Monday, December 5, 2016

Hurray!! The Bond Market is Crashing…

Hurray!! The Bond Market is Crashing…

Bert Whitehead, J.D., M.B.A. © 2016

The surprising election results have been followed by recent unexpected shifts in the financial markets. Stocks have soared, and bond prices have dropped substantially. Most of our clients have 15-year bond ladders in place if they are retired, or if they are still working the accumulation stages, they are building a bond ladder.

Looking at your brokerage statement now can be scary if you focus on how much bonds have dropped in value. If you have never experienced a rout in the bond market like this, don’t be unnerved. This is actually a very good development for the long-term growth of your portfolio because usually the stock market sky-rockets when bond values drop. And in fact, the stock market has been hitting market highs almost every day since the election so your total portfolio is likely increasing in value significantly if it is properly balanced between stocks and bonds.

Why does this happen? It doesn’t prove that the “right” person won or that it was caused by disfavor of the losing political party. Surprise events sometimes trigger market reaction, but the pressure for this kind of correction has been building over the past few years. Indeed we might have experienced the same market phenomenon (stocks going up and bonds dropping) if the other side won politically. What sparked the change in the market is probably the reduction in fiscal uncertainty which has been a drag on the global economy for several years. Financial markets abhor uncertainty.

The long-term favorable impact on your investment portfolio is a result of your stocks increasing significantly in value. A diversified stock portfolio is the growth machine for your finances. And your bonds, which provide safety, aren’t actually losing money.

We insist on using U.S. Stripped Treasuries in clients’ bond ladders. So the amount you have invested to buy your bonds plus all the interest earned, is government- guaranteed as a direct obligation of the U.S. Treasury if you hold the bond to maturity.

 If you became a client 15+ years or more before retiring, we have been buying some bonds for your ladder each year. This is called ‘dollar cost averaging’ and gives you the advantage of knowing your bond portfolio will end up earning interest equal to the market rate average over the past 15 years. The current increase in interest rates will be reflected in the bonds we buy for you as we are able to lock in these higher rates. So you are not gambling on interest rates and don’t have to fret whether rates go up or down.

While you have the security of knowing you will be able to maintain your current standard of living after retiring, we use the stocks to replenish the bond ladder during periods of economic growth, which pushes up the value of your stocks.

You may be wondering why your statement is showing your bonds dropping in value as interest rates rise, i.e. why bond value moves inversely to interest rates. If you buy a $10,000 bond when rates are 5%, you are guaranteed to receive $500 per year in interest until the bond matures and you get your $10,000 back.

But if you get scared (or greedy) when rates increase to 6% and want to sell your bond a year after you bought it you will realize a loss. This is because the investor who buys your bond will get only $500/year in interest whereas a newly issued bond would pay $600/year. So you have to drop the price of your bond to a “discounted value” of about $8333, so the $500/year in interest which is locked in will provide a yield of 6% to be competitive in the market.

The opposite is also true: over the past 10 years interest rates have been dropping so you may see the value of your bond increase. It doesn’t make sense to sell it however because you would pay taxes and transaction costs, and then you would have to invest at a lower rate.

So bond prices move up and down all the time, but holding your bond ladder to maturity assures you will be repaid your investment in full including interest. For long term investors who use bonds to provide their safety net and hold to maturity, the market fluctuations in value are just “noise.”

Buying and holding bond ladders provide another important benefit-- the security they provide keeps clients from panicking when the stock market crashes. The worst investment decision an investor can make is to sell low when holding a long-term investment.

The take-away from this discussion is: “Don’t let your political convictions dictate your investment strategy.” Political convictions are an exogenous issue over which you have no control, whereas with our Functional Asset Allocation model your investment returns are endogenous and tailor- made for your situation without regard to market shifts.

Thanks to Shari Cohen for copy editing.

Saturday, January 9, 2016

"Deja Vu" All Over Again

"Deja Vu" All Over Again
Bert Whitehead, M.B.A., J.D. ©2016

2016 will be a year which separates the gamblers from the investors.  Of course, we all want to think we are knowledgeable, prudent investors.  In fact, people who are most worried about the current financial upheaval are closet gamblers.

The Dow Jones Industrial Average has tumbled more than 1,000 points since the beginning of 2016, which was a much better performance than the Chinese stock market that stopped trading most of the first week of the year.  This panic impacted virtually all global stock markets, and aggravated the nosedive in commodity prices.  Gamblers anguish that this is just the start of the collapse of the world economy, which some economists predict will drop 80% in 2016.  The world seems unsafe from ISIS's distressful terror attacks in Europe, to North Korea's claim to have set off a hydrogen bomb, compounded by the emerging conflict between Saudi Arabia and Iran, and the misery inflicted in Syria by both Russian and U.S. bombers.

