Money matters can be a significant source of stress for individuals and their families. News of the recent overwhelming trading losses at JPMorgan (a firm that has heretofore been considered an industry icon in risk management) is a tell-tale reminder of the vagaries of the financial markets. Adding additional stress is the European situation which, again, has cast itself into the limelight as Greece contemplates leaving the EuroZone and Spanish banks are struggling. The impact on the world equity markets over the last couple of weeks has been a steady downturn.

As you know, we protect our clients against this short-term volatility by ensuring that funds needed within the next one to two economic cycles are not subjected to equity principal risk. Being able to ride out this inevitable market volatility and avoiding having to sell when equities are relatively lower is a key to long-term investment success.

The article below, which recently appeared in The New York Times, delineates some of the reasons that retirement planning has becoming increasingly complex in today’s more dynamic world. However, creating a plan and maintaining a straightforward investment approach can appreciably reduce the stressors exacerbated by our instant-information world.

We hope you find the article to be a relevant, thoughtful piece, and we look forward to receiving your feedback…

Making Sure Money’s Still There When It’s Needed
By JOHN F. WASIK
Published: May 9, 2012

In years past, retirement was guided by simple arithmetic. You knew exactly how much Social Security, savings and your defined-benefit pension would pay you, then cut back any unaffordable expenses when you hit 65.

Retirement
Now that Social Security and Medicare are being eyed for cutbacks and 401(k)’s produce ever-varying lump sums, the retirement planning process requires a more sophisticated strategy.

Hobbled by two recessions and major market downturns in the last dozen years, future retirees are frustrated about their ability to plan ahead. They may not have enough money to maintain a comfortable lifestyle and need to make adjustments.

This new retirement reality is reflected in the fact that only 14 percent of Americans polled in the 2012 Retirement Confidence Survey conducted by the Employee Benefit Research Institute said they were “very confident they will have enough money to live comfortably in retirement.”

Because of this widespread pessimism, more than half those surveyed said they had not even tried to calculate how much money they will need in retirement. With the stock market and economy rebounding this year, perhaps that will change.

There are plenty of routes to address retirement planning needs, ranging from simple online calculators to employer-provided preretirement services. Financial advisers, including certified financial planners and chartered financial analysts, also offer their services to create customized comprehensive plans and portfolio management. Whatever avenue you choose, it’s going to get complicated.

Stephen J. Lansing, chief investment officer for Financial Soundings in Alpharetta, Ga., has found that “the vast majority of people don’t take the time or make the effort to plan for retirement and many who try do a poor job of it.” The complexity can be daunting. How much money will you need, given your investments, rates of return, life expectancy and amount of risk you’re taking in your 401(k) portfolio? Mr. Lansing’s company and others will provide a range of probabilities of employees meeting their goals, then give advice on what they need to do. Many financial advisers, mutual fund companies, brokerage houses and planners also provide this service.

For many people, Mr. Lansing said, the preretirement profile shows a “funding gap,” indicating that changes in behavior are needed to meet objectives. This Rosetta stone of planning is essential because it may necessitate increased contributions to retirement plans, a larger allocation to stocks or greater outside saving.

“The biggest problem is people don’t save enough,” Mr. Lansing added. “Sometimes they have to save two to three times more than they are currently setting aside.”

At the very least, preretirement planning or a “readiness profile,” will tell you if you’re on track to retire when you want to. It will also tell you if you have to bolster your nest egg, adjust your portfolio or scale back your retirement objectives.

Most boilerplate retirement models assume you’ll need to replace 80 percent of your preretirement income. Yet you may need less than that if you downsize your home, move to a state with no income tax (Florida, Nevada, New Hampshire, Texas or Wyoming) or broadly cut your living expenses. [Comment from Doug Pauley: In my experience, the number is specific to the person/couple, but in the early years of retirement, desired spending level may be 120% or more of the pre-retirement needs.]

Here’s what a basic retirement analysis might tell you: Based on your salary before retirement of $125,911, you’ll need $100,729 in your first year of retirement to replace 80 percent of your income. If combined savings, pension income and Social Security can’t match this number, you’ll need to address the shortfall.

Your retirement comfort number, of course, will change depending on what happens to Medicare and Social Security. Several proposals have been floated in the last year, ranging from Medicare “premium support” plans that will give you money to buy privately issued insurance policies to means-tested benefit reductions for higher-income retirees. In nearly every benefit-cut assumption, though, you’ll most likely dig deeper into your pocket.

Just what will happen with any of these proposals will depend largely on what happens in the November elections, which will shape the direction Congress will take.

In many cases, simple math can provide answers on how to fill the gap. You can tell your employer to raise your pretax contribution to your retirement plan. Retirement vehicles abound: Roth individual retirement accounts for tax-free withdrawals; conventional I.R.A.’s, and mini defined-benefit pension plans you can set up if you’re self-employed. You can also set up taxable portfolios in brokerage accounts that buy dividend-paying stocks.

Aside from crunching the numbers to define a comfortable retirement, “softer” questions — often neglected in planning — require contemplation. The International Foundation for Retirement Education (infre.org), found in a retirement readiness survey that only “one-third say they have some plans but are mostly just looking forward to having more time for leisure activities.”

“What is the money for?” Robert Stammers, director of investor education for the CFA Institute, said investors should ask themselves. “What does retirement mean? Clients need to tell their advisers what they want to do when retired, although that’s difficult for most people.”

For some people, full retirement may not be an option — or even desirable. You may want to work longer or part time. You may even consider a phased retirement where you gradually reduce your working hours. Or you may have a need for social engagement and find being a full-time volunteer desirable.

It may be helpful to talk not only with your partner or spouse and a trusted adviser but also to do a more comprehensive breakdown of social, personal and wealth goals in retirement. Still, much will depend on how healthy you are and how you plan to occupy your time. The latter can be planned better than the former. Thoughtful preretirement planning may even lead you into another career or several new pursuits.

If life expectancy continues its upward curve, you’ll have your work cut out for you, because you may need to think about what you want to do in your 10th and 11th decades. If you’re fortunate, you’ll have plenty of time to think about it.

A COSTLY APPROACH

Earlier this year, Harry S. Dent Jr., advisor and author of The Great Depression Ahead, predicted stocks would start to plummet in June. He noted that personal spending is 70% of the economy and that, over time, as baby boomers become elderly, their personal spending will dive. The American economy, the advisor said, will fall off a cliff.

The man's comments seemed logical and rooted in common sense, and many investors seemed to buy his horror story. After the talk, several investors ostensibly decided to hunker down for bad times. (Does anyone remember the prediction that the markets wouldn’t be able to function as a result of crossing over from 1999 to 2000?)

Dent can be persuasive. In his new book, The Great Crash Ahead: Strategies for a World Turned Upside Down, he predicts the Dow will fall to as low as 3,000 by 2014.

History, though, shows a different story. Dent had also forecast the Dow to hit 40,000 in 2010. In 2009, he told people to get out of the stock market - just before the surge. The defunct AIM Dent Demographic mutual fund and the newer Dent ETF both badly underperformed the averages.

Persuasive as it sometimes sounds, investing based on these predictions has proven quite costly. And so it was for those who relied on the Wells Fargo chief economist, John Silvia, who boldly stated that rates would "definitely" rise last year. The January effect failed in 2011, as did what many claimed was the "always good" third year of the presidential cycle.

Some forecasts, though, are spot-on. Gary Shilling, president of A. Gary Shilling & Co. in Springfield, N.J., was one of the few economists who correctly foresaw the real estate bubble and recommended against owning stocks in late 2007. Shilling became infamous in 2009, however, when he predicted a down market and ended up being dead wrong.

The same goes with Meredith Whitney, the widely followed banking analyst who predicted the financial collapse in 2008, but was way off on massive municipal bond defaults in 2011. Following an expert who was prescient for one year can be extremely costly the following year.

WHY WE LISTEN TO FORECASTS

In Jason Zweig’s book, Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich, finance writer Jason Zweig notes that there's a human compulsion to make forecasts, and calls such compulsion "prediction addiction". Zweig says that when it comes to investing, the pursuit of recognizing patterns in random data is a fundamental function of our brains. Though other animals have the ability to recognize patterns, humans are uniquely obsessive about it, says Zweig, who sits on the editorial board of the Journal of Behavioral Finance.

When it comes to investing, clients naturally search for order by finding patterns, and that order gives comfort. Unfortunately, we usually think we have discovered order where none actually exists.

Clients expect their financial planners to be studying economics and the markets, and they think they can rely on us to be experts in making order from the chaos of the markets. Many investors think they are paying us to bring this order to their portfolios, thinking we can predict when markets will surge or plummet, which asset classes will outperform next year, and which stock will become the next Apple.

Yet we don't bring order at all by making such predictions. For example, advisors under the TD Ameritrade platform had invested just 26% in cash and fixed income at the height of the stock market on Oct. 9, 2007, and 51% in cash and fixed income at the market bottom on March 9, 2009. In both cases, they were exactly wrong! By maintaining our strategic asset allocation for your long-term portfolios, we move the opposite way of the herd – buying when markets are low and selling when they are high. This is a recipe for making money… “buy low, sell high”.

UNCONSCIOUS AND AUTOMATIC

Breaking any addiction is a monumental task, and this particular one may be nearly impossible as it is part of our natural brain wiring. According to Zweig, our brains constantly leap to conclusions in an unconscious and automatic way.

To get a better picture of what goes on between our ears, conducting an MRI of the brain while thinking we are about to rake in a quick windfall looks like that of a drug addict about to get his or her next fix. Dopamine is the brain chemical that drives our prediction addiction. It's produced organically and is responsible for propelling our brain to take action to seek rewards.

When we get information, it's nearly irresistible to avoid taking action. Even knowing what we know about Dent and how his predictions have played out, we find ourselves sometimes naturally fighting our own reaction to sell assets, thinking that this time he may be right. When a client asks me what I think stocks will do for the rest of the year, I've found the best approach is not to compare such thoughts to those of a drug addict, but to educate the client on the subject of behavioral finance.

NOT KNOWING

To show the destructiveness of acting on predictions, a recent study of some mutual funds shows that investor returns badly lag the fund returns. Human nature seeks out what has performed well in the past and makes the seemingly logical conclusion that the same actions will lead again to a great performance. Next, fear sets in when the strong performance doesn't continue and we sell.

Carl Richards, author of The Behavior Gap: Simple Ways to Stop Doing Dumb Things with Money, writes that people will "repeat until broke". He says, "When people ask me to predict the future, I always just chuckle and say 'I have no idea.'" Most people, he says, know that we don't know and find it refreshing when we admit it. Our only “bet” is that the long-term trend is “up and to the right” as it has been through the Great Depression, the Great Recession, World Wars, the Crash of ’87, the Tech Wreck, et. al.

Advisor Rick Ferri, founder of Portfolio Solutions in Troy, Mich., offers an innovative answer to future seekers. During his quarterly conference call with clients, he walks them through the state of the economy, describing the implications of the predictions of economic indicators such as GDP, inflation and unemployment. He also tells clients how he thinks equities may perform in the short-term.

He lets every investor know, though, that his views have nothing to do with how he invests their money. The call helps clients who want to know the future without using market timing techniques that are likely to harm them. Yet, his firm relies on strategic asset allocation and rebalancing toward targets, just as we at Pauley Financial do.

While we can't predict the markets, we can predict something almost as valuable - human behavior. With near-perfect certainty we can predict that, if stocks go up over the next year, people will move into stock funds. And if they do poorly, people will pull money out. We tell clients that rebalancing is the one way to be a true contrarian. In investing, herds get slaughtered and true contrarians come out ahead.

Accepting that the future is uncertain can be a quite unnerving feeling. Education is the key to helping our clients accept and understand the inevitable uncertainty. Our investment approach is designed with no fallacies about being sooth-sayers. But we can apply discipline to avoid the ‘buy-high, sell-low’ herd mentality. In investing, knowing we don't know is one of the keys to avoiding herd behavior – and, thereby, increasing returns.

I founded Pauley Financial over 16 years ago because of my passion for helping and serving others. I decided early on that the FeeOnly™ approach of aligning our firm’s interests with that of our clients was best suited for the my personality and, more importantly, best for our clients. We remain steadfast in our belief in this approach, as it ensures that no other financial incentive is provided by any institution to our firm - that we do not receive commissions on the actions we take on our clients’ behalf.

Yesterday’s Op-Ed piece in the New York Times entitled “Why I am Leaving Goldman Sachs” reinforces the bedrock values that Pauley Financial was founded on. In professional circles, we often talk about a "client-first" attitude, which is shorthand for giving your clients the same quality of financial advice that you would give your mother. It's a useful shorthand way to navigate through a financial world that is still beset by incentive payments, expensive rewards for sales production, under-the-table or soft dollar incentives, and a host of other ways that product vendors try to buy their way into your portfolios.

"Client-first" simply means that the client's financial success and well-being comes before all other considerations. It's what you would expect from a doctor or other professional, and, many of us believe that you have a right to expect the same level of care from your financial advisor.

Wall Street firms and sales organizations are very good at hiding the real agenda behind their advice and do a masterful job of hiding the profits they skim off the top when you take their recommendations. This is why it was so startling when, in the above-mentioned New York Times opinion piece, Goldman Sachs executive director Greg Smith essentially pulled the curtains back (a la “The Wizard of Oz”) and showed how Wall Street really works.

Smith declared that he was resigning from the venerable brokerage firm - perhaps Wall Street's most highly-respected organization - because, in his view, its culture is all about putting the client's interests last. "To put the problem in the simplest terms," he writes, "the interests of the client continue to be sidelined in the way the firm operates and thinks about making money."

Pulling the curtain aside a bit further, he said that the criteria for promotion and success was not "leadership" or "doing the right thing". Instead, he said, "if you make enough money for the firm (and are not currently an ax murderer) you will be promoted into a position of influence."

How do you make money for the firm? Smith outlined three ways. A Goldman broker or executive can rise in the ranks by "persuading your clients to invest in the stocks or other products that we are trying to get rid of because they are not seen as having a lot of potential profit". (Just what you want to buy for your retirement portfolio, right?) Or, alternatively, "get your clients - some of whom are sophisticated, and some of whom aren't - to trade whatever will bring the biggest profit to Goldman. “Call me old-fashioned," said Smith, "but I don't like selling my clients a product that is wrong for them."

Pulling the curtain back still farther, Smith said that "It makes me ill how callously people talk about ripping their clients off. Over the last 12 months, I have seen five different managing directors refer to their own clients as 'muppets', sometimes over internal e-mail... Will people push the envelope and pitch lucrative and complicated products to clients even if they are not the simplest investments or the ones most directly aligned with the client's goals? Absolutely. Every day, in fact."

He said that the most common question he gets from junior analysts about derivative investments is: "How much money did we make off the client?" He wonders what the effect will be on that junior analyst who sits in the meeting rooms hearing senior executives talk about "muppets", "ripping eyeballs out", and "getting paid".

You can read Mr. Smith's comments in their entirety here, where you will also see a nice illustration of vultures at feast. He predicts that companies - and people - who care only about making money will not be able to keep the trust of their customers.

Millions of people routinely trust their brokers and the big firms that buy Super Bowl advertisements, never seeing this messy view on the other side of the curtain, unknowingly chipping in their retirement dollars to the outsized Wall Street bonus pools.

You find yourself wondering: who's going to tell those "muppets" - your hard-working friends and neighbors - that their broker is quietly, invisibly, cleverly putting their interests last?

All financial consumers owe a debt of gratitude to Mr. Smith for helping reveal how some in the financial industry behave. Fortunately, there are many who don’t. Certainly, we do not. We continue to uphold our fiduciary responsibility of “clients first” and do so in a way which does not create a conflict of interest between our clients and ourselves.

Focus on IRAs

Individual Retirement Arrangement is the technical IRS term for what most investors have come to call Individual Retirement Accounts or (“IRAs”). [Note: this article does not address SEP-IRAs – simplified retirement plans for the self-employed.] As the tax deadline of April 17th for 2011’s calendar year contributions approaches, we are writing to ask our clients and friends to focus on this annual opportunity before it passes again. Below are some lesser known attributes and components of establishing and adding to an IRA account. We look forward to hearing your thoughts on how useful this material is, and as always, we welcome your suggestions for topics for future newsletters.

The IRA Opportunity

IRAs provide investors with the opportunity to defer taxes on the gains in a Traditional IRA or later take out gains tax-free on contributions made to a Roth IRA. And, the government permits a taxpayer to delay that decision up until the time of filing the tax return for the previous calendar year (but not later than April 17th).

