Monthly Archives: March 2009

The Taxpayer Certainty and Relief Act of 2009

BAUCUS UNVEILS LEGISLATION TO PROVIDE TAX CERTAINTY, RELIEF TO MIDDLE INCOME FAMILIES
Finance Chairman’s proposal makes permanent middle income tax rates, child tax credit, fixes estate tax and AMT for all Americans

Washington, DC – Senate Finance Committee Chairman Max Baucus (D-Mont.) today announced legislation that would make existing tax breaks permanent for working families and individuals including the child tax credit, marriage penalty relief, and lower middle-income tax rates among other provisions. The measures were originally passed as part of tax legislation in 2001 and 2003, but are set to expire in 2010. Baucus unveiled his proposal after a Finance Committee hearing today that examined the affect of the current economy and the U.S. tax code on America’s middle class.

“Today we’re offering a piece of certainty during an uncertain time for millions of hard-working, honest Americans. These measures are not excessive or outrageous, but timely and targeted, and will build on earlier efforts to stabilize the economy,” said Baucus. “By guaranteeing a little extra cash in the pocket of working moms and dads, and by making sure that the AMT and the estate tax can move with the economy, we avoid sweeping tax increases for millions of American families. By promising spouses tax fairness in marriage, giving help to those helping others through adoption, and by giving lower-wage workers confidence at a critical time, we can restore our footing, and begin to climb back to a position of national strength and economic security.”

Original co-sponsors of the Baucus legislation include Senator Jay Rockefeller (D-WV) and Charles Schumer (D-NY).

Elements of the Baucus proposal include:

– Permanent protection for more than 20 million Americans from being hit by the alternative minimum tax

– A measure to make permanent the 10, 25, and 28 percent individual tax rates, as established by the Economic Growth and Tax Relief Reconciliation Act of 2001

– Permanence of the income eligibility threshold for the child tax credit, recently set at $3,000 by the American Reinvestment and Recovery Act of 2009, to give families up to $1,000 for every child under age 17

– For taxpayers in the 10, 15, 25, and 28 percent tax brackets, a proposal to make permanent a reduced tax rate on capital gains and dividends, as established in the Jobs and Growth Tax Relief Act of 2003 and extended by the Tax Increase Prevention and Reconciliation Act of 2005

– Permanence of the marriage penalty relief provision, so that married couples will not be taxed more severely filing jointly than they would as two single persons filing separately

– Estate tax relief, making permanent 2009 levels for taxation of family possessions and property. The measure would also index exemption amounts for inflation

– Makes permanent the 45 percent credit rate for the refundable earned income tax credit for lower wage taxpayers with three or more children, as passed in American Recovery and Reinvestment Act of 2009

– Permanent expanded assistance for families that adopt a child including a $10,000 tax credit per eligible child

– Makes permanent the 35 percent credit rate for child care expenses up to $3,000 for one child and $6,000 for two or more children
The Taxpayer Certainty and Relief Act of 2009

I. Permanent Middle Class Tax Relief

Individual Tax Rates. Current ordinary income tax rates are imposed at 10, 15, 25, 28, 33, and 35%. These tax rates expire at the end of 2010. The proposal would make permanent the 10, 25, and 28% tax rates. (The 15% tax rate is already permanent law.)

Capital Gains and Dividends. The proposal would make permanent the reduced tax rate on capital gains and dividends for taxpayers in the 10, 15, 25, and 28 percent brackets. The 2003 tax bill created a new tax rate of 15 percent (5 percent for low-and middle-income taxpayers, going to zero percent in 2008) for dividends. Prior to passage of this bill, dividends were taxed at ordinary income rates. The 2003 bill also reduced the capital gains tax rate from 20 percent (10 percent for low- and middle-income taxpayers) to 15 percent (5 percent for low- and middle-income taxpayers, going to zero percent in 2008). These reduced tax rates were originally set to expire at the end of 2008, but were extended until the end of 2010 in the “Tax Increase Prevention and Reconciliation Act of 2005” (TIPRA).

