Frank Talk - 2nd Quarter Newsletter (2014)
Table of Contents
I want to open by thanking you for your warm thoughts and well wishes following our New Year’s Letter where we announced that 2014 marks our 20th anniversary as a successful financial planning and investment management firm. We are truly touched by the number of clients, friends and business partners who have reached out to congratulate us and wish us well. Our success is a direct result of the trust you have placed in us.
Join Us for the Sixth Annual Cleveland Economic Summit
We know that our commitment to providing independent advice, objective guidance and unbiased research is an important part of earning and maintaining your trust. That’s why we launched the Planned Financial Services Annual Cleveland Economic Summit six years ago as a platform for bringing multiple perspectives and insight on the financial markets, economy and political landscape to our clients, friends and members of the local business community. Each year we have seen exponential growth in attendance, and have enjoyed welcoming both new and repeat attendees to this popular event.
Once again we are pleased to extend an invitation to join us for our Sixth Annual Cleveland Economic Summit and luncheon on June 10, 2014 at Windows on the River in Cleveland, Ohio. There is no cost to attend this event and we invite you to bring a friend or business associate. Visit us at www.facebook.com/PlannedFinancialServices to learn more. Call Michelle Velotta at 440-740-0130 ext. 221 or email: Michelle@PlannedFinancial.com to RSVP. Space is limited so we ask that you RSVP by June 2, 2014.
PFS Awarded 6th NEO Success Award
In March, we were invited to attend The NEO Success Award luncheon as a six-time recipient of the coveted award (2006, 2008, 2009, 2012, 2013, and 2014). The NEO Success Award is unique in its combined measurement of business success in sales, growth and profitability. It showcases the success of businesses in the region annually by recognizing the top-performing companies in Northeast Ohio. Winners reflect the region’s determination to expand and revitalize its economic status.
Meet Our Newest Team Member
Our firm’s growth and expansion is a welcome result of continually challenging ourselves to enhance the best-in-class, personalized service we provide to all of our clients. In January, we had the pleasure of welcoming Lauren Jirousek to the PFS Team as Administrative Manager focusing on day-to-day operations and ensuring the support systems are in place to provide the best possible service to our clients.
Lauren joins us following a successful 23-year career in the energy industry where she gained valuable experience in the areas of Human Resources, operations, organizational development and information technology. She also managed the utility scenario for a major railroad and has supported new systems technology at one of the world’s leading healthcare providers. She has both undergraduate and graduate degrees in Business with a focus on Industrial Relations, and is a Notary Public for the state of Ohio. Lauren is a native of Brecksville, Ohio where she lives with her husband and their two children.
Frank Fantozzi Featured in Crain’s Finance
I had an opportunity to have an article published in the special Finance edition of Crain’s Cleveland in March. My article, Market Might Be Better Than You Think, debunks broadly circulated rumors regarding a correlation between recent stock market activity and historical activity leading up the Crash of 1929. It discusses how and why we believe this purported “apples to apples” scenario is not only highly unlikely but more of an “apples to broccoli” than even an “apples to oranges” comparison. Our Outlook for the markets throughout 2014 continues to be positive as outlined below.
Financial Market Highlights and Outlook
As 2014 began, the foundation was in place for better economic growth as the drags on the U.S. economy in 2013 were poised to reverse. But Mother Nature had other ideas, and severe winter weather caused significant disruptions to the U.S. economy. However, signs have emerged in recent weeks that the economy has made some progress underneath all that snow and ice. Underlying fundamentals in the labor market suggest that the job market may be thawing, and businesses are beginning to invest more in future growth through capital spending.
- The stock market, much like the U.S. economy, got off to a bit of a slow start in 2014 after a booming 2013. Still, the S&P 500 Index’s 1.8% first quarter return marked the fifth straight positive quarter for the broad market index and extended the current bull market into its sixth year. Stocks did suffer a pullback of just over 5% during the quarter because the widely anticipated pickup in economic growth failed to materialize. Emerging market concerns also contributed to stock market volatility.
- The stabilization that began late last year in the commodities markets carried through to the start of 2014. The Dow Jones-UBS Commodity Index produced a strong 7.0% gain during the first quarter, reversing much of last year’s decline. The biggest contributor to the gain in the asset class was agriculture, as droughts in the United States and Brazil contributed to sharply higher grain prices.
