Desert Home Prices Falling Fast

Case-Shiller is out with their home price index again today and I thought I'd take a look at the desert cities of Phoenix and Las Vegas.

Prices generally fell faster in July than in previous months with only 6 of the 20 cities reporting home price gains. New home sales data indicates that the higher-priced homes were harder hit. Jumbo mortgages are proving to be hard to get at reasonable rates. Going from a $400,000 mortgage to a $425,000 jumbo mortgage will push your payment up by $500 per month for a 30-year fixed rate. That's hit home prices in the more expensive coastal areas, but the desert has a different set of problems.

Arizona and Nevada saw tremendous population growth in recent years. That helped fuel a housing boom. But the torrent of people headed to the desert, has dried up in recent months. Phoenix area schools show no increase in enrollment this year compared with last. Tucson school enrollment is down by 2%. So is enrollment in Flagstaff schools. Phoenix, in particular, has thousands of foreclosed and vacant homes. The following graph shows the historical price pattern and my expectation through August of 2009.

Bear Market Statistics

This graph shows the DJIA and the S&P500 are currently at bear market levels less then 2% above their July 2008 lows. Us asset allocators have our fingers crossed that the S&P500 does not make a fifth lower low in a ongoing bear market.


The NASDAQ is showing relative strength at 4% above its bear market low set in March 2008. The worry with the NASDAQ is it broke the potentially bullish trend of higher lows by making low Friday that was lower then its July and August lows.

It was refreshing to hear bond guru, Bill Gross of PIMCO, tell his readers and people on CNBC last week that he was too early buying troubled bonds which has resulted in losses.

From Bill Gross's September 2008 Investment Outlook

Too bad for us and for everyone else who bought too soon. There are few of these deals now priced at par or above, which is bondspeak for “they are all underwater.”

Bear Market Statistics:

S&P500 Chart

Last Market High 10/11/07 at 1,576.09
Last Market low 07/11/08 at 1,200.44
Current S&P500 Price 1,242.31
Decline in Points = 333.78
Decline in percent = 21.2%
Max Decline = 23.8%

=>This means the decline from intraday high to intraday low is 23.8% and we are currently 21.2% off the peak.

=>The decline in the S&P500 from the closing high to the closing low was 22.4%

DJIA Charts

Last Market High 10/11/07 at 14,279.96
Last Market Low 07/15/08 at 10,827.71
Current DJIA Price 11,220.96
Decline in Points = 3,059.00
Decline in percent = 21.4%
Max Decline = 24.2%

=>This means the decline from high to low has been 24.2% and we are currently 21.4% off the peak.

=>The decline in the DOW off the closing high to the closing low was 22.6%

NASDAQ Charts

Last Market High 10/31/07 at 2,861.51
Last Market Low 03/17/08 at 2,155.42
Current NASDAQ Price 2,255.88
Decline in Points = 605.63
Decline in percent = 21.2%
Max Decline = 24.7%

=>This means the decline from intraday high to intraday low is 24.7% and we are currently 0.211646998 21.2% off the peak.

=>The decline in the NASDAQ off the closing high to the closing low was 24.1%

CAL (2-0) won 66 to 3, GO BEARS!

==>Sept 6: Charlie Maxwell Says $300 Oil Inevitable <==

==> More Oil Price Charts <==

==> Very Best CD Rates with FDIC <==

Denver and Minneapolis Home Prices

S&P is out with the new Case-Schiller Home Price Index for June. In May, 7 of the 20 cities in the index showed an increase in average sales price from April. In June, 9 of the 20 cities showed a price increase. Some of this is a result of normal seasonal patterns, but I believe it provides further proof that the worst of the home price declines are behind us.

Two of the cities that show an increase for both May and June are hosts to the Democratic and Republican National Conventions. So I thought that this month I'd focus on Denver and Minneapolis.

Both cities have more severe climate swings than the California and Florida markets I looked at last month. In the past two years the seasonal effects on home prices there have been even more pronounced than usual. The following graph shows the historical price pattern and my expectation through August of 2009.

















The price swings upward in both cities is likely to last only for the summer, followed by a new, but more subdued price decline. Neither Denver nor Minneapolis have had prices run up as fast as the national averages, so they are not likely to fall much further.

