Enjoy!

As of Friday, interest rates of conventional mortgages with no points were quoted in the mid/upper 2% range for 10 years, high 3% range for 15 years and low 4% range for 30 years. If you have a mortgage with an interest rate at or above 5.5%, I highly recommend that you review refinancing options now. If your mortgage is from 5% to 5.5%, I think it may not be an idea to run the numbers as well.

Now the type and term of your mortgage should depend on your needs. For example, it may be a great time to switch out of your 30 year mortgage and refinance to a 15 year mortgage. You may find that the monthly payment doesn’t change much at all depending on your balance. However, if your needs dictate flexibility in cash flow, you may want to refinance to a 30 year mortgage and pay extra principal payments instead, cutting them off if a cash flow need arises.

The other thing to consider is recouping the refinancing costs. Mortgage people always like to talk about the breakeven point where the monthly savings from the refinancing eventually pays back the closing costs. But be careful. If you are extending the term of your current loan, then there is a cost for this as well. So if you have 25 years left on your mortgage and you refinance back to 30 years, that’s five years of extra payments that you didn’t have to make before. This reduces the benefit and extends the breakeven beyond the simple method of dividing the closing costs over the monthly savings to get the breakeven time.

Also bear in mind, real estate values are lower and underwriting is tighter. So you may not get the best loan depending on your credit qualifications. Or you may be limited in how much you can refinance if your home value is less than what it was before. But I wouldn’t let this stop you from checking out your options. For clients of Bogue Asset Management who want to explore if refinancing makes sense, feel free to contact me as soon as possible.

The problem with gold is it does not have any productive value. No interest, no dividend and no rental payment, it sits there and fluctuates in value solely on the whims of those who want to buy and sell. And to boot, it costs money to unearth it and to store it in a safe place. Warren Buffett once said about gold, “It gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

The spectacular increase in gold doesn’t have any fundamentals backing it. In the article Gold, Store of Value in the July edition of The Economist depicts how demand for traditional uses has plunged while investment demand has surged. Gold’s primary use is for jewelry with some small use for industrial and dental purposes. Demand for traditional uses has declined by approximately a third over the last decade while investment demand has grown nearly sevenfold; for the first time investment exceeds jewelry demand. The article went on to report that India, one of the largest populations of consumer buyers in the world has experienced a wave of people selling their gold jewelry. In contrast, the exchange traded fund SPDR Gold Shares currently is now the sixth largest holder of gold bullion in the world, only a handful of central banks have more. The hollow shell of speculation usually comes when investment demand becomes detached from fundamentals.

Is this bubble about to burst right now? No one can answer that. Many people can identify bubble behavior, but they can’t predict the end of it. When speculators were flipping condos daily on the Gulf Coast of Florida five years ago, people could tell something was wrong. It took a few years for the tide to turn. The last stages of bubbles are usually fueled by the performance chasers, the ones who predicated on greed see great past returns and want to join the party. This creates one last surge that goes beyond all reason. Maybe it’s already happened, but I’m not convinced. This bubble may have a little more life. Gold has reached all time highs in nominal terms, but not in inflation adjusted terms. If gold were to reach all time highs in inflation adjusted terms, $2,400 an ounce wouldn’t necessarily be a reach. Many people couldn’t believe when oil hit $140 a barrel a few years back.

I’m not totally against gold. Gold is one of those investments that tend to do well during times of global crisis, sovereign debt issues, currency debasement and inflation fears when most everything else doesn’t do well. It’s an investment of doom and gloom. Being a cautious optimist I have a gravitation to find little use for it. However if you want expand your diversification to a wide spectrum of investments and protect against Black Swan events, I see no reason having part of the portfolio allocated towards gold or other bear type investments. But solely as portfolio insurance since gold and other bear market strategies are betting against progress. Adding gold to an already diversified portfolio usually helps mitigate volatility and smooth overall returns. This concept can be appealing to most people, but investors usually don’t think of using it in this manner; they are speculating rather than investing. Also most investors lack the patience to have it linger in a portfolio as these types of investments can go flat for long periods of time. That’s why allocation towards these types of assets should be in small doses, no more than a few percent of a well diversified portfolio. And beware, gold is very expensive portfolio insurance these days. Better to buy when nobody cares about it.