We generally advise our clients to prioritize this opportunity among their myriad investment choices. We are happy to work with your tax advisor to ensure you maximize this opportunity each year.

Income Limits and Tax Deductible Contributions

It is a common misperception that income limits can prevent IRA contributions altogether. More accurately, the opportunity to deduct one’s contributions to a Traditional IRA are determined by IRS rules. We have copied links to those IRS tables below for your ease of reference so you can preliminarily assess whether you can make deductible contributions to a traditional IRA whether you are covered by a company retirement plan or not.

HOWEVER, in some cases, it may make sense to contribute to an IRA with non-deductible (after-tax) dollars. Under current tax law, this can be done up to the annual contribution limit (i.e. if they have the commensurate “earned” – not “investment” - income) regardless of whether their current income exceeds the published limits. The time value of money and the ability to convert the account to a Roth may provide you the incentive to make a non-deductible contribution.

Again, we are happy to complete the analysis for you and work with you to decide whether to proceed with investing in a deductible (if you qualify) or non-deductible IRA.

2012 IRA Contribution and Deduction Limits (for those covered by a work retirement plan)

2012 IRA Contribution and Deduction Limits (for those NOT covered by a work retirement plan)

Roth IRA Conversions

In the preceding paragraphs, we articulated the importance of prioritizing IRA contributions. We also have gathered from speaking with our clients that most investors have not taken the time to think through whether they should consider a conversion of their existing IRA accounts to a Roth IRA. While no one can predict how our tax laws will change, we are happy to evaluate and make recommendations to you about whether you should consider a conversion of your existing IRAs to a Roth IRA. There are advantages of the Roth IRA that may be quite beneficial to your plan and/or your goals to pass on assets to your loved ones. As an example, Roth IRA accounts have no required minimum distribution for the account owner and a beneficiary of an inherited Roth is not required to pay income taxes on distributions.

For your ease of reference, we have also included the IRS table for outright contributions a Roth IRA in the below link:

Inheriting an IRA--What You Need to Know

Finally, the rules governing inherited IRAs can be complicated. Here are the major issues to consider.

Transferring inherited IRA assets

If you inherit a traditional or Roth IRA from someone who isn't your spouse, your options are fairly limited. You can't roll the proceeds over to your own IRA, treat the IRA as your own, or make any additional contributions to the IRA. You can transfer the assets to a different IRA provider (or keep the inherited IRA with the existing provider), as long as the registration of the account continues to reflect that the IRA is an inherited (or beneficiary) IRA, and not your own.

If you inherit an IRA from your spouse, however, you have additional options… You can roll over all or part of the IRA proceeds to your own IRA (or to a qualified plan). If you roll the proceeds over to your own IRA (an existing one, or one you establish just for this purpose) the rules that apply to IRA owners, not beneficiaries, will apply from that point on. If you're the sole beneficiary, you can also generally treat the deceased’s IRA as your own by simply retitling the IRA in your name.

But, you aren't required to assume ownership of an IRA you inherit from your spouse. You can, instead, continue to maintain the inherited IRA as a beneficiary. You might want to do this if, for example, you inherit a traditional IRA and you'll need to use the funds before you turn 59½ (distributions from inherited IRAs aren't subject to the 10% early distribution penalty but distributions from IRAs you own are subject to the penalty, unless an exception applies).

A spouse beneficiary can also convert all or part of an inherited traditional IRA to a Roth IRA after paying the income tax on the converted amount. This option is not available to non-spouse beneficiaries.

Required Minimum Distributions (RMDs)

Non-spouse beneficiary: Federal law requires that you begin taking distributions (called required minimum distributions, or RMDs) from an inherited IRA (traditional or Roth) the year after the IRA owner dies.

Spouse beneficiary: If you rollover the deceased’s IRA over to your own IRA (or treat it as your own), the RMD rules apply to you the same way they apply to any IRA owner--you'll generally need to begin taking RMDs from a traditional IRA once you turn 70½ (note: no lifetime RMDs are required at all from a Roth IRA). If you don't roll the IRA assets over or treat the IRA as your own, then the same rules described above for a non-spouse beneficiary generally applies to you, except that you can defer receiving distributions until your spouse would have turned 70½.

Note: In both cases, if the IRA owner died after turning 70½ and didn't take a required distribution for the year of death, you'll need to make sure to take that distribution by December 31 of the year of death in order to avoid a 50% penalty.

Taxation of Inherited Roth IRAs

Qualified distributions to a beneficiary from an inherited Roth IRA are free from federal income taxes. To be qualified, the distribution must be made after a five-year holding period. The five-year period begins on January 1 of the year the deceased IRA owner first established any Roth IRA, and ends after five full calendar years. If you take a distribution from an inherited Roth IRA before this five-year period ends, any earnings you receive will be nonqualified and subject to federal income taxes.

For example, you inherit a Roth IRA from your father on January 1, 2013. Your father established this IRA in June 2012. Your father also established a separate Roth IRA, which you did not inherit, in December 2008. Distributions you receive from the Roth IRA will be qualified, and tax-free, because the five-year holding period (January 1, 2008, to December 31, 2012) has been satisfied.

If you're a spouse beneficiary, and you roll the inherited Roth IRA over to your own Roth IRA or treat the inherited IRA as your own, then you'll be eligible to take tax-free distributions only after you reach age 59½, become disabled, or have qualifying first-time homebuyer expenses. You'll also need to satisfy the five-year holding period, but a special rule applies. The five-year period for all of your Roth IRAs--including the inherited IRA--will be deemed to have started on January 1 of the year either you or your spouse first established any Roth IRA.

In Closing

It is our responsibility to focus on and keep track of these details for our clients and friends. Whether your situation is unique or it falls into one of the scenarios delineated below, we are happy to assist when:

•You are considering an IRA contribution (deductible, non-deductible, or Roth).
•You are considering a conversion of an IRA to a Roth IRA.
•You inherit an IRA and need help understanding your choices and/or RMDs.
•You don't want or need inherited IRA funds. (You may be able to disclaim the IRA and have it pass to another beneficiary. This must be done in accordance with strict IRA rules.)

Our Fiduciary Standard

Perhaps you missed the announcement, buried on page C7 of the January 24, 2012 issue of the Wall Street Journal, but it caused a stir in the financial planning world. The Securities and Exchange Commission has put off implementing a key part of the Dodd-Frank Act: creating a fiduciary standard for all who give investment advice, whether they are brokers (like Goldman, Merrill , UBS, etc) or SEC-registered registered investment advisors (like PFSI).

Anybody who saw Fabrice "Fabulous Fab" Tourre boast about his prowess selling complex toxic securities to his unsuspecting customers, or watched Goldman Sachs CEO Lloyd Blankfein testifying uncomfortably to Congress that his firm had no duty whatsoever to protect the interests of his customers in these transactions, quickly realized that Wall Street is not totally about creating vast wealth for the people who receive brokerage advice. I hope you were sitting down for that. This was further underscored when Smith Barney traders chortled in their internal e-mails that betting against some of the toxic mortgage pools they had sold their customers was "the best short ever."

Dodd-Frank was supposed to change all that, by asking the SEC to require that brokers who made investment recommendations be held to a fiduciary standard "at least as stringent" as the standard that investment advisors (like PFSI) are held to. Under heavy lobbying pressure from Wall Street, the SEC has dragged its feet on this issue so effectively you might think it was wearing shoes made of cement. And for most investors, this stalled effort at reform has remained completely under the radar.

What does it mean to act as a fiduciary? The fiduciary concept is actually pretty simple, and can be found in the very first written legal code, the Code of Hammurabi (roughly 1770 BC) and in Cicero's orations during the Roman Republic around 50 BC. In the ancient world, a trader would take his caravan (or sailing ship) to some distant land to trade Mesopotamian clay pots or bronze artifacts for furs, tin or copper. Since the trader would be gone for months or sometimes years, somebody had to make basic business and financial decisions on that person's behalf while he was on the road. And it was important that this person make decisions that were in the trader's interest, not his own. When somebody came to offer the merchant a great business opportunity, he wouldn't want somebody who would jump in and buy it for his own profit instead, or buy it and then sell it back to the merchant's account at a fat markup.
As Cicero put it:
“…in cases where we ourselves cannot be present, the vicarious faith of friends is substituted; and he who impairs that confidence, attacks the common bulwark of all men, and as far as another depends on him, disturbs the bonds of society.”
(Oration for Sextus Roscius of America; Cicero 106 – 43 BC)

And so, the basic idea of a fiduciary is a simple standard of behavior. You are watching out for and protecting the interests of someone who has given you their trust. You are making decisions and recommendations that will benefit that other person. You would, under this simple standard, have to avoid triumphantly selling at a markup the same securities that your colleagues are confidently betting will blow up and leave your customers with frightening losses--while generating outsized gains that will flow into the Wall Street bonus pool.

With this in mind, it becomes a lot easier to see why Wall Street has lobbied so hard to stall being held to this standard.

SEC-registered Registered Investment Advisors (like PFSI) have been living under a fiduciary standard--the one referenced in Dodd-Frank--since 1940. It's true; you don't see RIA firms routinely handing out seven-figure bonuses to their brokers and sales agents. But many advisors who live under this business model make a good, honest living--and, most importantly, they don't have to squirm uncomfortably when somebody asks them to explain their recommendations.

As you know, at Pauley Financial we believe the core fiduciary standard is the most transparent and true method of minimizing conflicts of interest. That's not to say that there aren't honest, ethical members of broker firms that do offer advice. Conversely, there are RIA advisors held to fiduciary standards that elect to not comply. Yet, not requiring such a standard leaves wiggle room. Simply put, our choice to adhere to the fiduciary standard offers another layer of protection to our clients. In a nutshell, it comes down to the Golden Rule applied - plain and simple.

A Cork on the Sea

In our industry, there are a few writers that have emerged as authors by summarizing articles published in the most highly respected trade journals for wealth managers and financial planners.  Everybody wins; the authors make a good living, and, we get to read more than we might otherwise have been able to.

In that spirit, what follows is my own summary of a recent article in Money Magazine by Pat Regnier.  We received this magazine by accident - perhaps because we got on a mailing list of prospective subscribers.  We don't subscribe to Money Magazine because it is normally replete with articles prognosticating about the future, the "Best Stocks for 2012", "Secrets of Picking Stocks", etc.  Of course, you know by now that we are not market-timers and don't pretend to be able to predict the future.  However, since it happened to be at arms-length during breakfast, I flipped through it and was pleasantly surprised to read "My Brilliant Trade".

Regnier describes a scenario in which he "brilliantly" dumped his entire equity position on July 26th, 2011.  And then, go figure - his disaster bet paid off.  The very next week, the stock market had the biggest one-day loss since the 2008 financial crisis.  He "felt like a genius".  Acting on a forecast and seeing it proved true is exhilarating - possibly even addicting.  Much like golf, a few good holes can keep one coming back for more.  Or, one big fish can keep you in the boat for months without so much as even a decent nibble.

However, Regnier then honestly proceeds to tell us, in a slightly self-deprecating manner, that even he realizes he would be ignoring an awful lot of evidence suggesting the world really isn't predictable.  On top of that, he now has himself squarely in a pickle: when to get back in.  He quotes a study by Philip Tetlock, a psychologist at the University of Pennsylvania, who evaluated the responses of experts to make predictions of world events - particularly, the global economy.  The experts barely beat a simple formula that assigned equal probabilities to each possible outcome.  There is a well known bias regarding feeling worse about bad things happening because of something we actively do, versus when bad things happen to us.

"The mistake I made was selling without defining the conditions in which I would get back in."  He still is not back "in" and is now wrestling with a decision that seems to have existential stakes with the equity markets now at six-month highs - higher than when he got out!  If he gets back in and the market goes down, he'll have erased his genius moment.  He is now reminiscing about how nice it would be to return to being a "cork on the sea...bobbing up and down with the tide", i.e. staying fully invested in an appropriate asset allocation for your goals and risk tolerance.  As you know, this is the approach we take with your long-term portfolio after protecting your short- and medium-term portfolios from these ups and downs of the markets.

Regnier notes that for most people, active trading turns out to be just a reliable way to erode returns over time.  To back this up, he quotes a Morningstar statistic: "From 2000 to 2010, equity funds earned an annualized 1.6%, but, the researchers found that the typical investor captured only a 0.2% return".  Why?  Because they didn't stay fully invested for the full time.  He then proceeds to make another point with which we concur.  Your human capital, or earning potential, is the greatest contributor to your wealth.

So, shutting off CNN and getting back to work might just be the ticket.  In the mean time, Reigner is sweating his next decision because he didn't define the "trigger" for getting back in when he got out.  Stay tuned...

Tightwads and Spendthrifts!

Happy New Year!  We hope the year is off to a great start for you and yours.

At Pauley Financial, we have kicked off the new year with a valuable addition to our team. We are honored to welcome Brian Cox to our firm as we continue to challenge ourselves to provide better service to our readers and clients. Doug first met Brian over 10 years ago. A brief bio of Brian follows:

Brian received his Bachelor of Science (Economics) degree from the United States Military Academy (USMA) at West Point in 1995. Following graduation, he completed Airborne, Air Assault, and Ranger training, and served as an artillery officer. At the completion of his active service, Brian volunteered for Reserve Officer duties, and was later called back to serve in Baghdad as a member of the Special Staff for the Commanding General of the Multi-National Forces - Iraq.

After earning his MBA from the University of Michigan in 2003, Brian followed his lifelong passion for investing by joining the JPMorgan Private Bank as an Investment Associate in New York. He has taken on positions of increasing responsibility in the asset management industry, most recently as a Principal of WestSpring Advisors, LP. He has managed institutional and high net worth client relationships globally, and his background and experience in both traditional and alternative asset classes appropriately complement Pauley Financial. He has served as a panelist and industry awards judge for various institutional industry groups and publications.

Brian is married with three sons. He enjoys triathlons and volunteering - as a youth coach, as a Service Director for the Wounded Warrior Mentorship programs, and as an active member of his church. Brian and his family now reside in New Braunfels, Texas.

Moving onto our topic - "Tightwads and Spendthrifts - Unite"! I'm sure none of you reading this article could relate, however, in the event that you may know someone that shares these characteristics, perhaps they might find this article of interest. We have adapted this newsletter from a Kiplinger article published in February 2012 authored by Bob Frick.

Consider the results of brain scans performed on people while they made buying decisions… Researchers found that when subjects were shown products and then prices, about 30% of them experienced a fired-up insula. The insula is the part of the brain that's active "when we're getting socially excluded or somebody's unfair to us or we have to smell something gross," says Scott Rick, a professor of marketing at the University of Michigan and one of the researchers. The study also found that about half of subjects had a more measured response when contemplating a purchase, and 20% seemed to feel pleasure and little pain.

That study was the genesis of a scale that measures how likely you are to be a tightwad or a spendthrift. Spendthrifts don't feel enough pain for their own good, so they overspend, carry more debt and feel guilty later. Tightwads, however, experience too much pain, which leads to feelings of regret for not having spent enough. Rick says it's worse to be a spendthrift because of the financial costs, but neither extreme is as good as the middle group, labeled unconflicted. "Spendthrifts are bad off financially and psychologically," he says. "Tightwads have big bank accounts, but we find that they're less happy than the unconflicted group."

Where Do You Stand?

You don't need a brain scan to figure out where you land on the scale; a simple survey will do. In a 2008 paper, "Tightwads and Spendthrifts," Rick, George Loewenstein, of Carnegie Mellon University, and Cynthia Cryder, now with Washington University, surveyed more than 13,000 adults. They found that spendthrifts were three times as likely as tightwads to be in debt, regardless of income. (Take the survey yourself: Are You a Tightwad or a Spendthrift?)

Fatal Fiscal Attraction

Rick and two colleagues, Deborah Small, of the University of Pennsylvania, and Eli Finkel, of Northwestern University, applied their scale to a study of married couples, "Fatal (Fiscal) Attraction: Spendthrifts and Tightwads in Marriage." Researchers found that tightwads and spendthrifts regret their spending habits and often marry spending opposites to compensate. Such a marriage starts out well, says Rick. The spouses "help each other meet in the middle." When dining out, for example, "they don't spend a million dollars on a great meal, but they don't go Dumpster-diving either."

