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.