Child Tax Credit. Generally, a taxpayer may claim the child tax credit to reduce income tax liability by up to $1,000 for each qualifying child under the age of 17. If the amount of a taxpayer’s child tax credit is greater than the amount of the taxpayer’s income tax liability, the taxpayer may receive a refund if the income threshold is met. The Economic Growth and Tax Relief Reconciliation Act of 2001 set the income threshold for child tax credit refundability at $10,000 (indexed). The American Recovery and Reinvestment Act decreased the threshold for the 2009 and 2010 tax years to $3,000. The proposal would make these changes to the child tax credit permanent.

Marriage Penalty. A “marriage penalty” exists when the combined tax liability of a married couple filing a joint return is greater than the sum of the tax liabilities of each individual computed as if they were not married. A “marriage bonus” exists when the exemption amounts and rate brackets are larger for the joint returns filed by married couples than for singles’ returns. As part of the 2001 tax cuts, the standard deduction for married filers was scheduled to increase annually until 2009. In addition, the bill eliminated the marriage penalty in the 15% tax bracket and for the earned income tax credit. The marriage penalty relief expires on December 31, 2010. The proposal would make the marriage penalty relief permanent.

Dependent and Child Care Credit. The dependent care credit allows a taxpayer a credit for paid child care expenses for qualifying children under the age of 13 and disabled dependents. The credit is 35% of eligible expenses. This rate decreases by 1% for each $2,000 of income above $15,000, but the rate never falls below 20%. Eligible expenses are limited to $3,000 for one child, and $6,000 for two or more children. (After 2010, the amount of eligible expenses returns to the pre-2001 amounts of $2,400 for one child and $4,800 for two or more. In addition, the 35% credit rate decreases to 30% and the income threshold decreases to $10,000.) The proposal would make 2009 law permanent.

Earned Income Tax Credit. The EITC is a refundable tax credit available to low wage workers. Because the credit is refundable, a taxpayer will receive a refund if the amount of the EITC is greater than the amount of the income tax liability or if no income tax liability exists. The American Recovery and Reinvestment Act increased the credit rate for taxpayers with three or more children from 40% to 45% and increased the phase out range for all married couples filing a joint return (regardless of the number of children) by $1,880. The proposal would make these changes permanent.

Adoption Credit and Adoption Assistance Programs. Current law allows a maximum adoption credit of $10,000 per eligible child and a maximum exclusion of $10,000 per eligible child. These benefits are phased-out for taxpayers with modified adjusted gross income in excess of certain dollar levels. These tax incentives go back to $5,000 per child ($6,000 for child with special needs) after 2010. The proposal would make 2009 law permanent.
II. Permanent Alternative Minimum Tax Fix

For the 2009 tax year, the American Recovery and Reinvestment Act provided a patch for the AMT, setting the exemption amount at $46,700 (individuals) and $70,950 (married filing jointly), and allowed the personal credits against the AMT. When this patch expires, the exemption amounts will return to $33,750 (individuals) and $45,000 (married filing jointly) and the personal credits will not be allowed against the AMT. The proposal would make the 2009 exemption levels permanent and index them for inflation. In addition, the proposal will permanently allow the personal credits against the AMT.
III. Permanent Estate Tax Relief

Under current law, U.S. citizens and residents must pay taxes on transfers of property both during life and at death. These taxes are due under three separate tax systems: the estate tax, the generation-transfer skipping tax, and the gift tax. Currently, the top tax rate for all three taxes is 45%. Both the estate and generation-skipping transfer taxes currently have a $3.5 million exemption for individuals ($7 million for couples). The gift tax has an exemption of $1 million ($2 million for couples). For the 2010 tax year, the estate and generation skipping transfer taxes are repealed. In the same year, the gift tax rate will fall to 35%. In 2011, the estate, generation skipping transfer, and gift taxes are scheduled to revert back to pre-2001 levels, with an exemption of $1 million, a 55% rate, and a 5% surtax on large estates.

The proposal would make permanent the 2009 estate, gift, and generation skipping transfer tax laws going forward and index the exemption amount. The proposal would also reunify the estate and gift taxes. In addition, the proposal would allow portability of exemption for spouses. Finally, the proposal would increase the amount available under the special use valuation revaluation to equal the estate tax exemption.

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Is Obama’s Estate Tax Plan The Nail In The Nonprofit Coffin?

