The first priority for what gets paid starts with the interest on our national debt which would take $207 billion.  The next priority would be military operations, which is budgeted at $965 billion.  The amount left over to fund all other U.S. government spending would be just shy of $1 trillion.  It would require a 60% cut across the board to all of the other federal programs in order to balance the budget.  This would affect every person who receives benefits from Social Security, Medicare and Medicaid, education, transportation and infrastructure, unemployment, low income housing, environmental services, national parks services, public safety, prison security and on and on.

Trying to predict what would happen if the politicians in Washington failed to reach an agreement is difficult.  However, because of the untenable nature of the spending cuts it doesn’t seem likely that a government shutdown would last long.  The last two times it occurred, it lasted a total of six days in 1995 and around three weeks in late 1995 to early 1996.

We believe that a deal will get done before a shutdown happens.  Our assessment of where things currently stand is that a deficit reduction package that both sides can come to an agreement on may not be possible by August 2^nd.  What can happen, however, is an agreement to punt the issue of making structural changes not only to spending but also our tax code (revenue) to the 2012 election.  The leadership in the Senate is working on a backup plan that would give the President the authority to raise the debt limit without a specific approval by Congress.  This would accomplish a short-term solution allowing more time for discussion of the two longer-term potential problems, health care costs and the appropriate level of tax revenues, to be addressed.

Photo Credit: iandavid via flickr

Recently, Fitch Ratings became the latest ratings agency to issue warnings of impending downgrade on U.S. debt.  A statement issued by Fitch’s warns that U.S. Treasury bonds would be rated as “junk” if the government misses any debt payments by August 15.  However, we interpret this as a lack of confidence based on short-term political wrangling rather than the real issue of our long term fiscal position.  Notice Fitch references the risk of “stalemate” leading to failure to raise the debt ceiling.

In other words they are afraid that in essence our government will choose to not pay its debt rather than the United States being unable to pay its debt.

Unfortunately, politicians are making hay by confusing two wholly separate financial problems- 1) the short term which is a high deficit caused by the worst recession since the Great Depression, and 2) the long term projection of US government debt.

For the short term problem we fortunately have examples of two other episodes where we had large deficits- the 1940’s and the 1980’s.  As you can see from the following chart, our current deficit is bigger than the 80’s but smaller than the 40’s.  Not only did the country not collapse after those episodes, but we thrived.

Notice that in the 1980’s we saw both decreased revenues and increased spending just like now.  Given that the 1980’s policies were successful in getting the economy going, it makes sense that we used Reaganomics on steroids to help pull us out of this deeper recession.

1940-2011 US Government Revenues & Expenses

As for the long term, the fiscal problem is mostly about two issues: 1) the appropriate level of tax revenues going forward and 2) getting a handle on rising health care costs.  We’ll be posting some additional blog posts to explain why these are not unsolvable problems.

Saving too Much?

Eligible to Contribute?

Roth IRA’s have been around since they were established by the Taxpayer Relief Act of 1997 and are named for the late Senator William Roth of Delaware who introduced the legislation.  They have grown in popularity because of the special tax treatment they receive as long as certain requirements are met.  Although you don’t receive a tax deduction for contributions to a Roth, the earnings grow tax free.  There are certain rules that you have to meet in order to contribute to a Roth; you have to have earned income and your adjusted growth income cannot be above certain limits – for 2011 those limits are $179,000 for married filing jointly and $122,000 for single filers.

I Contributed Too Much!

If you have made a contribution to a Roth IRA and find out later that you either don’t meet the requirements or that you’ve contributed too much you’ll need to take corrective action.  IRS publication 590 explains that an excess Roth contribution “withdrawn on or before the due date (including extensions) for filing your tax return for the year is treated as an amount not contributed.  This treatment only applies if any earnings on the contribution are also withdrawn.”  The earnings will be subject to a 10% early withdrawal penalty if you are under the age of 59 ½. If you have losses in the Roth account since the excess contribution was made then you’ll need to take out the excess contribution less the losses associated with the contribution. Note that the gain or loss is calculated across the account and not the individual holding that was purchased with the excess contribution.

Making the Correction

In the IRS instructions for form 8606 you can find an explanation that a corrective distribution includes the excess Roth contribution plus earnings and must be reported on form 1040, lines 15a and 15b for the year that the excess contribution was made and you should attach a statement explaining the distribution.  You cannot deduct a loss that occurred.  If you were under the age of 59 ½ the earnings generally will be subject to a 10% penalty which is calculated on form 5329.  The following year you will receive a 1099R from the custodian of the Roth account with a distribution code P in box 7 which indicates return of contribution taxable in a prior year.  If you have already filed your return you still can withdraw the contributed amount plus earnings as long as you do it within six months of the due date of the return.  You’ll need to file an amended return in this case.
The other option for correcting the excess contribution is to apply them to the following year.  Be sure, however, that you expect to qualify based on the earned income and AGI limitations for the year you want to apply the excess contribution as there is a 6% excise tax for each year that it is considered an excess contribution.  If you have chosen to apply the excess contribution to the next year the tax reporting is treated differently.   You will report the excess contribution on form 5329 where the excise tax of 6% of the smaller of the excess contribution or the value of your Roth IRAs as of the end of the tax year is calculated.