- The Barclays Aggregate Bond Index finished the first quarter with a positive 1.8% total return, equal to that of the S&P 500 Index after reinvestment of dividends, after the second-worst loss in the 40-year history of the index in 2013. Bond prices rose across the board, and yields fell, with the 10-year Treasury yield closing the first quarter 0.3% lower near 2.7%. Credit paced gains in the bond market though all segments participated.
Our research calls for better economic growth, which we see leading to stock market total returns likely in the low double digits (10–15%), derived from earnings per share for S&P 500 companies growing 5–10% and a rise in the price-to-earnings ratio (PE) of about half a point. That better growth may lead to rising yields and flat bond market total returns, with the 10-year Treasury yield likely ending the year at 3.25–3.75%. (Derived from the expectation for a 1% acceleration in U.S. GDP based on many of the drags of 2013 fading.) The primary risk to this outlook is that better economic growth does not develop.
As we close the books on the first quarter of 2014 that saw gains for stocks, bonds, and commodities, we are mindful that the U.S. economy is struggling to emerge from the winter’s deep freeze and that better growth has not yet materialized. Against this backdrop, we continue to seek out attractive investment opportunities, while remaining watchful for risks.
You can depend on your team at Planned Financial Services to provide ideas to help you address personal, financial, and social goals through individual meetings, letters, and electronic communications throughout the year. We thank you for your business and for the trust you place in our team to help you pursue the Return on Life® you desire.
Frank Fantozzi, President
CPA, MT, PFS, CDFA, AIF
Planned Financial Services
Registered Investment Advisor
P.S. Remember to call Michelle Velotta at 440.740.0130 ext. 221 or email: Michelle@PlannedFinancial.com to RSVP for our Sixth Annual Cleveland Economic Summit by June 2, 2014 to secure your place at the table!
Making the Best of Capital Loss
Depending on whether you have a “glass half empty” or “glass half full” mindset, you might consider incurring a capital loss to be an unfortunate part of investing or an opportunity to lower tax liability and reposition your portfolio, respectively. While no investor wishes to experience a capital loss, being able to save some taxes can ease the sting.
On the bright side
A capital loss occurs when you sell a security for less than your “basis,” generally the original purchase price. You can use capital losses to offset any capital gains you realize in that same tax year, even if one is short term and the other is long term.
When your capital losses exceed your capital gains, you can use up to $3,000 of the excess to offset wages, interest and other ordinary income ($1,500 for married people filing separately) and carry the remainder forward to future years until it’s used up. Alternatively, you can forgo offsetting any of the excess losses against ordinary income in the current year and instead carry forward the entire amount.
In with the new, out with the old
Years ago, investors realized it was often beneficial to sell a security to recognize a capital loss for a given tax year and then — if they still liked the security’s prospects — buy it back immediately. To counter this strategy, Congress imposed the wash sale rule, which disallows losses in situations where an investor sells a security and then buys the same or a “substantially identical” security within 30 days of the sale, before or after.
Waiting 30 days to repurchase a security you’ve sold might be fine in some situations, but there may be times when you’d rather not be forced to sit on the sidelines for a month. Likewise, you might hesitate to double up on a position in which you have a loss and then wait 31 days to sell the original stake — a strategy that also avoids a wash sale violation because the purchase occurs more than 30 days before the sale.
Fortunately, there may be another alternative. With a little research, you might be able to identify a security you like just as well as, or better than, the old one. Let’s assume you own stock in a networking equipment company that has lost value since you purchased it. After researching the industry, you discover that the company’s chief competitor is more attractively valued and has better growth prospects.
Your solution is now simple and straightforward — you simultaneously sell the stock you own at a loss and buy the competitor’s stock, thereby avoiding violation of the “same or substantially identical” provision of the wash sale rule. In the process, you’ve added to your portfolio a stock you believe has more potential or less risk.
The same strategy can be applied to mutual funds. In that case, your financial advisor can help you identify a mutual fund or exchange-traded fund with a similar investment sector, strategy and size.
If you purchased shares of a security at different times, give some thought to which lot can be sold most advantageously. The IRS allows investors to choose among several methods of designating lots when selling securities, and those methods sometimes produce radically different results.
If you’re buying mutual funds, it pays to know when the next capital gains distribution will occur and how large it will be. If the distribution is sufficiently large and the date is imminent (they often occur in December), you might want to delay your purchase to avoid incurring a sizable tax liability. At the same time, bear in mind that prior dividends paid and reinvested in mutual funds you own were taxed, and therefore increase your tax basis in the fund.