We folks who deal with high net worth clients have wondered for years what will happen with estate taxes when the current plan sunsets in 2011. Let me make a guarantee here (which is something I don’t often do). I guarantee that estate taxes will be addressed before 2010 which is when they are set to return to zero and return to 2001 levels when 2011 begins. Already, congress is abuzz with talk about what to do about it. Frankly the estate tax has been the running joke in the planning community for years when congress said that the estate tax would disappear in 2010. People said that they would start to write special instructions for “pulling my plug”, but only if it were advantageous from an estate tax planning perspective. All kidding aside, regarldless of what gets decided, I guarantee that there will be implications. As The NY Times reported in 2005, the last time there was talk about eliminating the estate tax, charities remained shockingly silent for fear that any attempts to block the measure would be donor suicide. I mean really, would you give to a charity that intentionally lobied for higher estate taxes? Are you crazy? Make no mistake, this time, I guarantee there will be legislation being passed and it will have a major impact on both the wealty, and nonprofits.

While many in the nonprofit community have been quite vocal against Obama’s plan to lower the charitable tax deduction, if history is any guide, I don’t think they will be speaking up now. Perhaps they should. I believe that the changes to the estate tax will have a much bigger impact on charities than the income tax deduction. Charities felt that they had nothing to lose by speaking up on the proposed change to the deduction because the change would be bad for BOTH the wealthy, AND the charities. By lowering the deduction, the wealthy would be losing a tax incentive to give to charity (perceived as bad for the wealthy), and the charities would be hurt by that. Nobody had a problem speaking up to say this was a bad idea. The estate tax is a completely different animal and I would argue, will hurt charities much more than the income tax deduction. Have you heard anyone talking about this? Nope. This will be a silent walk to the grave for the nonprofits. Here’s how it will happen.

Year/ Exclusion Amount /Max Top tax rate:
2001 $675,000 55%
2002 $1 million 50%
2003 $1 million 49%
2004 $1.5 million 48%
2005 $1.5 million 47%
2006 $2 million 46%
2007 $2 million 45%
2008 $2 million 45%
2009 $3.5 million 45%
2010 repealed 0%
2011 $1 million 55%

In the above chart, notice that the estate tax exemption amounts have been going up since 2001. From 2001 until 2008, the exemption amounts didn’t go up that much; essentially from $1-2 million. The period from 2001 to 2002, up until recently, was the worst period of time for the markets since the great depression. While the exemption amounts did go up slightly from $675,000 to $1 million dollars, that was not a big increase in real dollars for the wealthy. From 2003 up until 2008, the stock market experienced a bull market while the exemption amounts only increased from $1 million to $2 million. This year however, the exemption amounts went to $3.5 million. That means that a husband and wife can leave $7 million dollars free from federal estate taxes. Compare that to only $2 Million total in 2002 ($1 million for each individual), and that’s a lot of extra millions. Let’s add somthing else here. Portfolios are down much more than the last recession. This means that exemption amounts are much higher, and people have less money. Well that’s great for the wealthy right? How about for the nonprofits? They are still talking about how the drop in the income tax chariable deduction is going to impact them. Folks, wake up, you have a new problem. It’s called the estate tax. While nonprofits have had lots of other things to deal with lately, I fear that what’s being discussed with the estate tax is going to be yet another blow to their ability to continue to operate as they had been.

Before the wealthy shoot me here, let me point out that there’s a fine balancing act that needs to take place here. Nonprofits play an essential role in society and they perform many responsibilities for society that the government isn’t good at and has no place in. If charities are not fundamentally strong, society is worse off and someone else needs to pick up the slack. If the government needs to do more, guess what, that means we all will wind up paying higher taxes anyway. It’s in our nation’s interest to make sure they remain financially healthy.

At present, the latest word on the street is that the Democrats support leaving the estate tax at the current level of $3.5 million. The exemption amount has never been this high before and only time will tell how much of an impact that will have on charities and donations. In my business, avoiding paying estate taxes is one of the primary functions that a wealth manager helps clients peform. While emotion has been the primary driver of charitable contributions, not taxes, I fear there’s a perfect storm that is lining up. For many in the wealth managent community, charity is only a means of avoiding taxes for their clients. Unless an adviser can use charity as a way to save taxes for their clients, they generally don’t bring it up. Doing so means less under management for the adviser and that translates directly to less fees. I assure you, right now, many advisers are just struggling to keep their doors open and discussing charity with their client is the last thing on their mind. The big question is, how many potential donors were lost by dropping investment portfolio values, raising the estate credit amounts from $2 million to $3.5 million, and cutting the charitable income tax deduction?

