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There is a Catch-22 to hiring a financial adviser. If you hate dealing with your finances, you probably need a broker or planner. But if you really hate dealing with your finances, you probably won't make a serious effort to find a top-notch adviser. Result: There is a real risk you will end up with a rotten broker or planner. Jonathan Clements WSJ 4-11
The study finds that two-thirds of that decline in the core inflation rate reflected slowing increases in rents and rapid declines in used-car prices. When the Fed slashed rates, auto makers introduced 0% financing. The move increased demand for new cars, but it hurt demand and increased the supply of used cars, driving down their price. Similarly, Fed policy drove mortgage rates down sharply and spurred many apartment renters to buy homes. Rising apartment vacancy rates restrained rent increases. That also indirectly held down the measured cost of owner-occupied housing, which is based on rents for similar housing units rather than house prices. These developments "reflect not a fundamental weakening in housing and vehicle demand, but, instead, the dynamic effects of interest rates on consumer demand for substitutes," according to Andrew Bauer and Nicholas Haltom, of the Atlanta Fed, and William Peterman, now at the Brattle Group. If price trends for used cars, rent and housing had remained the same after November 2001, core inflation today would be 2.7%, instead of 1.6%. After accounting for the used-car prices and rents, "the recent downturn in the business cycle appears to have had little impact on the path of overall core inflation," the authors write. If the study is correct, underlying inflation may not be as low as it appears. Further, it suggests that once the Fed begins to raise rates, the unusual behavior of used-car prices and rents may stabilize or reverse, pushing up measured inflation rates, said Jonathan Basile, an economist at Credit Suisse First Boston. Between November 2001 and December 2003, the "core" inflation rate - the annual increase in the CPI ex-food and energy - plunged to 1.2% from 2.8%. The fall prompted the first serious worries at the Fed about deflation in more than 50 years and contributed to the central bank's decision to cut its short-term rate target to 1% last June and hold it there since. The study, which made no inferences about monetary policy, doesn't represent mainstream Fed thinking. Chairman Alan Greenspan and most of his fellow policy makers consider productivity growth and the degree of unused slack in the economy more important to the course of inflation than the behavior of individual prices.
"Our moving quickly has been a reflection of how the companies have responded," says Don Phillips, managing director at Morningstar. "For us to ignore reforms and wait another six months before commenting would have been a mistake." Morningstar created several categories to accommodate a wider array of alleged or admitted wrongdoing and now has placed 20 fund groups into three main groups: Don't send new money, consider selling and proceed with caution. Morningstar's 'Consider Selling' List: Alger, Heartland, Invesco, Janus, Nations, PBHG, PIMCO Equity Advisors, Strong. Morningstar's 'Don't Send New Money' List: Columbia, Excelsior, Federated, Scudder, Seligman. Morningstar's 'Proceed With Caution' List: AllianceBernstein, Franklin, MFS, One Group, PIMCO, Putnam. In contrast to Morningstar's broad actions, Standard & Poor's Investment Services, which also operates a fund-rating service, has placed just three funds, rather than entire firms, on a do-not-buy list since the scandals surfaced: Putnam International Equity Fund, AllianceBernstein Technology Fund and PBHG Growth Fund.
Ivy McLemore, director of corporate communications for Aim Investments, argued that the funds shouldn't be forced to disclose information to Morningstar that they don't provide to fund shareholders. Eaton Vance raised privacy concerns on behalf of its fund managers. But Morningstar is standing its ground. Funds that don't respond could end up with lower governance scores. Even more detailed disclosures could soon be required. The SEC has proposed a rule that would force funds to reveal to shareholders more data about both areas than has been requested by Morningstar. This isn't the first time Morningstar has run into objections from some corners of the fund industry for pushing for more disclosure, says Don Phillips, managing director at Morningstar. A few fund companies initially balked at providing the names of fund managers and at Morningstar's inclusion of sales fees when comparing fund returns. Moreover, many companies are answering the questions. Morningstar hopes to roll out the new governance grades early this summer and eventually apply the ratings to the approximately 2,000 funds followed by its analysts. Each fund will receive grades from A to F. In addition to an overall grade, they will be rated on board independence and pay, expenses, corporate culture, regulatory issues and the fund manager compensation and investment questions. More on Morningstar Christopher Oster, WSJ 5-25-04 In another pending change, Morningstar plans to roll out "sector deltas," which will show if a fund is making big bets on a specific sector of the economy. When a fund is dangerously concentrated in one area of the market, this will riase a red flag. The current star ratings don't take 'concertration' into account. That move is in response to the late 1990s bull market, when many funds loaded up on technology stocks and subsequently lost huge sums in the tech collapse of 2000 to 2002. This new feature will alert investors to such concentrated bets before they blow up. Morningstar is also highlighting flaws in that much-vaunted star-rating system. In articles published in recent weeks on its Web site, the company took pains to point out that certain funds with high ratings weren't suitable for investors because of problems such as high expenses and volatile returns. That system, for which Morningstar is best known, awards funds one to five stars based on their risk-adjusted returns compared with funds with similar objectives. In April, Morningstar published on its Web site an article headlined "Great Funds with Low Star Ratings" that recommended funds that received only two or three stars. Another article last week, "Low-Quality Funds with High Star Ratings," panned several funds with four or five stars.
