Investment Strategies Part 1: Rebalance into Stable Investments in an Appreciating Market (2009-05-25) by David John Marotta

Investment Strategies Part 1: Rebalance into Stable Investments in an Appreciating Market

(2009-05-25) by David John Marotta

Diversifying your portfolio means finding assets that have value on their own merits but do not move exactly alike. A critical investment metric called "correlation" is used to construct a portfolio most likely to meet your personal financial goals.

Correlation measures how much two different investments move together, measured on a scale of positive one (+1) to negative one (-1). A perfect correlation (1.00) would mean that both investments always move in the same direction with the same magnitude. A perfect inverse correlation (-1.00) would mean that two assets always move in opposite directions.

Correlation comes into play at three levels of investment allocation: stocks and bonds, asset classes and sectors of the economy. At each level it can provide you with a better chance of boosting your returns and protecting your investments. But the way correlation is used is different at each level. In this column we will cover its use at the highest level.

The most basic allocation in your portfolio is between investments that offer a greater chance of appreciation (stocks) and those that provide greater portfolio stability (bonds). These two categories have the largest negative correlation. Thus decisions made at this level are the most important in determining how well behaved your portfolio returns will be.

Not only do these two categories have the largest negative correlation, but they also have very different expected average returns. Stable investments like bonds have an average return of about 3% over inflation. Appreciating assets like stocks have an average return of approximately 6.5% over inflation.

If your portfolio is 100% in stocks, it will have the greatest long-term appreciation, but it will also be the most volatile. Consequently, it may not give you the best chance of meeting your goals. For example, a long-term average return around 10% from U.S. stocks certainly sounds appealing. But they also have a 19% standard deviation. So about six or seven times a century, you will experience a decade of flat or negative returns.

These awful returns happen even more frequently than a Gaussian function (or bell curve) would predict because stock market returns are not well-behaved Gaussian statistics. They behave more like fractal power laws, which in lay terms means the curve has lumpy tails far from the average.

We all know, at least experientially, what a lumpy tail looks and feels like because we just lived through one in 2008. According to Gaussian statistics, you should not experience such terrible years in the U.S. stock market as frequently as you do. Sometimes such events are called "black swans," or outliers. Sometimes we just say that the markets are inherently volatile.

This wild volatility may threaten the fulfillment of your financial goals. Aiming for a 10% return with wild volatility doesn't make sense if you only need a 7% return to guarantee meeting your financial goals. So sometimes slightly lowering your expected return can vastly lower your expected volatility. As a result, you increase the odds of exceeding the modest return you need to meet your goals.

Because of the difference in returns between stocks and bonds, they won't rebalance themselves over time. Left to itself, the allocation to stocks will grow larger and larger until it represents close to 100% of your investments. As this happens your portfolio will also grow more and more volatile and your goals more susceptible to market corrections.

Due to the difference in expected returns and the need to handle withdrawals during retirement, we consider the categories of stability and appreciation to be larger than asset classes. Correlation at this level will not boost returns because stocks normally outperform bonds. But it will definitely protect your investment. Consistent rebalancing by selling stocks and buying bonds helps protect your net worth and consequently your lifestyle. The reverse, selling bonds and buying stocks, is not as necessary and only appropriate for younger investors who are still adding to their portfolio.

Older investors should have at least five to seven years of their safe spending rate allocated to stability. For them, replenishing the allocation to stability during times when stocks are appreciating helps secure future years of spending.

Only younger investors who are still a number of years away from retirement or who have more stability than they need to support their lifestyle can afford to rebalance from stability back into stocks after a market correction. Doing this can help boost returns somewhat, but it has risks if the markets continue to decline. Therefore never shift more than you can put at risk back into uncertain appreciating assets.

All investors should set a limit to their losses and allocate that limit to stability. That limit generally should be five to seven years of safe spending, but it could be eight to 10 years for very conservative investors. If an investor is frugal enough, he or she can afford to be 10 years in stability. Forgoing the chance of appreciating won't endanger a sufficiently frugal lifestyle.

Using the negative correlation between stocks and bonds properly means trimming stock market gains regularly to keep portfolio risk and volatility under control. This discipline gives you the best chance of supporting your safe withdrawal rates during retirement.

from http://www.emarotta.com/article.php?ID=338

Achieving Family Harmony in Estate Planning Part 2: Make Sure Your Plan Fits Your Unique Needs (2009-05-18) by David John Marotta

Achieving Family Harmony in Estate Planning Part 2: Make Sure Your Plan Fits Your Unique Needs

(2009-05-18) by David John Marotta

Estate planning must begin with family harmony as the goal. Thus personal dynamics are more important than avoiding probate and estate taxes. Planning begins by selecting the right trustee. Here are some additional principles to help you assure family harmony in your estate planning.

