Financial Abundance

With the stock market in turmoil and interest rates at all time lows, you might be tempted to purchase a deferred annuity. The deferred annuity sales person will tell you about the tax deferred benefits, the guaranteed return if you were to die and may even provide a product that gives you market related returns when the stock market is up, while guaranteeing that you will not have a loss in value during a down market. If this sounds too good to be true, it probably is.

Since the deferred annuity sales person will be paid a commission as high as 10% on your deferred annuity purchase, let’s take a closer look at what he/she is trying to sell you. Here are some areas that are not always well explained by the deferred annuity sales person.

1) Mortality and Expenses (M&E) Charges – All deferred annuities have M&E charges to pay for the life insurance guarantee, the sales person’s commissions and the administrative expenses of the contract. M&E charges are usually between 1% and 2% of the contract value, paid every year. If your deferred annuity has a value of $100,000, up to $2,000 annually will be used for M&E expenses. Even though you will likely never see these charges, they are being taken from your investment each year.

2) Surrender Charges – Virtually all deferred annuities that are sold through commissioned sales people will carry a surrender charge. Typically, these charges begin at 7% for the first year of the contract and decrease by 1% per year. Seven years after you purchase the contract, you may still have to pay 1% of its total value if you want to cash it in. Sometimes, you are allowed to withdraw up to10% of contract value yearly. However, the surrender charges assure that the insurance company will have your money long enough to pay for the high sales commissions required.

3) Management Fees – If you buy a variable annuity, the subaccounts are very similar to mutual funds. A typical subaccount will have a 1% or higher management fee. This expense is over and above the M&E fees that were previously discussed. While these fees are somewhat consistent with the fees charged for actively managed mutual funds, they are up to 5 times as high as the fees charged for indexed mutual funds and Exchange Traded Funds (ETFs). The subaccount returns will be net of the management fees, but they will not show the M&E fees that are assessed each year.

While it is true that a deferred annuity will be tax deferred until you cash it in or annuitize it, all gains of the deferred annuity will be taxed at your ordinary income rate when you receive your returns. Since the deferred annuity is typically held for 10+ years, this tax advantage may completely disappear when you cash it out.

If you believe that a deferred annuity is right for you, before you buy the product that your sales person is offering, contact Schwab, Fidelity, Vanguard or another discount brokerage house. They will likely have a similar deferred annuity product. Compare M&E expenses, surrender charges and management fees of the non-commissioned product with the one you are being sold. You will likely find that the non-commissioned product provides a better total return than the one that you are being sold.

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Last month we examined how the first step in structuring a safe investment portfolio is to develop a personal investment policy that is consistent with your investment goals and the current investment markets.

When you develop an investment policy, you define the asset classes you will consider for investments as well as the minimum and maximum portfolio percentages which may be allocated to each asset class. The asset classes you chose and their allocation ranges depend upon your age, risk tolerance and your total financial resources.

In the previous article, we considered two of the most common investment classes, equities (stocks) and fixed income (bond) investments. This month we will consider three additional asset classes.

Real Estate – The most common methods of investing in real estate are rental properties or Real Estate Investment Trusts (REITs). Owning rental real estate requires active management of the investment properties. Rental real estate is also illiquid, often requiring several months to sell at an acceptable price. If these two drawbacks are acceptable, the next step is to accurately evaluate the rental property’s total investment return.

With the current high foreclosure rate, you may find well priced rental properties. However, before you purchase, do a thorough financial analysis of your expected investment return. A simple way of doing this is to compare rental real estate “yields” to the yields of fixed income investments.

For rental property, annual “yield” is net income divided by your net property value. Net income is the expected annual rental income less all expenses, including mortgage payments, property taxes, insurance, property management fees and a reasonable property repair allowance. Net property value is the appraised property value less mortgage balances and all costs required to sell the property, such as realtor fees, closing costs, etc. Because of the previously described drawbacks, annual rental property “yield” should always exceed the yields available from fairly safe fixed income investments.