Tensions rise with purchases that really matter, such as cars and houses, says Rick, a self-described spendthrift. Such marriages "might be refreshing at first, but my own guess is that they then become maddening" as couples begin to bicker over spending issues. The study suggests that spendthrifts who marry tightwads, as you might expect, tend to be better off financially than spendthrifts who marry spendthrifts. But spendthrifts who marry spendthrifts tend to have a happier relationship, even though their financial situation is often worse. When two tightwads marry, they enjoy both better finances and a more satisfying relationship.

Balance Your Spending

To help rein in spendthrift tendencies, you can focus on the opportunity costs of buying more than you need. For example, when buying a car, instead of spending $3,000 on the luxury-options package, think how that money could be put to better use.

Tightwads can frame some outlays as investments -- think of a vacation as an investment in productivity, Rick suggests. They can also buy with plastic because it's less painful than paying with cash.

As we said tongue-in-cheek as we introduced this topic, we are certain that you and yours fall nicely into the 'unconflicted' category! In the event, however, that you may be able to relate to either of these personality types, or know someone that does, know that we continually work to help our clients find the right balance of living for today and saving for tomorrow. The trick is finding and tweaking the balance that works for you.

As Kimberly and the kids will tell you, I'm not known for being succinct, so I have challenged myself to get to the point…  Culturally, the very meaning of “retirement” is changing out of necessity and desire, and I don't think that's a bad thing.

Before 1930, people generally worked until they died - "retirement" per se didn't exist.  From 1930 to 1970, retirees began living longer, and the notion of “retiring” became part of our culture.  From 1975 to 2010, as more cruise lines and golf courses marketed to them, people came to view “retirement” as an “entitled period of leisure”.  Today, life expectancy continues to increase, but many can no longer afford a long, luxurious retirement, and a large number are re-examining their preconceived notion of “retirement”.

So, welcome to “Retirement 3.0”, which seems to be a nice medium between the extremes.  54% see it as a new chapter in life.  Many are delaying “retirement” due to financial considerations or concern about personal relevance.  Even more (about two-thirds) expect to remain productive, active, and involved instead of just giving in totally to a life of leisure.  While medical advances are enabling our bodies to live longer, people live healthier if they remain engaged and have a purpose.

While we work to help our clients gain “financial freedom”, we also encourage them to remain engaged and active.  “Financial freedom” is getting to the stage financially where you can have more control over your time and don’t necessarily have to have a full-time job.  But, if you are passionate about what you do, are contributing, and feel relevant, it's not really “work”.  (Note: even better if you’re getting paid for it!)  This notion of “Retirement 3.0” reflects more of a graceful “wind-down” than a screeching halt.

So, as the new year approaches, try to shape your view of “Retirement 3.0”.  What would it take to enable you to achieve your “financial freedom”?  How will you remain engaged and purposeful?  Let us know if we can help you think this through.

Wrangling Over a Phantom Stimulus

The headlines are screaming again, this time about the Capitol Hill controversy over payroll tax cuts. And, as usual, there is more to the story than what you're reading.

First the good news. Earlier reports said that a stalemate on the tax cut would shut down the government, but before the Senate went home for the holidays, it passed a separate bill that finances the government through next September.

Better news: by all reports, Republicans and Democrats were--and are--in general agreement that there should be some kind of stimulus to the still-recovering economy, and the biggest, least-stimulated sector is consumer spending. The Republicans argued for more tax relief for the wealthiest Americans, and want to reduce pollution controls and force the President to approve the proposed Keystone XL pipeline, which would deliver oil from tar sands in Alberta, Canada to refineries in Texas. Meanwhile, the Democrats wanted a broad-based stimulus measure that would put spending money in the hands of more mainstream American consumers. And they supported environmentalist opposition to the pipeline and the pollution proposals.

Naturally, the two sides couldn't agree on a compromise, so the Senate, by an overwhelming majority, kicked the can down the road for two months by agreeing to continue the reduction in Social Security taxes from 6.2% to 4.2% until Congress could get back in session early next year.

It seems clear that the Senators expected their colleagues in the House of Representatives to follow this simple solution as they’ve already left town! But, nothing is simple in this partisan political atmosphere, and the House (for now, at least) has rejected the measure.

There are several interesting complexities here that should have gotten more attention. One of them is the problems that this wrangling has created for employers, who will have to scramble at the last minute to change their payroll systems to reflect either the 6.2% rate or the 4.2% rate. Which will it be? Who knows? All anybody knows for sure is that the withholding amount will need to be correct starting January 1, and the National Payroll Reporting Consortium has already said that, as a result of the brinkmanship, there is now not enough notice to accommodate any changes that quickly.

Of course, if and when the whole issue is taken up at the end of the proposed two-month extension, companies would face exactly the same dilemma. Chalk this up to a Congress that is oblivious to the consequences of its actions on the business community--especially small businesses.

Behind the scenes, there are other dramas. One involves the very complicated way that the Social Security tax reduction is structured. Reducing the payroll tax would obviously reduce the flow of money into the Social Security trust fund, which is famously experiencing solvency troubles of its own. Neither side wanted to be seen as making the entitlement mess any worse, so the stopgap bill would have had the U.S. Treasury pick up the payments--a sideways accounting move that has no real substance. The bill also prevents doctors who accept Medicare payments from receiving a 27% reduction in reimbursement payments, which would weaken the financial stability of another entitlement program; so, the Treasury will pay that out of its pocket as well.

But, the surprising thing here is that this is actually a revenue-neutral piece of legislation. The Treasury coffers would be replenished through a side door that nobody seems to have noticed. Title IV, entitled "Mortgage Fees and Premiums," would have raised the amount that Fannie Mae and Freddie Mac--the organizations that back a majority of home loans in the U.S.--would collect in mortgage fees after January 2012. In all, the raised mortgage fees--which would increase the cost of homeownership at a time when the housing market is staggering--would pay for the two month extension of the payroll tax cut (estimated at $20 billion) plus two months of additional jobless benefits for 2.5 million out-of-work Americans (an estimated $8.4 billion) and two months of added Medicare reimbursements (an estimated $6.6 billion).

It certainly is interesting math. Even more interesting that the stimulus is coming at a cost to the next two big fiscal issues for the U.S. – Medicare and Social Security. Our elected officials created a band-aid solution for the debt problem and are now working to create two larger crises (which are already issues they’ve neglected to address). Clearly, they can’t see beyond their next election and address the big issues our country needs. Hopefully, we will all remember this come next November…

Time-Out

"Time-Out" is a method many adults use with children who need a few moments to regain composure before returning to an activity that had been causing them some kind of stress (i.e. toy sharing, not winning, etc). While this may be an effective re-directive "pause" for children, I suggest to you that it is NOT an effective investment strategy. Active market-timers will disagree with me vehemently (after all, exorbitant fund fees must be justified somehow). However, since I don't pretend to be able to predict the future (earthquakes, political unrest, terrorist attacks, cataclysmic weather events, dishonest business schemes), it follows that I couldn't possibly predict the largest swings - in both directions - the markets will bear. So, for your friends and neighbors that may get antsy about "this time it's different - let's change our investment strategy mid-stream," I would turn their attention to the summary below and suggest that a "time-out" of the market would need to be followed by an insightful (magic?) time and trigger to get back in. Although the holiday season is quite magical in many ways, I'm not willing to risk our client's investment portfolios - and more importantly their goals - on insight that no one can possibly, sustainably possess.

Let's say you're looking at a stock market that has lost 81% over the past 2.7 years during a time of severe economic contraction. The headlines are not encouraging: the country is mired in depression, and so, too, is the rest of the world. Are you feeling bullish, or is this a great time to unload your stocks and stop the bleeding?

If you decided to unload, then you would have missed at least some of the dramatic market increases that started in 1937--4.7 years of annualized 32.1% gains, for a total gain of 266%.

Okay, suppose the market has dropped a total of 63% over a torturous 13.6 year period, and Business Week magazine has just proclaimed "The Death of Equities." Buy? Sell?

Again, the correct answer would have been "buy." After 1982, the S&P 500 gained a remarkable 666% over the next 18 years.

The accompanying chart, created by Doug Short for the Advisor Perspective services, shows a number of market ups (blue) and downs (red) since 1871, and the thing you notice is that virtually every major market move, up or down, was unexpected. The bull markets came as a surprise, and the bear markets came at times when the markets seemed to be on a long-term roll. (The scale here is logarithmic, which means that if the chart were expressed in absolute terms, the long-term rise would look much steeper.)

In truth, the decision that faced most investors in 1921 (market down 69% over the previous 15 years) or 1949 (market down 54% over the previous 12 years) was not whether to make some kind of dramatic move into stocks. The decision, made daily as the newspaper carried discouraging news over and over again, was whether to stay invested in stocks and eventually reap the gains (396% and 413% respectively) that nobody could have predicted in advance.

The most important long-term statistic to come out of this analysis may be the dramatically different size of the gains and losses. Taken together, the various bulls since the market trough in 1877 brought investors gains of 2,075%--an average of a 415% gain per bull market. The bear markets, in aggregate, cost investors 329%--an average downturn of 65%.

Nobody knows when the markets are going to suddenly take off after a bearish period, and the longer and deeper and more discouraging the downturn gets, the less likely the next bull market seems. But, history suggests that patient investors get more return during market upturns than they lose when the markets drop. Long-term, trying to outsmart the market and sidestep losses would have led to missing even bigger gains.

Having a plan doesn't mean it should not be adjusted over time, but it does mean it shouldn't be adjusted regularly because of CNN Headlines News.

Occupy Wall Street - the Big Picture

My step-son asked last week what this "Occupy Wall Street thing" was all about. He's a Boy Scout so the “tent cities” on the news caught his eye. I mumbled something about it was a grass-roots effort to bring attention and correction to the corruption in many of our financial institutions. I've spared him the longer answer that follows (for which I know he's very grateful!), but I look forward to a day when I can revisit this topic with him. I'm hopeful that in that conversation I can explain to him that an across-the-board fiduciary standard (one like Pauley Financial adopted 16 years ago) is the only way out of this mess. I know we cannot legislate morality, but we can at least set the bar high. The bar is currently being set now by the very same people profiting from setting it low. There's a saying about a fox and chicken coop that comes to mind...

If you look hard enough, you can find a lot of silliness in the Occupy Wall Street movement. This is unfortunate because, somewhere behind the tents and weird finger communications and alleged drug use, there's a real story to be told. And the story seems to be bigger than the media can get its arms around.

For example? Financial insiders and those of us in the financial planning profession have watched the brokerage industry fight furiously--and successfully--against having to register their brokers with the Securities and Exchange Commission as registered investment advisors. Why? Because that would require the registered brokers to give advice that puts the interests of their customers ahead of their own and also (quel horreur!) ahead of the companies that employ them.

Perhaps more to the point, those of us in the financial profession have to live with the fact that the major Wall Street firms are rarely held accountable for crimes and other actions that would be severely punished if you or I committed them.

Such as? Consider the recent settlement of an enforcement case that goes back to the 2008 market meltdown. The Wall Street Journal reported that U.S. District Court Judge Jed S. Rakoff is questioning how diligently the U.S. Securities and Exchange Commission enforced securities law when it investigated Citigroup (parent company of brokerage giant Smith Barney – and, one of those “too big to fail” companies) regarding its sale of some of those infamous toxic mortgage-based debt instruments. Smith Barney brokers were selling the subprime mortgage instruments to their customers as highly-rated, safe bond instruments at the same time that the company's traders were betting heavily that the same packaged bonds would spiral down the toilet. In internal e-mails, one chortling trader described betting against the investments the company was selling, at a commission, to its customers as "The best short ever!!"

This once-in-a-lifetime short bet, combined with selling the dog investments in the first place, resulted in what the SEC estimated to be $160 million in fees and trading profits to Citigroup's bottom line. The SEC's proposed fine, questioned by the judge: $95 million. The math is, to say the least, “interesting.”

It gets worse. In the SEC's boilerplate language when it settles with major Wall Street firms, Citigroup and Smith Barney were allowed to neither admit nor deny the charges that they would be paying fines to settle. Judge Rakoff questioned whether there wasn't "an overriding public interest in determining whether the SEC's charges are true." Indeed.

Very little of these various issues are understood specifically by the people who are squabbling with police over whether they can pitch their tents in parks near the largest financial offices. The Occupy Wall Street crowd is acting on nothing more than a strong instinct that something is terribly wrong in America, and that the large banks are somehow at the center of the problem. The press can only seem to get its arms around little individual pieces of a very big picture.

What Wall Street fears more than anything else is a debate that asks whether much of what goes on in the largest investment banks--perhaps as much as 90% of it, based on current statistics--is doing our country and our economy more harm than good. Even more, it fears the idea that its hired representatives should have to give advice that primarily benefits their customers--which would immediately put an end to both the lucrative sales of creative new toxic securities and the revenue streams that would come from betting against them.

If we can start that debate in earnest, maybe the tents can come down. Or, at least, the people living in them could tell the reporters who cover them exactly what it is they're protesting.

Deficit Reduction by Default

Last week, while many of us were eating turkey, our country's elected representatives were busy disagreeing on the shared bounty (tax money) resulting in a complete failure of the "Super Committee" to reach a meaningful deficit reduction plan. (Raise your hand if you are surprised!)

The 12-member panel, made up of six Republicans and six Democrats, basically took hard-line positions on partisan issues, including the pledge not to raise taxes or reduce the social entitlement programs, and never moved far enough to reach agreement. This is yet another epic failure by our elected officials to act in the best interests of our country. As a result, Fitch Ratings followed the lead of Moody’s Investors Services and lowered its outlook on the US government’s triple-A rating to negative. This is a precursor to a likely downgrade – a step Standard & Poor’s took this past summer.

As financial advisors, we counsel our clients to protect their credit rating at all costs – it is their most significant asset which doesn’t appear on their balance sheet. Yet, our Congress apparently sees it as “no big deal” if the credit score of the US government is lowered, despite the impact on all of us.

What now? The original Congressional deal specified that there would be across-the-board government spending cuts adding up to $1 trillion, beginning in 2013. Those would eliminate $3.54 billion from the Federal Department of Education, including $134 million in student aid and $136 million in adult education. Payroll taxes would revert from 4.2% this year to 6.2% in January. The Economist reports that overall, the U.S. military would have to cut up to $1 trillion--almost a fifth of the total--from its spending plans. That would leave the U.S. with its smallest ground force since 1940, the fewest ships since 1915 and the smallest air force in its history. These cuts pose a threat to our national security.

The automatic cuts were described as "a pistol that Congress pointed at its own head in order to frighten itself into cutting the deficit." (Apparently, they needed a larger gun!) The hard decisions weren’t made. Apparently, failure to agree and across-the-board cuts was more politically palatable than helping to put our country’s fiscal house in order. For now, we can only watch, hope, and take an active role in our democracy as next year’s elections roll around.

Family Legacy Conversations

(The content of this newsletter was, in part, adapted from an article from Eric Winder, Ph. D. which appeared in The NAPFA Advisor, August 2011 issue).

As many of you know, one of my great passions is teaching. Our teenage children are somewhat less enthusiastic about this passion than they will be when they are older I'm sure (this thought reassures me anyway). Nonetheless, they continue to participate in our iMoney classes now buoyed by the thought of getting paid for assisting Kimberly and me during class. One of the great lessons I learned at business school was 'people do what you give them the incentive to do'; so, our solution of paying them to learn and participate in teaching about all things financial seems to be working for the moment.

A greater challenge with our children is the topic of this letter. Kimberly and I continue to evolve our conversations on the family’s estate planning with our children and our parents with age-appropriate provisions taken into consideration. I encourage you to do the same. There are many resources available to help guide these conversations as well; so, know that you don't have to go it alone. With the holiday season coming up and varied gatherings of friends and family, many of us will have the opportunity to at least begin.

Consider this scenario:

A 35-year-old man recently learned the facts of his father's estate plan. For years, he had enjoyed a positive, loving relationship with his father. As his father battled numerous physical ailments, the two consulted on many life decisions. The son knew his father didn't have much time left and knew the financial plans for the estate had recently been drawn. Still, it hit him like a ton of bricks when he learned that his father decided to leave all of his estate to his younger sister. The son's rage was not based on the money and other assets. It was not a large estate, and the young man was quite accomplished and was not wanting for money. He knew his younger sister was in greater need. The son was upset at being left out of the process. In fact, the father did not inform either of his children in advance of his decision. He did not want to deal with their emotional reactions. The son began to wonder if his father and sister worked behind the scenes along with the financial advisor to develop the estate plan. What was once a fairly close sibling relationship is now filled with accusations, bitterness, and threats of litigation.