By comparison, the U.S. economy seems strong:  unemployment has dropped (although fewer workers are in the workplace). Most economists expect our Gross Domestic Product (GDP) to grow more than the GDP of the majority of western nations.  While some whine about the 'growing inequality' in this country, that is a rather parochial view because world-wide the middle class is the largest in history.  We no longer are concerned about the starving millions in China and India as their prosperous middle class has grown in proportion to our decline as a profitable manufacturing nation.  The global economy is so intertwined that economic issues in any of the larger world economies impact other countries.

The Past Does Not Predict the Future

Just as the proverbial broken clock is right twice a day, so the price of any stock or of the stock market as a whole measures only the value at a single point in time.  Market volatility is the method the market uses to find the right balance in pricing stocks over a market cycle.  Generally market cycles are extremely variable, lasting from 3 to 15 years.  Thus, past performance is not a reliable predictor of future value.

The reaction of gamblers is to try to determine which factor in the global economy is decisive.  These market timers foolishly believe that they can figure out future value from past market trends, just as gamblers bet on roulette using past patterns as their guide.

Sharp drops in stock prices are the time when investors who dollar cost average make the most profit in the long run, which is ideal for working people in the accumulation phase.  The biggest mistake investors make is to panic during a downturn and sell out.  Avoiding this outcome requires the investor to make two decisions right:  when to sell and when to buy back in.

Reduce Volatility for Peace of Mind

The reason our compliant clients prosper is because they have U.S. Treasury bond ladders.  These securities reduce the volatility of the whole portfolio, and are psychological assurance that they won't get wiped out.  Of course if we have a worldwide financial collapse and we all have to learn Arabic, our wealth could be at risk.  But in the end, our clients will still have more money than their neighbors.
For those of you who weathered the 2008 market crash, the current situation may be deja vu.  In 2008 I wrote 16 blogs which are on point in evaluating the present situation.  If you were not able to read them before, or perhaps don't remember them, you can review them at

Thanks to Shari Cohen for copy-editing.

Wednesday, April 30, 2014

I.R.S Scams and Identity Theft

I.R.S. Scams and Identity Theft

Bert Whitehead, M.B.A., J.D. ©

Don't be too surprised if your tax return is rejected by the IRS because someone else has already filed with your social security number. This scam is increasing exponentially, and nearly every tax preparer I’ve surveyed this year has had clients who have experienced this.  One of our clients last year had to come up with $8,700 to avoid liens (which he was refunded), his credit was ruined for a year, and it took him eight months to settle the issues.  That's how he learned it is important to look at his statements every month!

It’s a long, frustrating process to straighten this out if you’re getting a refund. If you owe money to the IRS and send them a check, the matter somehow gets resolved much more quickly.

This is technically identity theft even though these thieves don't have to access any other personal information. To file your return, all they need is your name and social security number. There have been instances where crooks have just used a random number generator to make up social security numbers. If they’re able to obtain other information (PIN #, address, etc.), they may wipe out your bank account.

These fraudulent returns are filed electronically early in the season, such as early February. The crooks make up the information needed from your W-2 so that all the necessary entries are shown on the return they file, and of course they have the refund sent to their address or P.O. Box.

Indications of Tax Fraud

There are several other ways swindlers are fleecing taxpayers. For example, some will call and impersonate an IRS agent and demanding that you immediately pay them using a preloaded debit card or wire transfer.  This scam has recently been reported by an increasing number of clients.  Emails are often used, usually by "phishing," which involves setting up bogus email accounts or websites to induce you to send them your social security number, ostensibly so they can verify it.

Of course there are also dishonest preparers who skim part of their client refunds, or use the information provided to steal cash from legitimate bank accounts. Some scams try to enlist you to help them track a suspect by divulging your bank account numbers. Taxpayers have even been urged to send their money to an overseas bank account to avoid government “spying” by the National Security Agency (NSA).

If you receive a letter from the IRS saying that more than one tax return has been filed in your name, or showing income from an employer you don't know, or a refund offset, you should suspect fraud. If you have lost a wallet or purse and suspect someone may use your information for identity theft, fill out the IRS Identity Theft Affidavit, Form 14039. The toll-free number of the IRS Identity Protection Specialized Unit is 800-908-4490. Be sure to also file a police report, as it will be necessary to provide a copy of the report to various entities when you’re trying to reclaim your identity.