According to popular understanding, a wide deficit reflects the propensity of an irresponsible American population to consume more than it produces or to spend more than it earns. The current-account deficit is also politically incendiary because exports are associated (inaccurately) with jobs at home while imports are associated with jobs overseas. So, for anxious observers, the trade deficit symbolizes jobs for foreigners at our expense. There is something badly wrong with this picture. In fact, the whole picture is upside down. For one thing, U.S. exports include many consumer goods that we could have consumed ourselves, and our imports include many investment goods such as equipment and other resources that enable businesses to create jobs. While it may be true that there will always be a net inflow of capital from the rest of the world to offset whatever imbalance exists between exports and imports, that's a tautology; every transaction has two sides. The important question is which comes first: the international flow of capital, or the flow of goods and services? Which is the cause and which is the effect? As usual, there are two opposing explanations, but the investing public usually gets to hear only one -- in this case, the gloomy one. Allegedly our stubborn overspending causes U.S. exports and imports to be mismatched, and foreign capital is forced to flow in to finance the difference. Much more reasonable is the explanation the media ignores: It is capital that chooses to flow into the United States, and a discrepancy between exports and imports arises to balance that flow. The imbalance between exports and imports is a passive and automatic consequence of investor choices. Trade falls easily into line because, as a rule, people care far less about where the goods they buy come from than they do about where their savings are placed. The balance of trade is driven by investors, not consumers. The trade deficit is a consequence of a successful economy in the present and not a menace to economic growth in the future. Countries with deficits are growth opportunities, and they are net absorbers of capital, just like growth companies. In the end, the problem is semantic. The term "deficit" has a negative connotation, associated in the popular mind with debt and insolvency. The more neutral word "imbalance" still implies that something, somewhere, is wrong, while actually, this particular imbalance is a sign that something is absolutely right. Maybe if the current-account deficit were simply relabeled the "capital-inflow surplus," we could all see it for what it really is - a barometer of our economic health.
"For the last year we've had a massive relief rally but now we're in the second stage of a bull market, driven by the durability and growth of earnings," says Abby Joseph Cohen, Goldman Sachs's global strategist. "Rising rates are just the flip side of the coin that the economy is doing better," and this means increased profits and a strong environment for stocks. In contrast to the usual advice to shed financial stocks when rates rise, some analysts say investors should boost their holdings of certain financial stocks. That's because many banks and securities firms have been anticipating higher rates, and have made protective moves. And as the economy revs up, more businesses tend to take out loans, despite higher rates, and they miss fewer interest payments, helping banks. And banks are more diversified, so companies like Citigroup profit as investment-banking fees surge in a strong economy, even if rates rise. Another reason to like financial stocks: They've held up surprisingly well in past periods of climbing rates. Financial stocks rose more than 5% on average during the nine periods of soaring rates since 1990, according to RiskMetrics Group, a risk-analytics firm. But Collyn Gilbert, an analyst at Ryan Beck, recommends that investors be wary of companies that focus on making new mortgage loans. Meanwhile, tech stocks and cyclical stocks also should advance as companies boost spending on capital equipment, Ms. Cohen believes. In fact, stocks in the Dow Jones Communications Technology index rose more than 24% on average in periods of rising rates in the past 14 years. Ms. Cohen recommends stocks such as U.S. Bancorp, MBNA Corp. and General Electric, a stock that could do well as the economy improves.
When it comes to dividend-paying stocks, you cannot focus on the short term. Go back just one more year, to the start of 2002. Measured from that point, dividend payers in the S.& P. are leading the market, returning a cumulative 17.4% through Thursday, versus 14.4% for nonpayers, according to Howard Silverblatt, equity market analyst at S&P. Buy-and-hold investors may be surprised to learn that they could have generated nearly as much income over the last two decades by investing in the S.& P. 500 as by putting the same amount of money to work in the broad bond market. T. Rowe Price Associates recently studied the fortunes of two hypothetical investors: one who put $10,000 into the S.& P. 500 on March 31, 1984, and held it there for 20 years, receiving the dividends in cash, and one who invested the same amount in the Lehman Brothers U.S. Aggregate Bond index and didn't reinvest the annual interest. T. Rowe Price found that the S.& P. 500 investor would have collected a total of $16,372 in income over the entire period, not that far from the $17,776 that the bond investor would have earned in interest. Had today's favorable tax treatment of dividend income - brought about by the tax-cut law of 2003 - been in place over the last two decades, you would have earned slightly more after-tax income through stock dividends than bond interest. And that doesn't take into account capital appreciation. The $10,000 stock investment would have grown to $70,750, not counting the dividends, versus $11,979 for the bond investment. In the T. Rowe Price example, the bond investment threw off substantially more income than stock dividends did early in the 20-year period. But as interest rates fell, rising dividends made up for some of that lost bond income. This is why it's important to own a mix of bonds and dividend-paying stocks. The second lesson is this: Current yields aren't everything. In the example's final year, the S&P threw off $1,054.39 in dividend income. That is a yield of nearly 11% based on the original $10,000 investment. The case for investing in dividend-paying stocks is becoming only stronger. After climbing 8.1 percent in 2003 total payouts among S.& P. 500 companies are expected to jump an additional 10.7 percent this year. Scott Glasser, co-manager of the Smith Barney Appreciation fund, said he thought that payouts would continue to grow 10% to 12% annually - faster than corporate profits are expected to increase - for the next five years or so. Of course, you should consider the greater risks of capital losses when owning stocks versus bonds. But while you're doing that, compare the risks of owning dividend-payers against a stock portfolio that pays out nothing. As the bear market taught us, dividend payouts, as paltry as they seem, can sure protect you.
