Tuesday, May 28, 2013

Capital Gains Tax 2013

As you can see, rates vary a lot depending on income. Some investors with less than $72K (married) income pay no capital gains tax. Most investors with income in the $72-$223K range pay 15%.  Over that rates get higher, but in all cases capital gains tax rates are lower than marginal rates on ordinary income.

Source: IRS. Chart provided courtesy of Lord Abbett    www.lordabbett.com

Monday, May 20, 2013

Financial Advisor (Broker) or Investment Adviser (Manager) ???? One Insider’s View

Advisor with an “o” or Adviser with an “e”. Is there a difference that matters? One way to evaluate or compare competing models of service is to see how the participants spend their time. The below analysis is based on my personal experience of nine years as a Broker (ending April 2013) and five years as a Investment Adviser. 

Customer Service includes meeting and/or talking and communicating with clients about their investments, opening accounts, processing deposits and withdrawals, etc.  Administration and Compliance includes general administration of running the practice, actions to insure compliance with regulations, and the maintenance of appropriate records.

Sales includes activities related to new client acquisition and solicitations of clients to buy investments.  Investment Review, Selection and Management is time spent evaluating present and potential investments and investment portfolios, macro-economic  circumstances considered,  in order to achieve clients’ goals and objectives.   Here is an estimate of time spent:

                                                 Broker     Investment Adviser

Sales                                         50%             5%

Investment Management          10%             60%

Service                                      20%             20%

Admin                                        20%            15%

Notice the dramatic difference between the two models of financial services. 30% of total time attending to client investments versus 80%!  A Broker generally spends at least 50% of his time selling—most of which (70%) is finding new clients.  (20 sales calls per day is the norm.)   Only 10% of the Broker’s time is normally spent analyzing investments and clients’ investment portfolios. Annual reviews, Seminars, and other client communications are often nothing more than an additional sales opportunity. (One major brokerage firm’s training program stipulates that the Broker should spend even more than 50% of his time selling—urging him to delegate the Service activities to a “Sales Assistant”.)  Usually investments sold are either recommended by the home office or are mutual funds recommended by the fund’s sales force known as a “wholesaler”.  An Investment Manager on the other hand spends only about 5% of his time selling with the bulk of his time analyzing clients’ portfolios and evaluating potential investments that might improve portfolio performance.

The Broker’s income depends primarily on the buying and selling of investments, primarily from new clients. His skill set is persuasion and the ability to accept personal rejection. The Investment Adviser’s income in the long run depends primarily on clients’ satisfaction with the performance of their investment portfolios. Most of his business comes from referrals and sales related activities are therefore minimal. His skill set is research, analysis and problem solving.  

Is one model more "expensive" than the other.  In my opinion, the cost over the long term is not much different.  One difference is that by regulation, the costs dealing with an Investment Adviser are more visible and transparent--there is that fee documented by an invoice each quarter.  Dealing with a Broker, the transaction "confirmation" shows the commission that is sometimes quickly forgotten. And, costs associated with mutual funds are buried inside a prospectus and annual report.  
My experience is the successful Broker and the successful Investment Adviser enjoy about the same amount of income for the same amount of time spent.  I do believe however that it is the client’s best interest to deal with Investment Advisers rather than Brokers. Like children and flowers, investment portfolios usually develop better with more individual attention---this belief and opinion is strong enough that I stopped being a Broker and work solely now as an Investment Adviser/Manager.
This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk.  Most investing involves costs. A complete analysis of these costs should be undertaken before making any choice. Costs, risks and expected results should all be weighed in the balance.

Thursday, May 9, 2013

When it seems too good to be true…

The general sense one gets by paying attention to the mainstream and financial media recently is that “Happy Days are Here Again”.  (BTW..The song is probably best remembered as the campaign song for Franklin Delano Roosevelt's successful 1932 presidential campaign. Even though stocks had risen in the summer of 1932, stocks did quite poorly after the 1932 election-- so his emotional appeal was a bit early.) There is no shortage of pundits telling us that “stocks are cheap” and “we are in a bull market”.  Despite bad news about the economy—since it’s not getting worse, according to some it seems to make sense that “it must be getting better”.  And as long as the Fed is pushing QE, markets “have to” go up. (Not true!) It is claimed that based on P/E or price earning ratio’s, stocks are cheap compared to historical averages.  It is claimed that we are a special situation where TINA (There is no other alternative) to stocks because interest rates are so low. Kind of makes one wonder if we are being left behind and the “train is about to leave the station”.

All of these pundits might be right—there is a possibility. But, I am very skeptical. Based on my observations and experience, there is a better than 80% probability they are very wrong. Bull markets do in fact “climb a wall of worry” as new, previously skeptical, buyers enter the market over time. So mixed opinions are normal and healthy. And, although you don’t hear many skeptics on CNBC, just pay attention to the bond markets and cash on the sidelines.  Interest rates are not rising like you would expect in a bull market. The bond market tells us there is a lot of very negative sentiment.

Bull markets are the result of a re-pricing of assets based on expectations of an expanding economy. Rising stock prices almost always are accompanied by rising interest rates caused by an expanding economy. Expanding economies also tend to cause commodity prices to rise—not fall like they have since the first of the year.
In the current situation, we have a slowly recovering economy, but nothing to justify the dramatic rise in stock prices since the first of the year while interest rates continue to be low, taxes have risen, and government spending is falling.   A slowly rising economy should result in a slowly rising stock market.
So what is going on? 
Markets are affected by fundamentals in addition to greed and fear.  While fundamentals are slowly recovering, justifying a steady rise in stock prices over time since 2009, markets have fluctuated significantly based on swings in psychology from extremes of fear and greed.   I believe that there is a high probability that we are at the extreme on the greed scale.

Most people realize that markets today are strongly influenced by institutions and their money managers who use very complicated derivatives that affect markets in ways that are counter-intuitive. (Warren Buffet has said that derivatives are weapons of potential mass destruction.) When traders expect markets to rise (because of QE for example) they buy call options—an option to buy stock later at a fixed price. The seller of the option is now at risk---if stocks rise more than the premium he charged for the option.  To hedge that risk, many option sellers will buy the underlying stock—an action by itself that drives the price up—especially if market volumes are relatively low.  The rising price attracts more gamblers and can sometimes cause prices to rise significantly--until the options expire.  As soon as the options expire, there are no more buyers—only sellers and prices can drop significantly.    

While the gamblers are playing, the rising market can sometimes attract the unsuspecting individual long term investor who history shows tends to buy late and too high.  

Sometimes old fashioned advice is quite valuable. “When others seem greedy—be fearful”…and “When it seems too good to be true—it probably is” should be remembered. I’m currently fearful and skeptical.

BTW—options expire May 17-22 and again June 19-28.  One or both times may turn out to be buying opportunities for the long term investor.  
This paper is for educational purposes and for the sake of discussion. It is not a sales presentation and not a recommendation or personal investment advice. Opinions provided are exclusively those of Wayne Strout and are not the opinions by any financial institution. All investing involves significant risk of loss and there is no proven method to eliminate that risk. No investment should be made without a complete due diligence process, fundamental analysis and a discussion with your personal financial advisor.