Identity Theft Protection Plans
There are a number of plans available which cost about $100-150 per year that insure against losses from identity theft. A rider to your homeowner or auto policy may be even less, possibly $20-50 per year. The problem is that these services can't keep your identity from being stolen --- only you can do that. If your identity is stolen, all these plans cover is some out-of-pocket costs such as phone calls and postage. These costs are usually less than the deductible, which could be anywhere from $100 to $1,000. 

The most significant problem when your identity is stolen is the need to close your accounts, open new ones, and painstakingly advise creditors of the problem (usually including providing a copy of the police report). No insurance company can do that for you, nor do they reimburse any money which may be stolen from you. So in the worst case it could cost about $1,500 to clean up your identity (not including any losses which are covered automatically by your credit card companies). This hassle is compounded if you’re behind on your bills, as creditors will suspect that your claim is a ruse to further delay payment.
You can obtain ID theft assistance for free. For example, American Express provides 24/7 identity theft assistance to all cardholders with a toll-free number. They will assign an AMEX representative to "help you determine if you identity has been stolen, navigate the recovery process, and protect yourself in the future."

The best known identity theft insurer is LifeLock, which advertizes heavily with well-known celebrity endorsements. However, there are many complaints about their limited services:
·         If you need their help, they only contact banks (not credit card companies).
·         Once you sign on, it is very difficult to get them to cancel you.
·         Their service is very impersonal.
·         They do not monitor activity on your existing accounts, only new accounts opened in your name.

Checking Credit Bureau Reports

Identity theft may become evident through unexpected and unauthorized checks of your credit report. The three main credit bureaus (Equifax, Transunion, and Experian) offer various plans to offset identity theft. I have used Equifax 3-in-1 for about 5 years ( They charge about $150 annually. With this service I’m notified whenever a credit application is made in my name, or when there’s unusual activity on my accounts using parameters that I determine. The most comforting aspect of their service is that I receive an email whenever any of these credit bureaus receives a credit application in my name. In addition, I receive an email every month they have not detected any activity on my account. They also provide a free personal credit report annually.

Do-it-yourselfers can obtain a free credit report from each of the three main credit bureaus annually, so you can diligently check your credit for free every four months. The proper website to obtain these reports is
But if there was fraud involving any of your accounts during the four-month, interval you would miss it. Your credit report does not include your credit score.

Thanks to Shari Cohen and Laura Webber for copy editing

Thursday, March 6, 2014

Rich Kids, Poor Kids (Part 3)

Rich Kids, Poor Kids (Part 3)
Bert Whitehead, M.B.A., J.D. ©2014

This is the third of three related blogs covering a broad topic:

  • Part 1: A View of our World Through our Grandchildren's Eyes in 100 Years
  • Part 2: Intergenerational Tax and Financial Strategies to Leave a Family Legacy
  • Part 3: The Most Important Lesson to Teach Our Children Now

The foremost lesson for children is to always save 10 percent of all of their income—whether from their allowance, babysitting earnings, or gifts, as well their gross earnings and investment income. Even during retirement, save 10 percent of your income.
Often people think that “save” means to put money away for spending later, rather than investing their savings to grow their financial base, or building “investment capital.” When we refer to savings in this context, we are referring to saving money for investment, not to spending the principle.

As children develop the habit of continually saving 10 percent of their income, their total capital will grow. This is an opportunity to teach them the basics of investing, starting with a savings account or money market. Once they have accumulated enough, move their investments to an S&P 500 Index mutual fund; these are offered at a low price by Vanguard and other no-load funds. They have very low minimums if automatic investment is selected, so savings can be transferred monthly from the savings account to the mutual fund.

Once the child’s investment capital savings reaches a total of more than three times their annual savings, they will experience the “Miracle of Compounding.” This is the tipping point when they will realize that the amount earned from their investment capital now exceeds the amount they are saving each year. At this point, their capital mushrooms exponentially and their wealth is created through their savings and investments.

There is a widespread misconception that rich people become wealthy by taking money away from poor people. The truth is that wealthy people are rich because they always invest part of their earnings. Poor people who spend more than they earn always stay poor. Even people who make a lot of money often still spend more than they make, so they never become wealthy. But people without much money are never broke if they always save 10 percent!