Home Price Forecast

The Case-Shiller home price index fell again for the month of May. Home prices nationwide are down about 16% in the past 12 months. For most Americans, their home is their biggest investment. For them, a 16% decline in 12 months is brutal. An estimated 3 million homes will be foreclosed in 2008. That is flooding a real estate resale market that is now running at about 4.5 million homes per year. As a result, almost 2 out of 3 homes sold in the next 12 months will be foreclosures.

When foreclosures are a small fraction of the total real estate market, they don't affect the average home price. In a normal market Realtors won't even show a prospective homebuyer foreclosed homes. They either want to a) fix them up and flip them themselves for a quick profit or b) show the buyer something more expensive in order to earn a bigger commission. But the number of foreclosed homes has long passed the critical mass necessary to impact the average home price. One indication of this is the Realtors that are organizing bus tours of foreclosed homes.

At this time, every new foreclosure on the market lowers the average sales price. Every time a bank initiates a foreclosure, they are lowering the market price on the homes they are already trying to sell. It would make sense for the banks to tell borrowers that have missed a couple of payments, "Just pay us something. If you make at least half of your required payment we'll forestall initiating the foreclosure proceedings." Then they could focus on the serious deadbeats while they try to trim their inventory of homes that they already own. The result would be a higher average home price and reduced losses.

Unfortunately, the system is set up so that the company servicing the mortgage is not the same as the one that gets the partial payout when the home is foreclosed. The servicer is losing money with each missed payment, so the servicer has an incentive to foreclose as quickly as possible. But the servicer is not responsible for the value of the property when it is sold. To the servicer, what matters is cash flow, not loss mitigation. So as property values drop, homeowners have less incentive to make their monthly payments and foreclosure filings accelerate. The whole thing creates a negative feedback loop that floods the market with empty homes and reduces the value for all homeowners.

The drop in home prices has been long enough and hard enough that pessimism in the real estate and homebuilding industry is at an all time high. The prevailing wisdom is that this will continue for a long time to come. Yet the latest home price data offers a reason for hope. While home prices continue to drop, the veocity of the drop seemed to hit its peak in the first quarter of 2008. The rate at which home prices are decreasing slowed in April and May.

Some of this can be explained by seasonal patterns. Home prices tend to rise faster in April through August than during the rest of the year. But that seasonality explains only a small part of the flattening prices. It's dangerous to make long term projections based on just a few months of data flattening the curve, but it's now beginning to appear that home prices in general will continue to drop for the next 12 months or so, but are starting to stabilize.

Since California and Florida are two states of high interest, I've prepared two graphs that show the direction of home prices indicated by the current data. The graphs show forecast results up through August 2009.




























If you are interested in other cities, please reply to this post and let me know where your real estate interest is.

The data right now is pointing to a return to prices that represent a 4% to 5% annual return since 2000. Four percent is a sustainable level of return. The curves shown are simply a reversion to the mean. The data right now is not pointing to an overcorrection which would give us a 10-year annual return significantly less than 4%. If the economy were to go into a significant recession, an overcorrection would be not only possible, but likely.

Qout

S & P Earnings Estimates Update

S&P operating earnings estimates as posted by S&P for ‘08 and ’09. 

Operating earnings estimates continued their downward slide, accelerating this past week as reports poured in.  The 2009 estimates, IMO are not to be believed.  They project a 193.1% earnings growth in financials.  Want to buy land in Florida?

 

Report Dt 2008 2009

08/07/2007 106.59                 <-------2008 high

…

01/14/2008 100.32

01/22/2008 99.21

01/29.2008 99.00

02/05/2008 99.86

02/12/2008 99.51

02/19/2008 98.99

02/26/2008 98.63

03/04/2008 96.55

03/11/2008 96.71

03/18/2008 96.42

03/25/2008 96.26

03/31/2008 96.74

04/10/2008 96.79 115.42

04/16/2008 93.62 113.30

04/22/2008 92.31 112.17

04/28/2008 91.69 111.81

05/06/2008 90.91 110.29

05/13/2008 89.43 110.44

05/20/2008 89.29 109.53

05/27/2008 89.07 108.98

06/03/2008 89.27 109.04

06/10/2008 89.38 110.19

06/16/2008 89.03 109.94

06/24/2008 88.04 108.98

06/30/2008 87.83 108.77

07/08/2008 87.83 108.24

07/15/2008 86.73 108.22

07/22/2008 83.84 108.60

.