Why do we avoid what is one of the most important conversations we could possibly have with our family? Most families avoid talking about issues of inheritance. Tough questions about the future, asset distribution, and who gets prized possessions should be planned and discussed before documents are drawn up. However, raising these sensitive topics can naturally be unsettling for families.

Unaddressed, these issues often have negative long-term consequences. Studies show that when families fail to discuss what's important, their wealth and value system is usually dissipated over time. Family squabbles, little or no direct communication, secrets, ruined family relationships, and litigation all contribute to a bleak picture for asset preservation and relationships.

TRADITIONAL ESTATE PLANNING

Historically, inheritance decisions were based on a general theme: oldest sons got the farm, and oldest daughters received the dowry. In the 21st century, it's more complicated. Parents have many important decisions to make about asset transfer. How much money is enough? How should family heirlooms be distributed? What role does the principle of ‘fairness’ play? What about the principle of equal distribution? What about philanthropy? How well-prepared are heirs to manage assets once they receive them?

What can be done now to train the next generation to be good stewards of assets and values? These are weighty decisions, and the vast majority of people do not discuss them with the people who will be most affected by the results. While most of us know that their family dynamics play a vital role in estate plan development, the temptation may be to avoid dealing with such issues. Family issues that are ignored will usually become more problematic with time. These might include:

• Multiple 'chiefs' in charge of the estate
• Income disparities between children
• A special needs child
• An estranged child
• Disapproval of lifestyle of heirs
• Parental care-taking
• Oral promises
• Unstated expectations
• Conflict between siblings
• Conflicting values between generations
• Alliances between one parent and one or more children

Tools to help:

Five basic operating principles, as defined in the acronym VOICE, can guide families through the process of having a family legacy conversation. I also offer a seminar called "Tying up Life's Loose Ends" which provides tools and techniques to get beyond the legal documents and onto the relationship and value issues between family members. Just email Kimberly or me if you think you or a group you belong to might benefit from this seminar on ethical wills. The VOICE model though, lightly described below, will get you started…

• "V" stands for values and vision. These families take time to ask big questions and clearly define their core values and long-term vision. "Who are we as a family?" "How can our money be used to advance our values?" Numerous tools can be used in this process, such as an ethical will or a family mission (or vision) statement.
• "0" refers to family openness. Successful families do not keep secrets. They explain their intentions and the principles involved in all aspects of estate planning. While the final decision belongs to the testator, he or she is open to input from others. For example, testators may open up the books and share financial details with heirs at appropriate ages. Access to financial information can relieve anxiety for heirs and help them prepare for their future.
• "I" stands for inclusiveness. These families find ways to include all family members and make sure they each participate in the process. They don't leave out an estranged offspring. They know doing so only increases the chances of family conflict and potential litigation.
• "C" is for calm and connected family leadership. The family leader needs to find ways to calmly connect with all family members. Only then is he or she "a relationship master" who listens deeply and makes an effort to understand all points of view and minimize conflict.
• "E" stands for emotional neutrality. Successful families find ways to work together. Problems are viewed from a perspective of shared responsibility, rather than blame. A level playing field is created so that no one person has an advantage.

Families need not have a lot of money or a large estate to benefit from these grounding conversations and explorations. And you need not have a perfect track record (who does?!). The key though is to begin.

This Fall's College Costs

Most of us know someone who is (or will be) going to college. This newly released information from the College Board helps us better understand the current costs of a college education. The value an education can garner is, of course, up to the student.

Public colleges (in-state students):

• Tuition and fees increased an average of 8.3% to $8,244
• Room and board increased an average of 4.0% to $8,887
• Total average cost* for 2011/2012: $21,447
  

Public colleges (out-of-state students):

• Tuition and fees increased an average of 5.7% to $20,770
• Room and board increased an average of 4.0% to $8,887
• Total average cost* for 2011/2012: $33,973
  

Private colleges:

• Tuition and fees increased an average of 4.5% to $28,500
• Room and board increased an average of 3.9% to $10,089
• Total average cost* for 2011/2012: $42,224

*"Total average cost" includes tuition and fees, room and board, books and supplies, transportation, and other miscellaneous costs.

The report also noted that full-time undergraduate students received an estimated average of approximately $5,750 in grant aid (from all sources) and federal tax benefits at public colleges and $15,530 at private colleges.

Market Points to Remember

Yes, you’ve heard us say these things before, but days like today make them seem to be worth repeating:

   “The long-term trend is up.” [See SBBI chart below - his is the only “bet” we make in our investment approach.]

   “This time may be unique, but it’s not different.” [See SBBI chart below – lots of “unique” events, but the long-term trend remains up.]

   “Our Short- and Medium-Term Portfolios provide the ‘buffer’ to ride out one to two economic cycles - this prevents us from having to sell when the markets are down.”

   “Time in the market (vs. timing the market) is what counts.” [Look at the Asset Class chart below – can you discern a pattern? Hint: we can’t!]

   “Asset allocation and disciplined rebalancing” are key. Asset allocation provides a diversified strategy to investing and our disciplined rebalancing system forces us to “buy low” and “sell high.” (Emotion-driven strategies tend to lead to bad timing decisions.)

If think you'd find yourself mumbling an answer to this question, take comfort in knowing that you are not alone. Other than sensing that hedge funds have a somewhat exclusive, yet secretive, allure and are great for name-throwing at cocktail parties, most people (even people who own them!) don't really know what they are.

Bob Frick wrote an article for the November 2011 issue of Kiplinger which we think may help provide a better understanding. Below are extracts from his article.

What exactly are hedge funds?
They’re private investment funds for the rich. A broader, if somewhat cynical definition comes from hedge-fund manager Cliff Asness of AQR Capital: “Hedge funds are investment pools that are relatively unconstrained in what they do. They are relatively unregulated (for now), charge very high fees, will not necessarily give you your money back when you want it, and will generally not tell you what they do. They are supposed to make money all the time, and when they fail at this, their investors redeem and go to someone else who has been making money.”

Then why the hedge-fund mystique?
It mainly comes from some big-name managers, who win and lose billions on gutsy bets and wield immense financial power. For example, hedge-fund rock star George Soros bets on how currencies will rise or fall, and he is so influential that his opinions can affect a currency’s value. John Paulson made billions by betting against mortgages. The dark side of this mystique is hedge funds gone haywire. In the late 1990s, Long-Term Capital Management goofed in its bets on European, Japanese, and U.S. bonds, and it had to be bailed out under the direction of the Federal Reserve Bank of New York.

What does hedge fund mean?
The first was started by Alfred Winslow Jones in 1949, and it truly was about hedging - protecting against losses. Jones figured that by buying stocks he thought would do well in the long term and then selling short stocks he predicted wouldn’t do well (a strategy to profit when prices drop), he would limit or eliminate losses. However, over the years hedge fund became an umbrella label encompassing all the strategies these funds use. Today, less than 30% of hedge funds follow Jones’s long-short strategy.

We should also note that long-short funds didn’t cover themselves in glory during the meltdown of 2008. Morningstar reports that the average fund lost 18.6% in 2008, about half the loss of Standard & Poor’s 500-stock index. And their performance since the market bottomed in March 2009 has been less than one-third that of the S&P 500.

What are the funds’ other strategies?
Data firm Hedge Fund Research lists four major categories with 27 subcategories (and ten sub-subcategories). But hedge funds mostly do a few basic things in addition to the long-short strategy. They use futures to bet on the direction of currencies or commodities. They profit from differences in prices between two or more markets—buying cheaply in one market and selling at a higher price in another. Merger arbitrage seeks to profit from the likelihood that an announced merger will actually go through. Because many of these strategies are risky, about one in four funds are combinations of funds, which can decrease volatility.

How big is the hedge-fund market?
Big. The 9,400 or so hedge funds hold just over $2 trillion in assets. By comparison, 7,600 mutual funds -- including ETFs, closed-end funds and unit investment trusts -- have about $12 trillion in assets. But hedge funds use leverage -- meaning borrowed money -- far more than mutual funds, so their impact on markets is disproportionately larger. A relatively small number of funds dominate the hedge-fund industry, with 63% of hedge-fund assets managed by less than 10% of the funds.

The market crash in 2008 has stunted the growth of hedge funds. That year, assets actually fled the industry -- a first. (Investors withdrew about $154 billion in 2008 and another $131 billion in 2009.) Since then, the flow of assets into hedge funds has resumed, but it has slowed since the funds’ heyday in the 2002–07 bull market. The number of new funds is also down.

How have hedge funds performed?
They’ve been mediocre, overall. A recent paper in the Journal of Financial Economics says that from 1980 through 2008, the average hedge fund returned an annualized 6.1% after fees, compared with 10.8% for the S&P 500. One of the authors of that paper, Ilia Dichev, of Emory University, says that performance is worse than it appears because hedge-fund investors tend to chase returns more than most investors. Chasing returns is a bad strategy because you tend to buy high and sell low. In the case of hedge-fund investors, it has had the effect of cutting that 6.1% return in half, says Dichev. Another concern for investors is that many funds disappear—either because of illegal activities or because they make big bets on bad strategies, lose most of their value and liquidate, often paying investors pennies on the dollar. In 2005, when investors were sending hedge funds billions in new assets, 10% of them liquidated. And then there are the fees. The standard rate is “2 and 20,” which means a fund charges an investor 2% of assets annually, plus 20% of any gains. That puts a damper on investors’ returns really quickly.

Conclusion for PFSI and our clients…
So? We won't be investing in hedge funds anytime soon… They lack our investment strategy requirements for transparency and liquidity, not to mention the extraordinary fees. And, we’re not big on making bets with your (or our) money. The one bet our investment strategy makes is that the long-term trend of the markets is up over time – history has shown that to be a solid bet. We know the ride isn’t smooth – normal economic cycles prevail and external forces can have sudden impacts. But, that is why we have the short-term and medium-term portfolios, choosing only to make even that one bet on money that won’t be needed for one to two economic cycles.

2011 Year-End Checklist Released

We are pleased to forward to you the annual PFSI Year-End Planning Checklist!  We have approximately 2 1/2 months to take advantage of planning opportunities to assist you in achieving your overall financial goals.

The tumultuous markets make ongoing rebalancing even more important than in less volatile periods; and, these economic swings often offer tax harvesting opportunities to offset gains (current year and future years). Additionally, the checklist provides a host of other timely financial considerations. Even 30 minutes spent on this should be time well spent.

The RetireMentality

A "Research from Rand" report, two years old now, says that 44% of retirees worked for pay at some point after retirement, that 83% of baby boomers intend to keep working after retirement, and 14% of those currently working say they'll never retire. Fifty percent of retirees will follow a “nontraditional” retirement path that will involve partial retirement or no retirement at all. Mitch Anthony calls this an "un-retirement trend."

People are falling into the "un-retirement trend" for two reasons: need and desire. A commitment to responsibly working towards financial freedom early in life will likely ensure that you fall into the "desire" category. Regardless of why you get there, though, "un-retirement" has many benefits.

Much research supports the theory that lives built exclusively around leisure do not deliver hoped-for satisfaction levels, and the majority of retirees working are doing so because they want to. Those who don't work experience a sense of identity loss if they identified themselves with their work status, or they may experience social/relationship challenges when they lose contact with their co-workers and business peers. They experience a reduction in mental stimulation, psychological issues around not getting a paycheck, too much extra time to fill the day, and anxiety or depression.

Take some time to think about what your golden years might look like - as with anything (time, portfolios, diet) you can get too much of a good thing! Being challenged and active leads to longevity and a better quality existence.

The Roller Coaster

Market volatility continues to dominate our financial news. Our media offers us endless reasoning and prognosticating about the market movements - in both directions. As you know, however, we steadfastly believe these swings are not predictable in the short-term or medium-term. Market-timing models or 'active management' investment approaches are clearly hard-pressed to build into their models unforeseen comments by legislators, weather calamities, political gamesmanship, earthquakes, terrorist attacks, unethical accounting practices, Ponzi schemes, breakthroughs in science, etc. We do know, however, the long-term trend of the equity markets has been up despite much tougher economic times than we are currently experiencing. As long as the media doesn't successfully sell you on the idea that "this time it’s different" (i.e., the world is going to end), the only rational (non-emotional) approach is a consistently rebalanced asset allocation strategy designed to meet your goals.

Doug Named "Five Star Wealth Manager"

We are pleased to announce that Doug was once again honored with the FIVE STAR Wealth Manager award by Texas Monthly. This marks the third year in a row for Doug! Thank you to all who nominate and vote to make this a reality!

Market Volatility

Market volatility continues to make headlines. As we have stated before, no one can accurately predict the future, and we don’t pretend to. We believe the value proposition of advisors who promise consistent, above average returns is simply unsustainable and must change. Instead, at Pauley Financial, we focus on helping you to control all that you can control, allowing you to be in a better position to weather the storms and enjoy the long-term trend (which is up!) by avoiding having to sell when markets are down. Be mindful also that the downswings may offer opportunities for tax-loss harvesting to help offset future gains and up to $3000 of ordinary income annually. That is why we aggressively pursue them!

Fall is just around the corner bringing with it back-to-school, football, and hopefully cooler temperatures! We hope you and yours are enjoying the beginning of the seasonal transition.

Like the start of a new year, the fall season is characterized for many of us by back-to-school schedules, practice schedules and generally “buckling down”. The fall offers us a new chance to refocus on fundamentals. With the breezy days of summer nearing their end, it is time once again to look ahead at your financials. Third quarter is a great time to cross-check or update your estate planning documents and ensure that your beneficiary designations are in alignment with your wishes. Fourth quarter will also afford us the opportunity to look at end-of-year tax efficiencies.

In the interim, of course, the market roller-coaster ride continues to offer plenty of drama. As you know, at Pauley Financial, we adhere to a disciplined strategic asset allocation and rebalancing strategy aligned with your goals and risk-tolerance (re-measured annually). This strategy removes the drama and allows you to focus on what’s important: faith, family, and friends. We remain grateful for and confident in this investment strategy. No twitchy trading for us…

Bi-Polar Investing and Twitchy Traders

It seems that virtually everybody agrees that - during the last few weeks - the investment markets have been ruled more by emotions than logic. But, as we watch the markets rise and fall like giant ocean swells, it's fair to ask: how, exactly, does this happen?

A recent report by the Reuters news service, entitled "The Madness of Wall Street" offers some insight. It describes a "bipolar market" made up of traders and policymakers who are constantly trying to guess how daily events might affect other market participants, rather than buying based on what they perceive to be the actual value of the company shares. Some are using high-frequency trading algorithms that react to headlines and overall market trading patterns, which exaggerate every trend on the upside and downside. The article points to a study by the Tabb Group, a financial markets research firm, indicating that during the week of August 8, high-frequency trading firms and strategies accounted for 65% of the daily trading volume in the U.S.
The problem for the rest of us is that there is no good market forecast that will predict what might start these twitchy programs buying or selling. Meanwhile, the media has become a virtual echo-chamber; instead of a mature discussion of the economic fundamentals, you hear breathless reports of what is happening now (with overly dramatic overtones), which reinforces each current trend even further.

A number of economists in the article say that they expect this volatility to continue until the unlikely day that traders give up their algorithms designed to respond to headlines, and the news organizations decide to emphasize fact over frenzy. They worry that this experience, so close to the market panic of 2008, could change investor behavior for the worse, either driving more individual investors into the herd to buy high and sell low in a panic (a recipe for losing money), or to avoid the markets altogether and lose out on the higher returns that are generally associated with stock investing. Either behavior would endanger their ability to fund their retirement. It would also mean they would lose the chance to take advantage of stock bargains every time the twitchy programs decide to dump everything.

Because of this emotion, the stock market is the only part of our economy where people flock into the store to buy when prices are going up, and rush for the exits whenever prices go down. Here's a prediction: a few years down the road, a lot of investors will look back at their participation in the herd mentality and wish they could have had the fortitude to buy when everybody else was selling.

Maintaining perspective…

The “drama” of last week is still fresh in our minds leaving emotionally-based investors very jumpy.  We hope the informational emails we send out during times of high market volatility provide some rational thoughts and perspective to counter the hyped-up media sensationalism that is applied to a passing moment in time.

In what appears to be a respite from the dramatic swings of last week, we are forwarding some basic questions and answers that might help you frame the recent financial events.  These are excerpted from a book authored by Mitch Anthony and Scott West who have graciously provided their permission to pass along these snips from Story Telling by Financial Advisors.