Regulators now require fund firms to disclose how they vote on corporate issues, so fund shareholders can be certain the people managing their money are acting in line with their expectations and values. 'In the past,' Muhlenkamp's statement says, 'we've voted our proxies based upon what we perceived to be the merits of the individual proposals. In most cases, we've voted with management (if we don't like what management's doing, we wouldn't own the stock), but in areas such as poison pills and management bonuses, we've often voted against management.' The new proxy disclosure rule will "require us to keep records of our votes and, presumably, would require us to defend those votes at a future date. To better use our time and to simplify this hassle, we have adopted the policy of simply always voting in line with management recommendations." In other words: We'd rather pick stocks than vote proxies. Ron Muhlenkamp acknowledges that the firm's new policy flies directly in the face of what regulators were hoping for and is "the very opposite of what regulators intended by this. 'But I don't want to be in a position five or 10 years from now having to justify the way I voted on something today,' Muhlenkamp says. 'To defend my position today would require voluminous notes, which would take time that I don't have.' Mutual funds and pension funds can be [and have been] a force for reform in corporate governance. See posting below as a current example. Calpers Withholds Proxy Votes Reuters 4-26-04 Calpers, the biggest U.S. pension fund, said on Monday it would withhold proxy votes for 11 companies, continuing a campaign largely directed against boards that let auditors perform outside services such as consulting. The $166 billion California Public Employees' Retirement System said it would withhold proxy votes for directors at Alcoa, Adobe Systems, Broadcom, Coca Cola Enterprises, Clear Channel Communications, Capital One, Kimberly Clark, Kohl's, Merck, Popular, and Verizon Communications. Calpers has a reputation as an aggressive watchdog on corporate governance matters and has vowed to oppose decisions by companies to permit auditors to perform consulting services and approve executive compensation not linked to performance.
It's not that you can't learn from the decisions of professional investors, you just have to remember what motivates most of them. Few big traders are truly worried that rising rates will harm the economy; they just want to be sure they move their money before the next guy moves his. Strategic "programmed trading," often done automatically on behalf of hedge funds, mutual funds and other large investors, may account for more than half of average daily volume. Beyond arbitrage, programmed trades could be based on any number of variables, such as market momentum, derivatives, formulas to discern technical trends, or fluctuations in bond yields and interest rates. "There are all sorts of strategies employed for different reasons, some of which have nothing to do with the fundamentals of a company," said Sam Lieber, president of Alpine Funds. Over the long term, such trading probably has little impact on the market, but in the short-term it can produce "a lot of noise," Lieber said. This is especially true when companies are reporting results, he added, because "news can be interpreted in dramatically different ways." For a smaller investor trying to navigate a choppy market during earnings season, there's very little to be gained by jumping in at the same time as all the big traders, said Greg Forsythe, a senior vice president of equity research at Charles Schwab Corp. Paying attention to how the market reacts to a profit report is smart - after all, these are "people voting with their wallets," Forsythe said. Just don't assume you should follow the herd. "Professionals know what the consensus estimate is, they know the past growth rates, they're listening to the management and they react with a quick trigger finger," Forsythe said. "Smaller investors ... shouldn't try to outdraw the professionals in a duel." The market digests news quickly, so the volatility related to quarterly results usually subsides within a day or so. Unless the report contains a bad shock, which usually becomes clear immediately, investors with longer time horizons can afford to wait, Forsythe said. In addition to earnings, you should consider all the other indicators of good corporate health - revenues, sales, cash flow - and other measures that indicate strong profits are sustainable. "The individual investor should be looking at this report as a once-a-quarter reality check, and see whether anything changes the long-term outlook for the company," Forsythe said. "Make your assessment carefully and slowly, not reacting to the price being up or down a dollar the day it happens."
The Carry Trade Here is how the 'carry trade' works: Borrow money at slim short-term rates, usually close to or below Libor, the London interbank offered rate. Borrowing money for three months based on Libor is a skimpy 1.15% right now. Then just take that money and buy bonds with higher yields, such as mortgage bonds, long-term government bonds or foreign bonds. The difference between, say, a mortgage bond with a 5% yield and the 1% or so borrowing cost can bring big profits - especially for investors who use heavy leverage to increase the size of the positions. Some hedge funds and other traders have been using more than $25 of borrowed money for each $1 of their own to make this trade, according to traders. Now, [with bond prices dropping] some carry-trade investors are taking profits off the table from this trade and selling their holdings, causing recent problems for the bond market. From The Washington Post 4-25: The carry trade been the source of significant profit for banks, hedge funds and Wall Street firms in recent years and may be a reason the Fed is reluctant to raise interest rates. It is also a big reason the Treasury swap market has grown by more than $1 trillion since the Fed started cutting rates in January 2001. Curve Flatteners Other investors have been [borrowing short and then] buying long-term bonds on the bet that the yield curve, or the plot of different bond yields, will "flatten." That just means that long-term bonds will rally, sending rates on those bonds lower in relation to rates on short-term bonds. The only downside is if the longer-term bonds being purchased tumble in price, as they have lately. Call Plays Another hot trade has been buying callable, or redeemable, bonds with high yields. The idea here is that low rates will encourage companies that sell such bonds, such as Fannie Mae, to redeem them so they can sell even lower-rate bonds. So investors get a generous rate on what they expect to be a short-term bond. But now that rates are higher, few expect these bonds to be redeemed as quickly as they were being redeemed a few months ago. As a result, prices of these bonds are falling because investors now view them as long-term holdings with yields that look thin compared with others in the market. Floating Debt Others losing are consumers and companies that took out adjustable or floating debt, which usually has a lower initial rate than fixed-rate debt. Now that rates are moving higher these investors are going to find their interest payments rise. Leveraged 'Income' Closed-End Funds During the past three years, yield-starved investors lapped up a gush of new closed-end offerings that invest in bonds or income-producing stocks to pay income to shareholders. Nearly all of the closed-end funds launched during the bear market are allowed by their prospectuses to use leverage to boost their yield. This strategy typically entails borrowing money at low short-term rates or raising cash by issuing short-term preferred fund shares, then socking that cash into higher-yielding securities such as longer-term bonds or REITs. As long as short-term rates don't go up, this strategy provides ample extra income to pay out to fund shareholders, making these funds attractive. If the Fed raises rates, some of these funds will see steep losses, analysts say.
On Form 1040X, you're supposed to write down your income, deductions and credits as you originally reported them, the changes you're making and the corrected amounts, the IRS says. "Then figure the tax on the corrected amount of taxable income and the amount you owe or your refund." If you owe more tax, you're supposed to pay it when you file Form 1040X. The IRS says the tax owed won't be subtracted from any amount you had credited to your estimated tax. If you paid too much tax the first time around, you can have all or part of that overpayment refunded to you.
