Tax Rates - Where are They Headed?

A pretty strong consensus exists that tax rates are going up. The massive deficit spending and entitlement programs of our government make this a near necessity. Different political parties will express different solutions to our current fiscal crisis, but rising taxes is included in many of these. Although most people don't like paying taxes or the prospect of increasing tax rates, awareness can help us plan and be prepared for these impending changes.

Personal Income Taxes - It is unlikely that personal income tax rates will change in 2009 or 2010. The Bush tax cuts will expire at the end of 2010 and the top tax rate at that point will revert back to 39.6% from a 35% rate today. A surtax for high-income individuals has been proposed in various health care proposals, but this should not take effect until 2011. A higher capital gains tax rate and other tax increases would likely also take effect then.

Estate Taxes - The current estate tax is set to expire at the end of 2009, with no estate tax being due in 2010. It is extremely doubtful that Congress would let this revenue source go away. Various proposals are being debated in Congress right now. The current estate tax rate of 45% and the current estate tax exemption amount of $3,500,000 per individual could change, but this should become clearer in the next several weeks.

Business Income Taxes - Business income tax rates have not changed much recently, but Congress has implemented various bonus depreciation deductions and additional loss carryback provisions to try to give businesses tax breaks in recent years. A more comprehensive business tax overhaul is possible in the next couple years, but these changes are unclear at this point.

Taxes are a significant part of all individuals and families' financial situation. Although the tax impact of various financial decisions should not be the primary consideration, awareness of current and future tax rates and deductions is an important part of any financial plan.

Is Growth Returning?

The third quarter GDP (Gross Domestic Product) report was released today and it showed an increase of 3.5 percent. This means that the total value of all goods and services produced in the United States from July to September grew 3.5 percent from the prior quarter. This quarter of growth follows four consecutive quarters of decreases and officially marks the end of the current recession.

Is this all good news? The answer can be "Yes" or "No," depending on how you interpret the news and who you are talking to. It is a good thing to see some growth in the American economy again. We all benefit from growth and progress in our economy and standard of living. One caveat though, is that the American GDP is still 10 percent below where it was at its peak in 2008. The unemployment rate also stands at 9.8 percent, which is the highest it has been since the early 1980s.

Many corporations have shown earnings growth recently, but much of this is due to cost cutting as opposed to revenue growth. Much of the GDP growth was also due to consumers purchasing automobiles, many encouraged by the "Cash for Clunkers" program. Government spending in general has also been higher than normal recently.

An ideal situation is an economy experiencing fairly consistent, sustainable growth with low unemployment. The American economy has experienced this situation in the past and should again in the future, but much government intervention needs to be reduced and rolled back so the U.S. economy can stand on its own. American workers and consumers have the will and the desire to see our economy succeed. Our economy will move forward from a stronger base once a recessionary period is behind us. No one knows how the next few years will play out, but we are seeing more and more positive signs.

The Costs of Investing

Much has been said recently about a new sense of frugality in our economy. Down markets and higher levels of unemployment have a nasty way of forcing people to be more frugal. Whether this frugality continues is yet to be determined, but one thing is certain--consumers are more price conscious in today's environment.

So what is the price of investing? When I say price, I'm referring to the transactional or management cost of investments. The risk associated with stocks and bonds and the potential cost due to realized losses is another topic and a separate discussion. There can also be tax costs associated with investments which I won't address in this post.

The do-it-yourself investor will need to set up an online trading account and will typically pay a trading commission of $8-20 each time they buy or sell a stock. There might also be an annual maintenance fee. Mutual fund trades can have transaction fees, or might be "no-load," which means there isn't an initial cost to purchase the shares of the fund. Mutual funds also have ongoing management and trading costs, which can be quite significant. These costs are disclosed, but not easily obtainable or comparable for the individual investor. Mutual funds can also have front end (purchase) or back end (sales) charges.

The investor working with a professional financial advisor will typically pay on a transaction or ongoing management basis. Some advisors will also consult on an hourly basis. The transaction cost is often a commission or front end charge that is passed on to the advisor. Mutual fund management fees are also shared with advisors at times and surrender charges cost the investor for selling out of an investment before a specified period of time has passed. An ongoing management fee is typically charged based on the value of an investment portfolio.

The myriad of costs, fees, loads and commissions are often complex, confusing, and at times, unnecessary. They tend to enrich the advisor at the cost of the client or investor. Although any professional investment advisor needs to be compensated to make a living, I recommend three things to keep in mind with regard to investment costs.

1) Costs should be fully and completely disclosed. Financial advisors are more likely to hide their fees if they are unnecessary or unreasonable.

2) Costs should not be charged at multiple layers, if possible. Investing can be done in an efficient, institutional manner where costs aren't charged at many layers without any corresponding benefit.

3) The financial advisor's compensation should be fully aligned with the client's best interest. An advisor shouldn't be paid solely for a "sale" without any ongoing accountability for client success and service. Commission-based salespeople are motivated to convince you that their solution is the best because that is how they are paid.

Investing significant financial assets in an appropriate manner can be critical to a prosperous and flexible financial future, but careful attention should be given to the price of investing before moving forward with an approach.

