Increasing Your Return on Life.®

Frank Talk - 4th Quarter Newsletter (2014)

Published: 11/01/2014

Table of Contents

Editorial

Written by: Frank Fantozzi

This has been quite an eventful year for our clients and team at Planned Financial Services (PFS). We began the year celebrating our 20th Anniversary as a successful wealth management firm and will end the year as an even stronger team, providing enhanced capabilities as a result of welcoming the Plax & Associates Financial Services team to the PFS family in October 2014.

This year also provided an opportunity to spend time with many of you outside of our office. In June, we hosted our Sixth Annual Cleveland Economic Summit at Cleveland’s Windows on The River where many of you gathered to gain insight from industry experts on the local and national economic climate and the rapidly changing oil and gas industry. We look forward to hosting our Seventh Annual Economic Summit in spring 2015 and will communicate the date for this event early in the New Year.

In September, we were honored to host our clients and friends for an evening of fun and entertainment at the English Oak Room at Tower City Center for our 20th Anniversary gala.

This was a tremendously enjoyable event for our team, and we are honored that so many of you were able to join us in this celebration. We are grateful to have had this opportunity to spend time with and thank our clients and centers of influence who we credit with our growth and success over the past two decades.

October culminated in the expansion of our team as we welcomed Elisabeth Plax, CFP®, her team, and clients to our growing family, as well as ushering in our enhanced trading platform. The new platform further streamlines our investment management capabilities and makes it easier to quickly manage investment changes for our clients. The platform also enhances our ability to tactically manage client investments through Riskalyze software. This industryleading software more accurately measures client risk, and then more accurately measures the risk of any given portfolio to align specific investments with client objectives.

To better help our 401(k) clients using our 401(K) Plus® program we introduced our “K card” which is designed similar to an insurance card. It will help participants understand their plan rules and where to get help with specific questions all conveniently packaged on a colorful plastic card they can keep in their wallet or purse. The feedback has been great.

Financial Market Highlights and Outlook

Market Highlights

While October’s headlines have been monopolized by heightened concerns about Ebola and stock market volatility, we believe we are seeing a return to normalcy as the month winds to a close. The latest stock market pullback provided an unwelcome reminder that stocks do not always go up in a straight line. Even within powerful bull markets such as this one, pullbacks of 5–10% have been quite common and do not mean the bull market is nearing an end. It’s important to put the pullback into perspective to avoid making shortterm or rash decisions that may not be in your best interests over the long term.

Below, we look beyond this latest bout of volatility and share our thoughts on the current bull market, compare it with prior bull markets at this stage, and discuss why we do not think the bull market is coming to an end.

Pullbacks such as this one, which has reached 5%, are not abnormal. Sometimes stocks get ahead of themselves. When they do, investor concerns can be magnified and profit taking might take stocks down more than might be justified by the fundamental news. We see this latest pullback as normal within the context of an ongoing and powerful bull market and do not see its causes (European and Chinese growth concerns, the rise of Islamic State militants, Ebola, the Russia-Ukraine conflict, etc.) as justifying something much bigger.

Pullbacks Don’t Mean the End of the Bull Market

The S&P 500 has now experienced 19 pullbacks during this 5 ½ yearold bull market, during which the index has risen by 182% (cumulative return of 217% including dividends). The 1990s bull market included 13 pullbacks, and there were 12 during the 2002–2007 bull market. At an average of three to four pullbacks per year, we are in-line with historic averages since World War II.

To us, this looks pretty normal. Yet, we understand why it can be unsettling to many investors. When volatility has been so low for so long, normal volatility no longer feels normal. Investors have become unaccustomed to what we would characterize as normal volatility.

Understanding Volatility

While most of the 5% drop came in a short period of time during the week of October 6-10, the level of volatility experienced that week is not at all uncommon within an ongoing economic expansion and bull market. Volatility tends to pick up as the business cycle passes its midpoint, which we believe it has. Reaching this stage just took longer than many had expected during the current cycle. Also, keep in mind that the 335 drop in the Dow Jones Industrials that we experienced on Thursday, October 9, 2014, is not as dramatic as it once was. That loss was less than 2%, with the Dow near 17,000 when it occurred, compared with 3-4% losses associated with that number of points on the Dow earlier in the recovery.

Market Outlook

These pullbacks do not mean the end of the bull market is near, nor does the fact that we have not had a 10% or more correction since 2011. In fact, most bull markets since World War II included only one correction of 10% or more, and the current bull has already had two (2010 and 2011).