Almost immediately after your death, your family will have to decide what to do with your remains. Picture the scene: Your daughter is absolutely sure you would want a $10,000 funeral, while your son is convinced a simple $1,000 cremation will suffice. The nasty fight that ensues could have been avoided if you had left behind written funeral instructions. You ought to get a will [if you do not already have one] right away. If you die without a will, your assets will be distributed according to state law. That doesn't necessarily mean everything will go to your spouse. Having a will won't determine who gets many of your assets. For instance, your retirement accounts and your life insurance will go to the beneficiaries designated on those accounts. Similarly, if you own property jointly with right of survivorship, the property will usually go to the survivor, even if you list a different beneficiary in your will. Some estates of retirees will have survivor benefits from non-IRA retirement accounts. This is not determined by the will, but by who is the beneficiary listed with the deceased employer. If one of your children is assisting your billing paying and asset decisions or for some other reason has check writing priviledges [which is the same as co-ownership] of your checking and savings accounts, these accounts could [it may depend on the state you reside] go directly to the co-owner and not the estate. As you decide who gets what, think about the tax bill that will accompany each asset. Giving one of your three children (1) a $300,000 house, (2) the second $300,000 in a mutual fund in a taxable account and (3) the third your $300,000 IRA is not an even split. The first child will immediately get the house, with no capital-gains taxes owed on the portion he inherits. Similarly, the second child will automatically inherit your retirement account. But in the case of the retirement account, all the income taxes owed on the tax-deferred growth will still have to be paid. The monies in the taxable account will pass through probate [and probate expenses] before the third child gets the money. Even if you take the time to draw up a living will, health-care power of attorney, funeral instructions and a will, these and other papers aren't going to do a whole lot of good, unless somebody can locate them when the time comes. With that in mind, tell your family where you have stashed these documents. While you are at it, talk to them about how you have divvied up your assets and how much each of them can expect to inherit. You will die with taxes due, and with an IRS return due. It will help greatly if the person administering your estate is familiar with your tax situation. If you are getting income from a trust or partnership, they could be confused by K-1 distributions if they are not forwarned. If you have sold a REIT in the tax year of your death and the cost basis re-calculation needs to be done, the person administering your estate needs to be forewarned. If you die in the first quarter of the year leaving a tax bill and a funeral bill and several large medical bills, then you need to have sufficient non-probate waiting cash on hand.
An answer is that the Fed has kept short-term interest rates so low for so long that a lot of leveraged speculation has built up in what Wall Street calls the "carry trade," so named because the expected profits from the investment are more than enough to carry the cost of borrowing money to finance it. That was particularly true for bonds, but it was also true for stocks, currencies and commodities. Banks and hedge funds seem to have a lot of carry trades. The strong retail sales numbers on Tuesday reminded traders that short-term rates had to rise some day. Leveraged investors appeared to be cutting back on their positions in everything from copper to currencies. Then came the inflation report, which indicated that rising commodity prices are finally being passed through to consumers. Heretofore, the highest inflation was in areas not subject to international competition, like college tuition, which is up 10.2 percent in the last 12 months, the biggest rise in more than a decade. But now prices are increasing even in areas where they had been falling. It has been convenient for the Fed to assume that any inflation threat and, therefore, any pressure to raise short-term interest rates, is far, far away. Speeches by Fed officials have played down inflation, and it will be interesting to see if that begins to change. 'They will find themselves with a big credibility problem if they do not acknowledge that there is more inflation than they expected,' said Roger Kubarych, an economist with the HVB Group. By engineering negative real interest rates - rates lower than the inflation rate - Mr. Greenspan has bolstered the economy at the risk of encouraging speculation. Some of the increase in copper, from 60 cents a pound at the economic nadir in the fall of 2001 to a peak last month of almost $1.40, is because of rising demand from real users. But some of it reflects speculation on borrowed money. Similarly, the search for yield has allowed companies - and countries - with dicey credit to borrow money cheaply. Markets are starting to realize that the economy is too strong to justify keeping short-term rates so low. Now the Fed needs to change expectations gradually so that speculative trades can be unwound without causing unnecessary damage to markets. 'The last trick Alan Greenspan has to pull off,' said Robert Barbera, chief economist of ITG/Hoenig, 'is to get the federal funds rate up from crazy easy and still have everyone live happily ever after.' More on Fed Tightening Caroline Baum, Bloomberg 4-23-04 The most bearish of economists is looking for the funds rate to hit 2 percent by year-end, hardly a sign of contractionary policy. And the Treasury 10-year note is expected to yield 4.7% by the end of the year, according to a Bloomberg News survey of 72 economists conducted from 3-26 to 4-5. Steve Wieting, senior economist at Citigroup Global Markets, and his Citigroup colleagues think the Fed tightening cycle will extend into 2006, producing a `long cycle of interest- rate uncertainty.' Average federal individual income-tax deductions for some major categories, based on adjusted gross income, for 2002. Tom Herman, WSJ 4-15-2004
The ICI reports that the aggregate portfolio turnover rate of stock funds fell to 55% in 2003 from 62% the year before. Citing data from the University of Chicago Center for Research in Security Prices, the ICI said last year's turnover was the lowest in more than two decades. The annual average over the past 20 years was 67%, the institute added, with only small fluctuations from one year to the next. A 67% turnover rate means that a fund replaces about two-thirds of its holdings with new investments in a given year. By implication, at that rate the fund turns over its whole portfolio every 18 months. At a 55% turnover rate, the implied holding period stretches out to about 22 months. `Higher turnover rates are associated with higher transaction costs,' the ICI acknowledges. It adds, `Funds strive to minimize turnover and the consequent trading costs, especially since investors tend to concentrate their purchases in funds with higher returns.' Lately, buyers of fund shares also concentrated their purchases in funds with very low turnover rates. I verified this by checking the latest turnover rates as reported by Morningstar for a current list of best-selling funds compiled by the consulting firm Financial Research Corp. The 15 funds with the biggest inflows in January and February had an average turnover rate of 23, according to my calculations. That's less than half the industry average cited by the ICI. Three of the top 15 were index funds, which automatically tend toward very low turnover. If we exclude them, we still get an average rate of only 27 percent among the remaining 12, which include a couple of international stock funds, a fund specializing in smaller stocks and even a short-term bond fund. In the whole bunch, no fund had a turnover rate higher than 51. I grant you, these numbers cover only a short period. So my case is a bit like citing a few weeks' weight loss as evidence that a diet has succeeded. It's [also] probably true that most individual investors will never put a whole lot of weight on an individual statistic like portfolio turnover. Even with those caveats, though, I'd bet that what has happened lately will continue, and it already invites a couple of positive conclusions. First, if low-turnover funds really are a better way to go, investors act as though they are capable of figuring that out for themselves. Second, once they reach such a conclusion they are also capable of letting fund managers know with a message that is hard to miss.