At Brinkers 16 to 17 times operating earnings, applying it to the S&P 7/22 estimate places the value for 2008 now at 1341 to 1425, and 2009 at 1738 to 1846. (FYI, the 2006 actual earnings were 87.72 and 2007 actual earnings were 82.54)

.

Bob last projected 1600 near the end of ’08 or into ’09.  On 4/6/08, he stated on the show that he expected record highs near the end of ’08, which means 1565.15 on a closing basis, as Bob mentioned this number on his show.  On the 7/26/08 show he stated “Would the market get to new all-time-highs within your time-frame of 1 to 3 years? Yeah. For me, my opinion on that would be -- without question."

.

Brinker said on Saturday April 5, 2008: “My number for the S&P 500 for 2008 is way below, way below the Wall Street number for 2008.”  LOL, see Kirks comment

.

Bob Norton's Evergreen was last reported July 1, …an average recessionary profit pullback indicates that earnings could be as low as $77.50 next year. Low interest rates and 4% inflation suggest to us that the market will likely trade within a volatile range of 1225-1350 during the next twelve months.”

And also,

“In our last Quarterly Market Outlook, we projected that the market (S&P 500) would likely trade within a range of 1250-1450 for the remainder of 2008. After climbing to 1425 in mid-May, stocks have since backed-off to the lower end of our trading range and are unlikely to once again push through the upper end as consensus profit expectations for 2008 and 2009 are too high, in our opinion, and are expected to plunge in the months and quarters ahead. Since the S&P 500 is approaching bear market territory (1250 represents a 20% drop from last October's high of 1550) it appears the market is already discounting the prospects for recession in early 2009. Huge sums of cash on the sidelines, low sentiment levels, and stimulus-fueled economic gains may help set the stage for a second half rebound to the 1350 area. Downside support is in the 1225 range.”

 

John Mauldin commented in  "Outside the Box" that :  "As if this wasn't bad enough, in the past we have shown that analysts tend to be around about 10% too optimistic in their year-ahead forecasts of the earnings level. However, in recession years this jumps to 30% too optimistic. "

 

See Normxxx’s interesting posting “The Real P/E Ratio” here

S&P Earnings Estimates

Runner Twentysix wrote

S&P operating earnings estimates as posted by S&P for ‘08 and ’09.

Operating earnings estimates drifted over the past 2 weeks as few companies are now reporting. It is just drips and drabs right now. Reporting will pickup in earnest about the middle of July.

.....…………....2008………2009
08/07/2007…106.59 <-------2008 high
…
01/14/2008…100.32
01/22/2008….99.21
01/29.2008….99.00
02/05/2008….99.86
02/12/2008….99.51
02/19/2008….98.99
02/26/2008….98.63
03/04/2008….96.55
03/11/2008….96.71
03/18/2008….96.42
03/25/2008….96.26
03/31/2008….96.74
04/10/2008….96.79……115.42
04/16/2008….93.62……113.30
04/22/2008….92.31……112.17
04/28/2008….91.69……111.81
05/06/2008….90.91……110.29
05/13/2008….89.43……110.44
05/20/2008….89.29……109.53
05/27/2008….89.07……108.98
06/03/2008….89.27……109.04
06/10/2008….89.38……110.19
06/16/2008….89.03……109.94
.
At Brinker's 16 to 17 times operating earnings, applying it to the S&P 6/16 estimate places the value for 2008 now at 1424 to 1514, and 2009 at 1759 to 1869. (FYI, the 2006 actual earnings were 87.72 and 2007 actual earnings were 82.54)

• Kirk Comment: 16 x $89.03 = $1,424.48
  

The ‘Word” is that Bob is projecting 1600 near the end of ’08 or into ’09. On 4/6/08, he stated on the show that he expected record highs near the end of ’08, which means 1565.15 on a closing basis, as Bob mentioned this number on his show.
.
Brinker said on Saturday April 5, 2008: “My number for the S&P 500 for 2008 is way below, way below the Wall Street number for 2008.” LOL, see Kirks comments
.
Bob Norton's Evergreen was last reported on May 19, 2008 “we continue to project flat earnings ($85.00) for the full year and would consider the S&P 500 to be fairly valued within the range of 1450 by year end.” At 16 to 17 times earnings, 85.00 for 2008 would give a range of 1360 to 1445. In June, they reconfirmed holding at this estimate.

