Where in the World Should You Invest? (2011-03-28)

by David John Marotta

Finding countries where you can plant your investments in fertile soil may be one of the most important asset allocation decisions you make for the next several years.

In 2002 I coauthored a column with my father, George Marotta, entitled "Will the US Go the Way of Japan?" in the "Charlottesville Business Journal." Our answer to the question was no. We argued that when the United States has an Enron go under, there isn't a too-big-to-fail syndrome. But when a large Japanese company is in danger of failing, the government comes to the rescue. The company becomes a drag on their economy for the next decade or more.

In that column we wrote, "The ruthless culture that allows large companies to go bankrupt in the US hurts less in the long run than the Japanese style of business subsidies. In the US, the government keeps hands off business; in Japan the government interferes with the operations of business and commerce."

My, how times have changed. Now, unfortunately, the United States is going the way of Japan.

Now Japan is struggling to recover from a devastating earthquake. I was asked recently if that tragedy would stimulate its economy. Regrettably, nothing could be further from the truth.

I would suggest that everyone read Henry Hazlitt's classic "Economics in One Lesson." In Chapter 2, "The Broken Window," Hazlitt debunks the fallacy that a hoodlum throwing a brick through the window of a baker's shop is somehow good for the economy.

Certainly the baker has to pay to have his window repaired, but now he only has his window back and no money to buy a new suit. The community is poorer one new suit that could have been made and in exchange simply got its window back. But the community doesn't see what is never made.

The broken window fallacy may seem obvious, but it comes in many forms. Some pundits are mistakenly arguing that the earthquake and tsunami will be just the economic stimulus Japan needs to pull out of its malaise. This conclusion confuses need with demand.

In our country we print stimulus money and believe we have created wealth. Stimulus money may increase government spending, but the growth of government is a negative in the equation of economic prosperity. This fallacy mistakenly equates purchasing power with money.

Economic fallacies like these are "so prevalent," Hazlitt writes, "that they have almost become a new orthodoxy. . . . The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consist in tracing the consequences of that policy not merely for one group but for all groups."

The politicians in many countries focus instead on the short-run effects on a special-interest group and ignore or belittle the long-run effects on the community as a whole.

Japan wasn't the best place to invest even before March 11. Its economy is smaller now than it was in 1992. The MSCI Japan Index averaged an annual total return of -0.29% from March 1996 through February 2011. Japan dropped another 9% this month as a result of the earthquake. Most of Japan's troubles have been self-inflicted by its own government. Freedom matters.

Japan scored 72.8 out of 100 (mostly free) in the Heritage Foundation's Index of Economic Freedom. Since 1994, the Heritage Index has systematically measured economic freedom in countries worldwide. The foundation defines economic freedom as "the ability of individuals to control their own labor and property. In an economically free society, individuals are free to work, produce, consume, and invest in any way they please, with that freedom both protected by the state and unconstrained by the state."

Overall Japan is the 20th most free country, which isn't bad but is not great either. Not when 9 of the top 11 countries have large markets with easy ways to invest in them directly. In two important categories, Japan's scores are particularly poor. It ranks 145th in fiscal freedom. The top corporate income tax rate is 41%, the highest in the world. Even Japan realizes this is too steep. Next month they are cutting that rate to 36%. The U.S. top corporate tax rate is 35%, rising to 39.5% in 2013.

Japan also ranks 114th in government spending. Japan has some of the highest sovereign debt and deficit. Their ratio of outstanding gross debt to gross domestic product has risen from 68% in 1990 to about 230% in 2010.

Freedom matters. You can't afford to plant your investments in anything but fertile soil. If you simply invest in the MSCI EAFE foreign index, 22% of your investment is in Japan. What's worse, about 65% is in countries with low economic freedom and a high debt and deficit.

This isn't a reason to keep your investments here, however. Last year the United States lost its place in the list of countries with the most economic freedom for the first time in the 15-year history of the index. Part of the lower scores was a result of the U.S. debt and deficit exploding. If 65% of foreign investments are in countries with a high debt and deficit, then 100% of U.S. investments have the same problem.

Today, perhaps more than ever before, may be the time to overweight very specific foreign countries with low debt and deficit and high economic freedom. Put your investments in fertile soil where they can grow unimpeded.

I will be presenting an analysis of each country you should overweight in your portfolio at this week's NAPFA Consumer Education Foundation meeting, "Where in the World Should I Invest?" This presentation will describe what could be the most important trend to follow in today's sovereign debt investment landscape. The talk, which will take place on Tuesday, March 29, 2011, at the Charlottesville Northside Library Meeting Room from 7 to 8 p.m. with a question-and-answer session to follow, is free and open to the public.



from http://www.emarotta.com/article.php?ID=445

Save 97 Percent of Any Windfall (2011-03-21)

Save 97 Percent of Any Windfall

(2011-03-21) by David John Marotta

Surprisingly, studies show that onetime windfalls can actually impoverish you. They make you feel rich, which inevitably leads to overspending. But wealth is what you save, not what you spend.