In the end, the bigger they are, the harder they fall. Like technology, real estate, commodities and Bernie Madoff, gold I believe will be the next member of the bubble club. In parting, I will leave you with the following quote on the shiny yellow metal:

“Gold, the Last Refuge for the Desperate” – Jeremy Grantham, GMO Funds

Here are the steps necessary:

Note: all of those cute ads you see on the television are for an unnecessary service (for most people at least). The link below is where the truly free credit reports can be obtained. Here are the steps necessary:

1. go to https://www.annualcreditreport.com/cra/index.jsp
2. select your state and click “request report”
3. fill in your personal information, security characters from picture, and click “continue”
4. select Experian and click “next”
5. click “next” again
6. enter last four digits of your social security number and click “submit”
7. choose extras if you want to pay, I never do, click “annual credit report” at the bottom in gray.
8. check “I have read and agree to Experian’s Terms & Conditions, etc” if you accept them, click “Submit”
9. answer the “identity verification” questions and click continue.
10. click “print report” in upper right section of page.
11. print report

If you find there is something amiss, contact that agency immediately. You can contact Experian at 866-397-3742. In 4 months I will remind you to get another report from TransUnion.

On Wednesday, Warren Buffett said at a hearing of the U.S Financial Crisis Inquiry Commission in New York said that there will be a “terrible problem” for municipal bonds and said, “Then the question becomes will the federal government help.”

There is no question that local governments are under pressure as the financial crisis lowered revenues that they receive in the form of income, real estate and sales taxes. Further compounding matters, many pension plans are underfunded due to the market losses suffered a few years ago coupled with the rosy return projections and lower funding that came beforehand. Yes, from a prohibitive perspective this can create a vicious cycle and quickly become a contagion similar to the fall of 2008.

What should you do? Now for those who are currently receiving a pension, the odds are quite low that your benefits will be reduced. But I wouldn’t make the assumption that they are perfectly safe either. For the current worker that expects to receive a pension in the future, I wouldn’t hang your retirement hat solely on your pension. I believe the same would be said of people solely relying on Social Security.

For people who invest in municipal bonds, I’d be very careful. Regardless of the potential risk addressed above, I’m not a big believer in buying individual muni bonds as for most people the dollar amount needed to buy an individual bond makes it very hard to diversify the risk. Unless you directly buy from the issuer, brokers make an awful lot of money on the spreads as muni’s are very thinly traded, which eats away at your yield. This lack of liquidity also makes it more difficult to sell an individual muni at a favorable price. If you do purchase municipals, it is best advised to use mutual funds to accomplish this; in particular funds that only buy bonds with high credit ratings. If you must buy individual muni bonds, focus on the one’s that are backed by the taxing authority of the entity rather than revenue bonds, which repayment is backed on a specific project. Because of this project risk, these types of bonds are more likely to default than ones that have the ability to tax to pay back the debt. If you are at risk of paying the Alternative Minimum Tax (AMT), you want to stick to funds or bonds that generate little private activity interest as this is an exception item for the AMT.

Finally, there are some scenarios where you should never buy municipals. It’s simply a waste of time to buy municipals in an IRA as the tax benefits are lost. And you really don’t get much benefit if you are in a low tax bracket.

In the end, just keep in mind that the risk of municipal default is quite real. And I wouldn’t bet against what Warren Buffett has to say.

Higher taxes: If you are single and making over $200K or married and making over $250K, watch out. Starting in 2013 people with these income levels are going to see their Medicare payroll tax increase from 1.45% to 2.35%. In addition, any investment income such as interest, dividends, capital gains and rental income will be subject to a 3.8% Medicare Tax. This tax is egregious as if you fall just one dollar above the stated income limits, ALL of this unearned income is subject to this Medicare tax, not the dollar amount over the limit.

