Jarvis Financial

What will 2012 Bring?

Matthew — Tue, 03 Jan 2012 22:27:25 +0000

As my legal department would gladly remind you, there are no reliable indicators of future performance. However my confidence in the future is renewed by the following chart:

For those of you who don’t speak “stock chart,” allow me to translate: corporate revenues and profits continue to reach new highs, while share prices are still 15% below previous highs. Historically speaking, stock prices should catch up to corporate profits.

The Good News

Matthew — Wed, 21 Dec 2011 17:28:02 +0000

I could write a book on the number of things going well in the economy. Let me highlight just a few.

Manufacturing is Alive and Well: One of America’s largest manufacturers, Boeing, just landed the two largest airplane orders in the company’s history (280 airplanes worth more than $40B). Boeing is just one of many companies that maintain America’s position as the world’s largest manufacturer.

Equipment and Software Spending: While housing continues to lag, investment in equipment and software have grown at a 12.9% annual rate over the last nine quarters. Transportation related equipment is growing at a 43.3% rate during that same period.

GDP and Corporate Profits: Despite the claims of doomsdayers that the economy is not growing fast enough, real GDP (adjusted for inflation) just surpassed the previous high set in 2008. While 3Q GDP growth was “just” 2%, corporate profits were up 8.5%.

Consumer Spending and Debt: Consumer spending over the last 12-months is up 7.9%. Auto sales are up 10% during that same period. The consumer “financial obligation ratio” is at its lowest point since 1993. Reducing household debt is hugely beneficial to the economy (and the consumer).

Reading good news begs the question, why are the markets down for the year if the economy is doing so well? In the short term, the markets are controlled by fear and greed. Right now many people are selling at any price in a state of panic.

Successful investors refuse to make investment decisions based on emotions.

Dow Jones at 40,000?

Matthew — Fri, 21 Oct 2011 17:28:27 +0000

There are several methods of evaluating the “value” of a particular company and the stock market in general. Perhaps the most common method is the Price to Earnings ratio (P/E). The P/E ratio compares the price of a company’s stock to its annual earnings per share (EPS).

A less common method is the “capitalized profits model.” This model compares a company’s profits to the risk free interest rate found on the 10-year treasury bond (currently 1.92%).

If you combine the current growth rate of corporate profits, combined with an interest rate of 1.92%, the “fair value” of the Dow Jones is 40,000.

However, interest rates are currently being held to an artificially low level and profits are at historic highs. If we use a more conservative treasury bond yield of 5%, and cut corporate profits by 20%, the “fair value” of the Dow Jones is still 18,000.

Like all projections, the capitalized profits model is certainly no guarantee of future results. It does however give us just one more reason to be confident in the fact that the declines are temporary and the advance is permanent.

In the long run, the pessimists are always wrong.

Matthew — Mon, 08 Aug 2011 18:29:03 +0000

Where are the financial crises of yesteryear? What happened to the Dubai Debt Crisis or crippling oil prices? What about the Swine Flu or Bird Flu that was going to kill millions of people? How about the banking crisis of 2008 that was going to collapse the US economy? These events that were heralded at the time as the horsemen of the apocalypse, were in reality little more than a bump in the multi-decade investment time horizon of an average investor.

30 years ago (the length of an average retirement for a married couple), the S&P500 closed at 123. No typo here, the closing market value in August of 1981 was one-hundred-twenty-three. Ignoring dividends, the S&P500 has increased 10-fold during those 30-years. At the same time, the cost of living has nearly tripled. However, every five years or so, the S&P500 temporarily dropped in value 20% to 50%. Each of these bear markets felt like the markets would never stop falling and the economy would never recover. Just ask Jimmy Carter who in 1980 said “Our best days are behind us. We live in a world of lack and limitation and we must be prepared for a future of sacrifice.”

Jimmy Carter, like all pessimists, was wrong. In the end, all market declines are temporary. While all of history confirms that declines are temporary, let me give you just one example. The earnings of the S&P500 companies are on track in 2011 to surpass their previous earning peak set in 2006 just prior to the “great recession.” A recession that continues to be proclaimed as having forever stifled the US economy.

