Posted by Don Martin on Mon, Dec 17, 2012 @ 02:45 PM
The Effect of Republican’s Offer to Raise Taxes on Million Dollar Incomes on to the Economy
|
House Speaker Boehner offered on December 14 to raise taxes on those earning over $1,000,000 to avoid a breakdown in Congressional Fiscal Cliff negotiations.
This means the Republicans have caved in to the Democrats and will agree to tax increases. Starting a tax increase during a recession is a classic economic error that will make the recession worse. This will make bond prices go up and stocks go down. At first the stock market will celebrate an orderly conclusion of the negotiations and may go up in a bubble. But ultimately it will fall back down to its intrinsic value.
Artificially low interest rates have facilitated corporations’ ability to borrow money and fund stock buybacks which has made stock prices go up for artificial reasons. Ultra-low interest rates have enabled speculators to buy stocks on margin. However, when a crash comes they may encounter forced margin sales at fire sale prices, making the crash deeper than it needs to be, thanks to excessive debt.
The risk is that a 401k, if it holds stocks, could be hurt by a crash that was a result of the Fiscal Cliff negotiations.
Another aspect is that this could push more small businesses into becoming multinational corporations with subsidiaries in Ireland, Switzerland, etc. so that the owner can have his corporate income taxed at 8.8% to 12%. In some cases the income can legally be taxed in the Bahamas at 0%. Of course when the subsidiary repatriates the income then it is fully taxed, unless Congress offers a tax holiday. In this case the U.S. would get less tax revenue as a result of this restructuring and more dollars would be spent overseas instead of at home.
If everyone who earns over $1,000,000 was able to structure their business as a multinational corporation then the effect on the tax increase would be less drastic than if the income was simply taxed away. The business must be an operating business that provides goods and services and not simply a passive portfolio of shares of stocks and bonds. However, the foreign subsidiary is required to not lend the money to its parent so the funds could not be spent. The funds could be invested, so the owner could have the subsidiary take title to publicly traded stocks and bonds held in a brokerage account owned by the subsidiary. In that case there would be no net change in ownership of stocks in the economic bug picture and then there would one less reason for stocks to crash. Further this would give the owner extra money to buy more stock. So less consumption would occur (because the funds need to be kept in the subsidiary) and more investing could result, if the new tax proposal resulted in more foreign subsidiaries. Of course it would provide more employment for tax attorneys and CPA’s which would stimulate the economy.
I have written an article “Can a Black Swan Attack Your 401k?”
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Nov 20, 2012 @ 09:25 AM
Fiscal Cliff’s real threat to 401k’s
|
The Fiscal Cliff’s real threat to 401k’s is not the risk that Congress and the President won’t create temporary patch for the Fiscal Cliff at year end. Rather the real risk is that Congress will kick the can down the road by smoothing over the problem with phony placebo solutions. The risk will be that naïve investors will think the placebo was a true cure and they will overpay for stocks creating a fake boom (a bear market rally). The rally will be a set up to failure where investors are fooled into buying at the top of the market and then suffer losses as the truth comes out. Equities are overpriced in part due to artificially low interest rates and partly due to the Fed’s Quantitative Easing.
The odds of a compromise leading to a successful “deal” to solve the Fiscal Cliff are high. This is because the Republicans were badly hurt by the dangerous actions of the Tea party during the July 24-31, 2011 Federal debt ceiling negotiations. The Republicans no longer have a threat from the Tea party and are motivated to get a deal done before they lose control to tea party radicals, should negotiations with the Democrats drag on.
When the Fiscal Cliff solution is announced by Congress investors should ask themselves how sustainable is the plan? Will the private sector suffer a loss of purchasing power because of tax increases that will result in a recession? Will the planned cuts in spending merely be a promise to make cuts in the future or are these cuts substantial and immediate?
I have written an article “Fiscal Cliff to damage 401k’s”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Nov 16, 2012 @ 01:25 PM
Fiscal Cliff’s Hidden Risks to 401k’s
|
The negotiations regarding the Fiscal Cliff are not going that well. There is the risk of brinksmanship that could result in a failure to resolve the cliff.