Also be aware, the tax environment was already scheduled to get worse before the healthcare reform legislation was enacted. Next year the current tax bills “sunset” where qualified dividends will be taxed as ordinary income (from its current 15%) and long term capital gain rates will go to 20% (from its current 15%). So it may not seem like the new Medicare taxes are that costly, but the combination of this and the expired tax breaks may become very costly to some people. Think about it, some people will pay a 43.4% tax for dividends where they are paying 15% now.

If you are on the fringe of these income levels, you better plan now. For example, if you have investment property that you are considering selling that has a large capital gain, you may want to accelerate the sale into this year or at least by 2012 rather than waiting. You may want to begin repositioning any taxable investment accounts into more tax efficient holdings such as index funds, municipal bond funds or save more towards tax efficient IRA’s or employer sponsored retirement plans. If your situation dictates, you may want to consider converting a Traditional IRA to a Roth IRA if you have a taxable account that generates a lot of income now and is sufficient enough to cover the tax cost of the conversion. Not only could this lower the amount of unearned income that could be exposed to the new Medicare tax in the near term, converting it to a tax free Roth can reduce the chance you may be subject to the tax later in life. Finally, people who own C corps with high accumulated earnings may want to take a large dividend this year before the higher rates are imposed.

Now if you have a high deductible health insurance plan or are considering one, things will change here as well as the deductible will be limited to $2,000 for an individual and $4,000 per family. The lower deductible is most likely going to result in an increase in premiums. Current high deductible plans are grandfathered as long as they meet certain minimums so you may want to consider enrolling in a high deductible plan while you still can. It also would be advised to contribute as much as you can now to a health savings account.

Finally, if you decide not to carry health insurance, starting in 2016 you will pay a fine of $695 or 2.5% of income, whichever is greater. In 2018, if you pay premiums in excess of $8,500 for an individual and $23,000 for a family, then there is a 40% tax on the excess amounts.

The above just addresses planning aspects from an individual perspective. If you are a small business owner, there are a lot more planning implications that should be considered. But start planning now because all of the financial implications are right at our doorstep.

The new regulatory reform legislation originally had language that would address this issue. It would have required everyone who gives investment advice to the public to act as a fiduciary. Or in other words, the advice would have to put aside the interests of the individual and the firm that the person works for and give recommendations that are in the best interest of the client. If Goldman Sachs was a fiduciary, I would think they would be in a lot of trouble now. But Goldman Sachs does not have any fiduciary responsibility. Registered investment advisors have this obligation but Goldman and other brokerage firms do not.

This leads to the irony of the story. The language in the new reform bill requiring a fiduciary obligation was removed by Senator Tim Johnson of South Dakota earlier this year. Instead Senator Johnson wants the Senate to “study” the issue instead. I don’t have too much confidence in conducting a “study.” A few years ago the Rand Corporation was commission to do a study on the issue and came to the conclusion that consumers were confused and that’s about all that came out of that.

In the end, Goldman Sachs will probably prevail against the SEC suit. They aren’t a fiduciary; ethically questionable actions were made, but they are allowed to do this. So we may see them pay some fine without admitting any wrongdoing and both parties will go about doing what they do. In the end, these mortgage backed securities were not the reason for the financial crisis, but they played a hand in exacerbating the severity of the problem. And a fiduciary obligation probably would have played a strong hand of stemming this severity.

The sad part of this is that the Senate subcommittee totally danced around the fiduciary issue yesterday, but I truly feel they don’t get it. Earlier this year former Presidents George W Bush and Bill Clinton spoke together at a conference geared towards the financial planning community. When asked about fiduciary standards, they both looked at each other and didn’t know what to say. Senator Susan Collins yesterday seemed to be one person yesterday who knew the difference between who does and doesn’t hold a fiduciary obligation. In the end, when the subcommittee was chastising Goldman, too bad that Senator Johnson wasn’t asked to explain why he thinks a fiduciary standard isn’t that important. And it isn’t too late to ask your Congressperson why its not important either.