Myth: Mutual-fund investors are oblivious. For decades, Wall Street strategists and fund-world observers have bemoaned Main Street's investing IQ, using them as contrarian indicators and bombarding them with "ripped from the headlines" funds or sectors du jour. But rather than give up on the financial markets during the scandal's furor, average fund investors have yanked billions from implicated firms and invested it in funds run by firms not involved in the scandal. Many studies attesting to investors' ineptness might be off base. In any event, investors reaction to the scandal seems downright sensible. Myth: Mutual funds are obsessively regulated. Part of the reason mutual funds got their white-hat reputation was the layers of oversight they often touted publicly (and complained about privately). There was the internal corps of compliance attorneys and accountants, and a fund's board of directors, primarily comprised of company outsiders, scrutinizing everything from returns to fees on behalf of shareholders. Not to mention the SEC's inspection of firms on site every few years. Given the amount of abuse that was either missed or tolerated, it seems this vaunted series of checks and balances worked about as well as a bucket with a hole in the bottom. The good news: It's changing. Internal compliance staff, fund boards and SEC procedures are all getting a thorough review. The bad news: We now know how naive it is to think any policing system is foolproof. Myth: Mutual funds are cheap. Yes, many investors own shares of large funds that spread their money across a broad portfolio of stocks or bonds or both for less than 1% of their account's balance each year. But 40% of net new cash flows went to stock funds with fees north of 1% last year according to the ICI. Lump in funds' undisclosed trading costs, taxes, inflation, in addition to account maintenance and adviser fees, and one may wonder how investors make any money from their portfolios. Myth: Mutual-fund managers are American 'idols.' During the 1990s, fund managers in general, and growth- or tech-fund managers in particular, were often seen as august seers. Their faces graced magazine covers and TV screens. But the bear market brought them and fund investors back to Earth, just as it did the same for stock prices. More than 70% of the nation's actively managed stock funds trailed the Standard & Poor's 500-stock index in the 15- and 10-year periods ended Feb. 29. Even worse, the fund probe has dredged up evidence that fund managers profited from improper trading in their firms' own funds. Fact: Mutual-fund companies aren't all the same. Investors should pick funds and not "fund families," so goes the thinking. Different firms have different specialties. But the scandal has shown investors that different fund firms also have different cultures and different values. Make your decisions fund by fund, but don't ignore the name on the door, either. Does a firm routinely charge higher fees, roll out gimmicky sector funds or hype one or two years of hot performance? If so, you might wonder if they're cutting ethical corners elsewhere. Fact: You should assume no one is looking out for you. Yes, funds will have beefed-up compliance and governance procedures. But no one will care as much about how your money is being managed, what you're being charged and how you're being treated than you. Keep your eye on fund results. Considering funds after-tax returns and expenses. Fact: You usually get less than what you pay for. Given the common awe of hedge-fund managers and stars in the mutual-fund world, it's easy to figure you need to pay up for good asset management. Not really. In fact, since fund returns are reported after expenses, paying up actually makes it more likely that you'll end up with worse results, not better. The average U.S. stock fund with an expense ratio of 1% or less averaged a 12% annual gain in the fifteen years ending Feb. 29, compared with 11% for those with higher fees according to Morningstar. Looks like you were better off keeping those fees invested in stocks, not in your manager's pocket. Fact: When used wisely, funds are still a great deal. Funds that do their job by offering you broad diversification, sound money management and ready access to your money at a modest price are still the best choice for the vast majority of investors.
Normally when the Fed raises overnight rates, the yield curve flattens as short rates rise more than long rates. Not so in the early months of the 1994 tightening cycle. The rise in long rates matched the increase in the funds rate tick for tick. On the eve of the first rate increase on Feb. 4, 1994, the funds rate was at 3% and the benchmark 30-year bond yielded 6.3%. By the time the funds rate hit 4.25% in mid-May, the 30-year bond had already grazed 7.6%. The reason? The `carry trade' was the rage in 1994, just as it is now. And in 1994, the carry traders were being carried out on a stretcher. Because so many positions were financed with borrowed money, the rise in financing costs forced leveraged investors to dump their longer-term notes and bonds. It can't happen again -- it won't happen again -- traders say. There's no need for the Fed to raise rates aggressively. Consider two points: One, the Fed is starting from a more accommodative perch (1% versus 3%); and two, the bond market - and overall economy - is more highly leveraged than it was in 1994. `If the Fed overstays its visit, it may have to go past neutral to reach equilibrium,' says Michael Lewis, president of Free Market Economics. But what is neutral? The 3.5% rate suggested by retiring San Francisco Fed President Robert Parry in an interview in the Sunday San Francisco Chronicle `may be at the low end of neutral,' Lewis says. `It may be 5%, which is not priced in.' Besides, Parry's neutral rate was predicated on inflation of 1% to 2%. Prices seem to be rising everywhere except in the official statistics. Point Two: As far as exposure to interest-rate fluctuations is concerned, the bond market is twice as leveraged as it was 10 years ago, according to Bianco. Bianco calculates the degree of leverage by aggregating various measures, including overnight repurchase agreements as a share of total market value, net borrowings by primary dealers and open interest in Treasury futures contracts relative to notes and bonds outstanding. Away from Wall Street, Main Street has taken the Fed's bait as well. `More and more consumer debt is adjustable,' says Stephanie Pomboy, president of MacroMavens, an independent advisory firm. `Of the $2.3 trillion increase in consumer debt over the past three years, 44% is tied to short rates.' And don't forget the U.S. Treasury, which `has reduced the average maturity of current issuance to a mere 27 months,' Pomboy says.
