Optimizing Your Portfolio
By Dr. Marvin Burt, CFP
The stock market continues to be extremely volatile. As of this date (November 15, 2000), the S&P 500 index is down 6% since the beginning of the year, the NASDAQ is down 23%, and the Dow Jones Industrial Average is down 7%.
We talk a great deal about the advantages of diversification in reducing volatility and risk in one’s portfolio. Indeed, the experience this year proves yet again the importance of diversification in preserving one’s capital. Because of our diversification, our U.S. stock portfolios are in positive territory this year, while the market is down significantly. Maria Cornelius’ article addresses diversification by company size, which is one of the diversification strategies that we pursue. Another type of diversification strategy that we pursue is diversification by asset class (e.g., stocks, bonds, cash equivalents, etc.). Our bonds are having an exceptionally good year, thus substantially improving our investment performance.
Some people wonder what we actually do in managing investment portfolios. There seems to be a general understanding about what we do in financial planning, but investment management seems to be more of a mystery. Being active managers, we do a great deal behind the scenes that is not readily apparent. Chris Rhim’s article discusses some of our activities.
Few issues are as poorly understood as minimum distributions from IRA’s and retirement plans. Yet, decisions made can have enormous impact on one’s heirs’ income taxes. One can defer income taxes for many years by following an advantageous strategy. Christine D’Amato discusses some of the more basic issues in this very complex area.■
This year, once again we have seen the benefits of holding a well-diversified U.S. equity portfolio. The stocks of many mid-sized companies have led the market over the first three quarters of the year while many large stocks that previously led have struggled.
There are a couple of reasons that the stocks of mid and small-sized companies did well this year. Most importantly, at the beginning of this year, the stocks of large companies were quite simply overvalued. Over the past few years, these large companies were attracting investors regardless of their stocks’ steep valuations. Mid-cap stocks, on the other hand, had much more reasonable valuations.
Another reason is that many large U.S. companies derive a significant portion of their revenue from sales outside of the U.S. The U.S. dollar has strengthened considerably relative to nearly all foreign currencies. This has resulted in making U.S. goods and services more expensive overseas, and has depressed sales and earnings of these multi-national companies.
Our portfolio contains several very good funds, invested in both mid- and small-cap stocks, which have significantly increased our performance this year. While most of the broad equity indexes have declined for the year through October 31, the returns on our U.S. equity portfolio have been positive. We view the returns of our U.S. equity portfolio to be quite favorable since capital preservation is one of our main goals.
It is very difficult to determine which segments of the stock market will outperform. With that in mind, we build a portfolio that will benefit from a number of different market environments. Over the past several years, our portfolios have done very well due to our large-cap stock exposure. While large-cap stocks are currently being over-shadowed by mid- and small-cap stocks this year, we are benefiting from our significant exposure to mid- and small-cap stocks.■
How Your BAI Advisor Adds
Value On An Ongoing Basis
By Chris Rhim, CFP
Did you ever wonder how your
financial advisor actually manages your money?
While investment results are self-evident, sometimes it’s harder to
discern behind-the-scenes activities of how we actually make your money work
for you. This article will highlight a
few of the ongoing money management activities of all BAI advisors.
The Investment Committee is
composed of Dr. Marvin Burt, Maria Cornelius, Jennifer MacLennan, Christopher
Rhim and Christine D’Amato. This
committee approves and implements policy decisions at BAI. Market strategy considerations, asset
allocation policy and individual security examination are some of the topics
discussed in these meetings. For
example, we review our proprietary stock mutual fund screening criteria to
determine if mutual funds still meet our investment objectives. Did a fund manager retire? Is the fund investing in a manner consistent
with its stated investment objective?
Are expenses under control?
Should a fund not meet all the criteria, we discuss why it does not and
then decide whether to put this fund on our watch-list.
We also manage cash and cash
equivalents to maximize return, provide liquidity and be prepared for
investment opportunities. For most of
2000, our money market funds are yielding compounded returns of 6.1% to 6.5%. These are excellent returns given that
year-to-date returns for most major stock indices are negative. We also use short-term bond funds. These funds historically provide returns
greater than money market funds. We
currently have cash earmarked for investment back into the equity markets when
the stock market drops a predetermined amount. On October 12, we moved a
significant amount back into the stock market due to a 15% drop in the S&P
500 from its high. As of this writing,
this has had a positive impact on our portfolios.
Before the purchase or sale
of any of your investments, we will always give consideration to its tax
impact. For example, on October 12 when
we moved into the market, we purchased a mutual fund for all retirement plan
accounts since these accounts defer taxes.
Simultaneously, we purchased an ETF (exchange-traded fund) for our
taxable accounts to avoid year-end capital gains distributions of mutual funds. This is an index-matched security that,
unlike a mutual fund, trades on a stock exchange. We may use ETFs due to their inherent lower tax liability and
extremely low fees. We also consider
the timing of our purchases. Currently,
we are delaying until January the purchase of an international fund to avoid
the December capital gains declarations by the fund. Conversely, if we decide to sell a fund and capture a tax loss,
we would sell the fund before the capital gain is declared by the fund.
Improving Bond
Yield and Quality
As active bond managers, we
are always looking to improve the quality and total return of our bond
portfolios. While U.S. Treasuries
provide the ultimate in safety and high liquidity, we seek opportunities with
similar safety features yet higher yields.