Just to be clear, I would be in favor of  freezing the estate exemption limits. I feel people pay enough in taxes and they shouldn’t have to pay again when they die. Make no mistake though, this will be another blow for charities. Don’t drop the charitable tax deduction, raise it, by a lot. I’d also be in favor of paying higher income taxes to pay for things like universal health care, education, and alternative energy. I realize you can’t have your cake and eat it too, I just worry that the cake recipe is looking like pie and we’re all going to get some in the face if we don’t think these things through more clearly.

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Anderson Cooper 360 Story on Obama Plan to Cut Charitable and Mortgage Tax Deductions

Charity Navigator CEO, Ken Berger talked with CNN’s Anderson Cooper about Obama’s plan to cut the charitable tax deduction.

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Proper Nonprofit Twitter Etiquette

Are you representing your nonprofit organization on Twitter? Are you trying to use Twitter to get the name of your organization out there and possibly get new donors? If so, you had better listen up, and fast. There are a couple of things you should know before you start to make enemies on Twitter. You might call these the rules of the road. While it’s good advice for anyone looking to make new contacts, it’s particularly important for nonprofits.

  1. Follow people who follow you- This is one of the dumbest mistakes I see people making with Twitter charity profiles. My username on Twitter is “PhilanthropyCFP”. If you are a nonprofit, why wouldn’t you follow back someone with the word “Philanthropy” in their name? That’s just dumb. If your objective is to recruit people to follow your cause, the first rule is to follow them back. There are no exceptions to this rule in my opinion. If you don’t follow someone who has expressed an interest in your charity profile, not only will they likely be upset because you weren’t interested enough to follow them back, but they will find another charity who is “interested in them”. This is dumb. Don’t make that mistake. I can’t tell you how many nonprofits I have unfollowed because they didn’t follow me back. While I’m not making myself out to be anyone “important” here, the bottom line is that it is a lost opportunity. We’re in the same industry, yet for some reason, their organization wasn’t interested in what I had to say. I say “NEXT”…
  2. ReTweet interesting articles that people post. If you are generous, people will return the favor and your followers will grow.
  3. Post interesting content (Not just yours). Did you read an interesting article that your followers might find interesting? Great post it. Useful Twitterers will increase their followers.
  4. Show your personality (as long as it isn’t negative). In my case, it’s my company and I can be negative if I want. If people don’t like what I have to say, they can look elsewhere. I’m positive most of the time, but as my friends know, I do take a stand when needed (like here).
  5. My favorite: “Tweet others like you would like to be tweeted”

Twitter can be a great way to meet people for any number of reasons. Just understand these basic rules and you should be just fine. If anyone has other suggestions, please feel free to add them here.

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We Forgive You Mr. Madoff: Love, Advisors, Nonprofits, & Jewish Community

Dear Mr. Madoff,

We in the Investment Advisory, Nonprofit, and Jewish community forgive you (well maybe not EVERYONE) Let me explain:

About a week ago, I asked people if you could ever be forgiven for the crimes you have committed against charities who help to make others lives better, your own people in the Jewish community, and from advisers in the investment business (which happens to be the same business I’m in). I asked the question whether you could ever be forgiven, not because I believe that you ever will, but because I wanted to know because of my own sense of religious curiosity, whether someone who had committed the crimes you had could ever be forgiven in the eyes of god.

Prior to today, I wondered and questioned whether it was even plausible for someone who had the reputation that you did, to knowingly deceive your fellow Jews, charities who help people, and innocent investors who turned over their life savings to you. I didn’t think that anyone had it in them to be able to look someone squarely in the eye when someone turns over their life savings to you (lot of trust there right, I know, because I have these same conversations every day with people), and KNOW the way you DID that you were GOING to bankrupt them. You looked people in the eye knowing you were going to ruin them.  Whoever read my previous posting on this subject, please forgive me.