Suppose you are in your 60s and you just retired. You know you will have to start taking required minimum distributions from your retirement accounts at age 70.5, at which point your withdrawals will be taxed at 25% and possibly more. My advice: Begin drawing down your retirement accounts now, generating enough income each year to get to the top of the 15% income-tax bracket. [Note: Drawing the money does NOT mean spending the money. It just means paying the tax on the money starting now at probably lower tax rates.] In 2004, that means income of $37,000 if you are single and $74,000 if you are married filing jointly. As I see it, any time you can get taxed at 15%, you should seize the opportunity. This sort of tax management isn't just for retirees. Let's say you get laid off, so you have a year with scant income. To profit from your own misery, convert part of your IRA to a Roth IRA while you are having a year of suppressed income and thus lower rates. Today's 15% maximum long-term capital-gains rate is scheduled to disappear in 2009, when the old 20% rate makes its return. To avoid getting dinged at the higher rate, you might realize some gains now. This could be an especially smart move if you are heavily invested in a single stock and you need to diversify. One warning: Because of the alternative minimum tax, your stock sales could get taxed at as much as 22% by Uncle Sam. Without a tax-law change, 529 college-savings plans will lose their tax-free status in 2011. But that doesn't mean you should give up on 529s. Instead, try this strategy: Each year, start by making the maximum $2,000 contribution to a Coverdell education savings account. Coverdell withdrawals were tax-free before the 2001 tax law and thus, unlike 529 plans, aren't threatened by that law's sunset provisions.
The share of tax receipts paid by corporations has been declining for decades, US government figures show. But it has been falling at an even faster rate in many other countries. US companies paid an average of $11.88 in corporate taxes for every $1,000 in gross receipts, the study said. Small corporations were more likely to avoid taxation than large ones, it showed. About 38 percent of big companies (those with more than $250 million in assets or $50 million in revenues) paid no taxes during the five-year period. Foreign-owned companies fared better in some respects than their US-based competitors. The report found that 71% of foreign-controlled corporations paid no taxes on their US income, while 89% had tax liabilities of less than 5% of their income. The percentage of federal tax collections paid by corporations has tumbled from a high of 39.8% in 1943 to a low of 7.4% last year. It ranged from 10% - 11% percent in 1996-2000, the period studied by the GAO. But since World War II, the share paid by individual income tax filers has remained relatively stable, bouncing between 40% and 50%. Most of the difference is explained by higher payroll taxes for Social Security and Medicare. From John McKinnon WSJ 4-06: The GAO said 45.3% of large U.S.-controlled companies and 37.5% of large foreign-controlled companies had no tax liability in 2000. More than 35% paid less than 5% of their income. Despite the rising rate of tax avoidance among corporations, collections from the federal corporate income tax rose to more than $200 billion in 2000, from $171 billion in 1996. But over the next three years they fell each year, reaching $131.8 billion in 2003 - the lowest annual total since 1993. They are projected to reach $168.7 billion this year. How Fund Categories Fared Barrons 4-05-2004
Restricted Management Accounts As its name implies, a restricted management account places limits on an investor's control. The accounts involve a special agreement with a bank or trust company, giving the financial institution total discretion in investing the assets. During the term of the account, typically five years, the investor can't withdraw money without special permission. Moreover, investors can generally transfer the account's funds only to family members during that period. The benefit from a tax perspective comes if you transfer the assets to your family members. Because of the accounts' restrictions, the assets could be valued at 20% to 40% less than they otherwise would be, which could mean lower gift taxes. And if the investor dies during the term of the account, there could also be a similar discount for estate-tax purposes. David Sennett, vice president of Wachovia Trust, says that client interest in RMAs has jumped in the past year. The Citigroup Private Bank, among others, is working toward making them available to its clients, says a spokesman. Most RMAs have high minimums; Wachovia's have a $1 million minimum, for example. However, RMAs could face legal challenges down the road. Proponents argue that the accounts should pass muster because an independent third party has control over the assets. "They are truly arm's-length transactions," says David Handler, a partner at law firm Kirkland & Ellis, who helped develop the technique. Family Limited Partnerships While these estate-planning tools have lost some of their luster because of recent court decisions, they are still widely used, and can still be effective, as long as you're careful. Family limited partnerships are designed to trim estate and gift taxes by moving assets out of a wealthy person's estate and into a partnership. For example, in an FLP, a parent transfers assets to a partnership formed with the children. Most of the shares in the partnership are given to the kids. The parents, however, retain a small ownership stake and are sometimes general partners, which means they can make management decisions. The kids typically are limited partners, with less control. Because of this, the value of the children's shares can often be discounted by 20% to 40%, thereby lowering the gift-tax bite. Last May, a U.S. Tax Court judge threw out the family limited partnership of a deceased Texas businessman, Albert Strangi. The judge found that Mr. Strangi had maintained too much control over the partnership. The case is under appeal, but attorneys are now encouraging clients to reduce control over the partnerships by naming an independent third party, such as a bank, as the general partner. While that means that parents would have less control over the assets, it also means the partnership is more likely to withstand IRS scrutiny. FLPs should be set up as legitimate businesses, not tax-avoidance schemes. Use the partnership to pool together investment assets, like stock or real estate, or to manage an existing family business. Don't use partnership assets to pay personal expenses, and be sure to set up a partnership while you're in good health, rather than on your deathbed. Exchange Funds These vehicles, also known as "swap" funds, are generally pitched to wealthy investors with large, low-cost holdings in a stock who want to diversify without having to sell and owe capital-gains taxes immediately. The basic idea: Instead of selling your shares right now, contribute them to a pool, typically set up as a partnership or limited-liability company. Other investors contribute to the pool, too. Thus, you end up owning a chunk of a widely diversified portfolio. Different funds have different policies for redeeming shares. But if you stay in your fund for more than seven years, you'll get a diversified basket of stocks when you leave, and you typically won't owe capital-gains taxes until you sell. Among the largest sponsors of exchange funds are Eaton Vance Management and Goldman Sachs. Most funds typically have had minimum investments of around $1 million, although some have had much lower thresholds. New investment in exchange funds has fallen from the late 1990s, though the technique remains alive and well.