Seek professional advice
Given the volatile financial markets of the past few years, investors know that sometimes they must sell securities that are worth less than when they purchased them. If you incur a capital loss, discuss with your financial advisor your options to use it to reduce your taxes and reposition your portfolio. Your advisor can help determine if the tax strategies discussed make sense for you.
For Income-Seekers, Municipal Bonds May Be Worth a Look
Municipal bonds (often referred to as “munis”) can be attractive to income-seeking investors because they provide an income stream exempt from federal and, in certain cases, state and local income taxes. Like other fixed-income investments, munis involve risk. But as part of a broadly diversified portfolio, they can offer you an effective way to increase your after-tax earnings.
Invest in state and local projects
Municipal bonds are debt securities issued by state and local governments — or entities on their behalf — to generate funds for various public needs. Examples include toll roads, schools and hospitals, as well as general use bonds of cities, counties and states.
For investors, the main selling point of munis is that their income is exempt from federal income taxes. What’s more, if you live in the state in which the bonds are issued — or if you buy bonds issued by U.S. territories, such as Puerto Rico or Guam — the securities’ interest payments may also be exempt from state and local taxes. One federal exception is that not all municipal bond income is exempt from the alternative minimum tax.
Beneficial for affluent investors
Municipal bonds may be appropriate for investors looking to manage their tax exposure and traditionally have been of greatest use for upper-income taxpayers. In general, the higher your combined federal, state and local income tax rate, the more valuable munis become. (See the sidebar “Comparing apples to apples.”)
Consider that the top federal income tax rate is 39.6% and high-net-worth individuals face an additional 3.8% Medicare tax on net investment income. The bite is even greater for residents of high-tax states. In California, for example, the top state tax bracket is now 13.3%, meaning that, for every dollar earned over $1 million, you’d potentially face a combined income tax rate of more than 55%.
Consider the risks
As with any fixed-income product, municipal bonds are vulnerable to rising interest rates. Investors saw this first hand in the spring and summer of 2013, when munis across the board experienced big price declines. However, these recent declines followed several years of gains thanks to historically low interest rates.
Municipal bonds also face credit risk — the risk that a bond issuer won’t be able to repay its debts. Even the mere idea of a default can cause bond prices to drop. Last year, widely publicized credit problems, such as Detroit’s bankruptcy filing and Puerto Rico’s credit rating downgrade, weighed on nearly the entire municipal bond market. Even securities that seemed highly creditworthy lost value, because investors were worried about the potential for additional bad news.
Although credit risk is a real challenge — especially when dealing with lower-rated municipal bonds — it’s worth noting that munis have historically defaulted much less than comparable corporate bonds. According to credit rating agency Moody’s Investor Service, just 0.13% of municipal bond issuers defaulted on their debt between 1970 and 2012, compared to 11.17% of corporate bond issuers. And for bonds rated Aaa and Aa — the top two credit ratings — just 0.01% of municipal bond issuers defaulted during that time, compared to 1.34% of similarly rated corporate bonds.
This doesn’t mean that corporate bonds are necessarily a worse investment. Many corporate bonds offer higher yields as compensation for the increased default potential and higher taxes. But it does suggest that the credit challenges faced by a few states and municipalities in recent years aren’t necessarily representative of the risks involved with tax-exempt debt.
Individual bonds vs. mutual funds
Even though you can buy individual bonds directly from municipal issuers, most investors find it more efficient to gain exposure to this asset class through mutual funds. The latter provide a few significant advantages — for example, they’re more liquid and
Generally provide better diversification than most investors can achieve on their own buying individual bonds.
Your financial advisor can be a valuable resource as you determine whether municipal bonds make sense for your situation and, if so, how best to incorporate them into your portfolio.
Sidebar: Comparing apples to apples
Because they’re tax-free, municipal bonds generally offer lower yields than comparable taxable bonds. That said, when you consider how taxes affect municipal vs. taxable bonds, you may find that municipal bonds provide the better deal. To compare taxable and tax-free bonds, calculate the latter’s tax-equivalent, or before-tax, yield by dividing the tax-free yield by 1 minus your tax rate. For example, let’s say your municipal bond fund has a tax-exempt yield of 4%, and you’re comparing it to a taxable fund yielding 5.75%. If you’re in the top federal tax bracket of 39.6%, you’d have a before-tax yield of 6.62% — well above the 5.75% provided by the taxable fund. (Bear in mind that this doesn’t consider state and local taxes or the 3.8% net investment income tax.)