How Important is the Dow Jones Industrial Average? (page 220):

"People often become anxious and fearful when they hear the media shouting about the Dow going up and down. Have you ever wondered how important the number really is?

The Dow Jones Industrial Average represents only 30 stocks out of the more than 35,000 stocks that trade on the various exchanges in America. The Dow represents only 0.09 percent of all the stocks traded. The number the media shouts about often excludes what is happening to the other 99.91 percent of stocks.

Don't let the headlines about the Dow average seem any more significant than they are. It's like saying that the NFL is in a major slump because one running-back is having a bad year."

On Predicting Bear Markets and Long-term Investing (page 214):

"Predicting when we will see a bear market is equal to predicting when a dart will hit a bull’s-eye. The majority of the time throughout market history, the markets have been rising. History shows that the chances of your money growing in stocks is much like the odds of your next dart hitting any number on the dartboard but a bull's-eye. If you are going to try to time moving money in and out of the market, you have to ask yourself how confident you can hit a bull's-eye every time you do it."

On Staying Above the Emotional Fray (page 224):

"People become hyper about the market when they listen to hyperbole. The press, in an effort to get viewers' attention, exaggerates events in the marketplace and thus excites the emotions of investors who are swayed by fear. This emotional Ping-Pong game results in illogical investment behavior, such as buying at market highs and selling at market lows. The wise investor has learned to look past the colorful adjectives that describe daily market fluctuations and to keep his or her eyes fixed on long-term trends."

Questions and Answers Regarding Today's Market

Normally, the very last thing we would want to do is call your attention to daily market movements, because all of the worst investment decisions are made with a short-term focus. But I want you to be aware that we are following, very closely, the market events and their impact on your investment portfolio and ability to fund future goals.

As you no doubt heard in the media echo chamber, the U.S. markets recovered in dramatic fashion on Tuesday after the Monday free-fall. By the end of the trading day, the S&P 500 index was up 4.74%, and the technology-heavy Nasdaq index was up 5.29%. This helps to offset the roughly 16% drop over the past 11 trading days.

What does this mean? Here are some good questions that you may be asking yourself, and the best answers we can provide at the moment.

What's was different about Tuesday (when the market was dramatically up) from Monday (when the market was dramatically down)?

Very little from the standpoint of fundamentals. The economy is no stronger or weaker from one day to the next, corporate profits didn't make any radical adjustments, and the underlying worth of the business enterprises and debt obligations that you own have been pretty much the same throughout these Summer doldrums.

The main difference can be found in investor emotion, which is not predictable by any measure that we've been able to find. It causes markets to “over-correct” – both to the low and high sides. The Federal Reserve Board gave the optimists something to cheer about when it announced that it would maintain low rates--which tend to stimulate the economy by encouraging banks to lend and companies to borrow (and build factories, and hire workers)--through mid-2013. That means that even though the federal government's expenditures won't be stimulating the economy during this time of highly-partisan belt-tightening negotiations, at least higher interest rates won't push the economy into recession.

What about the ratings downgrade? Won't that hurt the economy and the markets?

Over the last couple of days, economists and veteran market watchers have been mocking the Standard & Poors rating agency. The kindest things they are saying is that the other rating agencies--Moodys and Fitch--have continued to give U.S. Treasury debt their highest safety ratings. Warren Buffet recently came out with a statement that U.S. government debt is the safest on the planet, and should be given a AAAA rating (which doesn't exist), rather than a downgrade.

Those who are less kind are pointing out that the downgrade came from the same Standard & Poors that rated boatloads of subprime debt as 'AAA', fueling the fire that resulted in the 2008 financial crisis. During that same period, it raised the credit rating of Bear Stearns an astounding 5 notches to AA- in March of 2008--the same month that the brokerage firm declared bankruptcy. Lehman Brothers, as a company, held an S&P rating of 'A' the week they went under, and the rating agency reaffirmed its 'AAA' rating on some of the company's securities just three days before it filed for bankruptcy and basically defaulted on everything. It made similar mistakes with Merrill Lynch and Morgan Stanley (rated A and A+ respectively the week they had to be bailed out), and completely missed the problems with the Republic of Iceland.

It has been noted by many economists and commentators that the downgrade was more about the lack of political will and dysfunction than about US economics. We share this view.

Meanwhile, despite the downgrade, the prices of Treasury securities surged for the second straight day, sending the 10-year yield to an all-time low of 2.03% before it settled at 2.19%. Sophisticated investors around the world seem not to be worried that the U.S. will default on its debts.

Is this a good time to sell? Or to buy?

Some economists are saying that the market was oversold on Monday--which means that stocks, in general, were selling at a discount to their true value. But we aren't as confident that we know the true value of stocks in an uncertain economy, and it seems clear that emotions are ruling the recent market moves. It is possible that the emotions will take the markets further down, and it seems equally possible that the optimism we saw on Tuesday will continue.

It is worth remembering that in the first half of last year the market experienced a 17% decline (which was greater than the current downturn), and yet finished the year ahead by double-digits.

And, so, we will continue to stick to our investment strategy which is based upon sound economic theory and years of learning rather than try to react to the minute by minute emotional swings of the markets. This will enable us all to sleep better at night.

What should I do about these uncertain markets?

As we have discussed in the past, investing is a long-term process, and generally full of unpredictability and surprises. If you look back three years ago, the Dow had dropped to around 6,000. At the end of the day Monday, it was still around 11,000--almost double the low of a few years ago. Think back to all the scary headlines about double-dip recessions, sovereign debt crises in Europe, unemployment and all the rest, and you realize that the headlines were telling you to sell when it was much more profitable to hang on.

Consider turning off the financial media’s sensationalist banter. It may sell newspapers and air time, but it does little to provide an even-handed approach to what is going on in the markets. That’s what we try to do. So, never hesitate to write or call. And, keep in mind our overall strategy – your short- and medium-term portfolios are designed specifically for situations like that which we are seeing right now. They are the buffers to keep you from having to sell when the markets are down.

Is this time different?

Probably not. Again, as we wrote the other day – the markets have survived the Great Depression, the world at war (multiple times), the Crash of ’87, the Tech Wreck, and the Crash of ’08. We have no reason to believe it won’t move past this speed bump as well.

America's Tarnished Credit Rating

By now, you've probably heard that the Standard & Poor's debt rating agency has downgraded all U.S. government debt with more than a year of maturity, from the top AAA rating down to AA+. To put that in perspective, now only 17 countries enjoy the AAA rating on their government bonds. Typically, that means that they are considered the safest havens for cash, and therefore are able to pay the lowest interests rates on their borrowing.

Here's the list, and we've included the current yields on each country's 10-year government bonds in parentheses. This lets you see what the top-rated countries pay on their debt, compared with the 2.34% interest our government has to pay on its 10-year U.S. Treasuries:

France (3.41%), Germany (2.83%), Canada (2.93%), Australia (5.75%), Finland (3.19%), Norway (3.29%), Sweden (2.82%), Denmark (3.06%), Austria (3.30%), Switzerland (1.53%), Luxembourg (NA), Guernsey (NA), Hong Kong (2.29%), the Isle of Man (NA), Liechtenstein (NA), the Netherlands (3.17%), and Great Britain (3.11%).

The first thing to notice is that our U.S. government is still borrowing at very attractive rates compared with the triple-A nations, and Treasury rates actually got better during the angry debate in Washington, as investors continued to beat down our doors to lend money to our government. Why? The downgrade and recent weakness in the stock market have made bond investors nervous, which usually causes them to buy the safest paper they can find. As an Associated Press report notes, the U.S. still offers the deepest and most liquid bond market in the world.

The second thing to understand is that, despite the high levels of government debt, there is really no crisis in the government finances or in the economy. S&P officials made it clear that they were more influenced by the recent messy debate in Congress than the fundamentals of government finance. They may have been particularly rattled by public statements by key members of Congress that it might not be a bad thing if the U.S. government defaulted on its sovereign obligations to its global lenders--sort of like one of us telling the bank that we're thinking seriously about not making any more mortgage payments. David Beers, global head of ratings at S&P, said in a supporting statement that the agency was concerned about "the degree of uncertainty around the political policy process." A separate statement by the rating agency said that policymaking and political institutional control had weakened "to a degree more than we envisioned."

Long-term, our government faces some difficult choices. The question now is whether we'll get action from Congress or more political posturing. We'll get an early look between now and Tuesday, as a new Congressional committee, made up of Democrats and Republicans, will be looking for $1.5 trillion in deficit cuts that have not yet been specified through the debt ceiling compromise. (A total of $917 billion in cost reductions has already been earmarked).

What does all this mean for investors? The investment markets were clearly rattled by the tone and uncertainty of the debt ceiling debate, with the S&P 500 losing 10.8% of its value over the ten trading days of the Congressional standoff. But a Money magazine report points out that when a country loses its AAA rating, it is not always terrible news for the nation's stock market. Canada, for example, was downgraded from AAA status in April of 1993, but the country's stocks gained more than 15% the following year. The Japanese government's bonds were downgraded in 1998, and the Tokyo stock market climbed more than 25% in the next 12 months.

The awful nature of the debt ceiling debate, plus the downgrade, has clearly added fear and uncertainty to an already sluggish economic recovery. The Treasury debt downgrade is a blow to U.S. pride, and a warning to Congress--particularly those representatives who think the U.S. can simply walk away from its obligations without consequences. More than anything, hopefully, it is a wake-up call to our sleeping, elected officials.

As the decline in Treasury rates made clear, the downgrade is largely symbolic. Congressional gridlock and partisan posturing could leave us with a long 15 months until the next time we have a chance to vote on their job security. But it might be helpful to think back to last summer, when concerns about a double-dip recession and mild panic sent the S&P 500 down a long unhappy slide to a low of 1022.58 on July 2, with a few additional bounces along the bottom until a September rally. Investors who sold out of the markets at that time missed significant--and largely unexpected--gains through the fall, winter and spring, as people gradually realized that the world was not coming to an end.

In the short term, emotions rule the market, and they are visibly negative right now. Longer-term, the market prices always tend to return to fundamentals, and it's helpful to remember that corporate profits remain strong, new jobs are being added and the economy is still growing. The U.S. markets weathered much worse than this in 2008, in 2000, during the first and second world wars and a lot of panic-stricken times in between. Without the ability to see the future, our best prediction is that the sun will continue to rise each morning (in the east!) and the U.S. will emerge from this crisis like it has all the others--and reward those who managed not to succumb to the panic like so many did last summer and so many other inevitable periods of anxiety when things don't go exactly as we'd hoped.

You CAN be prepared!

Over the last two weeks, the markets have prepared for and reacted to US debt “deal.” Obviously, it is fooling no one as the markets have shed all the gains made this year during that time period. It’s short on substance and doesn’t address the “big” problems. Yes, our politicians have managed to avert a crisis in the short-term, but they are only fooling themselves (not the markets or us). Sadly, their viewpoint only extends out to their next election. And, while we have averted another short-term crisis, we have, once again, compromised away the willpower to do the “right thing,” i.e. address our appreciable systemic problems – overspending, Medicare, and Social Security. In addition, there are other governments around the world which are “attempting” to deal with similar systemic problems. So, that’s adding to the malaise.

Should the markets end where they are as I write this, we will have what market technicians refer to as a “correction” – down 10% since the most recent “high.” Markets do tend to overcorrect and undercorrect as they attempt to reach an equilibrium price.

The “good news”… you CAN be prepared for this market volatility!

Quarterly, we send to our clients an updated status on their short- and medium-term goals and the money allocated to support these two portfolios. Those two portfolios provide the buffer needed to avoid selling long-term positions during a downturn. If you can avoid selling during a down market, you have the opportunity to ride the probable upswing when it occurs. Time has shown the long-term trend of the markets to be up despite the short-term volatility caused by the Great Depression, wars, the Crash of ’87, the Tech Wreck, the 2008 crash, etc. (See chart below)

The three-portfolio architecture is the very foundation from which we work with clients to build and maintain personalized financial plans. And, we stand by ready to make adjustments as “life happens” - marriage, birth, death, illness, divorce, inheritance, job-loss.

July Newsletter

Will our government have the ‘guts’?

As we advance in the ‘knowledge worker’ age, we recognize more clearly that some jobs are simply process-oriented, while more and more jobs lend themselves to creative wisdom. Set up a process correctly and the rest takes care of itself. It's challenging and frightening to get it right, but after that, you merely have to do the hard work of showing up each day. Do the work and you'll get the results.

Other jobs require a different sort of hard work: the guts to be wrong, a confrontation with the risk of looking stupid, failing at the job-at-hand, perhaps even being unpopular.

The parents that weigh precarious decisions about their teen, the comedian who fears that each new joke might fail, the writer who has to say something new, the leader who must improvise, solving new problems on a regular basis...what makes this work ‘hard’ is that it might not work.

Currently, our government is facing one of these opportunities as the debt ceiling deadline moves closer. There really is no magic. Earn more, spend less, or delay the expenses. Kimberly and I teach elementary school children this in our iMoney and MoneyMatters classes! And, THEY actually get it!

We remain vigilant monitoring this situation for you. None of us, of course, have a crystal ball (although many claim to). But, we are watching closely and writing our representatives reminding them of the simple lesson we teach our children. Let’s see if they have the “guts” to put our country first and provide a solution that is more than just a band aid when a tourniquet is needed. I'm not sure if this is actually from Mr. Buffet or not (I didn’t see the alleged interview), but it’s a clear example of “people will do what you give them the incentive to do:”

"I could end the deficit in 5 minutes," he told Becky Quick. "You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election."

Apparently, Mr. Buffet is unaware of how long it actually takes to get a law passed in D.C.! But, his reasoning (as you might expect) is sound as our elected officials’ radar screen only goes out to their next election day. As a result, we get short-term fixes to systemic problems. Of course, eventually, the wheel comes off and they are forced to face it, but only after a small problem has become a crisis. I don’t mean to be (too) cynical, but this appears to be the harsh reality (at least, from where I sit!).

Fixing Social Security

These days, as Congress debates the debt ceiling issue, Social Security is suddenly front page news again.

The first thing to understand is that there IS a solvency problem with Social Security. Alice Munnell, Director for the Center for Retirement Research at Boston College University, points out that, according to the Congressional Budget Office, the Office of Management, and the Budget and the Government Accountability Office, the benefits promised to future retirees exceed the scheduled taxes that are projected to be taken in. In fact, last year, Social Security began paying out more in benefits than it received in payroll taxes--years earlier than projected, due to the 2008 Great Recession.

The second thing to understand is that Social Security is not going away; too many people today (and in the future) depend on it for a crucial part of their retirement income. Munnell notes that Social Security accounts for 87% of non-earned income for the poorest third of households over age 65, 70% for the middle third and 37% for the highest third.

So the question becomes: how can Congress bring Social Security back into revenue balance? Many ideas and even software games have been modeled to allow you to try your hand at solving the problem. You can try your hand at solving the problem at http://www.actuary.org/socialsecurity/game.html.

You could, for example, move up by one year the day when people have to wait until age 67 to claim maximum benefits, and after that, index the retirement age to maintain today's ratio between expected retirement years and work years. This, alone, would solve 20% of the funding problem, and some would argue that it should have been done years ago since the average mortality age has gone up so appreciably since Social Security was enacted. At the time, the average mortality age was closer to 65. The government really didn’t expect to actually be paying out to all that many people! Now, it makes those payments to most of a post-65 population with an average mortality age 20 (or more years older).

As an alternative, we could reduce the annual cost of living adjustments in Social Security payments by half a percentage point. This would reduce the projected deficiency by 40%. Of course, it would also erode the purchasing power of elderly people who count on Social Security for a significant part of their income.

We could reduce benefits by 5% for future retirees, which would solve 31% of the problem.

Or , we could reduce the benefit formula for the top half of earners, who theoretically are less dependent on Social Security in retirement. That would solve 43% of the projected Social Security deficit. It would also mean that people who are able to fund a comfortable retirement will get much less out of the system than they put into it.

On the other side of the ledger, we could incrementally increase the revenues going into the Social Security system. For instance, if we raised the payroll tax rate from the current 6.2% to 6.7% for employees and employers, 48% of the shortfall would go away. As an alternative, we could tax Social Security benefits like we do IRA and pension benefits, which would make up 14% of the projected shortfall. Or, we could remove the annual earnings cap (currently, $106,800) for Social Security tax, that would completely solve the problem!