First, have an up-to-date plan. Too many people either fail to prepare an estate plan or let their plan become outdated. Changes in the law occur frequently. As Will Rogers said, "The only difference between death and taxes is that death doesn't get worse every time Congress meets."

Plus, your circumstances can change. Toward the end of your life they seem to change faster. Between ages 40 and 65, have a new estate plan drawn up every decade. In your 70s and 80s, consider revisions every 12 months.

Second, you have unique circumstances that your estate plan must address. Everyone does. As a result there are very few "simple estate plans."

For example, an attorney related to me the story of a man who wanted so-called simple estate plan drawn up for him and his wife. In the first 15 minutes, the estate planner learned the client was a citizen of the UK, his 25-year-old son had bipolar disorder and the son was actually not his biological or adoptive child, although he and the young man's mother have been married for 23 years.

In another case, a very wealthy man was seeking "a simple estate plan" for him, his wife, and his family. But he was in a second marriage, had three children from his first marriage, his new wife had four children from her first marriage and one of his daughters was in a prison for kidnapping.

You are unique. Here are some of the questions you may answer in a unique way: Do you donate regularly to charity? Or make substantial gifts to family members? Do you want those gifts to continue if you lose capacity? Do you own a business? Do you own property that should not be sold? Do you have a beneficiary who is likely to cause trouble or owes you money? Do you want to provide for the continuing care of a pet? Do you have a working farm or farm animals? Do you want to be cared for at home regardless of the cost?

Your estate plan should be carefully crafted to address your specific needs and circumstances. The more tailored your plan, the less room there is for family disagreements.

Third, be careful not to change your plan inadvertently. Suppose, for example, you have a will that provides for your estate to be distributed equally among your three children, and you have named your daughter Susan as your executor.

To make it easy for Susan to access your bank accounts in the event of a medical emergency, you have added Susan's name to all of them. What you have done without realizing it is to change your plan. Under Virginia law, those bank accounts will belong to your daughter at your death and will not be shared by your other two children. As a result, your estate might be distributed differently than you intended. It can also result in family feuds or adverse tax consequences.

Before doing any self-help planning--even something as simple as adding a child's name to a bank account--check with your legal advisor to see how it impacts your plan.

Fourth, make sure your fiduciary/executor gets adequate help. The actions of your executor, trustee or agent under a power of attorney are subject to a rigid and sometimes unforgiving legal standard. It is easy unintentionally to run afoul of those rules. If you name a child to serve in these capacities, introduce him or her to your legal adviser. Make it clear in your legal documents that your fiduciary is authorized to pay for that help from your estate.

Fifth, check that the person you choose is willing to act as your fiduciary before naming him or her in your legal documents. You may find an unwillingness or a reluctance related to some concerns that need to be addressed. For example, a child may never feel comfortable giving consent to take you off a ventilator, even knowing that was your wish.

Finally, use your discretion, but consider telling your family in advance what arrangements you have made. Explaining your plan to your family upfront gives you the opportunity to address any concerns, answer questions and clear up misunderstandings. Once you lose capacity or die, it is too late. Many family fights could have been avoided with an open and frank discussion, so everyone is best prepared to handle a loved one's loss of health or life. Eliminating surprises helps eliminate family fights.

In summary, most people who plan do pay enough attention to concerns such as probate and estate tax avoidance. But the best estate plans are drafted with family harmony as a priority.

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See also:

1. Achieving Family Harmony in Estate Planning Part 1: Leave Your Estate in the Right Hands
   
   

2. Achieving Family Harmony in Estate Planning Part 2: Make Sure Your Plan Fits Your Unique Needs

from http://www.emarotta.com/article.php?ID=337

American Mercantilism Descends into Fascism (2009-05-11)

American Mercantilism Descends into Fascism

(2009-05-11) by David John Marotta

Most people think the government should do something to solve perceived problems in corporate America. In my most charitable moments, I believe these sentiments are well-intentioned naiveté. In my more cynical moments, I believe fascism is on the rise in America.

Fascism is socialism hiding beneath a capitalistic facade. Whereas socialism abolishes private ownership, fascism retains the appearance of private ownership but intervenes in the free markets to bully nominal owners to act in the so-called greater national interest.

