BURT ASSOCIATES, INCORPORATED-6010 EXECUTIVE BOULEVARD #900-ROCKVILLE, MD 20852-(301)770-9880- FAX(301)770-9885
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Volume 10 Issue 2 May 2000
How to Handle Volatility
By Dr. Marvin R. Burt, CFP
The U.S. stock market has had a wild ride and there are no visible signs of it ending soon. As of this writing (May 3, 2000), the Dow Jones Industrial Average and NASDAQ are both down 7% in 2000, while the S&P 500 is down 2%. However, there have been enormous wrenching fluctuations during this period. The NASDAQ may be likened to a giant casino in which the players undertake great risk. Unfortunately, it is likely to be the individual investor who suffers substantial losses in this environment.
The best defense against this volatility is diversification. Our portfolios are diversified at two levels. The first level of diversification is by asset class. We utilize four major asset classes: U.S. equities, foreign equities, bonds and cash equivalents. Our allocations into these asset classes are designed to maximize the risk-adjusted rate of return for the overall portfolio. The second level of diversification is within each asset class. For example, we diversify within the U.S. equity asset class by allocating money to large capitalization stocks, medium capitalization stocks and small capitalization stocks. Further diversification is achieved by allocating to growth and value stocks and to different sectors (e.g., technology, energy, consumer stocks, etc.) Also, we will hold a large number of stocks in these various categories, which acts to further reduce volatility.
The result of our diversification process is portfolios that are significantly less volatile than one might expect. For example, while stocks have suffered this year, our bond portfolios are up more than 4% and cash equivalents are also up. These asset classes have served the purpose of stabilizing the portfolios. The article by Maria Cornelius provides a perspective on the volatility in the equity markets.
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Equity Update
Trying to Make Sense of the Market’s Volatility
By Maria G. Cornelius, CFP
We have seen a significant increase in volatility in the stock markets—so much, that the 11 o’clock news frequently comments on the positive or negative results posted for the day. Volatility, defined as instability or lack of predictability, can result in both gains and losses in the market. Of course, no one complains when the volatility results in positive returns, but when instability in the markets causes indexes to drop 10% or more in a week, investors worry. A number of different factors have contributed to the recent uncertainty in the markets, which results in volatility.
For much of the first quarter of the year, technology stocks, found mainly on the NASDAQ composite, continued to increase in popularity, following the trend established in the previous year. Some of these gains were in large well-established technology companies with solid earnings, while many others were small start-up companies with little to no track record or profits. The “old economy” stocks, such as General Motors, 3M and Dupont, found mainly in the Dow Jones Industrial Average, were negatively affected because investors were selling these stocks and reinvesting the proceeds into technology stocks. This process is called a sector rotation, and although it occurs frequently in the market, the most recent ones have been unusually dramatic.
So far, the start of the second quarter has seen a reversal in this rotation with investors flocking back to companies with strong fundamentals, after concerns with the volatility of technology stocks. Although this turnaround occurred around the same time that a U.S. District Court ruled that Microsoft had violated the Sherman Antitrust act, there were many other factors which contributed.
Interest rate fears, driven by Federal Reserve Chairman Alan Greenspan, have also been a factor in creating fluctuations in the market. Although growth in the economy, low unemployment, and low inflation all appear to be good things, the Fed views them as signs that the economy is growing too fast, which could result in inflation in the future. In addition, Alan Greenspan is quite concerned with the wealth created by the growth in the stock market. The gains, which investors see in their retirement and personal investments, have translated into increased spending. Although the stock market has been very choppy over the past few weeks with the NASDAQ tumbling significantly, until the Fed chairman sees that this is having an effect on excess spending, most believe that he will continue to raise rates. The stock market normally anticipates the rate increases, viewed negatively since they increase the cost of doing business, and has factored them into prices before the rate change has even occurred.
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While there are investors and portfolio managers buying on the dips (when the market has dropped), there seems to be just as many who sell at the peaks to reallocate their portfolios. New money continues to flow into the market every day and portfolio managers are responsible for investing that money as they see fit. It is this constant flow of money that continues to fuel the market.
We believe that it is important to put volatility into perspective. Over the short term, the peaks and valleys in the market can be very anxiety producing. It is essential to look at the markets over the long term--this could mean over the course of a year, or over the course of a business cycle (5-7 years). Certainly in the past, the overall trend for the equity markets has been upward. We continue to believe that, regardless of what happens over the short term, investors’ money will perform better in stocks, over the long term, than in any other investment class. The amount of stocks you hold in your portfolio depends upon your tolerance to the ups and downs of a volatile market as well as factors related to income needs and time horizons.
A Basic Understanding of Section 529 Plans
By Christopher H. Rhim, CFP
Education IRAs, UGMAs, and state pre-paid tuition plans are some of the vehicles available to those interested in saving for a child’s or grandchild’s college education. However, the latest and perhaps most attractive are known as Section 529 Plans.
What is a Section 529 Plan?
Named for the section of the federal tax code that authorizes them, these plans offer parents, grandparents and others the opportunity to help fund qualified higher education programs including undergraduate, graduate and accredited trade schools. Most states have Section 529 plans that are open to residents of other states. State plans do vary, usually offering tax advantages to in-state applicants. The major components common to all Section 529 plans include the following:
· Tax-deferred gains which are taxed at child’s tax rate when withdrawn for educational purposes.
· Donor (not beneficiary) retains control of the account.
· Potential state income tax savings for donor.
· Potential state income tax deduction for donor.
· No AGI limits for donor.
· Savings can be applied to any college in any state.
