Posted by Don Martin on Wed, Feb 29, 2012 @ 01:37 PM
Advice for CEO Compensation in Stock
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CEO’s wonder what do about getting compensated with their company’s stock. From a tax perspective stock grants or employer provided Non-Qualified stock options are taxed as earned income just like a cash bonus. (The stock options are taxed only when exercised. RSU stock grants may be taxed either at time of grant or possibly later.) Special rules apply for "Incentive Stock Options" (ISO's). Earned income is the worst type of income. The best type of income is long term capital gains or Roth IRA’s, neither of which can be provided by an employer.
Loading up with a huge position in company stock (either in options or in grants of shares) is risky because of the need to have a diversified portfolio. Further the risk of an employee owning company stock is that when his industry and employer are experiencing an economic crisis the employee could be terminated or lose his bonus and the stock could also drop in price. In extreme cases the terminated employee would need to sell stock to pay living expenses during a time when the stock price was depressed. So the financial planning profession takes an unenthusiastic view of a client holding a large position in his employer’s stock.
Don't spend a pile of cash on earned income taxation
Since employer grants of stock or options result in earned income it may be better to take these benefits as a cash bonus, pay the tax, reinvest in a diversified portfolio of stocks with the intent of generating long term capital gains. Further, appreciated assets are free of capital gains tax when someone dies, so the ultimate tax shelter is to hold growth stocks until death. (This waiver of capital gains tax upon death is not the same thing as estate tax, which is based on net worth instead of income.)
In some cases deferring tax for many years can prove beneficial but one must weigh that against risk of capital losses, liquidity crisis, etc. However, usually the need to avoid a mistake in investing is usually more important than to get the best tax outcome
I have written an article “Increasing Results Using Risk Aware Investing”.
Investors should seek independent financial advice.
Posted by Don Martin on Tue, Feb 28, 2012 @ 06:12 PM
My contribution to TheStreet.com was published today.
Posted by Don Martin on Tue, Feb 28, 2012 @ 05:14 PM
Do brokerage windows in a 401K allow for using a financial advisor?
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Some 22% of 401K’s allow a “brokerage window”. This enables the account holder to buy any publicly traded security, which allow for vastly more choices than a typical 401k. Since a 401k is offered by a Custodian that wants to earn a fee for money management then the Custodian would not want the account owner to go elsewhere to get independent financial advice. Thus it is unlikely that the 401K Custodian would allow brokerage window to use a financial advisor, unless the advisor was an employee of the Custodian, in which case it would be independent financial advice. So 401K owners need to hire an independent financial advisor on their own and pay them directly for 401K investment advice.
Considering that the large Broker-Dealers lack the independence of a stand-alone registered investment advisor then there is the risk that consumers could be “sold” overpriced or incorrect investments by a conflicted Broker-Dealer Custodian. Thus consumers should engage the services of an independent investment advisor to make recommendations how to invest their 401k.
Don't get buried in a blizzard of paperwork
Usually the best approach to the lack of freedom in a 401K is to do a tax-deferred rollover it to an IRA whenever changing jobs. A few employers allow a rollover “in-service” meaning during the time that someone is still at their employer they can roll it to an IRA.
People ask how a dollar devaluation would unfold a 401K. They wonder is their 401K safe? A 401k is actually very safe, except for the one “little” problem of trying to pick the correct investments! My recommendation is to avoid buying and owning stocks during a bubble when they are overpriced and then during a recession when stocks are low priced then it is time to buy when others are selling.
I have written an article “Must read avoid these seven 401k rollover mistakes”.
Investors should seek independent financial advice.
Posted by Don Martin on Mon, Feb 27, 2012 @ 03:02 PM
How high will the Consumer Price Index go due to higher oil prices?
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Oil price increases are not inflationary. The recent rise in oil prices is not inflationary because consumers will cut other expenditures to pay for the higher oil price. Personal earned income has decreased on an inflation adjusted basis since 1998. The ability to borrow money has decreased since the 2007 crash, so a consumer who suffers from a declining income can no longer use a credit bubble to camouflage his financial weakness by obtaining additional debt to pay for living expenses. In 2011 consumers on average relied on a modest amount of deficit spending either by borrowing or by raiding their savings accounts to make up for the reduction of income and to continue increasing their spending. This is unsustainable, especially since consumers are motivated by the recession to rebuild their balance sheets by cutting costs and increasing savings. Thus consumers will cut their spending resulting in downward price pressure on consumer goods. The tax increases that start in ten months will also be a deflationary event exerting a Jupiter-like gravitational tug on the economy that will be difficult to escape from.
