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Frank Talk - 3rd Quarter Newsletter (2014)

Published: 08/01/2014

Table of Contents


Written by: Frank Fantozzi

As we close in on the “dog days” of summer, life at Planned Financial Services (PFS) is anything but sleepy or dull. From the Fed’s plans to end six years of economic stimulus, to an “economic expansion” of our own—we’ve got plenty of exciting news to share.

Clients and Business Leaders Embrace Sixth Annual Economic Summit

I want to begin by thanking all who attended our Sixth Annual Cleveland Economic Summit on June 10th at Cleveland’s Windows on The River. More than 90+ esteemed business leaders, corporate executives, clients and esteemed guests gathered to gain insight from industry experts on the local and national economic climate and the rapidly changing oil and gas industry. Speakers for the 2014 event included Jeffrey Kleintop, Chief Market Strategist from LPL Financial; Cuyahoga County Councilman and President and CEO of Jergens, Inc., Jack H. Schron, Jr.; Todd A. Lensman, Co-founder and President of FOFM, LLC, and the founder and Managing Partner of Lensman & Associates, Ltd. law firm.

If you missed our recent email providing a summary and highlights of the Economic Summit, contact Michelle Velotta at 440-740-0130 ext. 221 for an electronic copy.

Firm Growth

We have agreed in principal and signed a Letter of Intent (LOI) to merge a local Cleveland financial planning and investment management practice into our firm on October 1st of this year. The three person all-woman practice features an experienced and independent team of advisors. The merger will further expand our capabilities and depth of experience across all aspects of wealth management, including issues and challenges unique to women investors, executives and entrepreneurs. Watch for our official announcement providing full details of the merger after Labor Day.

New Trading Platform

October will also usher in our enhanced trading platform scheduled to roll out October 1st. The new platform will further streamline our trading capabilities and make it easier to quickly manage investment changes for our clients. The platform will enhance our ability to tactically manage client investments more effectively and seamlessly to take advantage of market trends.

In addition, through Riskalyze software, a professional risk assessment software, we can help clients more accurately measure their risk tolerance through an interactive questionnaire. We can then take their current investment holdings and more accurately measure the risk of any given investment or the entire portfolio to align specific investments with the client’s strategy. Aligning actual portfolio risk with a client’s tolerance for risk enables clients to better stay the course emotionally as markets experience temporary corrections. It helps guard against the number one reason why most people who manage their own money fail: they change or abandon their strategy as market conditions fluctuate.  Riskalyze will help prevent the emotional urge to change direction as markets fluctuate, and help clients to remain on track toward their goals. 

A common worry among investors is that the stock market may fall as the Fed gets closer to hiking rates. But, historically, this has not been the case.

Financial Market Highlights and Outlook

After five-and-a-half years of keeping short-term rates in a range of 0–0.25%, many market participants believe the Federal Reserve (Fed) is now about 12 months away from hiking interest rates. This may affect markets in the months and quarters ahead as investors begin to brace for a change in policy.

  1. Over the five-and-a-half years since the Fed took the federal funds rate down to a range of 0–0.25% on December 16, 2008, participants in the fed funds futures market have had varying views on when the Fed may begin to raise rates for the first time.
  2. With the participants in the futures market pricing in the first rate hike at 12 months away,  I believe 10-year Treasury yields should be between 2.5% and 3.0%, based on the past five-and-a-half year relationship between them.
  3. The 10-year yield is at the low end of that range now. However, if this relationship persists and the year ends with market participants still thinking the Fed will hike rates in July 2015, the 10-year yield may end this year in a range of 3.0–3.5%. Of course, the markets have been wrong repeatedly over the past five years on how soon the Fed may hike rates. Past performance is no guarantee of future results

Market Outlook

1The potential for a rise in rates may put pressure on the returns from bonds and interest rate sensitive stocks, as has historically been the case in the year before the first rate hike. Looking back at the seven different times the Fed began to  hike rates over the past 35 years, the 10-year Treasury yield rose each time, putting downward pressure on bond prices. Also, the three weakest sectors of the stock market were utilities, financials, and telecommunications services, on average, during the year before rate hikes began.

A common worry among investors is that the stock market may fall as the Fed gets closer to hiking rates. But, historically, this has not been the case. In fact, the S&P 500 posted a gain in the 12 months ahead of the first rate hike from the Fed in every one of those past seven periods and gained 20.7%, on average.

1 Source: Jeffrey Kleintop, Chief Market Strategist LPL Financial, LPL Financial Research, Weekly Market Commentary, “Counting Down the Months”, July 14, 2014.

Moreover, the stock market does not appear to be prepping to deviate from that pattern this time. We expect that while the S&P 500 is unlikely to soar above the pace of gains seen in the past 12 months, the year ahead is likely to see solid gains. Our expectations for the coming months include:

  • S. economic growth may accelerate to about 3% in 2014 after three years of steady, but sluggish, 2% growth.
  • Stock market total returns could likely be in the low double digits 10-15%. This gain is derived from earning 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 from 16 to 16.5.
  • S. stocks were favored in 2013 over international stocks, but the tide is turning and some international exposure is warranted in 2014.
  • Bond market total returns could likely be flat as yields rise with the 10-year Treasury yield ending the year at 3.25-3.75%.
  • Prefer shorter-term and credit-oriented sectors of the bond market. High-yield bonds and bank loans are two sectors that have historically proven resilient and often produced gains during periods of rising interest rates.
  • Emerging Market Debt (EMD) is another way to add higher income-generating bonds to portfolios. In general, EMD issuers have lower debt burdens and stronger economic growth than their developed market peers. Developed international bond markets are less attractive.