This year, we have purchased GNMA (Government National Mortgage
Association) securities for some of our portfolios. This is a mortgage-backed security backed by the full faith and
credit of the U.S. government. We have
purchased GNMAs yielding at least 1.25% more than the yield on Treasuries of
similar maturity. The hallmark features
of safety and higher yield are typical of our weekly searches for your
portfolios.
As professional money managers, we strive to exercise sound, objective judgment over each investment in your portfolio. In an often volatile investment world, we have practices and standards designed to filter out the noise, inefficiencies and rashness of the investment world into a process which serves as the basis for your well-diversified portfolio. While our investment horizon is long-term, we strive daily for a better understanding of the markets and for continued stewardship of our clients’ investments.■
More Complicated Than You
Thought
If you are approaching age 70 1/2 or have already passed that point, you should be aware of some of the more complicated choices for meeting the required minimum distribution rules for Individual Retirement Accounts (IRAs) and qualified retirement plans. First, let's review the basics. If you haven't done so already, you should review IRS Publications 575 and 590 for the rules and requirements and then discuss them with your financial, tax, and estate advisors.
As many of you already know, your first required minimum distribution from IRAs and employer-sponsored retirement plans (not including your current employer's plan) must begin the year you turn 70 1/2. However, the IRS has allowed an extension of this first distribution up to April 1 following the year you turn 70 1/2, also called the Required Beginning Date (RBD). We recommend that you review your tax situation before deferring your first distribution into the next tax year since you will then be required to take two taxable distributions in one year.
Now, for the more complicated choices. Unknown or unclear to many IRA participants is the choice not only of the amount but also of the calculation method and the beneficiary. These choices determine how much you and your ultimate beneficiary must take out each year. You can always take more out of your IRA (or retirement plan) as needed but we will focus on how to minimize your IRA distributions in this article. Also important to note here is that minimum distributions must be calculated separately for IRAs and for employer-sponsored retirement plans, including 401(k) and 403(b) plans. Although you can combine IRA minimum distribution amounts and distribute the total from one or more IRA plans, you cannot combine IRA and other retirement plan distributions.
Not to make it more confusing, but the IRA owner can elect single life recalculate, single life term certain, joint life recalculate both lives (available only to spouses), joint life term certain, joint life recalculate owner's life (the hybrid method, subject to the minimum distribution incidental benefit or MDIB rules), or joint life recalculate spouse only. Life expectancy tables can be found in Publication 590 and different rules apply to individual retirement annuities. You can also name multiple beneficiaries of one IRA plan but under current regulations, only the eldest beneficiary will be factored into the distribution formula.
One reason you should spend time reviewing the options with your advisors is to minimize future required withdrawals after your death, thereby deferring taxes and stretching out the life of the IRA plan. For example, if the IRA owner or beneficiary has a terminal illness, then election of the term certain method may be the best strategy. Part of the planning process should include a consideration to split IRAs so that different beneficiaries can use their own life expectancy in the ultimate distribution formula as well as minimizing the current distribution amount. Trusts can also be named as beneficiaries but need to meet certain criteria to qualify for continuing the minimum distribution amount after the owner's death.
The election you make is irrevocable after the RBD
(April 1 following the year you turn 70 1/2).
Unfortunately, the IRS has not provided the IRA owner with a standard
form to make this irrevocable election.
It is up to the IRA owner to make this election. Some experts recommend that a written
letter, with a return receipt requested, be filed with your IRA plan
custodian. Some plan sponsors have a
form available upon request.
But what happens if the IRA owner fails to make a
written election of the calculation method and then passes away? The tax rules are complex in this area and
the IRS makes certain assumptions as to the method elected. If no written election was made or found,
then we need to look at the IRA plan
document, the designated
beneficiary as of the RBD, and the amount of the distribution already
being taken. Since the rules require
the distribution to continue at least as rapidly as under the method in effect
at the owner's death, we need to determine whether the method was single or
joint life, recalculate or term certain and what choices are available under
the custodian’s plan document.
Important to note here: if the
beneficiaries want to continue minimum distributions over the life expectancy
or term certain method in effect, their election and distribution must begin no
later than December 31 of the year following the IRA owner’s death.
As you can see, IRA minimum distributions are complicated
and need special attention when the owner wants to minimize them for himself
and his heirs. Please call us to
discuss these rules prior to age 70 1/2 and to review your required distribution
plan annually. We are currently
tracking pending legislation that will change the minimum distribution rules
and possibly allow for a revision to previous distribution elections. As a final note, your required IRA
distribution amount can increase each year if your portfolio is growing faster
than your distribution rate. Not a bad
problem to have, as long as you distribute the minimum amount each year to
avoid the 50% tax penalty.■
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PRACTICE NEWS Dr. Marvin Burt, CFP has once again been named by Medical
Economics magazine as one of the
best financial advisors in the nation. Christine D’Amato, CFP is serving as Director of
Government Relations of the Financial Planning Association’s local chapter. Jennifer MacLennan, CFP delivered Lindsay Cecelia
in May. Our web site (www.burtassociates.com) is fully
operational and contains information about BAI, our investment philosophy,
staff background, performance, and more. |