Take Advantage

Roth IRA’s are a great vehicle for retirement funding.  There are some rather complex rules associated with Roth’s, however, that can trip you up so you should seek out some professional advice if you are uncertain what applies to you.

Photo Credit: Lummmy

Take Steps Now

The end of the year is drawing ever closer and that can mean only one thing … tax planning.  Well, of course there are other things to worry about before the clock strikes midnight on Dec 31, however, making the right moves where Uncle Sam is concerned can save you money and that makes for a Happy New Year.   The current uncertainty in Washington regarding future tax laws makes tax planning that much more difficult, but there are still opportunities if you know where to look.  This article does a good job of highlighting a few of those opportunities.

Photo Credit: MudflapDC

Lots of people have made money in gold, right?  How about collectibles?  Hedge funds?  Wine?  As many investors discover, the world of alternative investing is cluttered with hard to understand rules that can create an uphill climb from the outset.  Take for example this recent story in Businessweek:

http://www.businessweek.com/magazine/content/10_31/b4189050970461.htm

The investor’s urge to do something different was driven by his desire to make up for losses in his portfolio.  So as he watched the price of oil plummet in early 2009 to $34 a barrel, he saw an opportunity to get in at a low price (buy low thinking is good!) and had his broker invest in an exchange traded fund, or ETF, that is designed to track the price of crude oil.

What he didn’t know about was something called contango.  Not only does this word sound like the famous dance, but it also a figurative dance as well.

As this investor learned, the contango trap happens when the price of oil, or other commodity, is rising, but the ETF designed to track the price of oil loses money.  Huh?…

It basically comes down to an inability to take delivery of the oil.  The ETF is a pool of investment dollars, not an empty oil tanker.  In order for the ETF to stay in the game, it has to renew its futures contracts.  So when the contract it currently holds is close to expiration, it buys another one at (you guessed it) a higher price, thus eroding the value of your original investment.

It’s not just individual investors learning hard lessons by using strategies involving alternative investments, there are plenty of examples of big pension and endowment funds gambling their assets on risky and overly complicated investments.

http://www.tampabay.com/news/politics/state-pension-funds-266-million-investment-disappeared-in-2-years/1034097

http://noir.bloomberg.com/apps/news?pid=newsarchive&sid=aHQ2Xh55jI.Q

The moral of the story is to control the impulse to go in a different direction just for the sake of trying something different.  If you are going to go down a new investment path be sure that you have charted the course by using a sound, straight-forward strategy.

As a rule of thumb, the more complicated an investment is the less likely the investor fully appreciates the risks they are taking.  As Warren Buffett once said, “Never invest in a business you cannot understand.”

Photo Credit: Rndoam

Smartphones and other portable devices allow the user to stay connected from even the most remote locations.  Social networking sites like Twitter and Facebook have amplified the chatter to a level that no one would have dreamed of at the beginning of the millennium.

A troubling byproduct of this flood of information is the ease with which extreme messages are being propagated.  From cable news shows to the blog-o-sphere, we are being bombarded with ideological beliefs that are driven mostly by emotion and have little use for facts.  During turbulent times especially, irrational views can become pervasive because they touch emotional nerves that otherwise would not be as sensitive.

A Ratings Game

Avoid Extremes

Larger than life persona’s on both ends of the spectrum do their best to keep us all in a constant state of anxiety because they know that if we are provoked enough we will continue to tune in.  The name of the game is ratings, because higher ratings translate into higher advertising revenue.

Glenn Beck and Michael Moore are polar opposites on the political sphere, but they have more in common than either one of them would care to admit.  The challenge they face is trying to blend editorial content within a format that is meant to entertain.  They both endeavor to create an emotional response in their audiences by enhancing certain aspects of the subject matter while leaving important details out that would possibly cause a different reaction.

Motivation that was born of their formative experiences is altered by a cycle of capitalistic one-upmanship that can distort even the purest of intentions.

Unfortunately, blurring of the lines between truth and fiction in the information landscape is all too common, and often the consequence for the consumer is drawing a conclusion without having heard the full story.

Separating Fact from Fiction

Keeping fact separated from emotion is an important part of our job and something that we spend a great deal of time doing.  A healthy dose of skepticism is necessary, as we have found that even the most respected source of information can often be influenced by their biases.

We employ various methods, such as quantitative research, to enhance the opinions and analysis gathered from our trusted sources.  We also talk to people in our industry as well as our clients to get a perspective as to how others are experiencing the economy.