If you're looking for an out-of-the-box solution to add to the mix, consider an article in the Christian Science Monitor, where former U.S. Secretary of Labor Robert Reich notes that a big (and largely undiscussed) problem with Social Security is the shifting balance of workers paying into the system to retirees collecting from it. Forty years ago, he says, there were five workers for every retiree; today, there are three. In 20 years, perhaps less, the ratio will be 2:1--that is, every two workers in America will have to pay whatever is required to support one retiree's Social Security benefits. How would he fix this problem? Reich proposes that we allow more immigrants into the U.S.--that immigration reform and entitlement reform are linked.

As the deficit debate goes forward, you'll hear a lot more about how to "fix" Social Security. Consider this a cheat sheet on the options that various parties will eventually put on the table. Or, go online and create one of your own – then, write your Congressmen.

Playing Chicken With the Debt Ceiling

As August 2 approaches, you'll likely hear increasingly urgent debate over the nation's debt ceiling – the folks in D.C. love a deadline (and coming up with shortsighted 11th hour solutions!). On July 13th, 2011, Moody's Investors Service, the credit rating service, placed the U.S. government's sterling Aaa bond rating on review for a possible downgrade. They reminded President Obama of this on Monday, July 18th, 2011.

There is no magic ultimate answer. Like all of us, our government needs to make more, spend less, or both. None of us yet know what level of brinksmanship that will be played between political parties as August 2nd approaches.

The reason that the possible downgrade announcement move was made is clear, but Moody's spelled it out anyway: there is uncertainty whether Congress will raise the U.S. government's debt ceiling by August 2. Technically, the $14.3 trillion ceiling was exceeded in May. However, the Treasury has been able to use certain accounting measures to temporarily extend the nation's ability to borrow. Assuming the creative accounting has reached its limit, and should our leaders not be able to reach agreement, the U.S. will join Venezuela (1998), Russia (1998), Ukraine (1998 and 2000), Pakistan (1999), Ecuador (1999 and 2008), Peru (2000), Argentina (2001), Moldovia (2002), Uruguay (2003), the Dominican Republic (2005) and Belize (2006) as a nation that has recently defaulted on its bond obligations. And not only that: if no deal is reached, the government would have to stop paying military active duty pay and veterans' benefits, IRS refunds, Medicare, Medicaid, Social Security, unemployment insurance, defense contracts--or Congressional salaries.

With all this at stake, why are so many seasoned observers yawning instead of panicking? A recent analysis by the Bipartisan Policy Center typifies the view: it says that despite the brinkmanship in Washington, it is unlikely that the U.S. government will be allowed to go into default.

Why? There are a variety of reasons. Simon Johnson, former chief economist of the International Monetary Fund, says that the U.S. business sector would be livid if Congress were to inject such a high dose of uncertainty into the capital markets. Johnson also points out that ordinary Americans take their debt obligations more seriously than the citizens of many other countries. The U.S. has had its fiscal resolve tested (and faced the easy way out of defaulting on its bonds) after the Revolutionary War, the War of 1812, during and after the Civil War, and in World War I and World War II. "The simple fact of the matter," Johnson says, "is that when the going gets tough, the U.S. pays its debts." Is Congress ready to throw away 200 years of building the best credit history in, well, history?

The thing to understand about the negotiations is that Congress is a feedback mechanism; it takes action, and then, if there is a backlash, it may reverse itself quickly. We all know how teenagers play the game of "chicken:" they aim their cars at each other, and then at some point fear (or maybe common sense) takes over and they quickly return to their lanes. Anybody watching the first part of the game would predict a different outcome.

If the game of debt-ceiling chicken goes past August 2, the default would have an immediate impact on Treasury auctions. The government would have to pay more to get the Chinese government and U.S. retirees to accept the added risk that Congress might decide to refuse to pay what it owes. Raising government bond rates would, ironically, make our government's current debt more expensive to finance, increasing the government's deficits--and make the problem that Congress is trying to fix much worse.

In addition, a temporary default would probably cause people to become a bit more nervous about everything else they took for granted, like the safety of the investment markets. Mohamed El-Erian, CEO of PIMCO (the largest bond investor in the mutual fund world) points out that in 2008, Congress denied the Bush administration’s request for $700 billion to prevent a financial-market collapse and economic depression. A dramatic 770-point drop in the stock market focused politicians’ minds, bringing them back to the table – and to agreement.

Stand by for news…

Deciphering Health Savings Vehicles

Health savings accounts (HSAs), Archer medical savings accounts (MSAs), health reimbursement arrangements (HRAs), and flexible spending arrangements (FSAs) are all personal health accounts that may help you control your health-care costs. But trying to figure out what's what can be confusing. Here's a brief description of each type of account, including some of their major features and benefits.

MSAs/HSAs

As of January 1, 2008, the MSA program expired and no new MSAs can be established, although if you already participate in an MSA, you can continue to receive contributions. HSAs have generally taken the place of MSAs because of their greater flexibility and options. In fact, in most instances you can roll over an existing MSA into an HSA. MSAs and HSAs are set up in a trust account with a financial entity. Contributions made through your employer are pretax dollars (or you can contribute to the account directly and deduct the contribution), no tax is due on funds in the account, or on any earnings until withdrawn, and if funds are used for qualified medical expenses, the withdrawals are not taxed. However, account withdrawals that aren't used for qualified medical expenses are subject to a tax penalty of 20%, in addition to regular income tax. Your account is portable, meaning if you change employers or leave the workforce, you can keep the account. To be eligible, you must be insured by a high deductible health plan (HDHP) that you maintain (if self-employed) or that's provided through your employer.

However, there are also differences between MSAs and HSAs. Generally, anyone with an HDHP can participate in an HSA. But to qualify for an MSA, you must have been either an employee of a company that employs 50 or fewer people, or be self-employed (or the spouse of such an employee or self-employed person). With an HSA, contributions can be made by you, your employer, or anyone else on your behalf within the same plan year. But MSA contributions can only be made by either your employer or yourself, but not both, in the same plan year. Contribution amounts also differ. In 2011, maximum HSA contributions are limited to $3,050 for single HDHP coverage and $6,150 for family HDHP coverage. MSA contributions can be up to 75% (65% if you participate in a self-only plan) of the annual deductible of your HDHP, but no more than your annual earnings from employment.

FSAs

If you don't participate in an HDHP, you still can set money aside for uninsured medical expenses through an employer-established FSA. Unlike an HSA, you must be an employee of the employer providing the FSA in order to participate (self-employed persons are not eligible and certain limitations may apply if you are a highly compensated participant or key employee). Pretax contributions can be made by either you, your employer, or both of you (except employer contributions used to pay long-term care premiums must be included in income). You determine how much money you want deposited each year up to the plan's maximum dollar amount or percentage of compensation; funds in the account are not subject to tax; and distributions are tax free if used to pay for qualified, unreimbursed medical expenses you've incurred (no advance payments for anticipated expenses). Unlike HSAs, if you leave your employer, you can't keep the money in the account or take it with you to another employer (it's not portable). Also, what you don't spend on medical expenses by the end of the plan year is forfeited and not available the following year (i.e., you must use it or lose it).

HRAs

Like FSAs, HRAs are only available to employees, not to self-employed individuals. And HRAs must be funded solely by an employer; you can't contribute directly to the account. The terms of the HRA are generally determined by the employer. For example, your employer's plan may or may not require you to have health insurance in order to participate. The plan sets the maximum amount of contributions, and determines whether a credit balance in the account can be rolled over from year to year, and if so, how much of the account can be rolled over. But contributions and reimbursements for qualified medical expenses are tax free. Reimbursements can be made to current and former employees, including spouses and dependents of employees and deceased employees. However, if the plan allows for any distribution to you or anyone else (e.g., spouse, dependent, estate at your death) for other than reimbursement for qualified medical expenses, then any distribution, whether for qualified medical expenses or not, is included in gross income.

PFSI Commentary

Why do we ask our clients to do a risk assessment each year? I suspect you won’t be shocked to hear that peoples' risk tolerance over time varies with market volatility, age and personal life events. Some people suddenly became a whole lot more risk-averse in the fall of 2008 than they were a year prior. Funny how that works!

Appropriate asset allocation, disciplined rebalancing, and “time in” the market (vs. “timing the market”) are the most important factors in goal achievement. We strive to keep your long-term portfolio asset allocation aligned with your risk tolerance – taking the least amount of risk possible to enable you to achieve your objectives. As you can see below, the longer you hold an asset class, the less risky it becomes – even for the most risky asset classes.

In addition, we keep you short- and medium-term portfolios less risky still, as there isn’t time for those portfolios to recover from an appreciable downturn given the relatively short time period before those funds are needed.

We believe the value proposition of many performance-focused, active-manager advisors is unsustainable and must change. To promise a consistent, long-term, above-average return is simply a promise that cannot be kept.

Balancing the retirement Equation

We've all read the headlines that show that most Americans are not financially prepared to fund their own retirement. The numbers look scary, and conjure up visions of thousands of elderly Americans sleeping on the streets covered with newspapers to keep them warm. But the difference between being able to afford retirement and not can be surprisingly thin if you know the right levers to push.

A recent article in SmartMoney magazine illustrates the point. It starts out by noting that the average retirement age in America is 64 for men and 62 for women. Then it points out that if you were to extend that average worklife by just four years, you actually pull three levers at once. You generate four years of additional income (and savings), which boosts the value of your retirement portfolio. At the same time, you take away four years of consuming your retirement portfolio, meaning that it will have to work less hard to support you in your retirement years. And finally, you raise the age at which you would take full Social Security benefits. For each $1,000 you could have received at age 62, you would receive $1,760 at age 70--and that amount is indexed to inflation, which means it retains its full purchasing power.

And, if more Americans were to work additional years, they would add more to the Social Security system and release some of the its financial strains.

There are two other reasons to consider adding those four years to your worklife. First, people today are living longer, and have the ability to contribute their skills to the global economy much longer than previous generations. When Social Security was first conceived, the average worker lived only a year or two after collecting benefits at age 65. Today, the life expectancy in the U.S. is 78.7 years, and today's 65-year-old is often healthy enough to take ski trips and scuba dive--and supervise a corporate team as it takes on complex projects.

The second reason to work longer is to avoid something very serious, and rarely talked about: mental atrophy after leaving the workplace. In his excellent analysis of traditional retirement--entitled "The New Retirementality"--author Mitch Anthony demolishes the notion that your golden years are best spent on the golf course. The human mind is like human muscles; it must be exercised vigorously in order to maintain its full functionality.

The book talks about an encounter between a person who had retired early with one who "stayed in the game." They are both the same age, but five years on the golf course - and what Anthony describes as increased mastery of the 19th hole (the club bar) - have not been kind to the early retiree, who sees in his colleague an enviable amount of vigor, connectedness, and above all meaning in his life, even as he complains semi-seriously about the increased demands of his position with the firm. An outsider who walks up to the conversation leaves with the impression that the early retiree is at least ten years older than the person who decided to continue working for five more years.

You may not need to pull all these levers at once - indeed, we work hard to help our clients retire on their own terms. But the next time you see dire projections about Baby Boomers living on dog food, you might take comfort knowing that there are relatively simple ways to change those numbers - and possibly improve people's lives (and the Social Security system) at the same time.

Market Week: June 20, 2011

The Markets
The Dow had trouble deciding which side of 12,000 it wanted to be on, but finally ended the volatile week just above that level, joining the S&P 500 in halting the recent six-week losing streak. The small caps of the Russell 2000 also managed to eke out a gain, but the Nasdaq continued to suffer, though the pace of losses slowed from the previous two weeks. Mounting concern about Greece not only hurt the Global Dow but prompted investors to keep the yield on the 10-year Treasury under 3%.

Last Week's Headlines

• As European leaders continued to argue over whether and how to let bondholders such as banks take a hit over Greece's debt problems, Greek workers took to the streets to protest the latest round of governmental austerity measures, and the prime minister announced a cabinet reshuffling. Standard & Poor's once again downgraded the country's bonds, this time to CCC (indicating a significant likelihood of default), and the cost of insuring Greek debt via credit default swaps hit a new record.
• Consumer inflation rose 0.2% in May, the Bureau of Labor Statistics said. That pushed the annual inflation rate for the last year to 3.6%, though without volatile food and energy costs, it was 1.5%. Meanwhile, inflation at the wholesale level rose 0.2% for the month, the lowest increase since last July. That put the annual wholesale inflation rate at 7.3%, the largest year-over-year gain since September 2008. The cost of raw materials fell 4.1% during the month.
• Retail and food sales fell 0.2% in May, providing fresh evidence that the economy may be slowing. Though sales were up 7.7% from a year ago, it was the first monthly decline in almost a year, according to the Department of Commerce. Automobiles, which have been hurt by supply-chain problems and were down 2.9%, were responsible for the bulk of the decline. Non-auto sales were up 0.3%, though gas prices accounted for part of that increase.
• For the sixth time this year, the People's Bank of China--the equivalent of the Federal Reserve--raised the reserve requirements for banks. The move is part of an effort to contain inflation that is running at 5.5% a year there, according to Beijing's National Bureau of Statistics.
• The Federal Reserve said industrial production would have risen 0.6% in May if not for auto supply-chain problems, which kept the number to 0.1%. However, both the Fed's Empire State and Philadelphia-region gauges of manufacturing activity turned negative for the first time since late last year.
• Housing starts were up 3.5% in May, though that's still 3.4% below last year, according to the Commerce Department. Building permits, an indicator of future construction, rose 8.7% for the month and were up 5.2% from last May. And according to RealtyTrac, the number of foreclosures hit its lowest level in more than three years. However, the reasons for the decline weren't good news. New lender-owned homes being put on the market continued to exceed the number sold, and the high level of unsold homes has caused banks to simply postpone foreclosures.
• The Conference Board's index of leading economic indicators resumed an upward trend in May with a 0.8% increase. The strongest numbers were seen in the interest rate spread, consumer expectations, and housing permits.

Eye on the Week Ahead

• Investors will continue to try to figure out whether Greece's predicament will be resolved by bailouts, debt restructuring, austerity measures, or some combination. They also will pore over the Fed's statement after its Wednesday meeting, just a week before QE2 is scheduled to dock.
• Key dates and data releases: home resales (6/21); Federal Reserve Open Market (FOMC) committee announcement (6/22); new home sales (6/23); final Q1 gross domestic product (GDP), durable goods orders, corporate profits (6/24).

It’s different…but still the same
-- Adapted from a blog post from Eleanor Blayney

Hindsight is 20/20. Ever wish you could impart your collected wisdom to the younger generations? We, as a society, have some success with this, but the world each new generation enters is not the world we cut our teeth on. For example, it is now acceptable, even normal, to live one’s life “out of sequence”. For example, once upon a time you might have been fortunate enough to go to college, then get a real job first, then get married, then have children and buy a house. Today, such a sequence is considered quaint yet unnecessary, like landlines and good penmanship.

The good news? Even though we aren’t always successful imparting our wisdom to our youth, our increasing longevity allows room for “do-overs” in one’s life. Even for our generation, mixing up the order of the cart and the horse does not necessarily spell disaster. It may, however, be expensive. Generally speaking, our finances are governed by an inherent cycle of wealth creation and depletion over our lives. When we sidestep this rhythm, we do so at our own financial peril. It’s one thing for a 50 year old to behave like a teenager when it comes to love or taste for fast cars, but quite another when the two have the same net worth.

So regardless of which generation you fall into, most of us have time to benefit from these snippets of wisdom.

1. Save before you invest and put today’s needs before tomorrow’s wants. You will no doubt hear that if you are young with a long planning horizon, you can take a lot of risks with your money. You may be tempted to take some money from your paycheck and take a shot in the stock market. However, your time horizon is quite short when it comes to equipping yourself for the demands of adult life. Most of us need a car, place to live, and a plan to reduce whatever debt we have accumulated. You’ll need a reserve fund to support you if you lose your job, or have to relocate for a new one. And, you’ll need health insurance and disability insurance so you are covered medically and financially in the event you get sick, or become disabled - something that could happen to any of us at anytime. In short, you need cash in the bank, insurance, food, shelter and transportation before you need shares of Apple or Google.

2. Borrow ahead of asset appreciation, rather than behind. In other words, be smart about debt. The best reason to borrow money is to finance an “asset” that appreciates over time, as opposed to losing value or depreciating. Your student loans are an example of good debt: your education is a human capital asset that should pay off in increased earnings in the future. A house qualifies too, the recent real estate market notwithstanding. We all know cars are depreciating assets, so borrowing to buy one only makes sense if the car is necessary for your employment or building a career.

