January 29, 2010
Dear Clients and Friends:
Net Worth Statements
We are in the process of preparing personal net worth statements as of December 31, 2009. These statements provide important information about your current financial position, often used as a starting point for reviews of casualty insurance, debt management, asset ownership, and estate planning.
Please respond to our requests for information in a timely manner. We only need rough estimates of requested values.
At this time last year we noted that 2008 was the worst year for financial assets in three decades. Our message was one of patience, in an effort to avoid panic induced selling. That patience was rewarded in 2009, as the financial markets staged an historical recovery. The challenges facing economies around the world are still significant. Be mentally prepared for higher volatility in the financial markets as a result of extreme uncertainty. In the section below, we review our investment process and the portfolio changes you can expect as a result our investment outlook.
The goal of the Investment Policy Statements (IPS) is to guide the management of your portfolios. It helps to formalize prudent allocations across asset classes, in a rational setting, irrespective of current market conditions. Within the guidelines established by the IPS, it is our responsibility to select and monitor specific investments for each asset class. In addition to selecting investments for the equity and fixed income core asset classes, we add investments that we believe are non-correlated to influence the performance and stability of the portfolio. We call this category of non-correlated investments, satellite strategies.
Each specific portfolio investment falls into one of the following categories:
1) It is a strategic investment to be held long-term through up and down markets as part of the core fixed income or equity asset classes.
2) It increases (decreases) exposure to certain asset classes or styles that we believe are underexposed (overexposed), based on near-term fundamentals.
3) It is a tactical investment, which means it is flexible in its ability to move between asset classes.
4) It contains manager style or security specific attributes that are less correlated to traditional equity and fixed income.
Asset Class Overviews and Recommended Changes
The heaviest weighting within this asset class is comprised of a blend of high quality intermediate term bonds, which is a conservative strategy. A lesser, but still significant, allocation is made to multi-sector bonds. In addition, there is a small weighing to emerging market bonds, denominated in local currencies (non-dollar). All of these are strategic investments (i.e. category 1).
While significant inflation may not be imminent, the extent of current and expected government spending, and the resulting increase in government debt and money supply, greatly increases inflation risk. In the near term, the lack of significant credit expansion and high unemployment could keep inflation tame. However, higher inflation becomes much more likely once the credit crisis is behind us, and the economy strengthens. Inflationary pressure causes government bond rates to increase, as investors demand a higher yield to maintain purchasing power of U.S. dollar holdings. Additionally, a decrease in demand for U.S. debt by foreigners, who now own a majority of our debt, would put additional pressure on interest rates to increase.
To add some protection against higher rates, we will be adding a small investment position that shorts 30-year treasuries. As interest rates rise, the prices of treasury securities fall. Shorting treasuries when prices are high and yields low, allows for the purchase of treasuries when rates are higher and prices have fallen.
There is a decent possibility that we are early in establishing this position. However, it is much cheaper to buy an umbrella when skies are clear than when dark clouds approach. This position would fall into category 2.
Please see the chart below to see the historical yields on the 30-year Treasury bond since 1978.
This asset class is comprised of U.S. and international stocks. All holdings in this asset class fall into category 1.
U.S. stocks make up about 42% of world stock market capitalization (total value of world stocks), but contribute less in terms of world GDP (total value of world goods and services). Furthermore, world GDP is growing at a faster pace than U.S. GDP since 2000 (see chart below).
It can be debated as to how much to allocate to U.S. versus non-U.S. securities based on market capitalization, share of global GDP, or even share of GDP growth. However, the trend is clear. The U.S.’s share of the world’s economic pie continues to decrease on a relative basis.
As a result, we will increase our weighting in international stocks as a percentage of equities by ten percent. This equates to a roughly fifty-fifty allocation to U.S. and foreign stocks. This move will be accomplished by selling some U.S. stock holdings and adding the Matthews Asia Dividend Fund. The Matthews fund family is a privately owned fund company that invests exclusively in Asia. They are the largest dedicated Asia-only investment specialist in the U.S. Based on Asia’s future growth story, we believe it is appropriate to have a dedicated allocation to this region.
Source: JP Morgan
There will not be any portfolio changes to the positions held in this asset class. All of the funds within it fall into category 3 or 4.
Timing of Changes
Clients will begin to receive confirmations of trades related to implementing these changes within the next few weeks. The timing of the changes will be influenced by each client’s individual tax considerations.
Income Tax Saving – 2009 Returns
Even if you do not itemize your deductions on Schedule A, you are permitted to increase your standard deduction by up to $500 ($1,000 if married filing jointly) for real estate taxes paid in 2009, and for any state or local sales taxes associated with the purchase of a new car after February 16, 2009. Delaware residents are also eligible to take a deduction for the state imposed transfer taxes on the purchase of a new car (Source: Kiplinger).
If you paid for any energy saving improvements, such as windows, outside doors, central air conditioners, water heaters, skylights, or high-efficiency furnaces, you can receive a tax credit equal to 30%, up to a maximum of $1,500. The maximum credit is for the two year period of 2009 and 2010 (Source: Kiplinger).
Contributions to help the victims of the earthquake in Haiti made before March 1, 2010, can be applied to either a taxpayer’s 2009 or 2010 tax return. If you made, or intend to make, a contribution, let your tax preparer know. We will be glad to work with your preparer to guide that decision (Source: RIA).
Please provide this payment information to your preparer.
Roth IRA Conversions
All taxpayers, regardless of income level, can convert some or all of their traditional IRAs into Roth IRAs in 2010. Any previously untaxed dollars within the traditional IRA that is converted will be subject to income taxation. The default election is for this tax to be spread over two years, 2010 and 2011. Taxpayers can elect to be taxed solely in 2010, and we would expect this election to come into play if an increase in tax rates appears likely for 2011.
We will incorporate Roth conversion reviews for clients as part of 2010 fall income tax planning. Each client’s available funds, tax situation, and stage of life are unique and will require a separate analysis. By delaying the conversion reviews until later in the year, we should have a better understanding of your expected marginal tax bracket.
Information of Tax Return Preparation
We will be sending a summary of financial planning and investment advisory fees paid in 2009, as well as a report of realized gains and losses, out via regular mail within the next few days. Let us know if you would like us to forward a copy of these reports to your tax preparer.
Annual Delivery of Privacy Statement
We are committed to maintaining the confidentiality, integrity, and security of the personal information entrusted to us. The SEC requires delivery of the enclosed copy of our Privacy Statement on an annual basis.
We continue to work daily to earn your trust and confidence.
Vincent A. Schiavi, CFP®, CPA/ PFS Ravi P. Dattani, CFP®, CPA