People ask “does the tax increase hurt 401k’s?”
The answer is that tax increases hurt the economy, making it fall into recession. This makes stocks go down in value. So 401k’s would be hurt by tax increases even though there are no taxes on 401k’s as long as the funds are left inside a 401k or properly rolled over to an IRA.
People ask “should I sell my 401k because of the Fiscal Cliff?” The technical answer is that funds in your 401k are stuck inside the account, but it is possible to sell off the assets and have the 401k hold only a money market fund that pays nothing. A more reasonable idea is to have the 401k hold mutual funds that hold investment grade bonds. These could go up in value if interest rates drop, although there is the risk that eventually rates will go up, making bond prices go way down. This could happen in a few years but one should be prepared for it to happen suddenly.
The real risk is that Congress would kick the can down the road with phony solutions that don’t fix the problem and that are financed by ever increasing amounts of debt, thus making the problem worse. Then investors might get lazy and dream that all is well instead of being aware of the growing mass of unserviceable debt and being aware that excess debt leads to recession or depression. This will make stock prices go lower in the long run; in the short run (when the Fiscal Cliff is resolved) stock prices could irrationally go higher causing investors to be fooled into chasing after a bubble and buying at the top of the market.
Until fundamental reforms are made to reduce the deficit then the economy’s problems will continue; to a certain extent the Fiscal Cliff is a phony crisis that distracts us from the real risk. It is like Y2K in 2000 where the Fed thought that computers would crash and ruin the economy so they created lots of “easy money”. This merely made things worse by making the tech stock bubble get even bigger. Ultimately the resulting crash was even bigger than it would have been due to excessive fed easing.
I have written an article “Election implies Fiscal Cliff to be fixed” and “Market getting riskier”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Nov 13, 2012 @ 02:58 PM
401k’s not prepared for the coming storm
|
Hurricane Sandy surprised people and severely damaged the local infrastructure in the New York-New Jersey area.
Could the coming “Fiscal Cliff” hurricane damage your 401k?
It's going to happen. Even if Congress solves the problem at the 11th hour the problem is that the cliff hanging suspense at the end could cause a market panic of significant proportions. Investors are used to the idea that they will always get bailed out by the Federal Reserve or Congress (the Greenspan-Bernanke Put option). But now that rates are at zero the Fed can't help and Congress will be tied up in debates. This could be quite a shock when investors realize they are adults, not children getting a subsidy from their parents (the Federal Reserve). When investors realize they have overpayed for bubble stocks and the Fiscal Cliff has arrived then the situation will not be pretty. The only question is how severe will the effect be on each individual's finances.
The Fiscal Cliff includes substantial tax increases that will hurt high income people. These people do a disproportionate amount of shopping so when they cut back on purchases to pay income taxes they will cause a recession. Government expenditures will be cut drastically resulting in layoffs of people who are used to guaranteed employment. These people will reduce purchases of goods and services, throwing the economy into a recession.
The net effect will be a 4% reduction in GNP from positive 2% to negative 2%. This will result in less tax revenue and more spending on unemployment, etc. with the result that the Federal deficit will be even higher. In conventional Keynesian economics there is no known cure for the long term Soft Depression that we are experiencing and the Fiscal Cliff will only make things worse.
If there is such a thing a Global Warming creating more intense storms that damage the economy then perhaps economists will claim there is Global Fiscal Cliff Warming that creates dangerous economic storms.
To prepare for the Fiscal Cliff one should sell off risky investments and switch to low risk investment grade bonds such as Treasuries. This is risky since rates are very low so if the economy should improve that would trigger inflation alarm bells which would make interest rates go up and bond prices go down. One may need to invest in near cash things like the two year Treasury Note to avoid the risk of inflation and avoid the risk that risk assets may crash during the coming “Fiscal Cliff” hurricane.
