Fund a Teenager's Million-Dollar Retirement

We teach teenagers a lot more about sexuality than we do about money. This can confuse them about what they should be learning. Give this article to a teenager and encourage him or her to start a Roth IRA.

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Squirrel Away Money While You Can

Franco Modigliani won the Nobel Prize for a simple technique that squirrels know intuitively from birth. You have to squirrel away some nuts during times of plenty so you can survive during times of scarcity.

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Are Investment Management Fees Tax Deductible?

I often get asked, "Are investment management fees tax deductible?" The answer is not a simple "yes" or "no." Like many tax questions, the answer is "It depends."

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Emerging Market Bond Funds

Emerging market bonds are an attractive way to get a higher yield, but historically they have come with higher volatility and a high incidence of default. But that has been changing.

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How Does Marital Status Affect Your Federal Taxes

Laws have always regulated who may marry, the obligations related to marriage and children and whether and how a marriage can be ended. Governments have always put their own social agenda above the pluralism of personal choice.

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Marotta's 2012 Gone-Fishing Portfolio

A gone-fishing portfolio has a limited number of investments with a balanced asset allocation that should do well with dampened volatility. Its primary appeal is simplicity. As a secondary virtue, it avoids the worst mistakes of the financial services industry.

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Using Dynamic Asset Allocation to Boost Returns

Think of static asset allocation as where to set your sails and dynamic asset allocation as a way to keep your balance as your boat glides and sometimes bounces through the waves.

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The Shiller Ten-Year P/E Ratio

What we would really like to measure are the changes in price (P) that cause a company with a good long-term track record to look relatively cheap. Economist Robert Shiller created just such a measurement.

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Style Boxes and the Efficient Frontier

The Marotta allocation method is a proportionally weighted allocation based on the square of each Sharpe ratio. Squaring the Sharpe ratio drastically reduces asset categories in proportion to their distance from the efficient frontier.

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Asset Allocation and the Efficient Frontier

Crafting portfolio asset allocations is a combination of art and engineering. Just as a blending of colors can produce cerulean, so a blending of indexes produces a unique shade of risk and return.

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The Efficient Frontier

The efficient frontier measures all investments on a scale of risk and return. Risk is commonly placed on the x-axis, and return is placed on the y-axis.

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Value: The Third Factor of Investing

A stock's valuation is measured on a continuum from "value" to "growth" In broad strokes, value stocks are cheap and growth stocks are expensive.

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Size: The Second Factor of Investing

The second factor of investing is size as measured by a stock's total capitalization. Over time small cap will outperform large cap even after factoring out measurements of volatility.

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CAPM: The First Factor of Investing

Modeling investment returns seeks to find an equation to predict your expected returns as much as possible. The simplest equation for the markets would be "Return equals 11.71%." This has been the average return from 1927 through 2010, the zero factor model.

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David John. Marotta CFP®, AIF®, is President of Marotta Wealth Management, Inc. of Charlottesville providing fee-only financial planning and wealth management at www.emarotta.com. Subscribe to "Money Advice," our free weekly email newsletter, at www.emarotta.com/newsletter-sign-up. Questions to be answered in the column should be sent to questions at emarotta dot com or Marotta Wealth Management, Inc., One Village Green Circle, Suite 100, Charlottesville, VA 22903.

To continue to view our weekly posts, visit us at www.marottaonmoney.com/continue-to-avoid-the-ring-of-fire-countries/

Continue to Avoid the 'Ring of Fire' Countries

by David John Marotta

Americans seem to be divided on the importance of raising the U.S. debt ceiling. Regardless of your personal politics, avoid investing in countries that cavalierly allow their debt and deficit to balloon.

A year ago I wrote the column "Avoid the 'Ring-of-Fire' Countries" that suggested readers should underweight investments in countries with a high debt and deficit and low economic freedom. That recommendation has proven brilliant. Given the dangers of worldwide sovereign debt, this may be one time when investors should continue to tilt foreign and toward specific countries.

Bill Gross, cofounder of the Pacific Investment Management Company (PIMCO) and the country's most prominent bond expert, coined the term “ring of fire” to highlight the dangers associated with countries with high debt and deficit. The eight countries he identified were Japan, Italy, Greece, France, the United States, the United Kingdom, Ireland and Spain.

Last year we forecast that U.S. "GDP [gross domestic product] growth, which has historically averaged 6.5%, is liable to slow to a more European rate of 3 to 4%. Official unemployment numbers will lower but only as people drop out and are no longer counted. Real unemployment is likely to remain high for some time."

Our predictions were accurate. GDP growth is at a sluggish pace of 1.8%, and even officially, unemployment remains at 8.7%.

We also suggested "lightening up on foreign investments that primarily just follow the MSCI EAFE index." EAFE stands for Europe, Australasia and the Far East. It represents all the developed countries outside of the United States and Canada. This includes large investments in all seven of the non-U.S. ring-of-fire countries. The EAFE consists of 22% Japan, 21% United Kingdom, 10% France, 4% Spain, 3% Italy and 1% Ireland and Greece. In total, 61% of the EAFE index is invested in ring-of-fire countries.

But before you stop investing in foreign stocks altogether, remember that 100% of domestic stocks are invested in the eighth ring-of-fire country, the United States. As I wrote a year ago, "Going forward may be one of the times when a strong tilt toward specific foreign countries may provide superior long-term returns."

This past year was a dynamite period for the markets. The MSCI Net EAFE return through the end of last month was 30.7%. The seven countries in Bill Gross's ring of fire, however, averaged only 17.9%. When weighted according to their share of the EAFE index, they performed a slightly better 21.7%, pulled up by the United Kingdom and France.

Underperforming the EAFE index by a weighted average of 9% is a poor return comparison against the benchmark. The United States, now well in the ring of fire, earned 24.2% by comparison.

I advised investing more in emerging markets. They returned 28.8%, beating the United States and the ring-of-fire countries.

I also recommended emphasizing countries with economic freedom such as Hong Kong, Singapore, Australia, Switzerland and Canada. These five countries beat the EAFE index, averaging 31.7%.

And I suggested overweighting mostly free countries with lower debt such as Denmark, The Netherlands, Finland, Sweden, Austria, Germany or even Norway. These seven countries did the best, averaging 35.9%.

Investing in countries with economic freedom continues to provide gains since I first mentioned it in a column in 2004. Underweighting countries with high debt and deficit is another important screen.

Last week I wrote about the advantages of a gone-fishing portfolio. My biggest worry with such a portfolio is that for simplicity's sake it invests heavily in the EAFE index. But the global sovereign debt crisis will likely continue for another decade and drag the returns of many countries.

My first adjustment to a gone-fishing portfolio would be to replace much of the EAFE index with countries with higher economic freedom and a lower debt and deficit. Such a change adds a great deal of complexity, but the additional returns are probably worth the headache of more holdings. These countries should outperform their debt-laden counterparts.

As Gross ended his newsletter over a year ago, "Beware the ring of fire!"

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Marotta Wealth Management, Inc. of Charlottesville provides fee-only financial planning and asset management. Visit www.emarotta.com for more information. Questions to be answered in the column should be sent to Marotta Wealth Management, Inc., One Village Green Circle, Suite 100, Charlottesville, VA 22903-4619.

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from http://www.emarotta.com/article.php?ID=457

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