The oil price increase will actually be deflationary because it will cause some businesses like travel and tourism and dining out to fail, resulting in higher unemployment. The unemployment rate is the key to inflation and thus to the setting of interest rates.
Eventually consumers will switch to energy consumption methods that use cheaper coal or natural gas, thus taking the pressure off of oil prices.
The resulting deflationary or disinflationary shock will make bond prices go up and stock prices go down.
Crack open the secrets of investing
I have written an article “contrarian view of inflation hysteria”.
Investors should seek independent financial advice.
Posted by Don Martin on Fri, Feb 24, 2012 @ 01:56 PM
Pension investment firm has lost most of its clients’ assets
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A pension management fund in Japan has lost most of the $2.3 Billion it managed and has been seized by regulators. The Wall Street Journal said in an article titled “Japanese Fund Loses $2.3 Billion”: “the regulator said investigators found that AIJ Investment Advisors Co. can't account for "most of" the 183 billion yen, or about $2.3 billion, in pension-fund assets under management.”
Investors need to have the securities Broker-Dealer style of protection available in the U.S. where the assets are held by a licensed Broker-Dealer and managed by an independent Registered Investment Advisor. That way there are different parties doing different things and no one gets to have a monopoly on control of the assets. The key is the concept of “separation of duties” so that no one gets corrupted with too much power which might make it easy to commit fraud. The U.S. way of protecting investors includes a corporate internal audit by the Broker-Dealer, an external audit by a CPA firm, an audit by the SEC, insurance by the SPIC. In the U.S. Brokers usually have the shares held in book entry form at the DTTC, so that is yet another layer of protection against embezzlement.
A lot of Yen were lost in a pension fund
The MF Global failure was a failure of a commodity futures dealer. That industry has a different, less protective regulatory regime and no investor insurance coverage.
I have written an article “MF Global crash affects your 401k” and “MF Global bankruptcy two points you must know to protect yourself”.
Investors should seek independent financial advice.
Posted by Don Martin on Thu, Feb 23, 2012 @ 03:15 PM
Solving unemployment is the key to fixing the economy
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What will get the developed world out of the Soft Depression? Fixing stubbornly high unemployment is the key to getting out of the Japan-style Soft Depression.
Some of the hardcore unemployed lost their low skilled jobs as a result of globalization. Others were addicted to a lucrative career in the bubble world of real estate, construction or mortgages and will not be able to replicate the previous boom in their lifetime. These people need to change careers and acquire skills in the new economy. Examples of a new career could be in health care, technology, internet based marketing, software training. The question is can a non-cerebral former real estate salesman learn to be a top quality software engineer or a nurse, etc.?
Perhaps these hard core unemployed are in the Baby Boom age group and they will disappear from the force due in a decade to reaching retirement age. Perhaps the new group of young people entering the workforce will be eager to learn about technology and work at apprenticeship level wages. So perhaps the “cure” for unemployment is like the cure for the dinosaurs problems: they had an evolutionary dying off and a new type of animal replaced them. This is why it may take a decade to fix the unemployment problem.
By coincidence it may take roughly a decade to fully recover the jobs that were lost during the 2008 crash because due to population growth an increase of 125,000 jobs monthly are needed and job increases have been roughly 200,000 a month, so if the net increase in jobs is 900,000 a year then it will take about 6.1 years (in 2018) from now to return to a 4.0% full employment rate from the current 8.3% rate.
Considering that the Eurozone’s problems have not been fixed then they will cause a worldwide drag on the economy thus hurting U.S. employment. Also there is the risk that China is in a Japan-style debt fueled bubble and when that ends then there will be less global demand for goods and services. And Japan still has not fixed its Soft Depression in 22 years. So be prepared for a decade of high unemployment from the 2008 crash until roughly 2018.
Open the door to new economic ideas
Also, when someone changes careers they often spend the first few years in the new career in a low paid trainee job where their ability to buy goods and services is less than what they were used to during the previous boom.
I have written an article “Jobless report no threat to bears” and “Unemployment report is misleading”.
Investors should seek independent financial advice.