One should be aware that high risk investments like companies with too much debt, with shaky earnings, with non-proprietary products, with speculative unreliable product lines are risky and could crash harder than the average stock. If you insist on owning stocks during a bear market then please study the principles of Buffett style investing in companies that have below average risk. It may be safer and simpler to simply exit the equity market until after the “battle” between recessionary forces and stocks is over. Or consider buying a hedge fund that employs Long-Short strategies.
I have written an article “Six things you must know about 401k risks”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Nov 06, 2012 @ 09:01 AM
The stereotype is that everyone should max out their 401k contributions.
Reasons against 401k contributions:
* Retirement accounts create problems including double taxation of them at up to 85% for people wealthy enough to have to pay estate tax
* People who want to start a business or buy a home (large down payments may be required in today’s tight lending standards) need access to their funds (although there are some restrictive work-arounds to this that may be available)
* If long term capital gains or U.S. Treasury income (U.S. Treasury interest is free of state income tax) is generated in a tax deferred retirement account they lose their special tax status and when withdrawn from the account they are taxed as ordinary income
* Capital Gains tax is waived by using basis step-up at death for assets in a taxable account but not in a retirement account
* There is no long term capital gains tax treatment for assets held in a 401k. Thus if someone seeks to buy stocks they should be held in a taxable account for the best treatment.
The other side of the story:
Traditional reasons to get a 401K:
* Get the employer’s 3% matching contribution
* Assets may be protected from court judgments, depending on complex rules
* Encourages people to avoid spending their savings
* Encourages people to avoid speculative short term trading
* Encourages people to save for retirement
* Shift income into future years when retired when maybe in a lower tax bracket
* Access to low cost Institutional class (I class) mutual funds in some cases
* Access funds through early penalty-free withdrawal at age 55 in unemployed
Generally the reasons against a 401k are only applicable to people wealthy enough to pay estate tax. But with inflation and a need to raise taxes it is possible that in a few decades people who are middle class will have the potential to come close to paying estate tax. That would depend on how long they live and what excessive medical costs they encounter, assuming Medicare in the distant future has huge “means testing” fees.
I have written an article “Six things you must know about 401k risks”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Oct 31, 2012 @ 09:13 AM
Small employer's 401k plans maybe too expensive
|
A small, new employer with mostly young moderate income employees may have very little in 401k assets. This means the 401k Custodian won’t be able to give a low cost 401k plan, so the costs could be higher percentage than plans offered at a giant employer. An article in SmartMoney “For 401k’s size matters” discussed this.
A good 401k should have available Institutional class shares of mutual funds with an annual fee of roughly 0.40% to 0.50% for actively managed bond funds and half of that or even lower for passive stock index or bond index funds. The lack of long term capital gains tax treatment in a 401k plus high fees may mean some investors should avoid a 401k and simply hold growth stocks in a taxable account and try to avoid selling the shares or at least hold them long enough to get a long term capital gain.
The solution is for the employer to find a Custodian that allows a “brokerage window” and “in-service withdrawals”. This will allow participants to use something other than the expensive choices offered by the Custodian.
An in-service withdrawal means that one can roll their assets from the 401k to an IRA tax deferred while still working at the employer. A brokerage window means that one can invest in any publicly traded security even though the funds are inside of the 401k.
It is important to remember that some 401k plan participants may be tempted to gamble recklessly with their assets so perhaps they would be better off with their assets trapped in a 401k using very bland generic mutual funds even if the fees were high. Assuming someone has the maturity, discipline and patience to invest in boring, conservative, high quality investments then they should seek a “brokerage window” and “in-service withdrawals” in a 401k. This might be a good feature to attract job seekers, since only 22% of employers have a 401k Brokerage window.
In transferring funds from a 401k to an IRA ask the broker to do a Custodian-to-Custodian transfer. Don't withdraw the funds yourself and then attemp to deposit them into an IRA.
I wrote an article “Do brokerage windows allow an advisor?” and “Protect 401k’s from stock crash with investment grade bonds”.
Investors should seek independent financial advice. 