The world can only end once, and odds are its not today.

“Are all of your recommendations in my best interest?”

Matthew — Mon, 18 Jul 2011 19:07:15 +0000

I was recently in a meeting with a group of very successful financial planners/advisors. During the course of the discussion I asked, “Everything you do is in the best interest of clients, right?” I was surprised by the number of advisors looking at their shoes, until one finally answered, “We hope so.” I suppose this should come as no surprise as FINRA (the primary regulator body over financial planners) only requires that recommendations be “suited” to the client. In other words, most financial planners have no legal obligation to make recommendations based on your best interests.

Unfortunately financial planners/advisors are not the only professionals who may not be watching out for your best interests. A recent study by Virginia Mason of Seattle looking at their treatment of back pain “showed that 90% of what we did was no help at all.” (Dr. Robert Mecklenburg).

While I don’t want to question the ethics of the doctors at Virginia Mason, I have to wonder if they, like many financial advisors, were simply making recommendations out of convenience or while focusing on their own profitability.

Because of this, I suggest that you sit down with any professional you employ, look him or her in the eyes and ask, “Are ALL of your recommendations in my best interest?” If you want to probe further, try asking, “How much will you be paid if I follow your recommendations?” and “What are my alternatives?”

Giving 110% to your favorite charity

Matthew — Tue, 28 Jun 2011 21:53:06 +0000

While “giving it 110%” is a tired (and illogical) motivational line, when it comes to the IRS and your favorite charity, a 110% is possible. Donations made to charity can typically be deducted at 100% of their market value.

For example a $10,000 donation to St. Francis Hospital will reduce your taxable Income by $10,000. Certainly a generous donation, but it falls short of its full tax savings potential. Instead of donating cash, you could donate a stock or mutual fund that has unrealized capital gains.

For example, say you paid $1,000 for a stock that is now worth $10,000. Upon selling this stock you would have to report the $9,000 gain on your tax return. This gain would be subject to a tax rate as high as 35%. If instead you donated this stock to your favorite charity, you would avoid paying taxes on the $9,000 gain and would still be able to deduct the full value of the donation. In other words, your $10,000 gift of stock would reduce your taxable income by $19,000 ($10,000 for the donation and $9,000 for the taxable gains that were avoided). In this ideal scenario, your donation resulted in a 190% reduction of your taxable income.

As always, there are limitations and restrictions that should be discussed with your accountant and qualified financial planner.

Tax Free Income – The Holy Grail

Matthew — Tue, 14 Jun 2011 19:06:12 +0000

Tax-free income is the Holy Grail of financial/tax planning. There are very few (legal) methods for obtaining tax free income. One of these few methods is through ROTH IRA accounts. Unfortunately Congress has imposed several restrictions on ROTH IRAs including income and contribution limits. Generally speaking, most people are limited to contributing $5,000 annually (plus an extra $1,000 catch-up contribution for those over age 50), and only if their income is under $122,000 filing Single or $179,000 filing Married Jointly.

There are at least three strategies for overcoming these restrictions. A handful of employers offer a ROTH 401k option to their employees. With the ROTH 401k an individual could contribute up to $16,500 annually (plus an extra $5,500 catch-up contribution for those over age 50), with no income limitations. Unfortunately these plans are not widely available and ROTH 401k contributions replace your traditional 401k contributions.

The second strategy is to make “back-door” ROTH contributions. This two-step process is perfectly legal, but it requires careful planning. Step one requires making non-deductable IRA contributions. In other words you add $5,000 to your IRA account without receiving a tax deduction. Step Two: a short time later you convert these funds into a ROTH IRA. The only tax due in this process would be on any growth that occurred between your non-deductable IRA contribution and the date of your ROTH Conversion.

Before attempting this back-door ROTH contribution, you will want to talk with a qualified financial or tax planner about potential pitfalls due to the “cream-in-the-coffee” rules.

The third strategy is through ROTH IRA conversions which I will discuss another day.