I therefore examined all election years back to the late 1800s, when the Dow was created. Was the market's average May through October change any different during those years than the rest of the time? My answer is "yes," though the difference is not so great as to convince a statistician that it is genuine. If we focus just on election years over the last 100+ years, we find that 73% of the time the stock market rose between April 30 and October 31. The comparable percentage is 56% for all non-election years. The Dow has risen 5.8% between April 30 and Halloween, in contrast to 0.9% during non-election years. At the 95 percent confidence level, a statistician cannot say for sure that the "Sell in May and go away" indicator works any differently in Election Years - the apparent differences notwithstanding. As best researchers have been able to determine, the "Sell in May and go away" pattern should be just as strong in Election Years as any time else. I base this comment on perhaps the leading academic study into this indicator, which was conducted by Ben Jacobsen, a finance professor at the Erasmus University Rotterdam, and Sven Bouman, a portfolio manager at Aegon, a Netherlands-based insurer. Believe it or not, they found that the likely cause of the pattern is the timing of investors' summer vacations. Francois Trahan, chief investment strategist at Bear Stearns pointed out that since 1950, money invested in the Standard & Poor's 500-stock index rose an average 7.4% from November through April, while rising only 1.4% from May through October. A study released by Russ Koesterich, chief U.S. stock strategist at State Street Global Markets, reached the same conclusion. For the seven months from October through April, the chance of stocks rising was 65%. It was 49% for the months of May through September. Ned Davis, founder of Ned Davis Research, says that in a presidential election year, the normal trend is turned on its head. Instead of rising until May, stocks tend to decline from January through the end of May. Then, with the election looming, they tend to recover. In an election year, he concludes, you don't sell in May. You sell in January and buy in June. The Dow industrials since 1900 have risen 4% on average from January through May in nonpresidential-election years. But during election years, the blue-chip shares have fallen an average of 0.75% during that period, according to Mr. Davis. From June through December, the Dow industrials have risen an average 11% in presidential election years -- compared with a 2% increase in other years. The third year of a presidential term tends to be the best one for the stock market. But by the start of the election year, the stronger economy tends to raise worries among investors about inflation and higher interest rates, which would be bad for shares. Stocks tend to fall -- which is exactly what happened this year. Then, around June, people begin to get over those worries and to get a clearer idea of how the election campaign is developing. After overreacting to all the earlier worries, stocks get ready to rebound from June through August. At that point, says Tim Hayes, global stock strategist at Ned Davis Research, something even more interesting happens. If the economy and the world situation are improving, investors conclude that the incumbent will win, which sends stocks up. Wall Street, which hates uncertainty, prefers incumbents and global stability. But if things are unsettled enough that the incumbent is in trouble, "the market begins to worry about the ramifications if the incumbent loses," Mr. Hayes says. In such years, the market has tended to fall after August. Monthly Job Stats March Stats & Comments There was no surprise in the strong employment report for March. On the contrary, it's been long overdue. The headline numbers, released Friday by the Bureau of Labor Statistics, show an unemployment rate basically unchanged at 5.7%, and a jump in nonfarm payroll employment of 308,000. The three-month average increase through March has been 171,000; and for the private sector alone, 161,000. The real significance of this report is that all the dots can now be connected. By summer '03, the economy began to grow fast enough for the joblessness of this recovery to come to an end: With growth in gross-domestic product running at an annualized 6.2% in the second half of last year (and probably better than 5% in the first quarter of this year), it was no longer possible to satisfy the increase in demand without hiring more workers. And perhaps just as important, with that kind of growth, new businesses begin to sprout up, creating new jobs in the process. So employment probably began expanding by late-summer of '03, as virtually every labor-market indicator has confirmed -- including weekly claims for unemployment insurance (down), announced layoffs by large companies (down), the index of help-wanted advertising (up), the employment indexes from the Institute for Supply Management and National Federation of Independent Business (all up), the unemployment rate itself (down), and the employment figure from which the unemployment rate is calculated. An increase of 171,000 per month is about right for this stage in the recovery; employers are always behind the curve. But if payroll gains do not run 250,000 per month or more by summer, then this influential indicator will again become the piece of the puzzle that doesn't fit. The BLS is probably underestimating the increase in employment from new-business formation. The agency itself has said that the "model" it uses for this purpose is bad at turning points. Since then, I've heard from business-people who have told me that in this expansion, they are outsourcing more than ever before to small enterprise for services that they used to do in-house. And no, they do not mean offshoring; they mean outsourcing, which in this case they do domestically. A house architect in upstate New York has told me, for example, that contractors no longer have employees on their payrolls, mainly to avoid paying workers' compensation insurance. If these anecdotes are more than just anecdotes, they indicate that the Bureau may be missing more jobs than ever before from small-business formation. In any case, we won't know until early next year. (Gene Epstein, Barrons 4-05) A Better Indicator The unemployment rate seems to indicate the job market isn't all that bad. At 5.7% in March, it is just a notch above its average of 5.6% for the past half