Posted by Don Martin on Tue, Oct 30, 2012 @ 09:13 AM
What is a good 401k investment if the economy crashes?
|
When the economy crashes stocks go down in value and investment grade bonds often go up in value as interest rates drop. To protect your 401k from a crash you may want to hold a portfolio of investment grade bonds in your 401k. Of course, once the crash has reached the bottom then you need to consider switching to stocks.
The best way to own investment grade bonds is to buy no load open-end institutional class shares of mutual funds that specialize in bonds. To understand more see my article “Protect 401k from stock crash with investment grade bonds.”
Avoid buying Eurozone related investments in your 401k. I wrote an article “Euro collapse to hurt 401k’s.
Stocks are 50% overpriced and need to decline at least 33% to be fairly valued. To really ignite a new stock bull market stocks need to go very low to a capitulation phase level of roughly a 10PE using the PE10 formula, which would be slightly lower than the SP’s low of 666 points reached in March, 2009.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Oct 23, 2012 @ 09:08 AM
Tax Dangers of 401k investing
|
The hidden tax risks of 401k investing (besides high fees and limited choices) is the “tax opportunity cost trap”. When you invest in a 401k and make a long term gain the income is treated as ordinary income, which has a higher tax rate than if the gain occurred in a taxable account. If you buy real estate in a 401k you can’t do a 1031 tax deferred exchange. If you own appreciated assets in a 401k and die then the appreciated assets don’t get a “basis step-up” and thus your estate will pay more in income tax on the capital gains then if the assets were held in your taxable account.
Perhaps the biggest hidden opportunity cost is that if assets are in a taxable account then one can borrow against them and buy more assets without selling. Then they can save on taxes by waiting for a long term capital gains tax treatment, or a basis step-up on death or a 1031 exchange. During a long bull market an affluent investor could live off of dividends and loan borrowings from appreciated assets without selling and incurring capital gains tax. Then when the owner dies the basis step-up means no income tax is due on the capital gain. This is not possible with assets held in a 401k.
Open the doors to creative investing
If someone wants to start a business it would be nice to have one’s assets outside of the 401k so that it would be easy to raise cash for the business. (There is a way to buy a business inside of a 401k, but it has some problems and limits that make it risky).
For estate planning purposes one should give as much as possible to their children up to the $13,000 annual limit. A married couple with a married child could give four times $13,000 a year free of gift tax. Over 30 years this is $1,560,000. Assuming a 55% estate tax, this saves $858,000, which may be more tax savings then that provided by a 401k. Further, the heirs could invest the funds and have the assets grow, hopefully in the form of long term capital gains, thus reducing the heir’s future tax. If the funds were trapped in a 401k then this would not be possible. If assets are in your 401k you can’t give away those assets until you die and then your estate would have to pay estate tax on them. Of course, estate tax is a problem mainly for "rich people" but with inflation it is possible middle class people will pay estate tax in forty years from now. The AMT tax has never been adjusted for inflation and now traps people who make as little as $50,000, but was intended for those who were very high income when the law was created in 1969.
I wrote an article “Are your funds trapped in a 401k?” and “401k contributions not always a good thing.”
On the other hand, the risk is great that some naive, selfish investors will gamble recklessly with their funds, so having funds in a 401k increases the odds that they will be forced to invest conservatively, which is the best way to invest. A 401k reminds me of a state liquor license law that tries to discourage drinking by making people buy liquor only at special stores with limited hours and limited customer service.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Oct 09, 2012 @ 09:49 AM
How to allocate 401k if Republicans win
|
Typically the stock market does better when a Democratic president is elected because they overstimulate the economy. If a Republican is elected they may insist that the stock market get no taxpayer subsidies or Quantitative Easing from the Federal Reserve and this could make the stock market go down.
However if a very free market Republican was elected president he might try to cut corporate tax rates which would be bullish for stocks. He might try to cut personal tax rates which would put more free cash into the hands of investors who could then buy stocks or consumer good thus benefiting the stock market or corporate profits.
It is difficult to know what a Republican president would do because his actions could be filibustered by the Senate. He would have his hands tied by the need to work on paying down the huge federal budget deficit, so cutting taxes might not be feasible. The market could fantasize he will cut taxes only to find out that he can’t due to the Jupiter-sized gravitational tug of the massive deficit. Then investors could become discouraged a few months after the new president was in office and stocks would go down.
