Expiring Tax Provisions

It seems like every year there’s a slew of tax breaks in danger of expiring.  Sometimes Congress extends the tax break, other times they actually expire and fall by the wayside. 2011 is no different, with 3 potentially useful tax breaks on the cutting room table.  Those who may be able to benefit from these tax breaks should consider taking advantage of them soon, before it’s too late.

  • Sales Tax Deduction – Individuals who itemize their deductions can elect to deduct their sales tax or their state and local income taxes, whichever is greater.  There are seven states without a state income tax, so those residents would surely elect the sales tax deduction.  Residents of other states may find that they paid very little in state income taxes and may decide to elect the sales tax deduction instead.  For those who are taking the sales tax deduction and considering a large purchase, such as a new car, it may be worthwhile to complete the purchase this year in order to maximize this tax benefit while it’s still available.
  • Energy Efficiency Credit – Individuals can take a credit of up to $500 for making energy efficient improvements to their homes, including upgrades for roofs, doors, insulation, windows, furnaces, air conditioners, and many others.  There are limitations on the amount of eligible credit for the various improvements, and you can find a list of those here. It’s also important to note that unlike many other credits, this one is a lifetime credit–so if you’ve utilized all of the $500 credit in the past, you cannot take any more regardless of your qualified expenditures now.  However, if you haven’t benefited from this tax break yet, and are considering making energy efficient improvements to your home, you may want to do so before year end.
  • Qualified Charitable Distributions from IRAs – Individuals older than 70 ½ can make tax-free distributions from their IRA to qualified charities.  The distribution is not includable in the donor’s income, but it is not deductible as a charitable donation either.  This provision primarily benefits individuals who are charitably inclined but don’t have enough deductions to itemize.  The qualified charitable distributions will count towards an individual’s required minimum distribution (RMD) for the year, allowing those who don’t need the money from their IRA to donate it without being taxed on it.  With year-end fast approaching, individuals who have yet to take their RMD may want to consider this option.

Each of the tax breaks above had been due to expire at some point in the past but was subsequently extended at the last minute.  It is possible that Congress will extend these breaks again, but nothing is certain given the deficit and debt problems currently facing our country.

If you think you may benefit from any of these tax breaks, please be sure to consult with your accountant to see how these tax savings may apply to your specific situation.

Evaluating new investment products

“People calculate too much and think too little.”

This is a quote from Charlie Munger, Warren Buffett’s right hand man, and a world-class investor in his own right.

It is one of my favorite quotes and has rung true throughout my investment career. In my experience, many financial professionals accept numbers too easily without fully understanding assumptions, sensitivity to inputs, and general rules of economics and competition.

We are always looking for ways to better design client investment portfolios. Every year, we are bombarded with new investment approaches, new products and new trading strategies to beat the market. Most new products can be tossed aside immediately, but a few require more detailed investigation. (more…)

We’ll say it again: The choice of assets can make a big difference.

There was an interesting article in the Wall Street Journal from March 8, 2011 called “Why Small-Cap Funds are Lagging.” It cites a study by Credit Suisse showing that “small-cap funds have increasingly been investing in companies larger than their category name would indicate—and the average fund is underperforming its benchmark.”

The article goes on to say “The average market capitalization of a company in a small-cap fund was about $3.1 billion at the end of 2010, compared to the average market cap of the benchmark Russell 2000 index of about $1.3 billion. The $1.8 billion gap between the two is the largest since September 2008.” (more…)

Are dividend-paying stocks good bond substitutes?

A rose by any other name would smell as sweet.

With bond yields so low, is it a good idea to substitute dividend-paying stocks for bonds? Some would say yes, since dividend-paying stocks yield more than some bonds, and have more upside potential.

However, I don’t think this is a good strategy.

Obviously, dividends are an important component of stocks’ total return. From 1930 through October 2010, for example, dividends provided 45% of the annualized percentage gain of the S&P 500. Dividends also help sustain portfolio income when interest rates are low.

But there’s no getting around the fact that stocks, including dividend-paying stocks, are generally more volatile than bonds. Substituting dividend-paying stocks for bonds will lead to a higher risk portfolio.

Let’s take an example of how volatile dividend-paying stocks could be. We’ll look at three exchange traded funds (ETFs). The first is SPY, which tracks the S&P 500. (more…)

Inflation and our Merriman bond portfolio

Here’s an article we recently mailed to Merriman clients, addressing some inflation questions that we felt our FundAdvice readers may also be interested in:

Some investors are concerned about the prospect of future inflation, based on fiscal and monetary measures the U.S. government has taken to respond to the recent market crisis. However, other metrics suggest that moderate inflation will continue. These include current inflation, bond market indicators and worldwide excess capacity.

Merriman’s recommended bond portfolio is structured to provide a reasonable level of protection against inflation.

The Fed’s view

The Federal Reserve, in a statement on April 28th said, “With substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.”

Notwithstanding this reassuring if somewhat abstruse statement, there is considerable debate about whether higher inflation will result from the fiscal and monetary actions the federal government used to curtail the market plunge from October 2007 to March 2009. Inflation is the nemesis of bond investors. An increase in inflation will cause an increase in interest rates and decrease the value of bonds. Conversely, if interest rates were to fall because of lower inflation, bond prices would rise.

What factors impact inflation and how is our bond portfolio structured to handle inflation risk? (more…)