Why This Pullback Is Unlikely to Get Much Worse:

  • The economic backdrop in the United States remains healthy. Gross domestic product (GDP) is growing at above its long-term average, providing support for continued earnings growth; the U.S. labor market has created 2 million jobs over the past year; and the drop in oil prices may support stronger consumer spending.
  • Our favorite leading indicators, including the Conference Board’s Leading Economic Index (LEI), the Institute for Supply Management (ISM) Index, and the yield curve, suggest that the bull market may likely continue into 2015 and beyond, with a recession unlikely on the immediate horizon.
  • The European Central Bank (ECB) is likely to add a dose of monetary stimulus to spark growth in Europe, the source of much of the global growth fears that have driven recent stock market weakness. China stands ready to invigorate its economy as well.
  • Interest rates, and therefore borrowing costs for corporations, remain low. The Federal Reserve (Fed) is in no hurry to raise interest rates.
  • Valuations have become more attractive. Price-to-earnings ratios (PE) have not reached levels that suggest the end of the bull market is forthcoming, based on history. We view PEs, which have fallen about 0.5 points from their recent peak, as reasonable given growing earnings and low interest rates.
  • The S&P 500 is marginally above its 200-day moving average at 1905. Historically, this level has proven to be strong support. Although the index may dip slightly below this level in the near term, we expect the range around that level (1900–1910) to provide strong support for the index again and would not expect it to stay below that range for very long.

We do not believe the volatility seen in recent weeks, which is in-line with historical trends, is an early signal of a recession or bear market. Nor do we think the age of this bull market means it should end, given the favorable economic backdrop, central bank support, and reasonable valuations. Although we will continue to watch our favorite leading indicators for warning signs of something bigger, we think this latest bout of volatility is nothing more than a normal, though unwelcome, interruption within a long-term bull market. We maintain our positive outlook for stocks for the remainder of 2014 and into 2015.

There is no doubt that 2014 has been an exceptional year for our growing team and our clients at Planned Financial Services. As the holiday’s approach, we remain grateful for the trust you have placed in your team at Planned Financial Services to help you pursue the Return on Life® you desire. We wish you and your family all of the joys of the upcoming holiday season and look forward to the year ahead as we continue to guide you through the changing economic and financial markets. As always, it would be our pleasure to provide the same level of caring service and guidance to any family members, friends or colleagues you feel may benefit from our advice and services. We are only a phone call away at 440.740.0130.

Wishing you continued health, happiness and a joyous Holiday Season,

Frank Fantozzi,
President CPA, MT, PFS, CDFA, AIF
Planned Financial Services
Registered Investment Advisor


Term vs. Perm

Written by: Sarah Horrigan

Demystifying life insurance choices

Life insurance can be a vital asset in planning for your family’s financial well being, but determining which type of policy — term or permanent — better suits your situation can be challenging. There’s no one-size-fits-all answer because different products fulfill different needs.

Term: Affordable, but lacks cash value

A term life insurance policy provides basic coverage. You pay premiums for a stated time period, and if you die within that period, the insurance company pays a death benefit to your beneficiaries. The contract is good only for the duration of the payment period, and it builds no cash value. In other words, if the policy expires before you die, you typically don’t receive any cash back.

A term life insurance policy is meant to cover you when your need is the greatest — such as while you have a mortgage to pay or a spouse and young children to support. Because a term policy doesn’t build value and is only in force for a specified period, the premiums generally are lower than those of a permanent policy. However, if the term expires and you want to renew your policy, you likely will face higher premiums because of your increasing age. Depending on your health at that point, you could even have become uninsurable.

Perm: A savings vehicle, but costs more

A permanent life insurance policy protects you for your entire life (assuming you continue to pay the premiums). This coverage could provide you with extra peace of mind if, say, you have a special needs child who won’t ever become financially independent. A permanent policy could also provide your heirs with liquidity to pay taxes on your estate if you expect its value to surpass the estate tax exemption.

The premiums can be considerably higher than those of a comparable term policy. Why? Because a permanent policy apportions part of the money toward a cash value, providing you with a built-in savings vehicle. In addition, premiums will remain level as you age and may even end at a point in time. And the policy will still cover you even if you become uninsurable.

A permanent policy offers tax benefits as well, with the earnings on your cash value accumulating tax-deferred. This may be attractive if you’ve maxed out other tax-advantaged savings vehicles such as 401(k) plans. You can make withdrawals tax-free by taking a “loan” from the policy, although doing so will reduce the net death benefit.