There is no doubt that 2014 has been an exceptional year for our team and our clients at Planned Financial Services. We look forward to the months ahead as we guide you through the ever-changing economic and financial markets; expand our professional team to further enhance the level of experience, insight and service we bring to you; increase our trading and risk assessment capabilities; and continue to celebrate, nurture and grow the relationships we have created over the last 20 years.

Thank you for the trust you have placed in your team at Planned Financial Services to help you pursue the Return on Life® you desire.


Frank Fantozzi, President

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A Primer on the Timing of RMDs

Written by: Sarah Horrigan

Planning for retirement is an important aspect of your overall wealth plan. And a key aspect of any retirement plan is knowing when to begin taking required minimum distributions (RMDs) from your employer-sponsored defined contribution plans and traditional IRAs.

You can begin taking penalty-free retirement plan distributions when you turn 59½. If you’re fortunate enough to have other income to fund your lifestyle and don’t need to tap your retirement funds at that age, you can forgo taking a distribution until you turn 70½. However, beware that, if you don’t begin taking RMDs at 70½, the tax consequences are severe: The penalty on any shortfall — that is, the difference between what you should have taken and what you actually took — is 50%.

Specifically, you must take your initial distribution by April 1 of the year after you turn 70½. However, you can take it during the year in which you actually turn 70½. Waiting until the following year to take your initial distribution may have negative ramifications. Why? Because you’ll be required to take two taxable distributions within the same year, and you may end up in a higher tax bracket.

Following your initial RMD, the IRS requires you to take subsequent ones by the end of each calendar year. If you’d like to spread out the distribution throughout the calendar year, you may take installments, so long as the total of the installments equals or exceeds the RMD.

You’re free to make withdrawals in excess of your RMD. This will reduce the balance used to calculate your RMD in future years. However, the excess over the RMD you withdraw one year doesn’t count toward your RMD in another year.

So what is the minimum distribution amount you can take from your account each year? To calculate, you divide your balance at the end of the previous tax year by the applicable IRS divisor. Your RMD will vary with the balance in the account, your age and possibly your spouse’s age. Before taking any action, be sure to discuss your options with your tax, legal or accounting advisor.

Floating-Rate Bond Funds Offer an Alternative Yield Source

Written by: Frank Fantozzi

When interest rates rise, bond funds can suffer. If you’re concerned about the potentially negative impact of rising rates on your portfolio, certain fixed-income investment strategies may help you manage the risk.

Floating-rate bond funds — also known as bank loan funds or senior loan funds — are one option to consider. These funds invest in floating-rate bank loans, which are short-term debt instruments with a variable interest rate. In fact, a floating-rate bank loan’s variable rate provides one of a floating-rate fund’s most attractive benefits: reduced interest-rate risk. However, these funds carry additional risks that you should carefully consider before investing.

Distinct from traditional bond funds

As their name suggests, floating-rate bond funds are mutual funds or exchange-traded funds (ETFs) that invest in floating-rate loans. Unlike traditional bonds, which have a fixed coupon payment and therefore lose value as higher rates make newer issues relatively more attractive, floating-rate loans pay a variable interest rate that goes up when rates do, and vice versa.

The coupon of a floating-rate loan periodically adjusts at a fixed percentage above a predetermined benchmark rate, usually the London Interbank Offered Rate (LIBOR). Typically, the loans’ rates reset every 30, 60 or 90 days, enabling them to reflect current market rates.

A second defining trait of floating-rate loans is that they’re often issued to companies with lower credit quality — that is, those rated below investment grade — or that are unrated. As with high yield bonds, floating-rate loans offer relatively higher yields in exchange for the higher risk of default — or credit risk.

Unlike high yield bonds, however, floating-rate loans’ credit risk is somewhat mitigated by their designation as senior-secured debt. This means the loans are at the top of the borrowing company’s credit structure, as well as secured by company assets held as collateral. If the company defaults, it’s required to pay back floating-rate loans first, ahead of its obligations to other bondholders and stockholders.

Higher income potential, less interest-rate risk

The unique characteristics of floating-rate loans provide some appealing benefits for investors, including:

Yield potential. As previously mentioned, floating-rate funds seek a high level of current income by taking bigger credit risks. On average, these funds have offered higher yields than certificates of deposit (CDs), money market funds and bond funds of higher credit quality. Accordingly, they can be an attractive source of enhanced income potential.

Buffer against rising interest rates. Because the coupons of floating-rate loans reflect market rates, floating-rate funds have low sensitivity to interest-rate changes. If rates increase, these funds are less likely to decline in value than other types of bond funds.

