Opinions and Facts

Recently, a local newspaper columnist pointed out that the Dow Jones Industrial Average ended 1981 almost 100 points lower than it began in 1966. He goes on to say that an index fund investor would have had nothing to show for 16 years of patience. How right he is. However, Mitchell Schnurman, a well respected Fort Worth Star Telegram writer, goes on to say “so much for buy and hold, that long admired investment style where you make a good pick and let it grow.” The problem with this statement is that it should be made when referring to Index Funds – not managed funds. Because there is a big difference in the two.

We believe that the buyer of index funds whether it be in a 401(k), a large pension plan, or an individual account, makes a big mistake when he latches on to an unmanaged index, especially now, where according to many economists, the evaluations and stocks could have further to fall. Some analysts call this a secular bear market, a trend that could last more than 10 years.

When overall, the major indexes decline or remain flat, it’s time to forget indexing and look for active managers.

"How do you do it?"

Our approach, of course, is to utilize the same concept that we’ve used for almost 40 years: observe and follow the five rules that are important in choosing a money manager.

• Tenure of the money manager – How long has he/she been managing money?
• Turnover of the portfolio – How often does he/she buy and sell?
• Expenses of managing the money – What percentage of the assets is charged?
• Volatility factors – How “risky” over 3 and 5 year periods, compared to the market.
• Results over meaningful periods of time – 1 year is not meaningful. Look at rolling 5 and 10 year periods.

When stock markets go south, active managers do better than the stock indexes. There are many reasons, but the main one is that they have the flexibility to keep their holdings in cash or utilize overseas markets. Active management means the manager can choose to hold or sell which gives a chance of capital gains. And as these are reinvested, the magic of compounding begins to work by increasing the number of shares in the account. Not so in the Index Fund.

"Maybe we were born yesterday, but we didn’t stay home."

We have discovered that most of our clients prefer to protect their capital in a bear market rather than go for the homerun when the bulls start running. That’s our approach, and when someone wants to go for the long ball at every at-bat, our answer is to either go somewhere else or only put a small percentage of the assets in more volatile funds. This was a lesson learned during the technology boom.

IRA Reminder

You have until April 15th, 2005 to contribute $3,000.00 to an IRA for tax year 2004. If you are over fifty, you can put away an extra $500.00 “catch-up” contribution.

Contribution limits for IRA’s are increasing for tax year 2005 (see box below). Remember, you can now make 2005 IRA contributions which can benefit you an extra year of growth.

WELCOME TO THE OWNERSHIP SOCIETY
What's so great about 529 plans?

You’re looking at four main advantages.
First, you get unsurpassed income tax breaks. Your investment grows tax-deferred, and distributions to pay for the beneficiary’s college costs come out federally tax-free. This treatment applies for distributions in the years 2002 through 2010. Unless Congress decides to extend this tax break, qualifying distributions made after 2010 will be taxable to the beneficiary (earnings portion only). Assuming that the student isn’t earning hundreds of thousands of dollars running a dot-com company out of her dorm room, you should still save taxes with her lower income tax bracket. Your own state may offer some tax breaks as well (like an upfront deduction for your contributions or income exemption on withdrawals) in addition to the federal treatment.

“You’ve got to do it my way”.

Second, you the donor stay in control of the account. With few exceptions, the named beneficiary has no rights to the funds. You are the one who calls the shots; you decide when withdrawals are taken and for what purpose. Most plans even allow you to reclaim the funds for yourself anytime you desire, no questions asked. (However, the earnings portion of the “non-qualified” withdrawal will be subject to income tax and an additional 10% penalty tax). Compare this level of control to a custodial account under the Uniform Transfers to Minor Acts (UTMA).

Third, a 529 plan can provide a very easy hands-off way to save for college. Once you decide which 529 plan to use, you complete a simple enrollment form and make your contribution (or sign up for automatic deposits). Then you can relax and forget about it if you like. The ongoing investment of your account is handled by the plan, not by you. Plan assets are professionally managed either by the state treasurer’s office or by an outside investment company hired as the program manager. You won’t even receive a Form 1099 to report taxable or nontaxable earnings until the year you make withdrawals. If you want to move your investment around you may change to a different option in a 529 savings program every year (program permitting) or you may rollover your account to a different state’s program provided no such rollover for your beneficiary has occurred in the prior 12 months. (There is no federal limit on the frequency of these changes if you replace the account beneficiary with another qualifying family member at the same time).

"So, are there limitations?"

Finally, everyone is eligible to take advantage of a 529 plan, and the amounts you can put in are substantial (over $230,000 per beneficiary in many state plans). Generally, there are no income limitations or age restrictions. Thinking about going back to college or graduate school in the future? Then set up a plan for yourself! There is no reason why you cannot be the beneficiary of your own account, although some investment firms do not presently allow you to do so.