The fact that many of you will ask, "What's wrong with the government forcing individuals and businesses to act in the greater national interest?" shows the prevalence of fascist thinking in America today. Mussolini argued that in the fascist state, citizens should honor the nation over their own selfish motives. Hitler argued that the state should retain total control to ensure that property owners could not use their property against the interests of others. Currently, both these dictators would receive accolades all around. Your own first reaction may be in sympathy with these views. But consider carefully before you decide to support the evils of governmental intrusion.

Political theory is lost on most of us without a concrete example. So let's consider my experience with the government's intervention in General Motors (GM). I purchased a GM bond in 2005 scheduled to mature at the end of 2014.

Even when I bought the bond, all was not well with GM. The company's hourly labor costs in the United States were $73.73 an hour, compared with only $48 for Toyota. Both firms actually paid about $40. But at GM, union-negotiated benefits had swamped profitability.

On the positive side, Rick Wagoner, GM's chairman and CEO, was moving toward profitability. GM's foreign production was profitable and growing. Wagoner cut GM's expensive American workforce from 177,000 to about 92,000. He also globalized GM's engineering, manufacturing and design. None of these changes were popular with the UAW, of course. Unfortunately, without enough concessions from the union, GM's international profits couldn't support its domestic labor costs.

Now GM is on the brink of bankruptcy. You might think I would welcome a government bailout. But as a GM bondholder, bankruptcy is not the worst outcome. What would be worse is a restructuring that leaves bondholders with only pennies on the dollar so the government and the UAW can siphon off most of the company's value.

GM has been paying insurance to the Pension Benefit Guaranty Corporation for years. Under current law, if the company goes bankrupt the government must cover retirees. Thus the government has a great incentive to avert bankruptcy. It would save massive pension insurance costs and also pay back the UAW for its support of the Democrat Party.

The union also has a financial motive to avoid bankruptcy because otherwise retirees' benefits would be capped. They would no longer receive company-sponsored health benefits. The government and the UAW are thus motivated to collude in any deal that isn't as drastic as the restructuring under a regular bankruptcy.

But these are both losses that hundreds of bankrupt companies have unloaded on workers and federal pension insurance in equivalent situations. What is completely unprecedented is to force bondholders, who had nothing to do with owning or running the company, to pay these losses. Bondholders are private entities or individuals who loaned the company money, expecting to be compensated. And in a standard bankruptcy reorganization, they are near the head of the line to be repaid.

When the government intervenes in the free markets, overrides the normal legal process and takes a position to help some people to the detriment of others for its own political purposes, that is fascism. The government is not intervening out of a sense of altruism. No benevolence is being shown to the widow whose pension includes a GM bond. The government is not forgoing its savings in the pension insurance program to help the company. Instead, it is taking the lion's share of GM capital when legally it deserves nothing.

Just because we don't see any storefronts with broken glass doesn't mean it isn't fascism. Many average investors are seeing their investment confiscated by political intervention to benefit federal pension insurance money and political special-interest groups such as the UAW.

On March 29, President Obama forced CEO Rick Wagoner to resign. Wagoner was responsible for increasing GM's focus on highly profitable trucks and SUVs at the expense of more politically correct fuel-efficient cars.

As the primary shareholder in a corporation, the government is in no position to experiment with socially engineering that will concentrate on green vehicles, only to turn around and pass tax credit legislation for manufacturing or buying such vehicles. It's this massive corruption and conflict of interests that makes fascism so dangerous.

GM has also gained most of its profitability from overseas manufacturing and sales. But with the government running the company for the benefit of the UAW, it will never approve GM expanding offshore. Even if it makes perfect business sense, the government would never allow GM to build a big new facility anywhere outside the United States. Rather than acting in a responsible fiduciary manner toward its shareholders and making the company profitable, it will pander to the political sentiment that opposes outsourcing jobs.

Many justify government intervention by citing the 1979 bailout of Chrysler under Lee Iacocca. Of all the misguided strategies of the past, the continued failure of Chrysler should be evidence enough. Perhaps if we hadn't rescued Chrysler, some of their market share would have helped make GM more profitable.

In fact, in 1979 it was again the government that profited from the Chrysler loan guarantees by exacting $300 million from the company in stock options. Bailing out Chrysler helped destabilize GM. And bailing out GM will destabilize Ford.

Since I purchased my GM bond, the political winds certainly have changed for the worse. I feel like Captain von Trapp in the "The Sound of Music." Max warns him, "What's going to happen's going to happen. Just make sure it doesn't happen to you."

The winds are blowing cold for free enterprise. I hear the crushing march of jackbooted capitalism. If all of this seems melodramatic, so did the fuss over a few broken windows among some Jewish small business owners in 1938.