REITs can be excellent investments during economic prosperity. From 2003 – 2006, REITs provided high yields and excellent total returns. Currently, REIT funds, such as the Ishares Cohen and Steer ETF (ICF) are at historic lows. While they yield approximately 10%, REIT prices will likely remain depressed until a sustained economic recovery begins.

When considering real estate, always examine your investment policy. Rental properties can require significant capital investments which could exceed your investment policy guidelines for real estate investments.

Commodities – Commodities are typically too risky to be included in a moderately conservative investment portfolio. However, there are times when a small investment in a specific commodity is prudent. Gold is considered a safe haven investment as well as a hedge against inflation. A small gold investment may prove worthwhile, especially if gold prices retreat. Many experts also believe that oil prices will continue to rise when the worldwide economy stabilizes.

If you wish to invest in commodities, I recommend using Exchange Trades Funds. Gold can be purchased with GLD (SPDR Gold Shares) and oil with USO (United States Oil). Commodity investments are extremely speculative and should not exceed 5%-10% of your investment portfolio.

Cash Investments – Cash investments include saving accounts, money market mutual funds and CDs that mature in one year or less. The principal is safe, but the yield is usually low or even negative, when offset by inflation.

Currently, most money market funds are yielding under 0.5% and 1 year CDs are yielding approximately 1%. With these low yields, only funds that may be required in the next 12-24 months should be kept in cash investments.

The key to investment success is a well-balanced portfolio, reflecting current economic and financial conditions. Until economic conditions improve, a conservative investment approach will likely serve you well.

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Being in the financial services industry, I am often asked for my financial forecast. Since my crystal ball is no better than yours, I never predict what the future may hold. However, by paying attention to macro-economic conditions, we can make informed investment decisions that will likely increase our total returns.

For 2009, there are some financial indicators that should be considered when planning investment strategies. Let’s examine how these indicators can be used to increase investment returns in 2009 and beyond.

When evaluating your investment portfolio, always consider economic and market conditions as part of your portfolio allocation process. In late 2007, seeing that future economic conditions were weak and the stock market was at an all time high, I decided to dramatically lower my clients equity (stock) positions and add a small position in gold. This decision has lead to significantly lower losses for my clients in 2008 than if they had stayed with their normal equity allocations.

In 2009, we know that economic conditions remain very weak and will likely show little improvement in the short term. We also know that the federal government is going to provide a huge economic “stimulus” program that will likely take the 2009 and 2010 budget deficits to a trillion dollars or more. Finally, we know that decreasing housing and oil prices have created a deflationary environment.

With this information, it appears that stocks will have a more negative than positive bias in the next few months. Therefore, I am not adding to my client’s equity holdings at this point. When market volatility decreases and company profits stabilize, I will slowly bring equity positions back to normal allocations.

Even though deflationary pressures will likely remain for a while, the Fed and the Treasury are determined to print as much money as necessary to reduce deflationary pressures. As the economy recovers, the additional dollars in circulation, combined with our exploding federal deficit, will provide an ideal environment for inflation.

If high inflation occurs, Treasury Inflation Protected Securities (TIPS) will be an excellent investment. 10 year TIPS are currently priced to reflect inflation of less than .5% per year, over the next ten years. If inflation exceeds this amount, TIPS will provide both inflation adjusted yields and an increase in price.

Another likely beneficiary of future inflation is gold. Gold can also be considered a “safe haven,” if economic conditions further deteriorate or the dollar weakens.  If you decide to add gold to your investments, keep your gold position to no more than 5% -10% of your portfolio.  As gold will likely fluctuate in price over the next few months, if you are patient, you may be able to buy it when the price of an ounce of gold is in the low $700s. The easiest way to own gold is through the SPDR Gold Shares Exchange Traded Fund (GLD).

There are many investment philosophies to choose from. After trying several different investment approaches over the past 25 years, I have found that following macro economic data can provide good insight on asset allocations and investments. Combining this information with a simple, diversified, index fund based portfolio has provided for excellent investment returns over the past seven years.