Will America Still be No. 1?

The recent economic times have caused some to question whether America will continue to be the economic superpower it has been in the past. The World Economic Forum recently ranked the United States number two behind Switzerland amongst the world's most competitive economies. While I'm a strong believer in a free-market economy and the uniqueness of America rooted in the ideals of our founding fathers, no one can say how the American economy will compare to other world economies several generations into the future.

As an investor, what should you do to adjust to this potential new reality? It really comes back to one of the basic principles of investing - diversification. Any well-designed investment portfolio should take a world view and include more than just U.S. stocks and bonds. Developed and emerging international markets should also be considered. European and other developed economies, along with emerging markets like China and India, can diversify the risk of a portfolio while potentially increasing the return.

Which countries should be invested in and in what ratio? More emphasis should be put on developed economies because of a longer track record and stronger government regulation and controls. Emerging markets offer enticing potential returns, but they bring increased volatility and the added risk of unstable governments or unethical practices. Limited emerging market investments are appropriate for most investors. The world economic landscape is always changing, but these changes create opportunities to adjust a portfolio to capitalize on the new economic realities.

Finance - It's About More than Money

Finance types like me might view money as a practical, unemotional topic. It's all about what comes and what goes out in dollars and cents, right? My professional and life experiences have taught me that it is often a lot more than that.

I attended a presentation this morning at my local chapter of the Financial Planning Association. The speaker, a counselor and expert on the emotional sides of money confirmed the role emotions often play. She pointed out that Adam Smith, the famous economist who wrote "The Wealth of Nations" in 1776, first wrote about how our mental fallacies can influence economics in "The Theory of Moral Sentiments" in 1759.

Money is a representation of our efforts, our blessings, and our good fortune. It can be used to provide for the necessities of life or to acquire the luxuries of the world. What we do with that money is largely determined by our values, morals, habits and desire for instant versus long-term gratification. How a husband and wife feel about money is often illustrated when they make a significant financial decision together. These feelings are often rooted in much more than the item at hand. Children often model the behavior they see in their parents.

As an individual, I try to consider what is behind my financial decisions and consider all parties involved and the greater good, not just my own biases. As a financial professional I use my education and experience and the non-emotional role I play in significant financial decisions to help my clients. I care greatly about their financial successes, but I separate myself from the emotional decisions that may be holding them back from even greater practical success in their lives.

The Value of a Certified Financial Planner

A select group of professionals have attained the CFP® certification and are referred to as a CERTIFIED FINANCIAL PLANNER™. Other individuals may use the title "financial planner," but have not earned the official designation. What is a CERTIFIED FINANCIAL PLANNER™ and what should one expect from a financial plan?

CFP® certificants are individuals who have met the CFP Board's education, examination and experience requirements, have agreed to adhere to high ethical standards and complete biennial continuing education requirements. Although many other respected financial designations exist, the CFP® is considered by many to be the best example of a professional qualified to give comprehensive financial advice to individuals and families.

Most CFP® certificants will work with individuals to prepare a comprehensive financial plan. Like any goal in life, it is difficult to reach financial goals without a plan. This plan is unique to each individual, but it should cover the areas of saving for future goals, investing, taxes, risk assessment, insurance, and estate planning. Although these considerations are overwhelming to many people, a good CERTIFIED FINANCIAL PLANNER™should help reduce these burdens by boiling down significant financial decisions into manageable tasks. A good financial plan will involve an significant investment of time and money by the individual, but it will pay for itself many times over if it is properly implemented and updated over time.

Is it different this time?

The significant economic events of the past year have caused many to proclaim that traditional buy and hold investing is no longer valid. Supposed experts have also proclaimed that modern portfolio theory is dead. I've also read that the efficient market hypothesis no longer works. Have things changed in the U.S. or world economies so much that the tested, proven and researched tenets of modern investing no longer hold?

I would argue that things haven't changed and the modern ideas of investing are still correct. History has changed. Although history tends to repeat itself and what we've seen recently has happened before, many of us are seeing economic events occur that have not happened in our lifetimes. The reaction to these recent events by individuals and our government has been somewhat unprecedented, but that is a political discussion I don't want to get into at this point.

The efficient market hypothesis states that markets are efficient and asset prices reflect all known information or instantly change to reflect new information. The enormous amount of market volatility that we've seen recently has been due to the enormous amount of economic uncertainty. Once the uncertainty starts to recede, the market will react, as we've seen with some of the positive information being reported recently and the corresponding positive move in the markets.

The efficient market hypothesis is the best working model of how world markets function. The best way to invest in markets is to develop a diversified portfolio (Modern Portfolio Theory) with the appropriate amount of risk exposure. As opposed to markets "failing," much of recent economic history has been due to investors reassessing their level of risk and making appropriate adjustments. Despite the economic pain that has been inflicted on many, recent events have been an opportunity to really experience market risk and why the return premiums from holding equities (stocks and mutual funds) exist. Can we learn valuable lessons from this or are we bound to repeat these cycles again some time in the future?

Watch this eight minute video to hear Eugene Fama, the father of the efficient market hypothesis, share his views.