And thousands like me have still been preempted in line to get our bonds paid back.

from http://www.emarotta.com/article.php?ID=336

Achieving Family Harmony in Estate Planning Part 1: Leave Your Estate in the Right Hands (2009-05-04)

Achieving Family Harmony in Estate Planning Part 1: Leave Your Estate in the Right Hands

(2009-05-04) by David John Marotta

The most important product of estate planning isn't avoiding probate or reducing estate tax exposure, it's achieving family harmony. As a result, we must watch out for personal dynamics that might threaten disharmony when a person dies or becomes incapacitated.

First, think carefully when you choose your executor or trustee. Being selected to manage an estate for someone who can no longer do so because of death or incapacity is an implicit compliment. It shows you trust the person you've named to do the right thing in the right way.

But it is also a very big job. Unfortunately, it can--and often does--feel like a thankless one. And what's worse is that lack of thoughtful planning too often results in irreconcilable family feuds.

We all know that someone must settle our estate when we die. But because people live longer these days, more of us will experience a period of incompetence before our death. We must plan for the possibility that someone will become responsible for our physical and financial well-being long before a final settlement of the estate can be made.

We often choose a close family member, who probably has no knowledge of what's required of a "fiduciary," the term used to describe a person to whom property or power is entrusted for the benefit of another. Taking on a new and unfamiliar task is stressful and difficult, especially if your life is already full.

Remember that serving as a fiduciary, whether as an agent under a power of attorney, an executor under a will or a trustee under a trust agreement, is a post of honor, but it is not an honorary post.

Don't name an oldest child just because he or she was born first. Ask yourself if your oldest has the traits of a good executor or trustee. Is he organized? Is she trustworthy? Will he see a job through to completion? Is she diplomatic and fair-minded? Might he abuse the position to settle old scores and wounds that are sometimes 30 years in the making? Is she sensible? Will she know when she is over her head and needs professional help?

In short, given all your available choices, is this child the best person for the job?

People sometimes want to name more than one executor so no child will feel left out. If you're so inclined, ask yourself, "Am I putting two scorpions in the same bottle?" The administration of an estate is not intended to be a therapeutic exercise that will ameliorate 20 years of bad feelings between brothers. Now don't get me wrong. Coexecutors can be a good way to go. But ask yourself first if they are people who can work together. Will they help or hinder each other?

Second, think through how you are leaving your estate behind. Family disharmony provisions are all too common.

For example, if you are in a second marriage, it's sometimes hard to be fair both to your spouse and to the children of your first marriage. In one situation, a 50-year-old man had concerns about his father's will. His dad left virtually everything in trust for his second wife. Such a trust commonly provides limited amounts of income and principal to the spouse during the surviving spouse's lifetime. When she dies, the assets pass to his children from his first marriage.

But because the stepmother is 55 years old, Dad effectively disinherited his kids. Don't set up a plan where your children are waiting for their stepmother to die to get their inheritance. Think of creative ways to be evenhanded to your present spouse and your children when you die. And there could be problems naming either the stepmother or the children as trustee.

Another planned disaster is leaving real estate equally to all your children. In Virginia, real estate drops like a rock through probate. It's not like money you can divide up equally. If your kids can't agree unanimously on what to do with the real estate, it can be a serious problem, for the only remedy the law provides is a partition suit. To keep the peace, provide an enforceable mechanism for either one child to buy out his or her siblings or for an executor to sell the real estate and divide the net proceeds up among the children.

Here is another dilemma that requires special consideration. You might recognize the need for one of your children to have his or her inheritance left in trust because of a poor credit record, mental instability, financial instability or a bad marriage.

Suppose that child resents the arrangement, which is quite possible. Who are you going to name as trustee of that child's trust? Are you going to name a sibling as the trustee of another sibling's inheritance? How will that decision affect the sibling relationship?

And if you name a professional trustee, such as an attorney or bank, are you putting your child at the mercy of that professional trustee? What if they provide poor service after you die? Or raise their fees? All those problems go away if you give someone you trust--such as the child you were thinking about naming as trustee--the unlimited power to fire the professional trustee and appoint a new one. It's no surprise how much better professional trustees perform when they know they can be replaced at any time.

Estate planning begins with selecting the trustee who will handle it best. Probate and estate tax avoidance is easy. Selecting the best trustee is critical. Be sure you structure everything legally in a way that will create unity, not animosity. Make that decision well, and you are halfway to drafting your estate plan with family harmony in mind.

from http://www.emarotta.com/article.php?ID=335