Buy term and invest the difference?

Some argue that you’d be better off buying a term policy and investing any premium savings elsewhere. In theory, by assuming a decent rate of return on your investments, such a strategy can look appealing. But, in reality, it’s rarely that simple.

Here are some of the main questions to consider when deciding which type of insurance policy to buy:

How do you expect to use the life insurance? If you’re a high earner or in a high tax bracket, you may benefit from a permanent policy’s tax savings. Or, as noted, you may need a policy that remains in force no matter how long you live and, regardless of your health, builds cash value for later withdrawal or provides liquidity for your heirs.

How likely are you to invest the difference? Good intentions won’t support your family or help your heirs cover estate taxes. Be realistic about whether you’d actually invest the amount you’re saving by buying term coverage.

How comfortable are you with investment risk? A portion of a permanent policy’s growth is guaranteed by the insurance company, helping you be more confident about reaching the stated goal. A do-it-yourself approach means accepting market risk — the potential for the value of an investment to decline as markets fluctuate.

A wide range of policy options

Beyond the basic concepts of term and permanent, life insurance products come in multiple variations, including hybrid products. Discuss your needs with your financial advisor to find the right combination of benefits for you.


Smoothing the Ups and Downs

Written by: Elisabeth Plax

Help protect your portfolio against market volatility

Financial advisors always warn inexperienced investors of the possibility of stock market volatility, yet when the going gets rough, some react irrationally and begin selling when it isn’t warranted. Seasoned investors use such tools as the Volatility Index (VIX) to better understand risk and follow strategies designed to lessen the effects of volatility on their investment portfolio.

ABCs of the VIX

When the stock market begins to gyrate, inevitably a hot topic of conversation in the financial media is the VIX. The VIX was introduced in 1993 by the Chicago Board Options Exchange (CBOE). According to the CBOE, the VIX “is a key measure of market expectations of near-term volatility conveyed by S&P 500 stock index option prices.” More commonly, it’s referred to as the “investor fear gauge.”

VIX readings below 20 generally indicate a relatively complacent mood among investors, while levels above 30 are associated with heightened fear. In October 2008, soon after the collapse of investment bank Lehman Brothers, the VIX soared to around 80. Although the VIX wasn’t in existence on Black Monday (Oct. 19, 1987), when the U.S. stock market plunged more than 20% in a single day, the CBOE later calculated that volatility spiked to an all-time high of 172.79 on the following day.

Ideally, the VIX would provide advance notice of when the stock market is headed for trouble and when it’s about to stage a recovery. However, there seems to be little consistency to extreme VIX readings. Each market cycle has its own particular dynamics, and perhaps the most you can glean from the VIX is a general sense of investors’ level of anxiety at any given time.

In addition to the VIX, there are two lesser-known indexes that can gauge fear: The Nasdaq Volatility Index (VXN) tracks sentiment based on options on the Nasdaq-100 Index®, and the DJIA Volatility Index (VXD) fulfills a similar function for the Dow Jones Industrial AverageSM.

Strategies to consider

Despite the VIX’s limitations as a predictive tool, you can take steps to help fortify your investment portfolio against volatility. Begin by acknowledging that periodic bouts of extreme volatility will occur. You can’t predict what the market will do in the future. However, you can see what it’s done in the past and use that information to your advantage. How you should react to significant market declines will depend on your risk tolerance, investment time horizon and financial goals.

Your advisor will likely suggest that you diversify your portfolio. Diversification can’t prevent losses or guarantee profits. But spreading your equity investments among various sectors of the market and allocating a portion of your portfolio to fixed income, cash and possibly other asset classes can potentially help mitigate losses when the stock market heads south. Remember, the best time to think about greater diversification is before the market plunges.

Try to avoid market timing. Investors who attempt to time the market may end up boosting their allocations to stocks ahead of market downturns and lightening up near important bottoms — just the opposite of what would be ideal.

Finally, consider dollar-cost averaging. Using this technique, you invest a set dollar amount every week, month or quarter, regardless of how the market is doing. Many people do this by investing the same amount in a 401(k) plan every payroll period. Consequently, you end up buying more shares when prices are low and fewer when prices are high. Again, profits aren’t guaranteed, and you need to consider your ability to continue to invest amid declining prices. But this method gives you a disciplined, steady way to help build your portfolio.