Today I learned the truth. You are a monster. You knew exactly what you were doing. Sometimes when the train has left the station, it’s difficult to admit when we have done something wrong. We may tend to ignore difficult things because we don’t like to deal with them, perhaps because we are afraid. Sometimes there are consequences for this.  That’s not what happened in your case though. With you, you knew what you were doing was wrong, you SAID you knew that one day it would catch up with you. Why would you CONTINUE to lure more victims when you knew would get caught? You took money from charities, Jewish ones, as a fellow Jew. You took from CHARITIES and gave to YOURSELF. The enemies of the Jews are rejoicing for what you have done. You ARE a terrorist of the worst kind. You ARE a monster.

Ruth Ann Harnisch and I exchanged a series of emails about you after she posted a comment on my article about you where I questioned whether it was possible for someone to knowingly do what you did. I couldn’t believe it. Perhaps I’m a softee and believe that people deep down want to do the right thing. Ruth Ann Harnisch didn’t think I was looking at reality. She was right. You are the monster. We already know that now though. The discussion that we proceeded to have is worth repeating to others. It has to do with forgiveness. This was the question that I had originally asked. Could you ever be forgiven? The answer we came to was YES.

The kind of forgiveness we are talking about is the same kind of forgiveness someone has when a serial killer murders their child. We forgive the act. We forgive, because WE don’t want to hold on to the poisonous venom that we feel for you for what you have done. We forgive because forgiveness is good for us, Mr. Madoff, not for you. Make no mistake Mr. Madoff, you ARE a murderer.

As I looked into “forgiveness” further, I came across the story about “casting the first stone”

The King James Version of the Bible, in John 8:1 – 11 scribes and Pharisees had caught a woman in the act of adultery (the woman commonly referred to as the prostitute) and told Jesus who was teaching in the temple that the Mosaic Law required she be stoned to death. Trying to make an opportunity of this to trick Jesus that they might accuse Him, they, with stones in hand, asked Jesus what He says about the Law. After Jesus tried to ignore their repeated questioning, He told them “He that is without sin among you, let him first cast a stone at her.” One by one each man dropped his stone and walked away.

Jesus was not arguing with the judgment. Nor was Jesus arguing the law nor the woman’s guilt. Jesus was arguing with our right to execute the woman. Once all the men had dropped their stones Jesus confronted the woman and asked her if any of the men were still there to condemn her. When she answered “No man, Lord”, Jesus told her that neither did He – He forgave her of her sin. He did not excuse the sin of adultery/prostitution, he forgave her of it. All that is sinful before forgiveness is still sinful after forgiveness. Not only was Jesus not afraid to call a sin a sin, He was not afraid to call a sinner a sinner. He even reminded her of the sin of adultery/prostitution by telling her “Go and sin no more.”

I asked my Rabbi about the process of asking for forgiveness when you have committed a sin against another. He told me that in Judaism, part of  repentance is the process of providing some form of restitution. Another smart man named Randy Pausch, whose “The Last Lecture” became an instant classic about how to live said this; “When you do something bad and want to apologize, know that a good apology has three parts.  1) I screwed up 2) I’m sorry 3) (This is the part most people don’t do) How can I make it right?”

Today in court Mr. Madoff, I heard you say you screwed up, and that you were sorry. What I didn’t hear was any interest in making good on the wrong you had done. READ WHAT MADOFF TOLD THE JUDGE Fortunately for you Mr. Madoff, you will have a lot of time to figure out how to make it right. Frankly, I’m not interested and don’t really care what you do. I’ve learned that to forgive, does not necessarily mean you have to “receive” someone back into your life. So with that Mr. Madoff, I’ll let you know that I’ve forgiven you, and now I’m done with you.

“You Go, and Sin No More”

SINcerely,

Investment Advisors, Nonprofits, and your friends in the Jewish community

Read my earlier post Can Madoff Ever Earn Forgiveness?

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The 5 Steps to Buying Your Happiness in Recessionary Times

President Harry S. Truman once said; “Recession is when a neighbor loses his job. Depression is when you lose yours.” While you may not have lost your job, more than likely, there’s a good chance you have lost a lot of money in your portfolio and are probably wondering what to do. It doesn’t matter if you are a business, individual, or charity, it seems as if all groups have lost faith in the buy and hold philosophy, and many are beginning to wonder if their advisers are actually doing anything to help them. Before you fire your adviser, put everything into cash under your mattress, and hunker down for nuclear Armageddon, there are a few things you should understand about how investments ideally should work within your plan, the role of advisers on your team, and important questions you should be asking whether you invest on your own, or you have someone helping you.