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In the story of the birth of Christ, the Magi gave Jesus gold, frankincense and myrrh. As many of us celebrate the Christmas season, perhaps we should consider giving ourselves one of these gifts, the gift of gold.

I have never been a gold enthusiast. However, gold can be both a hedge against inflation as well as a “safe haven,” when the investment markets are in turmoil. Even with declining inflation during the later part of 2008, November CPI was still up 1% over November of 2007. In the short term we could see deflation. However, with historically low Fed rates and a trillion dollar “stimulus package” on the horizon, long term inflation is a very real potential. In the 1970’s, gold was an excellent investment during that period of extended “stagflation.”

If the markets continue in turmoil, gold may also be a good investment, serving as a “safe haven” investment while other financial markets recede. In 2008, with the S&P 500 down 37%, the bond market down over 20% and most other commodities down, gold is virtually the same price as it was on January 2, 2008.

Since the beginning of 2005, the price of gold has doubled and is now at approximately $850/ ounce. Until 2008, the all time high for gold was reached in 1980 with a price of 850/oz. Based on this, it might appear that there is very little upside in a gold investment. However, in inflation adjusted dollars, the $850/oz in 1980 is almost $2200/oz. in 2008 dollars. Thus, on an inflation adjusted basis, gold is now trading approximately $300/oz. in 1980 dollars.

While gold should never represent a large portion of an investors portfolio, when we are considering a prudent asset allocation, we must consider the current financial turmoil. If inflation does increase as the economy recovers or if the economy deteriorates even more than is expected, the price of gold could increase. Thus, all of my clients have approximately 5% of their liquid assets in gold, which will remain in their portfolio until economic conditions change.

If you decide to add gold to your portfolio, one of the easiest ways of owning gold is through an Exchange Traded Fund (ETF). The most popular gold ETF is the streetTRACKS Gold Shares ETF, with the call symbol GLD. ETFs are traded like stocks and are easy and inexpensive to buy and sell through a discount brokerage house.

While a gold investment is not for everyone, adding the “Magi’s Gift” to your portfolio may increase your future portfolio returns.

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A recent Wall Street Journal article quoted a survey from Prince & Associates showing that “81% of investors, with $1 million or more in investible assets, plan to take money away from their current financial adviser.” Regardless of the amount of your investible assets, you may be considering whether you need a financial adviser or, if you already have a financial adviser, whether you should fire your current adviser and find a new one.

If you have an interest in finances and are willing to invest the time to learn how to comprehensively mange your personal finances, you may require no professional help. If this describes you, learn about the full spectrum of financial planning including tax minimization, risk management, retirement planning, estate planning and of course, investing. I wrote Financial Abundance Guide to help this you identify detailed strategies on how to comprehensively manage your financial resources and secure a prosperous future.

However, when markets are down and the economy is in turmoil, many people begin to question their capability of managing their personal finances. If you have recently felt that you have no idea whether to sell everything or to completely ignore the market and hope that in ten years you will be financially OK, you probably could use professional financial support. If you have concluded that you have neither the time nor interest to manage your personal finances, what kind of financial adviser should you choose?

The first question to consider is what type of financial advice is required. If you only need help in managing your investments, an investment broker or an asset manager may fit your needs. Be sure to determine exactly how the adviser will be compensated before you entrust them with any funds. The following are three types of investment advisers:

1. Commissioned based advisers typically sell both insurance based financial products and load mutual funds. They will often state that their financial planning services are “free” and that you will pay no commissions, as long as you hold the products sold for a period of five years or more.

2. With “fee based” brokerage advisors you pay an annual fee, based on a percentage of the assets in your account. For this fee, you usually may make unlimited trades without paying any brokerage commissions. However, these brokers often collect commissions on mutual funds (such as the 12-b1 annual load) and on other proprietary products as part of their compensation.

3. Fee only asset managers provide professional asset management and offer only products and services with no commissions. Their compensation is based entirely on an annual percentage of the assets that you place with them to manage.