John Mauldin commented in "Outside the Box" that : "As if this wasn't bad enough, in the past we have shown that analysts tend to be around about 10% too optimistic in their year-ahead forecasts of the earnings level. However, in recession years this jumps to 30% too optimistic. "

See Normxxx’s interesting posting “The Real P/E Ratio” here:

ECRI Says Inflation Pressure Fell in May 2008

ECRI says U.S. inflation pressures slipped in May, as disinflationary moves in measures of jobs, loans and vendor performance offset inflationary moves in interest rates and commodities prices, a report said on Friday.

The Economic Cycle Research Institute's U.S. Future Inflation Gauge (FIG), designed to anticipate cyclical swings in the rate of inflation, slipped to 116.7 in May from 116.9 in April, revised from 117.2.

The index's annualized growth rate, which smooths out monthly fluctuations, rose to minus 2.2 from minus 2.5 percent in April, revised from negative 2.0 percent.

S&P500 Operating Earnings Estimates

Runner Twentysix posted this recap today in our Bob Brinker Discussion Forum on Facebook.

S&P operating earnings estimates as posted by S&P for ‘08 and ’09.

Earnings continue their long running decline.

............ 2008………2009
8/7/2007...106.59 <-------2008 high …
01/14/2008.100.32
01/22/2008..99.21
01/29.2008….99.00
02/05/2008….99.86
02/12/2008….99.51
02/19/2008….98.99
02/26/2008….98.63
03/04/2008….96.55
03/11/2008….96.71
03/18/2008….96.42
03/25/2008….96.26
03/31/2008….96.74
04/10/2008….96.79……115.42
04/16/2009….93.62……113.30
04/22/2008….92.31……112.17

At Brinkers 16 to 17 times operating earnings, applying it to the S&P 4/22 estimate places the value for 2008 now at 1477 to 1569, and 2009 at 1795 to 19062. (FYI, the 2006 actual earnings were 87.72 and 2007 actual earnings were 82.54)

The ‘Word” is that Bob is projecting 1600 near the end of ’08 or into ’09. On 4/6/08, he stated on the show that he expected record highs near the end of ’08, which means 1565.15 on a closing basis, as Bob mentioned this number on his show.

Brinker said on Saturday April 5, 2008: “My number for the S&P 500 for 2008 is way below, way below the Wall Street number for 2008.” LOL, see Kirks comments "Bob Brinker's 2008 Operating Earnings Estimates"

Bob Norton's Evergreen was last reported at 85.00 for 2008, which would give a range of 1360 to 1445, which may be more realistic.

John Mauldin commented in "Outside the Box" that : "As if this wasn't bad enough, in the past we have shown that analysts tend to be around about 10% too optimistic in their year-ahead forecasts of the earnings level. However, in recession years this jumps to 30% too optimistic. "

See Normxxx’s interesting posting “The Real P/E Ratio”
.

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March Inflation Data Good News for TIPS and I-Bonds

I posted two articles worth reading. They are:

• Wednesday, April 16, 2008
  I-Bond Rates To Soar on High Inflation Data
  .
• Tuesday, April 15, 2008
  March Inflation Up on Higher Energy and Food Costs

Vanguard's TIPS index fund (VIPSX) was up 11.59% in 2007 and is up 4.74% YTD in anticipation of these high inflation readings. With inflation expected to moderate, I don't expect to see this level of performance continue.
Disclaimer: I have a fairly large position in TIPS in both my personal account and some of the newsletter porfolios in "The Retirement Advisor" investment letter. I also recommend TIPS as part of a 3-item alternative to the easy to track "Total Bond Fund" in "Kirk Lindstrom's Investment Newsletter" where I may again recommend iBonds with these attractive rates.
.
Come join us to discuss "I Bonds or iBonds" in our facebook forum "Investing for the long term."