Tyrone Solee wrote an article that beautifully explains the difference between people who are wealthy, and people who are simply rich. To summarize:

The main difference between being rich and being wealthy is knowledge. Wealthy people know how to make money, while rich people only have money. Being wealthy is defined as that status of an individual’s existing financial resources that supports his or her way of living for a longer duration, even if he or she does not work to generate a recurring income. Rich people, on the other hand, may get money in an instant such as inheritance or winning a lottery. However, because of lack of proper mindset and poor money management skills, all of it can be lost in a short period of time. In essence, wealthy people are financially free while rich people are not.

The name of this game is Capitalism and the winners are those who at some point are able to live off the earnings from their money instead of by the sweat of their brow. This is true freedom and an important lesson for all of our children. Rich kids always save 10 percent of their income and poor kids always spend every last dime!

Monday, February 17, 2014

Rich Kids, Poor Kids (Part 2)

Rich Kids, Poor Kids (Part 2)
Bert Whitehead, M.B.A., J.D. ©2014

This is the second of three related blogs covering a broad topic:

  • Part 1: A View of our World Through our Grandchildren's Eyes in 100 Years
  • Part 2: Intergenerational Tax and Financial Strategies to Leave a Family Legacy
  • Part 3: The Most Important Lesson to Teach Our Children Now

As discussed in the previous blog, our society is increasingly split between rich kids with a good educational and health foundation, and poor kids with a disadvantaged upbringing likely to hinder their futures. While we can’t restructure dysfunctional families, we can do our best to ease the way for our own children and grandchildren.
We send the best and brightest in our society to Washington to figure out what policies we need to become a better country. Frequently these policies are structured as tax incentives that reward specific financial actions. I believe that those of us who learn about these tax policies and follow the will of Congress are acting in the most patriotic way possible. I suggest three strategies for consideration: Donor Advised Funds, Roth conversions and Intergenerational Strategies.

Donor Advised Funds for Tax Benefits and Philanthropic Options

Donor Advised Funds (DAF) enable individuals and families to set aside funds, tax-free, under the umbrella of a 501(c)3 nonprofit foundation. Most brokerage companies (Schwab, Fidelity, etc.) and many large non-profit and community organizations (Jewish Federation, Southeast Michigan Community Foundation, etc.) offer these DAFs to all individuals at a nominal cost. Each DAF manages its funds, directing contributions to nonprofit groups chosen by the donor(s).

For taxpayers in the top tax bracket, giving $1,000 in cash to a DAF results in a $400 tax saving. However, if $1,000 in appreciated stock is donated to a Donor Advised Fund, the donor saves $400 through the income tax deduction and up to an additional $200 by avoiding the capital gains tax on the appreciated stock.

Our society depends on taking care of one another and these tax incentives make philanthropy more financially appealing. When my family gets together annually, each member identifies a nonprofit organization for a $100 deduction from the Whitehead Donor Advised Fund, and we make the grants online accordingly. When older grandchildren are away at school or jobs and unable to join us, they email me their choices for charities. This is a good way to develop a family commitment to help others.

Roth Conversions

Another way to save taxes for future generations is to convert IRAs to Roth IRAs. The money converted to the Roth IRA is taxed now, and future earnings accrue totally tax-free.  Withdrawals after retirement age are not taxed, and there is no required minimum distribution, which is normally required at age 70 1/2. Upon the death of the taxpayer, the spouse pays no income tax as the beneficiary of a Roth IRA. After the death of the second spouse the Roth IRA accounts can be passed on to their children, who will also receive the distribution from the Roth IRA tax-free. They can then elect to withdraw it gradually, with the minimum required distribution based on their life expectancy at the time they inherit the Roth IRA.

When IRA funds are converted to a Roth IRA, the transferred funds are subject to taxation as ordinary income. Generally conversions are made after significant wealth has accumulated and the taxpayer is in a much higher bracket. This disincentive to elect Roth IRA conversions can be mollified, however, with astute tax planning.

For example, while high income taxpayers are not allowed to contribute directly to Roth IRAs, they can fund non-deductible IRAs (the maximum contribution is currently $6,500 per year). The non-deductible IRA does not provide a tax benefit other than that the earnings accrue tax-deferred. The significant tax advantage is that the IRA can be converted later to a Roth IRA and taxes are assessed only on the accumulated earnings, not the original basis.

Intergenerational Tax Strategies

The creation of a Donor Advised Fund and conversion of an IRA to a Roth IRA can be combined for maximum tax benefit. By establishing a DAF, the tax deductions for the funds contributed to it can offset taxes on the funds converted to a Roth IRA.

Establishing a DAF and utilizing Roth Conversions are very effective ways to pass on our philanthropic values and conserve assets for future generations of our families.

Since these strategies can be somewhat complex, it is important to work with a tax professional to implement them correctly.