3. Seek financial advice from a financial planner before a financial crisis, rather than waiting until after. Notice I am using the term “financial planner", not “stock broker.” A true financial planner will help you develop a solid financial plan for all aspects of your financial life so that you can achieve your short, medium and long term financial goals.

The Taskmaster Premium
-- Adapted from a blog post by Seth Godin

How much are you paying for the privilege of having someone else tell you what to do?

Example: if you go to your gym and work out for an hour, the cost of that session is zero.  Hire a personal trainer to follow you around and give you instructions and that's $70.

If you take a job as a freelance writer doing short service pieces on assignment to a local paper, you might earn $10 an hour. Which is about 97% less than you'd earn if, like some writers, you dream up amazing pieces, write them on spec and turn them into blogs, books or films. This writer doesn't wait to get hired. He hires himself.

If you do publicity for an agency, working hard and precisely following the VP's and the client's instructions, you might earn $25 an hour. On the other hand, when you do your own PR, when you build a sensation and turn it into a following, you might earn many times that. (And enjoy it more).

Work for a coal mine and make minimum wage. Discover a coal mine and never need to work again.

We happily give up our freedom and our income in exchange for having someone else take responsibility for telling us what to do next.

How much are you giving up?

Playing Chicken with the Debt Ceiling

Boomerang Generation

Welcome to May – the Month of the Graduates!

Know a graduate in your life? Odds are good you do. This May, Doug and Kimberly have an elementary school “graduate” and two middle school “graduates”. Not the big ones for sure, but milestones none the less! We’ll take them!

We believe one of the greatest gifts you can give the young adults that you know is the concept of financial responsibility. They have time on their side in terms of compounding, but these suggestions serve as good reminders for all of us. We also offers this alternate gift idea if you are looking for something different this year to give the graduates in your life.

Kiplinger offers this timely advice for the grads in your life. The article is written from the perspective of answering a question from a reader about his daughter’s college graduation.

1. Make the most of new health insurance rules. If your daughter is lucky enough to get a job with health insurance, that’s usually her best bet. But if she doesn’t have a job with benefits, you no longer need to worry about finding new coverage after graduation -- adult children can now stay on their parents’ policies until age 26. If you already have family coverage to cover younger children, then you may not have to pay extra to keep your daughter on your policy. But if you’d have to pay extra to keep her on your policy (or if your daughter lives far away from your policy’s in-network providers), it might be worthwhile to compare the cost of buying her own policy. In most states, a healthy person in her early twenties can buy her own health insurance for less than $100 per month. She can reduce the premiums by raising the deductible, yet still have free preventive coverage.

2. Get free money from the boss. If your daughter’s employer offers pretax savings through a 401(k), 403(b), Thrift Savings Plan or another employer-provided retirement account, she should sign up right away. Her contributions will lower her taxable income and grow tax-deferred until retirement. Because retirement plan contributions are made with pretax dollars, they reduce her take-home pay less than the full amount of the contribution. For example, if she’s in the 25% tax bracket and contributes $1,000 to a 401(k), her paycheck shrinks by only $750. And if her employer matches her contributions, it’s one of the rare opportunities to get free money! Say, for example, she earns $50,000 per year and her employer contributes 50 cents for every dollar she contributes up to 6% of pay. If she contributes $3,000 to her 401(k) for the year, then she’ll get a $1,500 match from her employer.

3. Build tax-free retirement savings. Even if your daughter contributes to a 401(k) at work, she can also contribute up to $5,000 for the year to a Roth IRA, which can give her tax-free money in retirement. To qualify for a Roth, her modified adjusted gross income in 2011 must be $122,000 or less if single (or $179,000 or less if married filing jointly). And a Roth can be a particularly good deal for young people who are in a much lower tax bracket than they will be in the future. With a Roth IRA you don’t get a current income-tax deduction for your contributions, but you can withdraw the money tax-free after age 59½ (and you can withdraw your contributions anytime without taxes or penalties). And your daughter can also get an extra tax break for contributing to a retirement savings plan if her income is less than $28,750 in 2011 (or $56,500 if married filing jointly).

4. Buy renters’ insurance. The value of your daughter’s stuff can add up quickly, even if she just has a decent TV, computer system and other electronics, and basic furniture and wardrobe. Renters insurance can reimburse her if her possessions are destroyed and also provide valuable liability coverage if someone is injured while visiting her apartment. Policies tend to cost just $200 to $300 per year, and she could get a discount if she buys renters’ insurance through the same company that provides her auto insurance.

5. Shop around for auto insurance. Now that your daughter is on her own, she’ll need to get her own auto insurance. Rather than automatically switching to individual coverage through your insurer, she should shop around for the best deal. (An insurer that offers the best rates for family coverage may not be as competitive for young adults on their own).

6. Benefit from tax breaks. When your daughter is earning money for the first time, she’ll also want to learn to make the most of her opportunities for tax breaks. Job-search expenses aren’t tax-deductible when looking for a first job, but new grads can write off the cost of job-related moving expenses, including for their first job and even if they don’t itemize their deductions. And when they get that first job, they need to make sure they have the right amount of tax withheld from their paycheck so they enjoy a bigger check month after month rather than having to wait for a refund at the end of the year.

7. Set long-term financial goals. Now that your daughter is earning a paycheck, it’s the perfect time for her to start thinking about her longer-term financial goals beyond just paying the bills. In addition to setting aside some money for retirement savings, she may want to start saving for a down payment on a car or a house. But more importantly, she should start building up an emergency fund. Once she gets into the habit of saving, she might want to learn a bit about how to invest that money.

Luck is what happens when opportunity meets preparation.
- Anonymous

Upcoming Focus Areas for PFSI

1. Taxes are over… for most! Congratulations! The next tax deadline is the second quarter estimated tax payment due June 15, 2011 for those making estimated tax payments.
2. Speaking of taxes, it’s not too early for your 2011 IRA contribution(s) to be funded (SEP-IRA, Roth, Roth Conversions, Traditional Deductible, Traditional Non-Deductible). Many of you won’t know your contribution types or amounts until later in the year when your AGI is more clearly established; however, there are many that can be done now. The sooner you can put that money to work for you in a tax sheltered vehicle, the better off you will be.
3. Those needing to take Required Minimum Distributions can take those now as the calculation amount does not depend upon your 2011 AGI – it’s a function of your balance in your IRAs on 12/31/10.
4. Spring brings longer days, baseball, chocolate everything, and …graduates! Congratulations to the young adults you know moving forward. If you are looking for a unique and lasting graduation gift for a graduate you know, consider a two-hour private session for young adults looking to start out on the right foot financially. We often wish we had such an opportunity when we were young to avoid some of the mistakes we made along the journey.

The Other Side of the Debt Problem:

While the U.S. wallows in debt (and suffers the political recriminations that come with it), another country has an astonishing surplus of capital. By the end of 2010, according to an article in the Economist magazine, The Central Bank of the People's Republic of China had $2.85 trillion in foreign exchange reserves. That figure reached $3 trillion by the end of March, 2011.

So far, China's central bankers are mostly invested in U.S. government securities, but the magazine suggests that they could become more adventurous if they wanted to seek higher returns on their largesse. $3 trillion is enough to buy all of the outstanding sovereign debt of Spain, Ireland, Portugal and Greece--and still have almost half of its reserves left over. In addition, it could buy, outright, Apple, Microsoft, IBM and Google for $916 billion, purchase the 50 most valuable sports franchises in the world for another $50 billion, buy all the real estate in Manhattan (estimated value: $287 billion, up considerably from $14 in trinkets that represented the original purchase), and then pay cash for all the properties in Washington, D.C. ($232 billion).

Or, China could simply buy all U.S. farmland for $1.87 trillion and the global gold supply ($1.43 trillion).

However you calculate it, the sheer magnitude of China's reserves is stunning--and, for Americans looking at our own lack of government resources, a little depressing. This is an extreme example of what the consistent trade imbalance leads to--yearly movements of money from one nation to another that can add up to something pretty dramatic.

What does that mean for you? It’s more reinforcement of our position that it is impossible to predict the future or guarantee you can out-perform the indices (ie ‘beat the market’). We CAN diversify, shelter your short-term and medium-term liquidity needs, set and project reasonable goals, and move ahead knowing the long-term trend in the market has been up.

Fears of a Downgrade

As an investor, you probably noticed, among the screaming headlines and constant media coverage, that the Standard & Poor’s bond rating division has threatened to downgrade the credit rating of U.S. Treasury bonds. The U.S. markets dropped 1% almost immediately after the news broke, and the S&P 500 index of large cap stocks finished the day down 1.1%.

What was not always emphasized in the news coverage is that this is far from an actual downgrade. The announcement actually said that Treasury securities would be given a AA rating (the credit rating of Japan) rather than the current AAA (the highest credit rating, which is also enjoyed by France and Germany) if the federal budget deficit is not addressed within two years.

Coming from the same organization which, in 2008 and before, gave AAA ratings to subprime mortgage debt instruments, this credit evaluation might be dismissed--except that other parties seem to be equally worried. In February, PIMCO--the world's largest bond fund investor--announced that it had sold all U.S. Treasury securities in its $236 billion Total Return Fund. The company is worried that rising inflation and interest rates will cause bond values to drop. But it also noted that sustained deficits in the U.S.--like the much greater debts in Greece, Ireland, Iceland and other debtor nations--would cause global investors to demand higher interest rates on government debt. Higher rates on new issues would cause the value of existing bonds to fall.

But why are stocks falling when the conversation seems to be all about bonds? Investors may be worried that any rise in interest rates would raise the borrowing costs across Corporate America as the U.S. economy is still rebuilding from the Great Recession. But there may also be some concern that stocks haven't fully factored in the flock of black swans that are swimming around various corners of the global economy. An article in the April 17 issue of the Wall Street Journal lays out the case: Japan, the world's third-largest economy, has gotten clocked by an earthquake, tsunami and nuclear disaster--plus continuing aftershocks and more nuclear problems. North Africa and the Middle East--where much of the world's oil comes from--are seething with unrest and uncertainty. Portugal has joined Greece and Ireland in requiring a Eurozone bailout for its sovereign debt. Closer to home, the article tells us, many economists have dropped their first-quarter estimates of U.S. economic (GDP) growth to below 2%. Six months ago, the more bullish estimates were coming in around 4%.

Looking at all this uncertainty, one might think that getting out of stocks altogether is the wisest, safest thing to do until things settle back down again. The problem, of course, is finding a good place redeploy the money. Should you buy the Treasury bonds that PIMCO is unloading? Global stocks? The global economic uncertainty has actually caused inflows into the U.S. market, which seems to be an island of relative calm, and has always benefited from investor fear and a flight to quality. Plus, as the Wall Street Journal article points out, the jobs picture in the U.S. is starting to improve. About 230,000 private sector jobs were added in March, and U.S. retail sales rose for the ninth straight month.

Any hint that the U.S. government will lose its best-in-the-world credit rating is likely to be sensationalized, even if the event won't take place for another two years, even if it is conditional on no action being taken between now and then. If the government's cost of borrowing does go up from the current 3.40% on 10-year Treasuries, it would unhelpfully raise the cost of financing our nation's debts. But the news media never seems to provide a full perspective on these banner headlines. Japan's sovereign debt is, proportionately, higher than America's, and Japan received the dreaded credit downgrade to AA status earlier this year. That caused Japan's borrowing costs, on its 10-year securities, to go up incrementally--to, currently, 1.29%.

Market Recap:

Take that, S&P: Domestic equities rebounded from a downdraft that followed Standard & Poor's warning about U.S. debt, ending the holiday-shortened week with solid gains. Buoyed by some positive corporate earnings, the S&P 500 made another run at 1340 but remained in the trading range of roughly 1300-1340 that it's been in since early February. The Dow ended the week at its highest level in almost three years and took the lead from the small-cap Russell 2000 in the year-to-date performance sweepstakes. Treasury bonds also seemed to thumb their noses at the S&P warning. Ten-year Treasury yields ended the week basically flat; in fact, the Treasury had to set a minimum positive coupon rate for an auction of five-year Treasury Inflation-Protected Securities (TIPS), which had been trading in the secondary market with a negative yield.

Market/Index	2010 Close	Prior Week	As of 4/22	Week Change	YTD Change
DJIA	11577.51	12341.83	12505.99	1.33%	8.02%
Nasdaq	2652.87	2764.65	2820.16	2.01%	6.31%
S&P 500	1257.64	1319.68	1337.38	1.34%	6.34%
Russell 2000	783.65	834.98	845.64	1.28%	7.91%
Global Dow	2087.44	2177.52	2207.21	1.36%	5.74%
Fed. Funds	.25%	.25%	.25%	0 bps	0 bps
10-year Treasuries	3.30%	3.43%	3.42%	-1 bps	12 bps

Last Week's Headlines
Standard & Poor's issued a negative long-term outlook on U.S. debt, saying the potential for a prolonged stalemate over how to deal with budget shortfalls increases the chance of a downgrade of the nation's AAA bond rating in the next two years unless the issues are addressed.
Building permits were up 11.2% in March compared to February, and housing starts rose 7.2%, the

Commerce Department said. However, both were still down more than 13% from last March.
Sales of existing homes were up 3.7% in March, according to the National Association of Realtors®. While not stellar, the figure is an improvement over February's 8.9% decline.
Gold hit a new record of $1,500 an ounce just two months after first reaching $1,400, while oil prices showed few signs of retreating.
After rising for seven consecutive months, regional manufacturing tracked by the Philadelphia Federal Reserve Bank fell sharply in April. Though the 18.5% figure for the Philly Fed's manufacturing index still represented growth, it was a far cry from March's 43.4% increase.
The Conference Board's index of leading economic indicators was up 0.4% in March. The most positive factors were the 10-year Treasury/Fed funds interest rate spread and increased housing permits, while consumer expectations were a drag on the index.
Eye on the Week Ahead
Some Nasdaq-listed stocks could see volatility in advance of the May 2 rebalancing of the stocks that comprise the Nasdaq 100 index. The announcement coming out of the Federal Open Market Committee meeting--the next-to-last before the scheduled demise of quantitative easing (QE2) at the end of June--will be scrutinized for any clues about possible policy shifts. Finally, the initial estimate for Q1 economic growth will be of interest.
Key dates and data releases: new-home sales (4/25); home prices (4/26); durable goods orders, Federal Open Market Committee (FOMC) announcement (4/27); Q1 gross domestic product (GDP) initial estimate, pending home sales (4/28); personal income/spending (4/29).
Data source: Includes data provided by Brounes & Associates. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Past performance is no guarantee of future results. Equities data reflect price change, not total return.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 leading companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. Market indexes listed are unmanaged and are not available for direct investment.

The ABC’s of A/B and A/B/C Trusts…What’s Right for You?

If you're married, a combination of trusts, often referred to as A/B, A/B/C, or A/B/Q trusts, may be useful for estate planning purposes. The combination of trusts can sometimes be used to minimize total estate tax for two spouses, and can provide nontax benefits as well.

A federal estate tax overview

• An unlimited marital deduction is generally available for transfers of wealth between you and your spouse.
• Currently, an estate of $5 million can be sheltered by a $5 million basic exclusion amount and a tax rate of 35% applies to any excess. Any unused portion of the basic exclusion of a deceased spouse is portable and can be transferred to a surviving spouse. The $5 million amount will be indexed for inflation in 2012.
• Absent further legislation, in 2013, the amount that can be sheltered is reduced to $1 million, the top estate tax rate increases to 55%, and the basic exclusion amount is no longer portable.

The A, or power of appointment marital, trust

The A trust is structured to qualify for the marital deduction. You give your surviving spouse a right to all of the trust's income for life and the power to appoint who receives the trust property at your spouse's death. You would typically fund the A trust (together with a Q trust, if desired) with the amount of your estate in excess of the applicable exclusion amount.

The B, or bypass credit shelter, trust

You would typically fund the B trust with an amount equal to the applicable exclusion amount, or credit shelter amount. You can give your spouse interests in the B trust, but generally none that would cause the trust to be includable in your spouse's estate for estate tax purposes (thus, the B trust bypasses your spouse's estate). You can name the persons who will receive trust income or other distributions from the trust. You can also provide that, at your spouse's death, the trust will continue for the benefit of, or be distributed to, your children or other beneficiaries. Or, you could give your spouse a limited power to appoint property among a limited class of beneficiaries, such as your children from your current marriage.