Chart: DOW Daily Closing Values

Some people believe the market will correct to test the DJIA high of 1999/2000 at 11,722 from above. I've indicated it with the dashed green line on this chart.
Click Chart for Full Size viewing
You can see from the chart that the dashed green "support line" was resistance in 2006. The DOW rallied from a bear market bottom in 2002 to this resistance line in 2006 then made a significant correction at that line before gathering strength to turn that resistance line into support.

In early 2007, the market tried to test that breakout from above, but did not test all the way back to the dashed green line. It is very close to this now so "big money" may already be waiting for this to hold before committing to the new money to the market.

Of course, on an intraday basis, we've already tested the 2000 high from above
and I've been adding shares here....

How The Stock Market Works

This short explanation was posted today by Jerry S. in our Facebook discussion group "Investing for the Long Term."

Once upon a time in a village, a man appeared and announced to the villagers that he would buy monkeys for $10 each.

The villagers seeing that there were many monkeys around, went out to the forest, and started catching them. The man bought thousands at $10 and as supply started to diminish, the villagers stopped their effort. He further announced that he would now buy at $20. This renewed the efforts of the villagers and they started Catching monkeys again.

Soon the supply diminished even further and people started going back to their farms. The offer increased to $25 each and the supply of monkeys became so little that it was an effort to even see a monkey, let alone catch it!

The man now announced that he would buy monkeys at $50 ! However, since he had to go to the city on some business, his assistant would now buy on behalf of him.

In the absence of the man, the assistant told the villagers. "Look at all these monkeys in the big cage that the man has collected. I will sell them to you at $35 and when the man returns from the city, you can sell them to him for $50 each."

The villagers rounded up with all their savings and bought all the monkeys.

Then they never saw the man nor his assistant, only monkeys everywhere!

Now you have a better understanding of how the stock market works.

This not only explains the stock market, it explains

• homes and condos built on former cow pastures in Central California
• homes and condos built on reclaimed Florida swampland
• homes and condos built in the Nevada desert close to gambling that destroys rather than creates wealth.

now selling for far less than they were sold but often still above what they cost to build.

"Buy a stock the way you would buy a house. Understand and like it such that you'd be content to own it in the absence of any market. "
--Warren Buffett

Sadly, many home buyers became home speculators and forgot Warren Buffett's sage advice.

Ric Edelman radio show recap 1-12-08

The show covered many recurring topics but also focused on some timely information. As usual Ric shared his thoughts on keeping our minds on the long term goals and tuning out the short term noise. Major topics this week were 401(k) plans & ETFs. A follow up to the off shore question of two weeks ago. Other topics were capital gains, IRAs, college saving, mortgages, and life insurance. I enjoyed the chair analogy of how our investment plan should be like a four legged chair.

The opening monologue covered the exciting news this week on Wall Street, we’ve had the worst start of the year since 1991, a recession year. This can serve to help us see what we are really made of, psychologically and investment wise. It is easy to feel good when your portfolio is doing well. Being up when your portfolio down is the trick. It can be hard holding on when your portfolio is down and not panic. Investments do fluctuate. People just don’t like downside volatility while no one objects to up side volatility. The rules of investing are you can’t enjoy the upside unless you’re willing to tolerate the downside volatility. It is best not to make short term decisions base on what is going on now. Remember 1991 and what happened? It was a bad year for the economy however what followed it? By 1999 the DOW tripled in value. Morale, this too shall pass if you are invested correctly and have long term goals. If you have a many decade time horizon the short term is irrelevant. If you can’t handle the volatility check your allocation and examine if it is right for you. Build a diversified portfolio to weather the storms without undue worry and risks. Now would be a great time to reexamine what you own and see if you have antiquated mutual funds. Look to upgrade them into institutional share mutual funds or ETFs. In 2007 State Street Global Advisors data shows ETF assets increased 44%. ETF assets grew by $32 Billion last year. More than 270 new ETFs were brought to the market place in 2007. At the end of 2006 there were about 400 ETFs available now the number is over 600. Ric said you should consider ETFs for a portion of your portfolio. New data shows Vanguard now has taken over as the largest fund organization, most of it due to the growth in ETFs. American Funds held the top spot for the previous six years and they have no ETFs. This explains why they lost the top spot. Vanguard ETF assets are surging. Ric sited a study at economist.com titled “And God created alpha”