With large windfalls, people tend to spend about 40% of the money. So if you get $20,000, you might spend $8,000. But if the amount is small, you will squander a greater percentage, often more than you received. Thus if you win $75, you may actually spend an additional $125 before you stop celebrating.

Either of these scenarios will make you poorer. One goal of wealth management is to increase the amount you can spend each year rather than adopting a lavish lifestyle followed by thrift and austerity. A lifestyle is defined here as everything you can do with money, including generous donations to the charities of your choice. The goal of an ever-increasing lifestyle is not to consume more each year but rather not to allow your choices to outpace what you can continue to maintain. A year of living extravagantly is foolish if it isn't sustainable.

Consider this extreme example to see why spending even 40% of a onetime windfall breaks this principle. Imagine that instead of an annual salary you receive all your lifetime earnings in one $2 million lump sum at age 20. Spending 40% the first year is neither maintainable nor advisable. After blowing $800,000 the first year, you have reduced your potential standard of living by 40% for the rest of your life. Getting $1.2 million at age 21 is barely half as good as the original deal. Not only is your future spending severely diminished, but your expectations after a year of an $800,000 lifestyle are extremely inflated. You will struggle not to spend at least $400,000 the next year and may still feel slighted.

It is easy to expand your lifestyle and spending but very difficult to contract. Even if you give most of the $800,000 to charity, the organizations will want those funds again the following year. Prudent spending, even charitable giving, often involves continuous annual spending over a long period of time.

If your windfall is a once-in-a-lifetime event, only spend a very small percentage of it. If you are young, 3% would be reasonable and sustainable indefinitely. Saved and invested in a diversified portfolio, you should be able to earn at least 3% more than inflation.

Imagine inflation is running at about 5% and your investments are making 8%. So after a $2 million windfall, you can spend 3%, or about $60,000. Your $2 million portfolio will grow 8%, appreciating to $2,160,000. After spending $60,000, you will have $2,100,000 left. You may think you have more money, but you don't. Because this is only 5% more than you had originally, the increased amount will have the same buying power after adjusting for inflation.

The second year you can again spend 3% of the increased $2,100,000 amount, or $63,000. This will offer you the same lifestyle because prices are now 5% higher. As your portfolio increases 8% each year, you spend 3%. The other 5% simply keeps up with inflation.

Most people believe they are doing well when they save 60% of a windfall and contain their celebration to only 40%. Don't be fooled. It's like saying because it is OK to have a glass of wine every night why not just have 150 in one night and then not drink for the rest of the year. Moderation matters. You can't restrain your lifestyle and still spend 40% of a large windfall.

If you don't adjust your lifestyle spending, you will jeopardize your retirement plan. Progress toward retirement is measured by how many multiples of your standard of living you have saved. At age 40 you should have about 10 times your annual spending saved. If you spend about $60,000, you should have $600,000 saved.

You might think a windfall of $400,000 could only help your retirement plan. Now you have $1 million! Surely you should be able to spend more now that you are a millionaire.

You are better off, that's true, but only if you don't spend any of the windfall. If you do, you will have increased your lifestyle. That translates to increasing the amount you should have saved by age 40 as well as the amount you need to save each year to stay on track toward retirement.

Spend just $40,000 of your $400,000 lifestyle and your lifestyle balloons from $60,000 a year to $100,000. So by age 40 you should have ten times your standard of living or a full $1 million in savings. But because you spent $40,000, you are now $40,000 short.

Increasing your retirement goal also means increasing your annual saving toward that goal. You should be saving an additional 15% of your lifestyle each year. At $60,000, saving 15% meant saving $9,000 a year. But with your lifestyle now at $100,000, you ought to save $15,000 a year. Sustaining that increased level of savings will mean a lower standard of living in future years.

Escalating your lifestyle anything more than slightly can ruin your retirement plan. You can increase your spending each year by just 3% of any windfall. There are really few exceptions to that rule. Only a small number of families are sufficiently disciplined to rein in their celebration and save 97% of a windfall. Be one of those few. Build real wealth by saving and investing. In the end, your investments will be a dynamic engine of wealth creation and you'll enjoy financial peace of mind.

from http://www.emarotta.com/article.php?ID=444

Multiple Accounts: An Essential Management Tool (2011-03-14)

Multiple Accounts: An Essential Management Tool

(2011-03-14) by David John Marotta

To build real wealth, you need specific wealth management tools. One of these is opening the right accounts and using them correctly. Most families have less than half of the accounts they really need, and young newlyweds often only have a checking account.