Most investment management firms will offer some financial planning services. However, since they are compensated through the assets that they are managing, they are often not interested in providing comprehensive financial advice to their clients.

Many people require more financial support than just investment management. These clients require comprehensive financial planning to help plan for their children’s educational expenses, prepare for retirement, identify methods of minimizing taxes and financial risks while maximizing their cash flow and their investment income.

If you need more comprehensive help in planning your personal finances, find a fee only, Certified Financial Planner (CFP®) who provides comprehensive financial planning services. A CFP® will have completed extensive financial planning educational training and met both the experience and ethics requirements of the CFP Board of Standards.

Whether you only need investment advice or require a complete analysis of your current financial situation, be sure that your adviser can provide financial strategies that meet your risk profile. Also, be sure that their compensation offers no conflict with your best interests.

If you currently have a financial adviser who is not actively advising you on how to meet your financial goals, you may want to join the 81% of wealthy investors that plan to take money away from their present advisers. If your investment adviser or financial planner is not treating your financial future in the same manner in which they are treating their own, find a financial adviser who will!

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Much of our current inflation is due to the weak dollar.  In 2001, the Fed began lowering interest rates and kept them artificially low until 2005.   During that time period, the dollar went from being worth 1.12 Euros to a value of only .75 Euros.

With the current banking debacle and the recent lowering of the Fed funds rate the dollar has declined to just .64 Euros, almost ½ of its 2001 value.

Let’s look at what this decrease in the value of the dollar has meant in terms of oil and gasoline prices.   If the dollar was as strong today as it was in 2001, we would be paying $71 per barrel of oil instead of $125.  Likewise, gasoline would be $2.25/gallon instead of $3.95.

With increasing inflation, sinking stock prices and low investment interest rates, is there any investment approach that will protect your financial abundance?  I believe there is!   Here are some of my ideas:

1. Lower you exposure to equities (the stock market) – While I do not believe in market timing, paying attention to current investment conditions is always wise. With increasing inflationary pressures, it will be difficult for the US economy to grow. Until we see signs that our government is interested in addressing economic growth by lowering corporate income taxes (the US is the 2^nd highest in the developed world) and strengthening the dollar, I recommend that you keep you equity position at the lower end of your allocation range.

2. Invest in stocks of high quality companies with high yields - The stock market will likely continue to decline in 2008. However, GE is an example of a quality company, yielding 4.3%, that will likely increase in value in the long term. In the meantime, you will receive a yield that is higher than money market or CD rates, with the dividends taxed at a maximum of 15%.

I do not recommend buying stock in any financial institutions until the sub prime mortgage mess is completely understood. However, if you are willing to take some risk, you might consider a Business Development Company. My favorite is Kohlberg Capital (KCAP). KCAP has an expense ratio of just 2.5% vs an industry average of 5.7%. It is trading at over a 35% discount to its Net Asset Value (NAV) and it is currently yielding almost 20% annually.

3. Use Treasury Inflation Protected Securities (TIPS) – If inflation persists, it will likely prove wise to invest a portion of your fixed asset portfolio into TIPS. TIPS are inflation indexed bonds that are issued by the U.S. Treasury. Their interest rates will increase as inflation increases. Two easy methods of buying TIPS is either TIP, an Exchange Traded Fund that is currently yielding 5.6%, or the Vanguard Inflation-Protected Securities Fund Investor Shares (VIPSX) mutual fund. TIAA-CREF as well as most 401(k) or 403(b) plans also offer an inflation linked bond fund.

4. Gold is a good inflation hedge – Gold has increased over 25% since I added it to the Model ETF portfolio in Q3 of 2007. In spite of its current value, it may still prove to be a good hedge against future inflation. I do not recommend placing more than 10% of your equity portfolio into gold. An easy way to own gold is through the ETF (Exchange Traded Fund) GLD.

Regardless of how you decide to invest in these challenging times, remember to stay well diversified and do not chase the latest investment fad.