http://www.economist.com/finance/displaystory.cfm?story_id=10440545

Another advantage to owning ETFs is it gets you away from mutual fund scandals. Some owners of MFS mutual funds are now getting checks in the mail as a result of a settlement due to their involvement in one of the scandals in the industry. Over the past few weeks investors that used to own MFS funds are getting checks of maybe 10 to 40 bucks. Is this taxable income? MFS 9 sends 9 pages of instructions with the check. It tells you how to handle the tax consequence of the windfall. The next paragraph states you should not rely on the statement as tax advice.

A common mistake many investors make it to rely heavily on past performance. One record breaking fund beat S&P index 15 years in a row. Most didn’t hear about it until after the media reported it about year seven of the streak. If you bought the fund after the eighth year and held it yet today you made less than you would have by holding the S&P 500 the whole time. It did poorly the past two years. In 2003 it was in the top one percent of all funds. In 2006 and 2007 it finished in the first percentile. Meaning went from the best to the worst. It was also an exciting week in interest rates. They are now substantially lower than they have been the past couple years. Now would be a good time to consider refinancing. Housing prices are falling and so are rates. A double benefit for buyers that were previously shut out of the housing market. Mortgage applications have sky rocketed the last two weeks.

Caller has a 401k administered by American Funds. Is there anything he can do transfer out? No, Ric said he could ask for ETFs in plan. The caller has an advisor and they should be able to give recommendations on which choices best fit his needs. It is important to take a holistic approach to your investing by considering all holdings to avoid redundancy, overlap, and conflict. The caller can also lobby for changes in the plan. Companies do have a fiduciary responsibility if they sponsor retirement plans and employees can complain to department of labor. Edelman said to his knowledge there are 14 lawsuits pending involving high fees and retirement plan. Also a bill in Congress requires 401(k) providers to fully disclose fees to plan participants on statements.

Caller would like to know the differences between ETF and institutional shares. ETFs can be bought by anyone anywhere often through discount brokerages. Institutional shares often are available directly from fund companies on your own or in some cases are only available through advisors.

Caller is wondering about the costs of dollar cost averaging in ETFs when you are doing small amounts monthly. ETF commissions usually are $10 or $15 per trade. This would not be practical on small purchases of $50 a month. It is worth considering your time horizon and impact of higher front end costs and low long term costs versus no up front cost and higher yearly fees. A couple options are to look at using institutional funds or look at $600 once a year in an ETF. Either should work out well over the long haul. The most important thing is to take a top down approach to allocate assets first. Look at the big picture and start with allocation, which is what drives long term returns.

Two weeks ago a caller inquired if they should move all their money off shore because they heard Bill Clinton did. Ever since Ric has tried but yet to receive a response so he believes from the lack of response it is not likely to be true. However Bloomberg did report The former President did make an investment in an off shore account. Possibly a hedge fund based in the Caribbean. This is not uncommon for high net worth individuals but it is far different than moving all ones money off shore. Ric has not given up and is still seeking comment from Mr. Clinton.

Caller’s Mother inherited and IRA from her brother of $380,000. Her taxable income is about $25,000 per year. Is it better to transfer it as an inherited IRA to stretch out the taxes or take it all at once in a lump sum and being in the highest tax bracket for one year. The mother is 85 and the deceased was 80. Edelman said depending if it is a inherited IRA or a decedent IRA they could take distributions bases on the brother’s age. Chances are in this case no matter what, mom will be in the top tax bracket. It is best to do a tax analysis to find out and verify. You may discover taking it out slowly over a period of years may be pointless. Perhaps the money could be put to use better for family needs or improved lifestyle.