Here is a description of each wealth-building account, roughly in the order a young couple would need them.

Joint checking account: This account should only hold money you need to maintain your lifestyle. Keep the balance between two and three times your monthly spending. Save and invest any additional. Bank managers always encourage you to open a savings account along with your checking account. Resist. You aren't just trying to save money. You need to save and invest. Bank savings accounts are not investment accounts. Pick a bank with the lowest fees, and don't worry about the interest rate.

Taxable investment account: Many couples mistakenly believe that wealth is built only in qualified retirement accounts. But the government limits how much money you can put into retirement accounts. The excess has to go somewhere. You don't want to spend it, and accumulating cash won't grow your wealth. Saving and investing is the way to build significant wealth. This is the most important and overlooked account.

Investment accounts are best opened with a broker, not a bank. Pick a discount broker with relatively low trading fees. I've written previously about "Getting Started with Investing," available on our website.

Here is a short list of discount firms to consider: E*Trade (www.etrade.com), TD Ameritrade (www.tdameritrade.com), Scottrade (www.scottrade.com), Charles Schwab (www.schwab.com) and Fidelity (www.fidelity.com). Competition changes charges regularly. Avoid brokers with anything more than a small trading fee. Each broker has special promotions that may offer free trades, cash or electronic goods. Taking the best promotion is tempting, but first evaluate brokers without considering the promotion.

401(k) or 403(b) retirement accounts: If your employer offers a match in its retirement plan, take it. A safe-harbor match protects the plan against the claim that it only benefits the highest paid employees. With safe-harbor match your employer typically matches the first 3% you put in dollar for dollar, and the next 2% you put in is matched 50 cents on the dollar. For example, if you contribute 5% of your salary to the plan, your employer will match it with an additional 4% of your salary. This is an immediate 80% return on your money! Unfortunately, many employees fail to take advantage of this opportunity.

Your contributions always belong to you, and you can take them with you if you change employers. Sometimes what the company puts in requires you to continue working there for a number of years before you receive the full amount, which is called being vested. Learn the vesting rules, but some portion of the match will probably be yours even if you leave early, so go ahead and take advantage of the full match.

You will need two accounts, one for each spouse, through your employment. Each account can be subdivided into three subaccounts: One account is your contributions, one is the employer match that may or may not be fully vested and a third might exist for any corporate profit sharing or bonuses.

A 401(k) is more common in the private sector, whereas 403(b) accounts are for education or nonprofits. The principles are the same for each. Their names refer to the section of the IRS tax code that makes provisions for the account.

Roth IRA accounts: Unlike a traditional IRA, a Roth account does not get you a tax deduction, but there is no tax due when you take money out in retirement. Additionally, you can withdraw the amount you put in tax free after five years or more. There are limits on how much you can put into your Roth account. Put in the maximum each year.

Consider it this way. Imagine your taxable investment account has built up $100,000. Every year the government will allow each of you to move $5,000 from your taxable investment account into your Roth accounts where it will never be taxed again. Move the maximum each year. Your tax bracket will never be as low as it is right now. As you grow in wealth, your tax rate will grow considerably. Take advantage of your low rate now, and fund your Roth IRAs with the maximum allowed each year.

To fund a Roth IRA you must have earned income, but a spouse's earned income can count toward funding your own Roth. Therefore a couple needs two Roth accounts, one in each person's name.

Health Savings Account (HSA): You need health insurance to limit catastrophic medical risk, not to pool everyday expenses. This is especially true for relatively healthy young families. The best coverage to consider is a High-Deductible Health Plan (HDHP). The deductible is thousands of dollars. For everyday expenses within the deductible, consider a Health Savings Account (HSA).

An HSA is the only account where you get a tax deduction for putting the money in and you are not taxed when you use the money for a qualified medical expense. The money in the account can also be invested, and all interest, dividends and capital gains in the account are not taxed. And HSAs come complete with debit cards and checks. Your employer may provide you with an easy method of payroll deduction for your HDHP and HSA. Alternatively, you can sign up for an individual plan.

IRA rollover accounts: When you leave an employer you will want to roll your 401(k) or 403(b) accounts into an IRA rollover account where you can manage it yourself. Although the matching aspect is wonderful, a 401(k) account has limited choices and higher fees. Moving that money into an IRA is nearly always the right decision. Both you and your spouse will ultimately need IRA rollover accounts.

Living trust accounts: Estate plans can be written in many different ways. Some estate plans set up a bypass trust only after one spouse has died. Other estate plans prefer to set up a living trust each for husband and wife while they are still alive and fund it with investments. Make sure you understand your will and estate plan well enough to structure your investment accounts in accordance with your wishes.