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Do you want to reduce your estate by making a tax-free gift? Contributions are treated as a completed gift while the donor retains control of the account. A Section 529 plan can accept $50,000 per child in either a lump sum or spread evenly over 5 years ($10,000 per year). By comparison, the limitation on Education IRAs is $500 annually. What if the child decides not to go to college? Plan rules allow the donor to change the beneficiary to a “member of the family” which could include a parent, grandparent, descendents, brothers, sisters, uncles, aunts and more. Today, large brokerage firms such as Fidelity and Merrill Lynch professionally manage most plans. Funds are invested in various portfolios that seek capital appreciation with reasonable safety of principal, consistent with the ages of the beneficiaries. As the child approaches the first year of college, the portfolio emphasizes preservation of capital and liquidity to pay bills as they come due.
Section 529 plans are different than their precursors known as state pre-paid tuition plans. Traditionally, these plans attempt to “lock-in” the cost of in-state tuition at today’s prices. A common pitfall of these state-run plans is a limitation on gains up to the average state rate of tuition inflation. Also, if a child chooses a private or out-of-state school, the account balance might not be high enough to cover those costs. In addition, donors in these plans are prohibited from contributing to Education IRAs in the same year.
Another issue to consider when donating to all education savings vehicles is the EFC (expected family contribution) and federal financial aid eligibility formulas. Payments from prepaid tuition plans, which are considered a student resource, reduce financial aid dollar-for-dollar. This is in contrast with assets saved in the parents’ names, which reduce aid eligibility by at most 5.6%, while assets saved in the student’s name reduce aid eligibility by 35%. According to the U.S. Department of Education, grandparents can keep Section 529 assets out of the EFC eligibility formulas by keeping the assets titled in their names.
A Section 529 plan titled in a grandparent’s name is a unique college education funding and estate tax reduction tool. While assets are removed from the donor’s estate, for federal estate tax purposes, the donor retains control of the asset. Under current rules, this is considered neither a parent nor student asset in the eligibility formulas for Federal financial aid.
New Maryland College Investment Plan
Just recently, the Maryland General Assembly passed Senate Bill 140 creating the state’s new 529 plan. Highlights include:
· Contributors may reduce Maryland taxable income up to $2,500 per year.
· Contributions exceeding $2,500 may be carried over until 100% of contributions are taken as a subtraction from taxable income.
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· Assets and income of the plan are exempt from state and local taxation.
It is not yet determined whether the Maryland Higher Education Investment Board will manage the funds in-house or outsource this key responsibility. Tax provisions of this bill are applicable to all taxable years beginning after December 31, 2000. The bill takes effect July 1, 2000.
Choosing a Plan
With each state having a Section 529 plan, how do you select the right one? While difficult to answer for each unique situation, we feel comparisons based upon the following criteria would be most useful:
· Professional managers will generally do better than internally managed programs (such as the Virginia Education Savings Trust/VEST) due to superior research, existing administrative capabilities, size, and experience in the investment community. State managed programs are created by legislatures and are an entity paid for by taxpayers, subject to changing political climates.
· Plan investments and performance will vary according to investment alternatives available in the plan portfolios. To provide adequate diversification and return, the plan should have a pool of different investments to choose from. Although federal law prohibits donors from selecting investments, this should not prevent the donor from fully examining the investments in each portfolio. Generally speaking, the more choices the better.
· Expenses and fees include management fees, 12b-1fees and transaction costs. Different providers charge varying amounts from as little as .29% to over 2%. Total fees of around 1% would be competitive in today’s environment. Many plans also charge application fees that can range from $0 to almost $100.
· Varying state rules and regulations of each plan must be thoroughly reviewed and understood. Contributions, for practical purposes, are irrevocable. Withdrawals, other than for qualified education expenses, will be penalized. Particular attention should be paid to the relative tax merits of in-state benefits vs. the fees and expenses of such a plan. Generally, performance, investment alternatives, and plan flexibility should take precedence over tax benefits and fees. Each plan, however, should be judged on its own merits.
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Strategic Alliance
We are pleased to announce that we have entered into a strategic alliance with the firm of Dembo, Jones, Healy, Pennington, and Ahalt, LLC. Dembo, Jones has been providing accounting and consulting services in Montgomery County for more than 40 years. Our two firms will continue to be owned and operated independently. This is a non-exclusive alliance in that we will continue working with other CPA and law firms as we have in the past. This arrangement will provide Burt Associates, Incorporated the opportunity to create a closer working relationship with these highly respected professionals with whom we have worked closely for more than 10 years.
We Have Moved
Our firm has grown substantially over the past several years, and we need more office space. On April 27, 2000 we moved to a nearby location. Our new address is 6010 Executive Boulevard, Suite 900, Rockville, Maryland 20852. Our new phone number is
301-770-9880 and our new fax number is 301-770-9885. Convenient, complimentary parking is provided for our clients.
Practice News
We are pleased to welcome three new staff members. Christopher Rhim, CFP and Christine D’Amato, CFP join our staff as Financial Advisors. Christopher Rhim has a masters degree in business as well as a Certified Financial Planner designation and has
worked as a Financial Advisor for eight years. Christine D’Amato is a Certified Financial Planner with 11 years of experience as a Financial Advisor. Joy Burt, Vice President, Finance recently retired after having served 15 years with the company. Lorraine Jennings has been promoted to Administrative Officer and will take over Joy’s responsibilities. Jennifer Hurley joins our staff as Administrative Assistant, after completing her college career.
We are developing a web site (“burtassociates.com”) that will be operational in a few weeks. Please call the office if you would like to receive a copy of our ADV form. The SEC requires that we make this announcement once a year.
Thank you for your referrals. Nearly all of our new clients come to us through referrals. If you know someone who could benefit from our services, please suggest that they contact us.