Revisit Your Goals
What’s important to you? If you found out you only had 6 months to live, what would you want to do in your life? Try writing your own eulogy. How would you want to be remembered? What would you want people to say about you? By starting with the important questions of life, you can get a really clear gut check and determine if you are actually doing what you want to do in your life. What are the things that came up? Often, we have limiting assumptions about what is possible in life. We use phrases like; “Some time, some day, if only blah, blah, blah”. When you take the time to have these conversations with yourself (or an adviser), frequently our real values get uncovered and we identify things we’ve always wanted to do. For example, many people say, “I’d want to spend more time with family”, or “I’d want to travel”. Once you have a list of these things, then then think about the reasons or excuses you’ve been making on why now isn’t the time. Usually this sounds like “I don’t have the money”, or “I’m to busy”.

Prioritize Your Goals
OK, so if not now, when? How much is enough? When will be the day? Perhaps you’ve achieved success in your business but you simply just don’t want to be bored with a “traditional retirement”. The important thing to consider here is WHEN. While some goals might seem crazy, no worries, just write them down. Ideally, when would you want to spend more time with family? What would you do? Where would you travel? Start to create some ideal time frames for the things that you said were important to you. Don’t worry about whether you think they are realistic at this point, just recognize that spending more time with your family WOULD make you happy, and write it down. Keep doing this exercise until you have at least 10 items on your list. Once you have the items listed, then prioritize them in order of importance. I like using index cards to do this since it allows you to move things around as you think of new things. Now ask yourself which of your goals you would be willing to give up in exchange for achieving the most important ones. Once you have completed this exercise, you have the foundation of a very powerful life plan for yourself. Now the question becomes how to pay for it.

Buy Your Happiness
OK, so how the heck do you do that right? “But I always thought…,blah, blah, blah”…Stop. Yes, money CAN buy happiness. I know,… I had you at hello, right? Here’s the thing about that…Having money will NOT make you happy, however figuring out what makes you happy, (as we discovered above in the “eulogy” exercise) formed the basis of your new plan. Now that you know what DOES make you happy, (spending more time with family, giving back to society, etc., now the question becomes, how do I use my wealth to buy those things for myself? Before you go postal on me, ask yourself, how much would it cost to leave your job so you can spend more time with family? What’s preventing it now? Perhaps you answered that making a difference in the world would make you happy? Well how much does it cost to make a difference? How much time do you want to spend making a difference? What’s preventing you from doing that now? OK, so your job is preventing that, how much do I need to have in order to “retire” so I can do the things that are important to me. Are you following all this? The point of this is to start to think about what it will cost, both personally, and financially to achieve your most important goals.

Position Your Finances
More than likely, taking less risk with your investments was one of your goals, (aka “Sleeping at night). During our exercise with the index cards, I asked you to prioritize how important your goals were to you. Where did investment risk fall in that conversation? The question really is, “What are you willing to do to reduce the risk in your portfolio?”. I think an even bigger question is, “How much risk do you really need to take in order to achieve your objectives?”. In my experience, investors are quite familiar with the question, “What’s your risk tolerance”, but most people have no idea how to answer that objectively. I have good news for you. Now that you know exactly what makes you happy, what your priorities are, and what you are willing to give up in order to achieve them, you’ve just answered what I believe is the most important question in planning; “How much, by when”.

Get Help when Needed
The fact is, we as investors usually don’t take the time to do these exercises, but now more than ever is the time to start. You have to know where you are, and what corrections you can make to get you back on track to achieving what’s important. If you don’t know how to do that, find a good adviser who can. If you have an adviser, talk to them about what you discovered about your goals and see how they can help you achieve them. If you don’t feel comfortable discussing this with your adviser, perhaps it’s time to find another.

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When Buy and Hold Fails: From Scrambled Nest Eggs to Starting Over Easy

Perhaps buying and holding as an investment strategy isn’t feeling so good lately. Perhaps you’ve heard, eggs do have lots of cholesterol and eating too many of them can be bad for your heart. If you are one of those who have been relying solely on the conventional wisdom that buying and holding will turn out just fine, you may wake up one day with a financial heart attack from eating too many scrambled nest eggs. But don’t worry, the doctor is in, and the medicine may not be as terrible as you think.