OUR OPINION

In the 1930’s, as the country was going through the Great Depression, many of the elderly had lost income and assets but had no time to gain them back. And as the welfare state was undergoing birth pains, Social Security came into being, and everybody’s paycheck gave a little bit of payroll tax that was redistributed to anybody over retirement age. What we have discovered now is that this holding pen for the pay-as-you-go transfer was called, brilliantly if dishonestly, a “Trust Fund.”

In the 1930’s there were 41 workers for every one retiree and they paid about 2% of the first $3,000.00 of earnings in payroll taxes. As the years went by, Social Security gave politicians a lot of votes for expanding that program. One other problem is that life expectancy has risen to 78 years from 69 years for men born in 1940. And because of many reasons, the birth rate in 1940 was 2.2 children per woman; it was 3.7 in 1957, and now, its 2 per woman. Well, you know the rest of the story; payroll taxes have risen and are now 12.4% of the first $87,900 of earned income; add the fact that we have fewer younger workers, and you’ve got problems.

"I hope I get my share."

Over the next 20 years, when baby boomers start retiring, the number of retirees will jump to around 77 million from 47 million today. With these numbers in mind, the system will be running a deficit by 2018. While many pundits and politicians claim it’s nothing but a “chicken-little-sky-falling” mantra. They are wrong. The current administration is not afraid of the “third rail” that says in the past, reforming Social Security was the “elephant in the room.” Just ignore it, it’ll go away.

"Here’s one idea."

The Bush Administration has sent trial balloons up testing the air for setting up a method whereby a small percentage of annual Social Security contributions ($1000 to $1300) could be invested in mutual funds, thereby establishing a deeper “ownership society”, where an individual could establish his own investment account with the balance of the contribution eventually acting as a “safety net.” (Ah, how do we create a safety net against inflation? If you don’t know, you haven’t been listening.) Opponents of this plan claim the Republicans want to totally “Privatize” Social Security. They say the Republicans are trying to “destroy” this benefit which started in the 30’s.

"Follow the money, be sure it’s cash."

Now, according to a recent Wall Street Journal editorial, the immediate problem is that the withheld payroll taxes dating in the surplus period that began in the 1980’s were not saved in the mythical “Trust Fund;” instead the taxes were used to fund other government spending. And what rests in this Trust Fund? $1.3 trillion in special–interest bonds. By 2018 that figure will have grown to $3.2 trillion in today’s dollars. In some way cash must eventually replace bonds. And where does the cash come from? Taxes, of course.

So, for a moment, let’s ignore the possibility of separate individual equity accounts. The Wall Street Journal………. “these programs could still be funded, but there would be almost no money left in the federal budget for anything else. Faster economic growth along the way can help, but it will also not solve this problem by itself. Because of the way benefits are currently determined, as growth pushes up wages and payroll tax revenue, it also increases the benefits that Social Security has promised to pay.”

"Problem? What problem?"

Now, comes Paul Krugman, New York Times columnist, who says there is no reason to worry. He points out that by law Social Security has a budget independent of the rest of the U.S. Government and is currently running a surplus. He reminds us that when benefit payments start to exceed payroll tax revenues, Social Security will be able to draw on that trust fund. He ridicules the people who point out that the trust fund really doesn’t count because it’s invested in U.S. Government bonds, which are nothing but I-O-U’s. These bonds in the Social Security trust fund are obligations of the federal government’s general fund, the budget outside Social Security. He says that the general fund is legally obliged to pay the interest and principal on these bonds and Social Security is legally obliged to pay full benefits as long as there’s money in the trust fund. However, Mr. Krugman does not tell us where the general fund is going to get the cash to redeem the bonds.

In his OpEd column in the New York Times, Mr. Krugman goes on to spend most of his comments denouncing President Bush’s tax cuts and the prescription drug bill passed in 2003.

"Can you believe it? We agree with Mr. Krugman?!"

We can’t say that we disagree with Mr. Krugman in regards to the prescription drug bill. However, as many of our readers know, historically, the benefits of tax cuts have increased revenue of our federal government. Additionally, these cuts have affected psychologically, actions of the people who actually have the money to spend.

Another thing we agree on is that the system must be revamped. Period. However we do it, it’s a cinch that unless the politicians dare step on that third rail our children and grandchildren will face some big problems.

In fact, sooner or later people will realize that there are no free lunches. Daily, financial obligations for the future are being delegated to the individual by a more entreprenual, free market, and shrinking governmental society. Like it or not, we’ll all be eating our own lunch – the one we pay for ourselves.

That’s our take, yours is welcome