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“Trustees Show Permanent Deficits for Social Security” -WSJ

Matthew — Thu, 26 May 2011 18:08:49 +0000

The Social Security Administration’s (SSA) board of trustees recently released their annual report. The favorite soundbite from the report is that both Social Security and Medicare are headed for disaster. Those of us who have read the entire report find the situation much less dire. Under the current assumptions, the Medicare Trust Fund (currently $524 Billion) will be depleted in 2024 and the Social Security Trust Fund (currently $2,429 Billion) will be depleted in 2036.

Similar to a car traveling at 60 mph towards the edge of the Grand Canyon just 45 miles away, it is a true statement that in less than an hour we will plunge to our death. Entitlement programs in the United States are in desperate need of reform. Like our car analogy, in 13 and 25 years respectively, Medicare and Social Security will run out of money. However, the depletion of the trust funds does not mean the end of either program. If nothing is done over the next two decades, both programs will be forced to cut their benefits 30-50%. While this is certainly not a pretty picture, it’s not the end of the world.

Danish physicist Niels Bohr once said, “Predication is very difficult, especially about the future.” Trying to project what the world will be like tomorrow, let alone 25 years from now is an impossible task. While this does not mean we should ignore future problems, such projections need to be taken in perspective. Despite requiring enormous political will, both the Social Security and Medicare programs could be fixed with only moderate adjustments. A few minor changes to the systems (e.g. changing the full retirement date, modifying the inflation adjustment, means testing the benefit, changing the benefits formula), would bring both systems to full health. Social Security and Medicare are here to stay.

In regards to your financial plan, we recommend assuming your Social Security benefits will be just 70% of the projected benefit. This conservative projection is based on the assumption that benefits will be reduced in the future and/or benefits will be subject to some kind of means testing based on your income or networth.

It’s the end of the World (err.. Dollar) as we know it.

Matthew — Tue, 22 Mar 2011 21:37:47 +0000

In 1988 the rock band R.E.M. sang “It’s the end of the world as we know it.” Proclaiming the end of the world (or the Apocalypse Du Jour) has been a favorite attention getter of many so-called experts.

Ignoring that just in the last 5-years alone we have survived numerous “ends of the world” (i.e. Banking Crisis, Bird Flu, Swine Flu, Greece, etc.), there always seems to be a new catastrophe that will bring the end of the world. A current favorite is that the U.S. Dollar will lose its status as the world reserve currency, thus ushering in the first horseman of the apocalypse.

As the most stable, transparent and robust currency in the world, the US Dollar has been the preferred world reserve currency since the end of WWII. Currently 66% of the world currency reserve is based in US Dollars. In second place is the Euro at just 25%. Could the US Dollar lose its position as world reserve currency? Sure. Would it bring about the end of the world? Probably not.

Most experts estimate that the benefit of being the world’s reserve currency is about a 0.5% reduction on the rate the US Government must pay on its debts. While 0.5% is still a staggering amount of interest on $14 trillion of national debt, the increase will not usher in the end of the world.

Is the United States on a course for financial disaster? Yes. Will that course be corrected long before disaster strikes? Most certainly.

China – The monster under the bed

Matthew — Tue, 15 Mar 2011 22:55:14 +0000

Last month I debunked the myth that the US is shipping all of its manufacturing overseas (we are still the largest manufacturer in the world by a large margin). This month I would like to take on the “Monster Under the Bed,”– China.

Despite having a population AND land mass three times that of the United States, the economy of China is barely 1/3 that of the United States.

The accompanying graph showing GDP per capita in China and the United States clearly demonstrates the economic superiority of the United States. While at some point China’s total GDP will surpass the United States (2020 by some projections), their per capita GDP will still be 1/4th of the United States. However due to their 1-child law, they are facing demographic issues that dwarfs that of the Baby Boomers.

Contrary to the Media’s claims, China has virtually no leverage over the United States. If it were not for their ability to buy US debt, their economy, not ours, would be in ruins (please note this is not an excuse for the reckless spending of the US government).

Like the monster under my daughter’s bed, China’s threat to the United States is imaginary.