Posted by Don Martin on Wed, Feb 22, 2012 @ 02:50 PM
Stock market crash may occur due to rising inflation
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An article in on 2-21-2012 in the Wall Street Journal “Rising Chinese Pay Toughens Fed’s Job” warned that the rising cost of labor in China will result in inflation in the U.S. I agree with this but feel that domestic deflationary pressures will overwhelm the forces of inflation. If people can’t afford to pay higher prices they will have no choice but to reduce their standard of living and buy less. Of course buying less units of an increasingly expensive good is still inflationary but a reduction in the number of units sold puts pressure on manufactures to cut prices. A consumer who has to cut back on purchases is going to make a decision to stop buying some goods altogether and this will result in some business going bankrupt and having deflationary “fire sales” at depressed prices. One possible point where consumers could break under pressure would for them to move to a smaller, cheaper home or rental apartment, resulting in a continuing of the real estate depression.
Assuming I’m wrong and inflation returns then interest rates will rise. It was the constant lowering of interest rates in the 1990’s that was used by the bulls as justification for a massive stock market boom. In financial theory an asset’s value is determined by using a discount rate to discount the cash flow of an asset. If the discount rate (a hypothetical estimate composed of an interest rate and a risk premium) is greatly reduced then new, higher valuations may result, which is what happened in the 1990’s. But if interest rates rise as they did in the 1970’s then a rising discount rate will hurt stocks (it would hurt long term bonds even more). So if today’s low inflation and low interest rates are an artificial, temporary, phony thing then watch out because when interest rates return to “normal” then a rising discount rate will hurt stocks. If a discount rate of 2% is used to value an investment with a hundred year cash flow and then is changed to 4%, then, in theory the value of the investment would be cut to 56% of its previous value.
Since inflation makes people poorer then corporations will sell less units of goods and corporate profits will not outrun inflation and will be reduced on a “real” inflation adjusted basis.
I don't expect a return of inflation until several years from now. For the next few years I expect a Japan-style Soft Depression. The inflation insight of this article is an attempt to awaken readers to the idea that the stock market is overvalued in part due to an undeserved windfall from deflation's influence on interest rates which lower the discount rate for stocks. (The stock market discount rate is a hypothetical estimate which varies for each security and is not the same as the Federal Reserve's Discount rate).
I have written an article “Three things you must know about the crash” and “Bears should not capitulate”.
Investors should seek independent financial advice. 
Posted by Don Martin on Tue, Feb 21, 2012 @ 02:47 PM
Stock crash in 2013 due to higher taxes
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An article in FT.com by Tim Bond “Equities bull run to be powered by low valuations” on 2-20-2012 claimed that soon the economy will get better due to wage inflation and this will be the catalyst for a new stock market boom. The article failed to mention how wage inflation could occur during a period of stubbornly high unemployment and lack of demand for goods and services, so I think the article was wrong.
The best measure of unemployment is the employment to population ratio which has barely changed despite huge government stimulus. The monthly increase in jobs is a very modest amount of the 125,000 monthly minimum increase needed to exceed the population growth, so the “real” rate of net job increases adjusted for population is very minimal. Thus it will take nearly a decade to recover from the Lehman 2008 crash. As long as the unemployment rate is stubbornly high then there will be no wage inflation and thus consumers won’t be able to spark a true economic recovery.
The reason the world economy has not fallen into a worse condition is because the European Central Bank provided 500 billion Euros ($650 billion) of three year loans that are basically a form of money printing. This is a type of bogus stimulus that eventually will result in a false temporary boom which will then collapse when people realize there is insufficient real demand.
Only ten months from now it will be 2013 and Federal taxes on dividends for those in the top tax bracket will rise from 15% to 39.6% plus 0.9% for Medicare for the amount of earned income $200,000 (plus the employer also pays another 0.9%) plus and other 3.8% for health care. This is a total of 45.2% which is a 300% increase from the 15% rate.
Since investors are pursuing a policy of buying stocks for dividends the may decide that since the new tax rate means 35% less after-tax dividend income then they should value their stocks at 35% lower value, thus resulting in a drop in stock prices.
Also the lower amount of after-tax income means the private sector will have less purchasing power, thus leading to a recession. A recession means corporate earnings go down and thus stock prices will go down.
I have written an article “Jobless report no threat to bears” and “Unemployment problem unsolved”.
Investors should seek independent financial advice.