A great article was written in the Wall Street Journal at this link:
http://online.wsj.com/article/SB10001424052748703940704575089413832399630.html

There’s nothing wrong about wanting more. Elements of this keep us motivated and allow us to strive to improve. If a person is doing all the right things financially and life puts them ahead of the game, they have options. Sure the person could expand on their goals and continue to work, take the same level of risk in their portfolio, expand on their planned expenditures and continue to save or save more.

But there’s a cost to all of this. You can continue to strive for more, but the risk can remain the same or increase because of it. Or you may be sacrificing your current lifestyle only to end up with more money than you will ever really need. Equal time should be given to just enough. If you are ahead of the game, there is also nothing wrong with retiring sooner, paring down debt, saving less, spending more or taking less risk in their investment strategy. Many of these choices lead to less material wealth, but a lot less risk is involved. Not having to worry or being able to sleep at night does have its virtues. If you can afford to make these choices, they should be considered.

This is where financial planning has its value. It can help draw the line between more and just enough and giving you the option to continue to have more or decide that you have enough. Unfortunately most people let their investments and underlying investment performance dictate their goals when in reality it should be the other way around. I suspect that many people were ahead of the game before the tech bubble burst or before the financial crisis of 2008 began, but they didn’t realize it. Hindsight is always 20/20, but I’m sure that if many people knew the level of risk they were talking in their lives, they would have done something about it.

But as reported last week from the Wall Street Journal, there was one line that was quoted from the letter bothered me the most:

“Our first priority is and always has been to serve our clients’ interests,”

Really? It’s kind of interesting because there has been a lot of debate within the financial reform agenda concerning the obligations that financial advisors have when serving their clients. Registered investment advisors have a fiduciary obligation to act in the best interest of the clients first and disclose conflicts of interest. On the other side is the brokerage world, which including Goldman Sachs only has to adhere to suitability standards. Since the financial crisis, there has been a lot of talk about imposing this fiduciary duty across the board. In the meantime, Brokerage firms have been lobbying hard against this or creating a watered down definition of what it means to have a fiduciary duty.

What say you Goldman? Aren’t you a member of the brokerage world and part of the system that is against the fiduciary obligation? If you are, then actually do what your letter says, put your money where your mouth is and join the fiduciary club. Maybe then and only then will you find that acting on the best interests of the client isn’t such an onerous task. But until then, your letter is a lot of empty rhetoric.

Now if you buy individual Treasuries, there is a way to buy them directly without the middle man. But if you are buying from a broker there is a cost, you just don’t see it. Bond commissions are actually within the spread which is the difference between the price the broker pays and the price the firm sells it to clients. Spreads are influenced by the characteristics of the bond. For the individual investor, the problem lies within the trade size. The lower the dollar amount of the trade, the greater the spread you are going to pay. How much of an impact does the size factor present? If a recent study suggests, quite a bit:

Dollar Purchase Trade Cost
$25K or Less 2.23%
$25K to $100K 1.12%
$100K to $1M 0.36%
Over $1M 0.10%

That’s where an efficiency run mutual fund has the advantage as they can buy in bulk and minimize their spreads. Individual bond buyers can’t see the spread but they are made well aware of the expense ratio of a mutual fund. Being thrifty is important, but I think individual bond buyers in a lot of cases aren’t aware (or aren’t made aware) of this.

This isn’t the only reason why I prefer funds over individual bonds. Mutual funds provide more diversification. If you own individual bonds, it only takes one bond default to blow up your portfolio while funds have hundreds of holdings to diversify the credit and other risks. Mutual funds are also more effective if you have liquidity need as you can always sell off exactly what you need from a bond fund where you need to sell individual holdings to create the liquidity (and the spread happening again on the back side this time). The most important thing to get out of this is that you can still continue to believe that individual bonds are better, but they aren’t a free lunch.