with programs that have already been approved is here.

UPDATE (December 8, 2009):

And now "Cash for Caulkers"? Will this never end?

Planning Basics: A Philosophy of Financial Planning

"Personal financial planning, or financial planning, denotes the process of determining whether and how an individual can meet life goals through the proper management of financial resources."--
Certified Financial Planner Board of Standards, Code of Ethics and Professional Responsibility

AUTHOR'S NOTE: I want to start a series of posts about financial planning basics for my readers. My intention is that one post a week will concern these basics and a second weekly post will discuss a more advanced planning concept, a bit of timely news or a particular strategy of interest. The posts relating to basics will be denoted "Planning Basics". That way, if you are an advanced reader you can just skip them or tag them for perusal on a slow rainy day.

Once you read the above statement by the CFP Board, it is blindingly obvious (at least to me) that the emphasis in financial planning should not be the sale of products (such as life insurance, annuities and mutual funds) but the process for helping people meet their financial goals, either through the development of comprehensive plans (preferred) or through the use of a segmented approach for solving discrete problems (if appropriate and practicable). Why all the qualifications in that sentence? Well, sometimes what a potential client asks you to do can be neither appropriate or practicable and it is your job to say "No" even if it means that you won't be earning a fee. These don't have to be illegal (tax fraud) or immoral (abusive financial relationship) but can simply be mistakenly applied concepts or strategies. Or it may be that a client asks for something simple whereupon investigation you discover that the "simple fix" brings too many other moving parts into play. Instead of a fixing a flat tire you find the client needs struts, rotors and ball joints.

So what is that process we are talking about? Well, I don't believe we can talk about that without touching upon the areas of a client's financial well being impacted by the relationship nor of the planner's role in coordinating services for the client in these areas. Here are the key planning areas:

Risk Management Planning
Education Planning
Cash Management, Savings, Debt and Credit Planning
Estate Planning
Retirement Planning
Investment Planning
Tax Planning
Planning for Financial Independence

That's a lot! And that's a lot for one person (your financial planner)to have skills in. Even though a financial planner may understand how all of these areas interact, his/her expertise may only be in one/two or more but fewer than all eight of these critical areas. Hence the need to coordinate the activities of others such as a life insurance agent, tax attorney, estate planning attorney, broker, mortgage specialist, etc. (The act of coordination requires superior organization and communication skills.) As stated, some of these functions and activities can be performed by the financial planner. I would say that it is very desirable that the planner do so. But the more sophisticated planners recognize that in order to best serve their client, many circumstances warrant seeking the professional advice of others. Let's talk about three of them: attorney, accountant and portfolio manager.

Attorney

It's now a given that the legal community casts a rather suspicious eye toward the financial planning community. This is for two reasons. One, the legal community questions the credentials for such a complicated task as outlined above. Two, the legal community believes that the practice of financial planning "encroaches on its turf". Its suspicions are only heightened by statements such as this one, from Practicing Financial Planning (for Professionals) by Mittra, Sahu and Crane (2007) : "In the context of financial planning, an attorney's key function is to certify the legality of a proposal developed by a financial planner and to prepare the associated legal documents." What?! The attorney is someone who merely "certifies" and "prepares" what a financial planner has drafted? The whole notion is mistakenly naive and a violation of an attorney's Code of Ethics and Professional Responsibility. The authors go on to decry these "turf Battles" and "acrimony" between the two professions and then assert that "in [the] role [described]the attorney operates not as an adversary but an integral part of the team of professionals". No, the role described is 1) order taking and 2) ministerial as well as insulting.

Yes, your attorney has a vital and important role in the financial planning process. It is not as described in the above best-selling planning manual, but to provide sound and professional legal judgment through fact assembly and assessment, research, drafting, document preparation and client counseling in those areas of the financial plan that are affected by the law.

Accountant

Accountants and CPAs have traditionally performed two principal functions for the client: maintenance of records and preparation of taxes. However, the profession is often asked to do much more, namely, advice on the tax effects of certain financial transactions including investment purchases or sales or those of business entities. The CPA or accountant often coordinates with the client's tax lawyer in these regards, especially where the act of giving counsel may be interpreted as the giving of legal advice.