The amount of change from a Republican president
Obama was supposed to be a leftist anti-business president but the giant corporations and banks seemed to have gotten along just fine with him, thanks to their lobbyists, etc. So a switch to a Republican president who is constrained by possible Senate filibusters and a huge deficit may not result in much change.
Typically the start of a new four year term is the best time to introduce tax hikes and budget cuts which would make the stock market go down. The “fiscal cliff” coming on December 31, 2012 will be here soon and the market tends to anticipate bad news several months early, which will affect your 401k's stocks. The way to allocate a 401k if the Republicans win might be to assume that at first stocks go up but that after a few months disappointment sets in and stocks go down, retouching the lows of March, 2009 in the Spring of 2013. So allocate your 401k with low risk, high quality investment grade bonds (in a low cost mutual fund) and wait until the stock market has crashed before switching to stocks. Hopefully the coming crash will provoke congress and the president into making some major changes in the Spring of 2013 that will help businesses to grow out of the recession and this will provide a legitimate reason for an honest stock market boom instead of a false bubble.
I wrote an article “Elections imply big economic change”. The catch is that the implied change might never happen due to filibusters, etc. thus disappointing investors who would sell off their stocks.
Investors should seek independent financial advice. 
Posted by Don Martin on Fri, Jul 20, 2012 @ 02:56 PM
How Will the Euro Collapse Affect 401k Values?
|
The trade weighted dollar index published by the St. Louis Fed shows a high in 2002 of 130 and a recent low of 95 in 2011 with a current value of 101.819. If the Euro breaks up then it will probably retouch its old lows below $1.00 so the dollar index will retouch its old highs. This will hurt investments in foreign currencies. It will hurt U.S. corporations that export things, it will hurt U.S. corporations that use offshore subsidiaries as tax shelters. When a tax sheltered offshore subsidiary loses money the parent company can’t take advantage of the loss and get a tax deduction, so those shelters are two-edge sword. Ironically a rising dollar will reduce demand by foreigners for U.S. stocks and real estate because they would be more expensive in relative terms.
In another year or two the European Central Bank (ECB) will be forced to simply print money and buy government bonds at par even if the value has dropped. Excessive money printing could create inflation which would result in a much needed devaluation of the Euro. It will lead to a flight out of the Euro. Then the ECB’s credibility will be lost and only German taxpayers can save the Euro. Eventually German voters will tell their politicians the solution is to break up the Euro. This means letting the German banks that hold bad debt from southern Europe’s PIIGS countries go bankrupt. And it means spending the taxpayer’s money on rebuilding Germany’s damaged economy instead of subsidizing PIIGS countries that engaged in the reckless, selfish creation of real estate bubbles while Germans refused to have a real estate bubble.
The damage to Germany from a Euro breakup are allegedly higher than if they subsidized the PIIGS members of Euro. But the German subsidies of PIIGS countries would spiral out of control and create antagonism between Germans and southern Europe, so it would be better for Germans to pay extra for the more reliable solution of closing down the Euro and ending the uncertainty of the Euro’s problems.
Will investors say all I got from a Euro breakup was this worthless coin?
What will benefit from a rising dollar are Treasuries because foreign institutional investors can’t use bank deposits because the tiny $250,000 FDIC limit is too small, so institutions will buy Treasuries.
It is way too early to buy depressed European stocks because the continent has not yet reached the peak of their crisis.
People ask what will happen to their 401k if the dollar is devalued. They should instead be concerned about the possibility that their stocks could go down regardless of whether their stocks are in a 401k or held directly. Look at how (CMG) Chipotle stock crashed today down 21% in a day. When the dollar goes up then foreign tourists can’t afford to eat our burritos.
I wrote an article “Two things about devaluation you must know” where I discussed the possibility that an old paradigm was broken. It has not been broken as the dollar remains the least dirtiest shirt in a dirty clothes hamper of the world’s major currencies.
Investors should seek independent financial advice.