If you would like help in determining how to invest in these inflationary, turbulent times, contact me for a no cost consultation to discuss your goals and Financial Abundance’s low cost asset management approach.

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You may have substantial savings for your children’s education and/or your retirement. You probably have savings in both taxable accounts and tax deferred retirement accounts such as a 401(k).

With the extremely volatile stock markets and low current interest rates, how should you invest your savings? Here are seven ways to increase your investment returns in these turbulent times.

1. Invest in different types of assets – With the current stock market volatility, you may be tempted to get out of the market and put everything in cash. If you do this today, with money market rates at 2.25% and the inflation rate at 4%, you will be guaranteed a negative “real rate of return.” However, by investing in a variety of different asset classes, you will lower your portfolio risk and, over time, have a higher investment return.
2. Allocate all of your liquid assets – Common investment wisdom recognizes that asset allocation can produce up to 90% of your total investment return. When choosing different asset classes, be sure to consolidate all of your financial assets, including your taxable accounts, your 401(k) and IRA accounts, deferred annuities and even rental properties. Often, financial professionals consider only the assets that they are managing when they provide asset allocations. This limited asset allocation approach may provide higher risks and lower total returns on your consolidated portfolio.
3. Pay attention to financial trends – Don’t try to time when the markets will go up or down. However, pay close attention to current market cycles. Today, with a volatile stock market and a declining business cycle, it may be prudent to reduce your equity allocation. If inflationary pressures remain for the foreseeable future, consider having a portion of your portfolio in an inflationary hedge such as a gold fund or a bond mutual fund investing in Treasury Inflation Protected Securities (TIPS).
4. Learn to build “ladders” – Money market funds are typically yielding 2.25% or less. If you are sitting on cash that you won’t need in the short term, improve your yield by 1% or more with a short term CD ladder. Buy a 3 month, 6 month, 9 month and 12 month CD, with 25% of your cash in each CD. This approach could increase your annual yield to 3.5%. Plus, if interest rates start increasing, every 3 months you will be able to invest 25% of your cash funds at a higher interest rate.
5. Consider a Mid Cap allocation – Since 1981, when Mid Cap stocks were first tracked as a separate asset class, the Mid Cap index has performed significantly better than both the Large Cap and Small Cap stock indexes. Year to date, the S&P 400 Mid Cap index is out-performing the S&P 500 Large Cap index by over 10% and the S&P Small Cap 600 index by over 3%. Including a Mid Cap index fund with your equities may improve your total return.
6. Reduce your taxes on investments – Pay attention to which accounts hold your investments. Keep tax-efficient investments, such as municipal bonds and index stock funds in taxable accounts. Tax-inefficient investments, such as actively managed mutual funds and investments that pay non-qualified dividends (example: REITs), should be kept in tax free Roth accounts or tax deferred accounts such as a 401(k).
7. Minimize your investment fees – Investment sales expense (loads and 12b-1 fees), mutual fund operating expenses, brokerage trading costs and asset management fees reduce your total return. A low fee approach can substantially increase your investment returns. Over a 15 year period, paying an extra 1% yearly investment fee can reduce the total return on a $500,000 investment by $200,000.

In the 90s, making a decent return on your investments was easy. For the foreseeable future, you will need to pay much more attention to your investing in order to receive a reasonable investment return. More details on how to increase your investment returns are provided in Financial Abundance Guide.

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While the market had its usual positive reaction to the Fed lowering the federal funds rate to 2.25%, over the long term, lowering the Fed rate will continue to lower the value of the dollar, leading to higher inflation and a weaker US economy.

In 2001, the Fed began lowering interest rates. By the end of 2001, the Fed funds rate was below 2% and it stayed below 2% until the end of 2004. During that same time period, the dollar went from being worth 1.12 Euros to a value of .75 Euros, a 33% decease in its value. As the Fed raised interest rates in 2005, the dollar increased in value, hitting a high of .85 Euros in late 2005.