There is no easy solution to charting the course that we feel will provide the best opportunity for success.  By remaining consistently disciplined in a long-term approach to investing, we believe that we can gain an advantage by filtering out the noise.

Photo Credit : truthout.org

Deflation Fighter?

Gold’s average annual return (using average monthly price) from 1980 through 1986 as it followed the inflation rate down is a negative 10%; from 1980 to 2005 it is a negative 2%.  Meanwhile, gold didn’t hit its average monthly high again until over twenty five years later when it began its recent bull run in 2006.  Since 2006, gold has averaged a return of over 17% per year.  However, inflation has hardly been out of control during this time and, in fact, the prevailing fears currently facing the markets are those of deflation.  So how is it that a commodity that has a history of being used as protection against inflation is suddenly a haven in a deflationary environment?

Yosemite Sam’s Investment Choice

Gold is also a reflection of the overall faith (or lack thereof) in the economic and political system. Issues such as the European debt crisis, the Gulf oil spill, persistent joblessness, a housing crash hangover, etc. have created a sense that the problems we face are too big and might lead to widespread economic collapse.  Currencies will tumble in value in a collapse scenario, so the hedge with gold is that you will have protected your ability to trade for goods and services through the relative stability of its value.  That, in effect, is the bet that is being made by those who are pushing gold up into stratospheric territory.  The gold bet in 1980 didn’t break even for another twenty five years (even longer when adjusted for inflation), it will be interesting to see how well today’s gold bet plays out.

Are your Investments Growing?

Controlling Your Emotions?

Morningstar, an independent investment research company, compiled returns for how the average mutual fund investor did during the 2000’s. The research added a layer of analysis to the total return calculation by also tracking the cash flows in and out of the mutual fund.  They wanted to see what the performance looked like if you took into account additional buys and sells in the fund during the same time frame.  Then they compared the findings to the buy-and-hold strategy that mutual funds use to report investment performance.  What the findings show is that most investors suffer from bad timing as they get in when prices are high and get out when prices are low.  This is a reflection of how market forces can drive investor emotions and result in behaviors that cause poor relative investment performance.

Slow And Steady

Another interesting discovery is how fund companies provide different investing experiences for the average investor.  The institutions that stick to fundamentally sound investment principles were proven to have better investor returns relative to total returns than those companies that use a short-term, current-trends marketing strategy to attract investors.

Financial Symmetry’s composite results for the decade were an average annual rate of return of 4.93% compared to the average annual investor return of 1.68% across all funds.

Photo Credit: TheGiantVermin

Photo Credit: alancleaver_2000

Know Your IRS Numbers

Unfortunately, there’s no rhyme or reason that will help you to remember the different IRS form codes.  But, remembering the following two will assist you greatly if you encounter a situation like we described above.  After you initiate a rollover of a former 401k or 403b, you should expect to receive a Form 1099R.  This form is used to report distributions from IRAs whether they are taxable or not.  The second form, Form 5498, you will need is not as well-known but equally as important.  This form’s purpose is to report the rollover contribution made to your new IRA.  These two forms work from opposite ends in the event of a rollover, conversion or recharacterization.  Be especially vigilant when reviewing this information when a transaction starts at one trustee and ends up at another.

For example, if you completed a direct trustee-to-trustee rollover out of a Fidelity 401k into a Vanguard IRA you should receive a 1099R from Fidelity and a form 5498 from Vanguard.  The Fidelity 1099R should show the total amount in box 1 and a code G in box 7 for the direct rollover.  The Vanguard 5498 should show the same amount in box 2 Rollover contributions.

If you completed the rollover within 60 days, where you received a check from one trustee and then made the rollover contribution within that time frame you’ll want to make sure that the form 5498 is accurately reporting the rollover in box 2.  More than likely the trustee issuing the 1099R for the distribution will report a taxable transaction.  You should indicate “rollover” on your tax return and the IRS will get the form 5498 to back that up.

May 31st Tax Deadline?

The trustee that maintains your individual retirement accounts (IRAs) is required by the IRS to report contributions, required minimum distributions and the fair market value of the account by May 31.  This date may seem like an odd time to receive a tax form since you’ve probably already filed your return.  However, form 5498 reports contributions made to an IRA during the tax year as well as those made after December 31, but before April 15^th for the previous tax year.  Make sure that those contributions match up to what you have reported on your tax return. If not, contact the trustee that sent the form 5498 and request a correction.

RMD’s not WMD’s

Another place to be sure that the information provided by the trustee matches your records is Required Minimum Distributions.  There are some fairly complicated rules regarding RMDs, especially if the account was inherited, so it makes sense to double check the accuracy on form 5498.

Understanding how this form is used by the IRS can help keep your tax headaches to a minimum.

http://www.lifeandhealthinsurancenews.com/News/2010/4/Pages/Sebelius-Warns-Of-Health-Care-Reform-Scams-.aspx