Portfolio Manager

A portfolio manager helps design the vehicle that preserves or enhances a client's estate. An attorney may prepare documents that preserve the estate and a CPA may advise as to the existence of Tax Code provisions or strategies that also do so, but the portfolio manager uniquely constructs through use of investment vehicles and products (stocks, bonds, funds, annuities, limited partnerships, real assets, alternative financial products, etc) a portfolio designed to achieve the client's financial goals.

Insurance Counselor and Other Professionals

One important dimension of the overall financial plan is that of asset protection through the purchase of life, disability, property, casualty, professional liability, long-term health care, and other insurances. Aside from the insurance counselor, a planner may need to work with trust officers, real estate brokers,and investment bankers. In working with each the objective of the planning professional is to get sound objective advice in outside areas of expertise such that the financial plan is enhanced by its inclusion.

Summary

We are starting a series on financial planning basics. This is meant as a sort of "30,000 foot view". Today's article touches upon the philosophy of financial planning, and continues with a look at the planner's areas of impact and his/her role as provider and coordinator of services in those areas.

Mainstream Media Discovers Long Term Stock Value Measures

Readers know that I place strong reliance upon long term measures of stock values. Planners are usually not traders and there is a BIG distinction between trading and investing. I find that most mainstream media outlets (WSJ, CNBC, etc) are nearly universally focused on the former and not the latter. How refreshing therefore to find an article in the NY Times (Economix) that discusses a favorite measure of mine: Shiller's PE10, "Stocks Start Looking Dear Again" by David Leonhardt. What does it say?

Corporate profits may rise or fall in any given year depending on the state of the economy, but a share of stock is a claim on a company’s long-term earnings and should be evaluated as such. And over the past century or so, there has been a pretty strong correlation between the 10-year p-e ratio and future returns. When the ratio shot above 20, as it did in the 1920s, 1960s and recent years, stocks were headed for a fall. When the ratio dropped well below its 100-year average of 16, as in the 1930s and the early 1980s, a bull market typically followed. (The average of the past 60 years is about 18.5)

What does the ratio say today? That perhaps the recent rally has gone a bit too far.

The article gives links to history of the indicator and its development. It's short and worth a read. My usual cautionary note: These long term indicators say NOTHING about the direction stocks will take in the short term. Enjoy.

Reversing Last Year's Trade or Booking GAINS for Once

As part of my usual end of the year pontificating about tax strategies, I'm going to discuss capital losses and gains first. Why? Because the topsy-turvy nature of our capital markets from 2007-2008 to 2009 may give some opportunities for some unique strategies.

About this time last year I would have been advising you to offset capital gains with capital losses. In other words if you had sold profitable investments (lucky you!), I would have suggested you try to find some losing investments you could sell to minimize or eliminate your capital gains tax. In that environment it wasn't hard. However, a lot of investors now have significant losses in 2008 being carried over, and may have additional losses in 2009. Capital losses offset capital gains, and any excess losses are deductible up to $3,000 per year, which, given the degree of the carnage in the markets the past few years, may seem like a pittance to some. For example, if you suffered $100,000 of total capital losses in your portfolio but only $50,000 in capital gains, then your net capital loss is $50,000, but your total capital loss deduction for the tax year is merely $3,000. The remaining $47,000 in losses are carried over to next year. If this is you and, as a result of this you decided to stop investing and therefore never had another capital transaction, it would take you about 17 years(!) to fully utilize your carry-forwards.

What to do? Well, we might need to reverse the traditional advice and try to sell off investments with gains to offset losses.You could sell off profitable investments and repurchase them immediately. This books a capital gain for tax purposes, uses up some losses, and gives you a new cost basis position in the investment. You might be thinking, isn't this tactic prohibited by the wash sale rule? No, the wash sale rule only applies when you sell an investment at a loss and repurchase the same investment within thirty days. If you're selling an investment at a profit, the wash sale rule doesn't apply.

A little used tactic is to give appreciated stocks and other investments to someone with significant capital losses. Taxpayers can give up to $13,000 per year per person tax-free as part of the annual gift-tax exclusion. Under the scenario put forth above, a family member could give this individual stock or mutual funds or other investments that have appreciated in value with a cost basis of $13,000. The gains will be offset by the losses, and thus eliminating any capital gains tax.

One other note. You may want to think about the TIMING of the use of your losses. (I talked about this in my article on tax shifting.) President Obama has proposed increasing the tax rate on long-term capital gains to 20%. Perhaps you may want to keep carrying over some capital losses to offset future capital gains.

See your trusted tax advisor or planning professional about any of this.