Whether you are an individual, business, or charity, conventional wisdom says “buy and hold” is a winning investment strategy however, you could actually do more harm to your finances by holding depending on your circumstances. The key word here is YOUR circumstances. While it’s true that stocks have historically outperformed bonds and cash over the long term, there have been periods (like now) where this hasn’t been the case. Simply buying and holding can do a whole lot of harm if you don’t know exactly where you stand financially and have a good sense of what you will need to achieve your financial goals. Simply ignoring the market and hoping things will work out can be a great recipe for financial disaster. If you are close to retirement and want to draw income from your portfolio, or you are already are retired and withdrawing money, pay close attention (you Baby Boomers, I’m talking to you).

Forget returns, CASH indeed IS king, and that’s worth saying twice in today’s market environment. Cash IS KING. The question is not so much how much do you have, but how much you need. This is where we begin to scramble our eggs IMHO (In my humble opinion for those of you who are new). I’ve seen this over and over again and it goes to the heart of of why investors are losing faith in their advisers and burying their head in the sand, sticking instead to “buy and hold” and “have a long term view” to comfort them to sleep at night. That’s great if you are 20, 30, or 40 years old, but financial Russian Roulette if you are near retirement or already taking money out. Here’s why. Percentages are mostly meaningless. Generally speaking, the rule of thumb went that you could withdraw 3% from a portfolio indefinitely and not worry about drawing down principal. Go much above that number and you begin to run a risk that if the market goes down and you continue to withdraw money while the investment portfolio is down, regardless of how great of a percentage you earn when it recovers, it could have reached a “point of no return”.

Example:

How much can I withdraw from a $1M portfolio?

Using the 3% benchmark, if you incorrectly assumed you could draw $30,000 this year and raise it by 3% each year to account for cost of living increases and forget about it, take a look at this:

Assume 12/31/07, the portfolio value was $1M, you take an income amount of $30,000 on Jan 1, 2008 and assume the portfolio loses -25% over 2008. At the end of 2008, your hypothetical portfolio value would be $727,500

Assume 12/31/08, the portfolio value was $727,500, you take an income amount of $30,900 (income amount $30k inflated 3%) on Jan 1st, 2009, and assume the portfolio loses another -25% in 2009

On 12/31/09, your portfolio value would hypothetically be worth $522, 450.

The income withdrawal of $30,000 that was once 3%, is now closer to 6%. In addition, notice that while you lost 25% for two years in a row, your portfolio value of $522,450 is nearly half of what it was when you started but making 50% won’t do it. In order to get back to $1M, you need to earn almost 100%! That my friends is a case of scrambled nest eggs.

This is the danger of buy and hold when you are taking money out of a portfolio. Mother’s love to say “Ignore your teeth and they’ll go away”…I think the same is true here. Buy and hold at your own peril.

So what can you do? Good question. As I said earlier, “Cash is king”. It’s not the percentages that are important, it’s the dollar amounts. The doctor says the best prevention is a regular checkup. When you actually take the time to sit down and work through your goals, how much they will cost, and what YOU can do to help achieve them, that’s when things can begin to become clear again. Many people make the mistake of believing that good advisers can make money in any market. In my humble opinion, a good adviser helps clients make smart decisions in times like this. Perhaps taking less risk is more important and you would be willing to work a few years more in order to make that happen, OK, great. How about taking less income in exchange for taking less risk? How about making more contributions during your working years or planning to leave slightly less to your kids in exchange for not having to reduce  your income?

The fact is, there are really lots of choices that people never think to think about because they are too focused on the percentages in their portfolio. Many investors are talking to their adviser about the specifics of the investments, the portfolio strategy, or some fancy investment terms like “standard deviation”, “Alpha”, or “Beta”. Did you know that these terms ARE ACTUALLY Greek? Most advisers are actually speaking Greek to their clients. That’s not funny though, so don’t laugh…If you are simply buying and holding, it’s not a laughing matter either. As Ferris Bueller likes to say; “Life moves pretty fast…If you don’t stop and look around once in a while, you could miss it.” The same holds true for your portfolio.

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