Ride the roller coaster

Risk and volatility are major parts of making investments. Investing in the market, specifically, can feel like a nonstop roller coaster ride. The good news is that you can take steps to help ease the extreme ups and downs. Your advisor can help you assess your situation and implement the best strategies designed to tame volatility.


Keep More of Your Investment Earnings

Written by: Jeremy Bok

An investment’s performance is only as good as its after-tax return. That’s why tax efficiency is important to your overall portfolio strategy.

Two variables affect tax liability

Your tax liability on an investment generally is driven by two variables. The first is the tax treatment. It’s determined by how the investment generates earnings. Common examples are long-term capital gains, qualified dividends, ordinary income (such as interest from bonds or bond funds, and short-term capital gains), tax-free income (think municipal bonds), or tax-deferred income (from investments held in many retirement-savings vehicles, for example).

The second variable is your personal tax situation, which includes your marginal tax rate, as well as specifics related to the investment — for example, its sale price, the adjusted tax basis and any capital gain or loss.

Three tax-savvy portfolio guidelines

Following these three guidelines can help you effectively manage your overall tax burden:

  1. Maximize tax-advantaged retirement accounts. With an employer-sponsored plan such as a traditional 401(k) plan, you make contributions with pretax dollars, automatically lowering your current-year income tax burden. Additionally, your earnings grow tax-deferred, allowing you to sell securities without owing capital gains taxes. Distributions, however, are taxed at ordinary-income rates, not long-term capital gains rates. But, generally, this will be in retirement, when you may be in a lower tax bracket. With a Roth 401(k) plan, contributions are after-tax, but qualified distributions are tax-free.

    Both traditional and Roth IRAs also grow tax-deferred. With a traditional IRA, these earnings, as well as amounts attributable to contributions, are taxed at ordinary-income rates upon withdrawal. However, qualified Roth IRA withdrawals are tax-free.

    Contributions are also treated differently. Traditional IRA contributions may be tax deductible, depending on whether you or your spouse participates in an employer-sponsored retirement plan and your income level. Roth IRA contributions aren’t deductible, and the amount you’re allowed to contribute will be reduced or eliminated if your income exceeds certain levels. Another option is to convert some or all of your traditional IRA to a Roth IRA account. This may prove beneficial if you could be in a similar or higher tax bracket after retirement and you can afford to pay the taxes now, at conversion.
  2. Consider tax-efficient investments. Municipal bonds’ interest income is typically exempt from federal income taxes and, if you live in the state where the bond is issued, sometimes also from state and local taxes. Index funds may be more tax efficient than actively managed mutual funds because an indexing strategy tends to generate lower turnover of securities in the fund.
  3. Consider the tax implications of selling an investment. An investment sold at a gain after it’s been held for at least one year will be subject to the applicable long-term capital gains rate. This may be around 20 percentage points lower than your marginal ordinary-income tax rate, which applies to short-term capital gains. So holding on to an investment for more than one year can significantly increase your after-tax return.

    An investment sold at a loss can be used to offset capital gains elsewhere in your portfolio, reducing your overall tax liability. In addition, you can offset up to $3,000 per year of ordinary income with net losses, as well as carry unused losses forward to future years.

    However, tax-loss selling has some limitations, including the potential for higher taxes later on and a potential loss of value when substituting a new investment to maintain the same risk exposure. Also, be aware that the IRS’s wash sale rule prohibits you from claiming a loss if you buy a “substantially similar” security within 30 days of the sale (before or after).

Balancing tax and investment goals

It’s important to weigh tax ramifications within the broader context of your time horizon and risk tolerance. In some cases, the potential gains from an investment may be worth accepting a larger tax burden. Discuss the appropriate strategy for your situation with your tax and financial advisors.

Sidebar: Crafting a tax-savvy retirement plan withdrawal strategy

Minimizing the tax burden on your retirement distributions helps you keep more of your income and reduce the risk of outliving your money.

Crafting a tax-savvy withdrawal strategy for your situation depends on factors such as the amount of income you’ll receive from pensions and Social Security, the amount you’ve saved in various investment accounts, and your marginal tax bracket at retirement and whether that may shift over time — such as when you begin taking required minimum distributions (RMDs) from 401(k) plans and traditional IRAs. (Roth IRAs aren’t subject to RMDs.)

Because of tax-deferred compounding, it’s generally most tax-efficient to hold off on taking retirement plan distributions until they’re required (generally after age 70½) and then to take only the RMD. But distributions — or larger distributions — in any year when your tax bracket is low (as long as it’s after age 59½) may provide tax savings that outweigh the compounding benefits.


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