Caller asked about changes to the capital gains in 2008 making it zero if one is in the lowest bracket of less than $30,650. Ric didn’t know the numbers off the top of his head. But verified for some people it could be zero. Caller is not currently working. He lives off investment income which should be under the limit. His plan is to sell some of the low cost basis investments just to reestablish a higher cost basis. Edelman said to wait until near the end of the year and see if he will stay under the limit. Ric warned to be careful of the wash sale rule. You can’t buy an identical investment 30 days before or after and comply with the wash sale rule. For mutual funds you can buy a similar or equivalent fund just not the identical investment?

Caller asked if it is too late to open an IRA for 2007. No, as long as you do it before April 15^th. Don’t file tax return until after you open and fund the account. IRAs are more flexible than other types of retirement accounts in that you don’t have to fund them until April 15, 2008. Keogh and SEP IRAs etc. do have to be opened prior to December 31, 2007 but can be funded up until April 15, 2008.

Caller asked about a call last week concerning 529 plans and saving bonds being tax free. In this case they are not tax free because the caller bought them for her grandchildren’s college education. To be tax free for education requires digging into the fine print. Some of the requirements are; they have to be purchased by the parents, meet income guidelines, only for certain college expenses, and purchased after 1989. http://www.irs.gov/publications/p970/ch10.html

Caller asked if there are regulations on what types of investments have to be offered in 401(k) plans. None with regard to ETFs but section 404(c) of Department of Labor regulations that require the employer to offer sufficient diversification opportunities. An effective alternative solution is the use of ETFs. As of now Ric knows of only two major providers that offer ETFs within 401(k) plans. Some employers are offering a brokerage type accounts where you can pick what ever you want, this fulfills their fiduciary responsibility. It is starting to come to light in some cases mutual fund companies pay kick backs to the employers to offer their funds within a plan. This is a conflict of interest and a violation of their fiduciary obligation under ERISA.

Caller has a 15 year mortgage and is considering doing a refinance with a 30 year. Ric thinks the idea is worth exploring because rates are lower now than a couple years ago, by going to a 30 year loan the payment will be lower and the tax deduction will be higher. Edelman suggested checking with a mortgage broker and running the numbers, it might save her a few hundred dollars a month.

Fees are not the only thing that matters when it comes to investing. Ric used an analogy of a four legged chair that includes; risk, performance, service, along with fees. You need to get all four right or the chair can fall over. The GAO gave congress a report on 401(k) plans. http://www.gao.gov/new.items/d0721.pdf One point was, by increasing fees by one percent a year by retirement the decrease in account balance goes down by 17%. Now we know why Ric harps on the point about fees.

Caller is 70 ½ and has done IRAs since inception. In the past he had 5 years of non deductible contributions and did do a form 8606. All contributions were commingled into one account. Can he take out the non deductible amount first? No, when doing required minimum distributions it has to be done on a pro-rata basis. The good news is he has the records to avoid paying taxes twice. Most tax software isn’t equipped to handle this type of calculation. It might be best to hire tax preparation this year and see how it works. Then in subsequent years he should be able to do it correctly. This is important to avoid a 50% penalty in addition to the tax due. Yes he said fifty percent penalty! Upon further discussion we find out he thought he needed to take a RMD last year and did. Come to find out he would not have needed to until April 2009. For this reason Ric likes the idea of using an accountant instead of tax software.

Caller lives in Virginia and looking at the Virginia 529 plan for their seven year old. His wife has a 529 plan through a financial services company for the child. Should the current plan be transferred to the new Virginia plan? The rules give you wide discretion. The current plan has monthly automatic contributions and each month they are charged a fee for them “assisting” in investing the new money. Ric said yes get out of that plan. The best way is to open a new 529 plan in Virginia College America Plan and then transfer the old into the new with no tax liability. The new plan should help with the transfer. It would be good to know the fees charged to close the old account before making a final decision.

In 2001 a financial company advised a couple to borrow against their home and use the money to invest in life insurance policies. Time was running short so Ric held the caller over after the show ended but did share some thoughts for the listeners. It is a really bad idea and it needs to be undone because long term it is not in the caller’s best interests. In this case it looks like the primary beneficiary was the mortgage company and life insurance sales person.