Diversification. Historically, floating-rate loans have demonstrated low correlations to U.S. Treasuries and investment-grade corporate bonds — that is, they’ve tended to move out of sync with the types of bonds investors most often own. Assuming this trend continues, floating-rate funds may be able to lower the volatility of a core fixed-income portfolio, leading to smoother returns over time.

Consider the trade-offs

Before investing in floating-rate funds, be mindful of their risks. For starters, in exchange for their lower interest-rate risk, floating-rate funds have higher credit risk. When the economy is expanding or credit

conditions are favorable, companies have an easier time repaying their debts, making credit risk more manageable. During more challenging times, however, default rates can increase, which can lead to investment losses.

The floating-rate loan market is also small compared to other credit markets, which can make it less liquid at times and susceptible to declining loan prices. In such conditions, the value of your fund could fall. What’s more, despite their historically low correlations with other asset types, floating-rate funds can see their correlations rise with stocks and other riskier asset types during periods of significant market volatility.

Review your income goals

When interest rates are expected to move higher, floating-rate funds tend to garner more attention because of their compelling track record during previous rising rate environments. In the past, the asset class has benefited as its coupons increased along with short-term market rates.

But keep in mind that, just as floating-rate coupons reset upward when market rates are rising, the coupons will decrease when market rates are falling. If your goal is to provide a consistent level of income over an extended period of time, other fixed-income options may better suit your needs. Your advisor can help you assess your comfort level with the risks associated with floating-rate funds and determine whether the benefits these funds can offer may help you achieve your financial goals.

Exemption Portability vs. a Credit Shelter Trust

Written by: Jeremy Bok

One offers simplicity, the other provides additional benefits

A major advantage of current federal tax law is that estate tax exemption “portability” is now permanent. Portability simplifies estate planning by allowing a surviving spouse to use the deceased spouse’s unused portion of the $5.34 million (for 2014) gift and estate tax exemption amount.

This means that married couples can maximize the benefits of their combined exemptions without the need for sophisticated estate planning involving multiple trusts. However, for many people, particularly the affluent, more-sophisticated strategies — such as a credit shelter trust — might still be more beneficial.

How does portability work?

If one spouse dies and his or her estate tax exemption isn’t entirely used at death, the estate can permit the surviving spouse to use the deceased spouse’s remaining exemption. The surviving spouse can use that amount, in addition to his or her own exemption, to make tax-free transfers during lifetime or at death.

But portability isn’t as simple as it may first appear. For one thing, portability isn’t automatic. The executor of the deceased spouse’s estate must make an election on a timely filed estate tax return — even if a return wouldn’t otherwise be required. Another issue is that special rules apply to surviving spouses who are predeceased by more than one spouse.

Also, if your estate plan includes bequests to grandchildren, keep in mind that the generation-skipping transfer tax exemption isn’t covered by the portability provision.

Benefits of a credit shelter trust

While portability has its share of complexities, it’s still simpler than a credit shelter trust (sometimes referred to as a “bypass” trust). Nevertheless, creating such a trust can be a better alternative. Why? Because a credit shelter trust offers a major advantage over portability: It can protect future appreciation on the trust’s assets from estate taxes.

If you and your spouse have estates that exceed the combined exemption amount threshold (currently $10.68 million) or may do so at some point in the future, a credit shelter trust remains the most effective strategy for minimizing estate taxes.

When assets are placed in a credit shelter trust on the first spouse’s death, their value is frozen for estate tax purposes. This means that any future appreciation on those assets bypasses your surviving spouse’s estate. But if you rely on portability, future appreciation will be included in your spouse’s estate. This could trigger significant estate tax liability.

Even if you and your spouse’s combined estate is unlikely to ever exceed your combined exemption, however, trust planning offers such important benefits as:

Asset protection. Portability allows you to leave your wealth to your spouse outright without wasting your estate tax exemption. But it does nothing to protect those assets from your spouse’s creditors or financial mismanagement. Well-designed and managed trusts remain the most effective way to protect your assets and preserve them for future generations.

Remarriage protection. Trust planning ensures that your children are provided for, even if your spouse remarries. A credit shelter trust can prevent your spouse from spending your children’s inheritance on his or her new spouse or on children from the subsequent marriage. It also avoids the potential loss of portability benefits in the event your spouse’s new spouse dies. Portability is available only for a person’s most recently deceased spouse. If your spouse remarries and his or her new spouse dies, portability will be limited to the new spouse’s unused exemption — which could be little or nothing.

Generation-skipping transfer (GST) tax planning. The GST tax exemption ($5.34 million this year) is not portable. So if you and your spouse wish to maximize your GST exemptions for bequests to your grandchildren, you’ll have another reason to consider trusts.

Also keep in mind state estate tax planning. Unless your state’s law recognizes portability for estate tax purposes, you may need to use trust planning to preserve your state exemption amounts.

Plan carefully

Portability has the benefit of simplicity, but before you rely on it, review your situation and consider whether you’d be better off with a credit shelter trust. If you decide to rely on portability, keep in mind that it’s not automatic. A surviving spouse can take advantage of portability only if the deceased spouse’s executor makes an election on a timely filed estate tax return.

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