century. But many economists believe the unemployment rate can be misleading and that an obscure indicator called the employment-to-population ratio is more accurate. Alan Blinder, a Princeton University economist and former governor of the Federal Reserve Board, says the employment-to-population ratio is a cleaner measure of job trends. It simply measures the number of people employed, as a percentage of the working-age population. At 62.1% in March, the employment-to-population ratio is hovering near its lowest level in a decade. "What it tells us is that this job market is quite weak and has not snapped back much," Mr. Blinder says. So until the employment-to-population ratio starts to rise again, there is reason to be skeptical that the economy is creating a lot of new jobs. (Jon Hilsenrath WSJ 4-11) Just the Facts Stocks, Real Estate & Rising Rates History offers some examples of stocks and interest rates moving in the same direction for extended periods -- even before the positive correlation between stock and bond prices broke down in late 1997. `Interest rates started rising in 1945 in the U.S. and stocks went up right along with them,' says Paul McCrae Montgomery, a money manager and market analyst at Montgomery Capital. `In Japan, rates fell and stocks went down for 13 years.' Real estate, another asset that presumably suffers in a rising rate environment, saw prices soar in the post-1945 rising interest-rate environment, Montgomery says. Real estate became even more attractive when inflation accelerated: Investors prefer hard assets when money is losing its value. (Caroline Baum, Bloomberg 4-23) Managed Funds vs Index Funds Only 22% of the managed funds [in a study compiled by Morningstar] beat the comparable index funds in the 10 years ended Dec. 31. [From Meg Richards, AP 2-22: Only 17% of actively managed large-cap funds have out-performed the S&P 500 over the past 10 years.] With taxes taken into account, only 13% of the managed funds beat the indexers. On a pre-tax basis, the average annual return over 10 years was 10.63% for the indexers, 8.99% for the managed funds. That's a sizable margin. And it gets even bigger on an after-tax basis - 9.42% a year for indexers vs. 6.99% for managed funds. The five-year figures show 62% of managed funds winning on a pre-tax basis, and 55% winning with taxes counted. (Jeff Brown, Philadelphia Inquirer 3-30) Quick Facts, Stats & Opinions Investor interest in stock funds cooled in March, with the funds taking in $15.84 billion in net new cash, down from $26.21 billion in February, the ICI said. The March stock-fund number was smaller than an estimate of $23.3 billion calculated by fund tracker Lipper earlier this week. (Yuka Hayashi, WSJ 4-30) At least three major financial institutions have issued corrected tax-reporting forms after the April 15 filing deadline, which may force their clients to file amended 2003 tax returns. So far, it is unclear how many people are affected. But because of tax-law changes enacted last year, potentially thousands of clients of Merrill Lynch, Charles Schwab and OppenheimerFunds may not have received corrected information until after April 15. (Kathy Chu, DowJones Newswries 4-28) I was leaning toward the view that in 2004, some assets would continue to increase in value while others, such as bonds, would begin to fall by the wayside and enter longer-term bear markets. Upon further consideration, I am now increasingly concerned that sometime in the near future, 'everything' could begin to unravel! When interest rates rise . . . it is conceivable that bonds, stocks, commodities and real estate will all decline in value at the same time. (Marc Faber, Strategic Investment via The Washington Post 4-25) A Cornell study, published in the April issue of the Journal of Occupational and Environmental Medicine, found that workers who come in sick cost their employers an average of $255 each per year. Economists refer to slack productivity from ailing workers as "presenteeism." Absenteeism still costs employers more, an average of $645 per employee per year. (AP 4-22) Going forward, this bull market, which began almost 18 months ago, must be labeled mature, but, based on historical yardsticks, it is far from over. We say this because all of the bull markets since the 1950s have lasted, at the very least, two years. In fact, five out of the last 10 bull markets have lasted well over three years. It is somewhat debatable when the current bull market began. The purists will say that it started on Oct. 9, 2002. However, it could be argued that, for all intents and purposes, it started on March 11 of last year. On that date, the S&P 500 was only 3.09 percent above the Oct. 9, 2002, lows. (Dan Sullivan, The Chartist via Washington Post 4-18) After a long, painful bear market, the Nikkei 225 Index is back in high gear. Investors worldwide have once again anointed Japan as the place to be. (Ron Rowland, All-Star Fund Trader via Washington Post 4-18) The IRS received about 89.4 million returns as of April 9, down slightly from 90.2 million as of April 11 last year....The IRS also said it had approved around 73.2 million refunds, up 2.4%. Average refund: $2,090, up 5.2%. (Tom Herman, WSJ 4-15) The number of mutual funds fell from 8,305 at the end of 2001 to 8,126 at the start of this year, according to ICI figures. (Ian McDonald, WSJ 4-13) Downloading and sharing music online is legal under Canadian law, a Canadian judge ruled, rejecting efforts by the major record companies to force a group of Internet service providers to identify 29 customers in Canada who allegedly offered more than 1,000 songs each through file-sharing networks. (Washington Post 4-1) Tech Tips Goggle to Offer E-Mail Google announced it would launch a free, Web-based e-mail service to compete against popular services from rivals Yahoo and Microsoft. Google's service, called "Gmail," will include a built-in search function that will let people search every e-mail they've ever sent or received. It will come with 1 gigabyte of free storage -- more than 100 times what some popular rivals offer and enough to hold 500,000 pages of e-mail. But to finance the service, Google will display advertising links tied to the topics discussed within the e-mails. For now, Google is opening up the service only to invited users but expects to make it accessible to everyone within a few weeks. (Washington Post 4-1) Home Page Previous Factoid Top Sites
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