Even with higher Fed rates, the dollar continued to decline in 2006, going to .75 Euros in mid 2007. However, since the banking debacle and the recent dramatic lowering of the Fed rates, the dollar is once again in rapid decline, trading at just .64 Euros.

To give a slightly different perspective, if the dollar was as strong today as it was in 2001, we would be paying $62 per barrel instead of $109 and gasoline would be $1.80/ gallon instead of $3.15.

So what can the average investor do in this time of sinking stock prices and short term interest rates that are below the rate of inflation?

Before Christmas, I recommended gold as an inflation hedge and as protection against the continued decline of the dollar. Since the beginning of 2008, gold is up over 17%. With the present Fed approach to devaluing the dollar through lower interest rates, I still believe that gold has upside potential. An easy way to own gold is through the ETF (Exchange Traded Fund) GLD.

Another approach is to buy stocks in high quality companies with high yields. While the stock market will probably continue to decline in 2008, a quality company such a GE, which yields 3.7%, will likely pay off in the long term. In the meantime, you will receive a yield that is higher than money market rates and that is taxed at a maximum of 15%.

I do not recommend buying any financial institutions stock at this juncture. The picture is still too clouded, and no one knows if another Bear Stearns is around the corner. However, if you are willing to take some risk, you might consider a Business Development Company. My favorite is Kohlberg Capital (KCAP). KCAP has an expense ratio of just 2.5% vs an industry average of 5.7%. It is trading at a 35% discount off of its Net Asset Value (NAV) and is yielding over 15% annually.

Regardless of how you decide to invest in these challenging times, remember to stay well diversified and not to chase the latest investment fad.

Until we see a different approach from the Fed, it is wise to plan for a continued dollar deterioration combined with higher inflation. This combination will lead to lower real rates of return on bonds and money market funds, providing a challenge to all investors.

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In the biblical story of the birth of Christ, the Magi gave Jesus gold, frankincense and myrrh. As many of us celebrate the Christmas season, perhaps we should consider giving ourselves one of these gifts, the gift of gold.

While I have never been a gold enthusiast, gold can be an excellent hedge against insipient inflation. In the 1970’s gold was a good investment during the extended “stagflation” that the US experienced.

The nominal price of gold has increased by approximately 75% over the past five years and is now trading at approximately $800 per ounce. However, the Euro has also increased in value against the dollar by approximately 40% over the same 5 year period. Thus, more than ½ of the increase in the price of gold can be attributed to the declining value of the dollar.

With the recent recognition that the CPI is dramatically increasing, it is possible that the US economy may soon face an extended period in which the economy is flat to negative and inflation is above the historical 3% average. If this occurs, it is likely that gold will once again become more valuable as a hedge against increased inflationary pressure.

You may be thinking that gold is already near its all time high of $850/oz. (reached in 1980), so where is the upside of buying gold at $800/oz. ? While in nominal terms that thinking is correct, in inflation adjusted dollars, the $850/oz in 1980 is actually $2145/oz. in 2007 dollars. Thus, on an inflation adjusted basis, gold is now trading at $317/oz. in 1980 dollars.

I am not suggesting that anyone sell all of their stocks and bonds and use the proceeds to buy gold. However, proper asset allocation requires us to look at present economic conditions. If inflation does increase in 2008 and if the dollar remains weak, the odds are high that the price of gold in US dollars could increase. Thus, it may be prudent to put a small amount (5% or less) of your liquid assets into gold, until economic conditions change.

If you decide to add gold to your portfolio, one of the easiest ways of owning gold is through Exchange Traded Funds (ETFs). One such ETF is the streetTRACKS Gold Shares ETF, with the call symbol GLD. This ETF is traded like a stock and is easy and inexpensive to buy and sell through a discount brokerage house.

Gold investments are not for everyone. However, if you think that inflation will rise in 2008 and the dollar will remain weak, adding to your portfolio the “Magi’s gift” may increase your portfolio returns in 2008.

I hope that you have a joy filled Christmas and a Happy and Prosperous New Year.

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