But what if you’re in the 25% federal tax bracket? In this case, your tax-equivalent yield would be 5.33%, making taxable bonds your more attractive option.
The takeaway? Your tax rate matters significantly when you decide whether tax-free investments make sense for you.
Is College Right Around the Corner?
How to Prepare Your Finances for Big Expenses
If your children are teenagers, you’ll likely be facing big college bills in the near future. If you’ve been diligently saving for these costs over the years, you may be in the enviable position of being able to maintain your lifestyle while writing tuition checks.
But what if you aren’t so prepared? After all, when you consider tuition, room and board, travel, and other expenses, even affluent families can start to feel the pinch. Although there’s no substitute for a head start on college savings, there are several options to consider when it comes to meeting college costs head on.
Research scholarship opportunities
The best way to pay for college is with someone else’s money. Whether for academic success, athletic ability or community service, every dollar your child receives in scholarships is a dollar you won’t have to pay out of pocket.
Of course, receiving scholarships requires not only significant achievement — that’s up to your child — but also significant research time and effort. The good news is that millions of dollars’ worth of private scholarship funds are available. Your child’s school may provide assistance, and online search tools such as Fastweb.com can help match your child to other appropriate scholarships.
Save taxes where you can
Implementing tax-saving strategies can help you accomplish some of your college funding goals. If you’re self-employed, for example, consider hiring your child part time. It’s a win-win-win situation — you can deduct your child’s wages (lowering your taxable income), get help with your business needs and provide some spending money for college.
Another option is to make annual gifts to your children. You can gift up to $14,000 per year per child ($28,000 for married couples splitting gifts) free of gift taxes and without tapping your lifetime exemption. With this strategy, you can reduce your taxable income as well as your taxable estate. But think twice about this strategy if your child is hoping to qualify for financial aid, because children’s assets are more heavily weighted in colleges’ financial aid decisions.
Adjust your portfolio
As your child approaches college age, it’s generally prudent to shift a portion of your portfolio into conservative investments that tend to retain more of their value. That way, an unexpected shift in market conditions will be less likely to pose a major financial challenge to you at just the wrong time.
If you’re fortunate enough to have greater-than-average financial flexibility, you may be able to handle the risk of an equity-heavy portfolio for longer. This strategy allows your assets additional time to grow tax-free — assuming your savings are held in a tax-advantaged vehicle, such as a 529 plan, albeit at some additional risk. Ask your financial advisor about this strategy.
With college expenses looming, it’s easy to lose sight of the need to save for retirement. As you consider how to balance these two important objectives, keep this in mind: While your child may have access to private or public student loans, no one will step in later to cover your retirement expenses.
No time like the present
Even if you haven’t been disciplined about saving for your children’s college education costs, it’s never too late. Because college attendance generally takes place over four or more years, you can continue to address your financial needs even after your children have started their education. The most important thing is to get started, saving what you can, as soon as you can.
The opinions voiced in this material are for general information only and are not intended to provide or be construed as providing specific investment advice or recommendations for any individual security. To determine which investments may be appropriate for you, consult your financial advisor prior to investing. All indexes mentioned are unmanaged and cannot be invested into directly.
The economic forecasts set forth in the presentation may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Barclays U.S. Aggregate Bond Index is an index of the U.S. investment-grade fixed-rate bond market, including both government and corporate bonds.
The Dow Jones-UBS Commodity Index is a broadly diversified index composed of futures contracts on physical commodities.
Stock investing involves risk including loss of principal.
Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values and yields will decline as interest rates rise and bonds are subject to availability and change in price.
Municipal bonds are subject to availability and change in price. They are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise. Interest income may be subject to the alternative minimum tax. Municipal bonds are federally tax-free but other state and local taxes may apply.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
All examples are hypothetical and not intended to predict or project the performance of any specific investment. Actual results will vary. Investments in equities have been volatile historically. Investments in fixed income securities fluctuate in value in response to changes in interest rates.
A portion of this material was prepared by LPL Financial and PDI Global. PDI Global is a separate entity from LPL Financial and Planned Financial Services.
Securities offered through LPL Financial, Member FINRA/SIPC.