Inherited IRA accounts: If your parents or grandparents have died they may have left you money outright or they may have left you their traditional or Roth IRA account. If they have left you an IRA account, leave the IRA account as a qualified account where the interest, dividends and capital gains grow tax deferred. Taking the money out gradually, only the amount of required minimum distributions, provides the greatest tax benefit.

Segregated Roth conversion accounts: Tax law allows you to take the money in your IRA or IRA rollover account, pay the tax and convert those assets to a Roth account. Before you pay the tax, you even have the opportunity to recharacterize and unconvert the conversion. An additional tax-planning technique suggests dividing the portion you convert into separate accounts. Segregating the assets into different accounts allows you to invest them differently, keep the one that does the best and recharacterize the ones that underperform.

Charitable gift account (or donor-advised funds): To facilitate your charitable giving, you are allowed to transfer appreciated securities to the account. As you transfer them, you receive a tax deduction for the full value. They are sold and may be reinvested in a limited number of choices. And at any time you can direct that donations be made to qualified charities. This is an easy way to get the tax write-off for donating large blocks of appreciated securities and then subsequently give smaller amounts to individual charities.

More than a dozen different accounts are listed here, but you may not have them all until you are well on your way to becoming a millionaire.

from http://www.emarotta.com/article.php?ID=443

Don't Retire: Keep Significant Goals (2011-03-07)

Don't Retire: Keep Significant Goals

(2011-03-07) by David John Marotta

Most Americans fail to plan adequately for retirement and consequently miss out on opportunities to enjoy the last third of life. The best and most rewarding financial planning is not just about the numbers but rather takes place in the context of personal goals.

Retirement used to mean not only a complete withdrawal from the workforce but often a retreat from life. Even the word "retire" has the connotations of shuffling quietly off to bed.

We call that traditional concept a "cliff retirement" because it is so abrupt. One day you are working full time, and the next you are playing full time (or slumped in your chair watching TV feeling unwanted and over the hill). We all need meaning and significance in our lives. And close social relations are an intrinsic part of our humanness. For many people, work provides meaning, significance and social relationships.

Try this retirement planning exercise. Draw a large circle and write the names of 10 people inside the circle who you are genuinely close to. Don't include any relatives. They have to love us, and although our connections with our families can be very nurturing, it is friends who help validate us and widen our horizons.

Now cross out any of the 10 names you know through your work, which might eliminate half or more of the people you listed. Thus a cliff retirement can devastate not only your meaning and purpose but your social network as well. Retirees who no longer work at all say their close friends dwindle to an average of about nine people.

As a result of their isolation, people who opt for a cliff retirement often deteriorate quickly and die relatively young. Financial planning is easy when you die young, but we don't recommend it. Here are some suggestions to consider as you approach what is traditionally considered retirement age.

Consider postponing retirement. Delaying retirement until age 70 increases your Social Security benefits and also shortens the time you will be withdrawing from your portfolio. It gives you additional years to save and your portfolio more time to grow. By delaying retirement from 65 to age 70, you may have more than a 50% higher standard of living when you do stop working.

Or instead of taking a cliff retirement, think about retiring gradually. Move from full time to 30 hours a week, and then to half time. With this less hasty transition you can maintain contact with the people and purposes that give your life meaning and also have the time to develop goals and a network of relationships for your later years.

Envision your final years not as retirement but as financial independence. Now that you don't need to work exclusively for money, make a list of activities where you would like to focus your energies and use your skills and experience.

Consider developing a health and fitness routine. If work kept your mind and body engaged, you will need to replace that activity with other pursuits. Again, going part time allows you the luxury of processing the transition and adjusting to a new lifestyle.

Challenge and reexamine those stereotyped and overly rigid assumptions about retirement. Two books that may help you tailor your retirement to be a productive and satisfying time of your life are "Encore: Finding Work That Matters in the Second Half of Life" by Marc Freedman and "The New Retirementality: Planning Your Life and Living Your Dreams at Any Age You Want" by Mitch Anthony.

Of course crunching the financial numbers is critical as you begin to contemplate retirement. But your personal calling, support network and health and well-being are just as important. In the end, a holistic approach to your life is always the best starting place.

We offer just such an approach every year through the Osher Life Long Learning Institute at the University of Virginia. Beth Nedelisky and I are teaching the workshop "Planning for Success and Significance in Retirement." The course, intended for people age 50 to 70, covers cash flow projections and asset allocation as well as meaning of life issues. The three-week course begins Thursday, March 10, from 11 a.m. to 12:30 p.m. at Meadows Presbyterian Church. You may register online (virginia.edu/olliuva) or at the first class.

from http://www.emarotta.com/article.php?ID=442