The C, Q, or QTIP marital, trust

The C or Q trust, typically a QTIP trust, is also structured to qualify for the marital deduction. You give your surviving spouse a right to all of the trust's income for your spouse's life. However, you retain for yourself the right to designate who receives the property at your spouse's death. This can be useful when you have children from a prior marriage who you would like to benefit after your spouse's death. You would typically fund the C trust (together with an A trust, if desired) with the amount of your estate in excess of the applicable exclusion amount.

Everything to spouse versus A/B trusts

Because the exclusion amount is higher and portable in 2011 and 2012, some couples may think they do not need A/B or A/B/C trusts. Everything could be left to the surviving spouse who uses both spouses' exclusions. However, there are still tax advantages to using this basic planning strategy as shown in the following example.

Example:

John is married to Mary and has an estate of $10 million. Assume a $5 million basic exclusion amount that is indexed and portable and a top estate tax rate of 35%. John leaves $10 million to Mary at his death. The transfer qualifies for the marital deduction, no estate tax is due, and John's unused $5 million exclusion is transferred to Mary. Everything (except the unused exclusion) doubles in value. Mary's estate of $20 million is partially sheltered by Mary's applicable exclusion amount of $15 million ($10 million basic exclusion plus John's unused $5 million exclusion). After estate taxes of $1,750,000 are paid, $18,250,000 remains for John and Mary's children.

Assume instead that John leaves $5 million to Mary in an A trust and $5 million in a B trust for Mary and their children. No estate tax is due. Everything doubles in value. Mary's estate of $10 million is sheltered by Mary's basic exclusion amount of $10 million. No estate tax is due. The entire $20 million (the $10 million B trust plus Mary's $10 million estate) remains for John and Mary's children. By using the A/B trusts, estate tax has been reduced by $1,750,000, and the tax savings go to John and Mary's children.

Other trust benefits

The use of trusts can also provide other benefits, such as control over who receives your property and when, investment management of trust property for trust beneficiaries, avoidance of probate, and asset protection. To learn more, consult an estate planning professional.

Recovery

Two weeks ago, the world celebrated an unusual two-year anniversary: 24 months from the low point in the global markets, the point of maximum pain and panic following the 2008 economic meltdown and so-called Great Recession.

On March 9, 2009, the S&P 500 had fallen to its low of 676, which is about where it had been in October of 1996--13 years before. Since then, the S&P index has gone up about 95%, bringing it within 15% of its record high in 2007. The Russell 2000 index, which tracks small cap stocks, has gone up 140% in the same period, and the MSCI Emerging Markets Index is up 122%.

If you look back at the economic forecasts and market reports in March two years ago, you don't find, anywhere, a prediction that the markets would recover as they have. There was even some doubt whether the U.S. economy would survive intact, and the most common prediction was deflation, continued recession and more downside in the stock markets.

In retrospect, this most frightening time was the ideal time to shove all the chips on the table and bet everything on a stock market recover--but who had the intestinal fortitude for that? After the losses that virtually all investors had sustained, no matter where they had deployed their assets, few had the stomach, or the heart, to bet on a robust recovery. This is a terrific lesson in the value of disciplined investing; the consensus and our own gut feelings are often wrong and inevitably point us in the opposite direction from where the returns are going to come from next. In the past, every long-term upturn has been greater than the losses sustained in the prior bear market. We don't know how this one will end, but it seems to be following the same seemingly unlikely, but not unusual, course.

March Newsletter

The 10 Secrets of Success
Similar to attending a church service or a retreat, these reminders help bring these simple ideas back to the forefront of our minds. They help us get outside of ourselves, to push away the ringing phone, to pause from watching the ticking clock, to reflect, even briefly, how we might apply these principles to our lives that very day. I hope they help you in some small way today!

These were taken from an Investor’s Business Daily article years ago. “Investor’s Business Daily has spent years analyzing leaders and successful people in all walks of life. Most have 10 traits that, when combined, can turn dreams into reality.”

• How you think is everything: Always be positive. Think success, not failure. Beware of a negative environment.
• Decide upon your true dreams and goals: Write down your specific goals and develop a plan to reach them.
• Take action: Goals are nothing without action. Don’t be afraid to get started. Just do it.
• Never stop learning: Go back to school or read books. Get training and acquire skills.
• Be persistent and work hard: Success is a marathon, not a sprint. Never give up.
• Learn to analyze details: Get all the facts, all the input. Learn from your mistakes.
• Focus your time and money: Don’t let other people or things distract you.
• Don’t be afraid to innovate; be different: Following the herd is a sure way to mediocrity.
• Deal and communicate with people effectively: No person is an island. Learn to understand and motivate others.
• Be honest and dependable; take responsibility: Otherwise, numbers 1 -9 won’t matter!!

Feature Article:

What Do You Tell the Kids?
This article was adapted from an article by Steve Vernon posted on February 25, 2011 at Personal Finance News from Yahoo!

Should you be lucky enough to have “grown smarter” as your children (or any young adults) have moved beyond their teen years and through their twenties, you might be lucky enough to be asked this question: "Should I save money for retirement, a down payment on a house, or for my kid's college education?"

“Yes”

The challenge facing most people in their 20s and 30s is juggling competing priorities — usually there isn't enough money in the budget to do it all. So how do you prioritize?

In addition to saving for your later years, consider these as well:

• Invest in your career. If you don't make much money, or are in a declining industry with the threat of layoffs, it's hard to invest for retirement [we, at PFSI, prefer the phrase ‘financial freedom’ over ‘retirement’ – far different meanings – this is a subject for another newsletter!). So your first priority is to establish yourself in a career that has a future, that you are passionate about and allows you to live your values!
• Build your nest. It's a great time to be a first-time home buyer with low home prices and low mortgage rates. Consider saving for a down payment or enough to allow you to skip the PMI (primary mortgage insurance) component of the financing (usually requires a 20% down payment). But don't fall into the common trap of buying that large, fancy house to impress your friends; I promise you, they won’t help you pay for it.
• Establish smart spending habits. Live within or below your means. How? Drive your cars into the ground, don't eat out as much, avoid expensive and potentially unhealthy processed foods, and buy just enough clothes to fit your needs. Resist the temptation to go overboard on electronic gizmos in the house! Limit your credit card spending so that you can easily pay off the balance each month. Make every dollar count with your spending, so you can free up money to invest in YOUR future.
• Get healthy. One of the best things you can do for your later years is to establish lifelong, healthy, eating and exercise habits. Doing so won't increase your spending, but it will go a long way to preventing the depletion of your financial resources in your later years due to high bills for medical and long-term care expenses. To say nothing of your quality of life!
• Save 10% of every dollar you earn to allow you to reach financial freedom. We teach this in our classes to even our youngest audiences. This one simple rule will put you ahead of 90% of the population! Note that if you wait until later to save, you will need to save a larger percentage – your age minus ten is a good rule of thumb.
• Prepare to reach “financial freedom” by age 70. By the time you reach an age that you desire more flexibility in your work life, it's inevitable that Social Security's eligibility age will be pushed back. And if you've taken care of your health, there's a good chance you'll live to 95, so retiring at 70 could still give you a 25-year “retirement” in the traditional sense of the word.
• Invest time and energy into causes and relationships that encompass your values and principles. We do not believe there is a higher “return on life” to be achieved.

Our market recap follows.

The Markets
As the bull market neared its two-year anniversary this Wednesday, domestic equities investors managed to stay afloat last week--but just barely. Despite some triple-digit intraday swings in the Dow, equities ended the week not far above where they began.

Last Week's Headlines
•U.S. manufacturers continued to see improvement, according to the Institute for Supply Management (ISM), whose index for the sector rose to 61.4 in February from January's 60.8. That level of growth was last seen in May 2004 and represented the 19th consecutive monthly increase in the index. Meanwhile, the ISM's services sector index hit 59.7, its 15th consecutive increase.
•For the first time in almost two years, the unemployment rate fell just under 9%. The addition of 192,000 jobs to nonfarm payrolls helped lower the January number to 8.9%, the Bureau of Labor Statistics' best reading since April 2009.
•American incomes rose 1% in January. According to the Bureau of Economic Analysis, the increase was partly the result of the 2% reduction in Social Security deductions from paychecks. Personal consumption was up 0.2% for the month.
•Construction spending fell 0.7% in January, according to the Commerce Department, and was 5.9% below that of January 2010. Private construction was down 1.2% from December, primarily because of a 6.9% drop in nonresidential building, while public construction rose 0.1%, mostly as a result of educational construction.
•The Commerce Department said new factory orders were up 3.1% in January, driven largely by a 27.3% increase in orders for transportation equipment.
•Positive economic data and the recent rise in oil and commodity prices helped renew inflation concerns, which sent gold to a new high above $1,435 an ounce. Crude oil prices continued to haunt the $100-per-barrel mark.
•European Central Bank President Jean-Claude Trichet shook up currency markets with tough anti-inflation talk, raising speculation that a rate hike might be imminent for the eurozone.

Eye on the Week Ahead
With the postponement of a congressional spending showdown and a week that's relatively light on economic data, the state of retail sales will be watched as an indicator of consumer mood. Oil prices also will continue to be a focus.

Key dates and data releases: international trade balance (3/10); retail sales, business inventories (3/11).

1) What does your perfect day and a perfect week in retirement look like? Consider what time you will wake up and go to bed; if you’ll eat breakfast, lunch and dinner together; what errands and household responsibilities need to be done each week and who will do them; and discuss how much alone time each of you may want and need.

2) What does your job provide that you will miss in retirement? Think about the mental, social and physical aspects of your work that are important to you and what steps you can take to either maintain or replace them.

3) How will you identify yourself during retirement? Reflect on the last time you were introduced to a retired person. How did they identify themselves? What was your first impression of them?

4) What will you do with your time during retirement? Assess whether or not you will need to maintain a structured schedule or if you can effectively go with the flow. Be mindful of the fact that too much unstructured time can lead to the dark side of retirement including addiction and depression.

5) How will you stay connected with friends who are still working? Be sure to consider how moving or spending extended time in a distant location would impact both family relationships and friendships.

6) How will your retirement plans affect your family? Be sure to discuss if there will be more or less visiting, what role you will play with your grandkids, and how will you communicate your plans to your family.

7) Do family, friends or organizations expect or desire any inheritances? Think about what conflicts might arise with your heirs, and if you have a blended family, how assets and possessions be divided.

8) What thoughts, questions or concerns about retiring keep you awake at night? Whether it’s running out of money, losing a loved one, or how you’ll stay connected to friends, seek out professionals who can help you eliminate the stress.

9) What impact would the time, energy or cost of supporting an adult child, grandchild or parent have on your retirement budget and lifestyle? These issues are becoming all too common, so prepare by considering which family members are likely to ask you for money, move back home or move in with you. Set ground rules for the amount of money with which you can help, or how living arrangements might work.

10) What role will your physical and mental health play in your retirement? Consider what healthy habits you hope to incorporate into your retirement and what bad habits need to be monitored or curbed?

These questions can be a great starting point for developing open and healthy communication patterns between couples. They can also serve as critical building blocks to rely upon should retirement plans change. Whether it’s a stroke, car accident, or addiction, there are myriad things that can alter retirement - all of which make having healthy relationships as important as a traditional dollars-and-cents plan.

Popular indexed annuities called 'terrible ideas' for seniors
High hidden fees, long surrender periods just some of the pitfalls
By Bloomberg News
January 30, 2011

When Helen Siswein, a retired teacher, heard about an investment that might earn 8% a year and never lose money, she was sold.

“I thought, "Boy, if the market surges, I could make a lot,'” said Ms. Siswein, 82.

In July 2003, on the advice of an insurance agent who came to her former home in Bucks County, Pa., after her husband died, she put about $1 million into four different annuities linked to stock market indexes.

Ms. Siswein said that the agent didn't tell her that she was locking up most of her money until her 87th birthday or that there were caps on how much she could earn.

Five years later, it cost Ms. Siswein fees of as much as 15% of her account balances to get out of the investments, the contracts show. One annuity earned an average of about 3% a year after the penalty was subtracted, while the index it tracked, the S&P 500, returned 6.3%, including dividends.

Investors such as Ms. Siswein are buying more equity-indexed annuities — contracts that earn money based on the performance of stock indexes and don't decline in value if held to maturity. Although that protection may be attractive to investors who saw the S&P 500 plunge 38% in 2008, the contracts' complex terms and embedded fees make it unlikely they will perform as well as expected, said Kent Smetters, a professor of insurance at The Wharton School of the University of Pennsylvania.

“These contracts have really high hidden fees,” said Mr. Smetters, a former economic policy official at the Treasury Department. “That's why they're terrible ideas for older people, even though they're peddled to them.”

Insurers led by Allianz SE and Aviva PLC sold a record $8.7 billion of indexed annuities in the third quarter of 2010, up 16% from the year-earlier period, according to AnnuitySpecs.com, a market research company. The contracts generally earn nothing when stocks fall, and include caps on returns which insurers can change at will.

Sales representatives are paid commissions of as much as 12%, and some are rewarded with incentives. Unlike the fees on mutual funds, those costs aren't disclosed.

Indexed annuities are part of a boom in structured products, which are opaque investments pitched as a way for conservative investors to earn higher yields.

While more of the complex annuities are being marketed by insurance agents, stockbrokers are pushing structured certificates of deposit and notes, which are similar derivatives-based investments created by Wall Street banks. Sales of structured notes rose to a record $49.5 billion last year, according to data compiled by Bloomberg.

“The pure psychology of downside protection with upside potential sells really well,” Mr. Smetters said.

“These products are all very complicated,” he said. “The problem is, they're not transparent.”

Sales reps typically downplay the complexity of indexed annuities and their long lockup periods, said Barbara Roper, director of investor protection for the Consumer Federation of America. The contracts are “one of the most abusively sold products on the market today,” she said.

Insurers create the annuities using derivatives, which are financial contracts whose value is derived from stocks, bonds and commodities. Although the policies guarantee principal if held to term, they have withdrawal penalties that may be enforced for more than 10 years.

The dividends paid by stocks in the index generally aren't counted toward the annuities' returns. Buyers can convert the contracts into a lifetime stream of income at maturity.

Most don't, Mr. Smetters said. “You will never get all of the upside” of the stock market, because returns are capped, said Eric Thomes, senior vice president of sales at Allianz Life Insurance Company of North America, the largest seller in the United States. “You also don't need to worry about the downside, and with what happened in 2008, this type of benefit will no doubt interest a lot of people.”

Low yields on federally insured bank CDs are helping sales of indexed annuities, said Wendy Waugaman, chief executive of American Equity Investment Life Holding Co. American Equity is the third-largest seller of indexed annuities, according to AnnuitySpecs.

“It's really easy to see why they're so popular in today's environment,” Ms. Waugaman said.

Investors also are buying because they are “afraid of market risk,” she said.

The company is offering agents that sell at least $2.5 million of its products in the 12-month period through June 30 of this year a trip to Walt Disney World. Agents must sell an additional $600,000 of annuities to bring a child.

The trip is to the firm's annual convention, a standard industry practice, Ms. Waugaman said.

Insurers who sell indexed annuities buy derivatives from banks to cover the contracts' guarantees, making the business less risky than selling other investments with a guaranteed minimum return.

In 2008, insurers lost money on variable annuities with similar guarantees when the stock market plummeted. The Hartford Financial Services Group Inc. wrote down the value of a VA business by $274 million and Prudential Financial Inc. also recorded a loss.

Indexed annuities tend to underperform a lower-risk strategy of rolling over CDs “because of the high cost embedded in these things,” said William Reichenstein, professor of investments at Baylor University.

For example, an insurer may take $100 from a customer and invest $94.33 of that in bonds and keep $2, said Mr. Reichenstein, who has analyzed several indexed-annuity contracts. With that remaining $3.67, the company buys a portfolio of derivatives linked to the S&P 500 that will give investors some, though not all, of the index's returns.

Even with interest rates near record lows, CDs may still do better than the annuities because insurers will have to reduce caps on returns to maintain profitability, Mr. Reichenstein said.

“They're not playing Santa Claus,” he said.

Insurers must earn enough over time to recoup what they pay upfront to agents or brokers who sell the annuities, cutting into returns to investors, Mr. Reichenstein said.

Commissions range from 1.5% to 12%, according to AnnuitySpecs.

The opacity of the products' fees and complexity of the return calculations make it impossible for investors to figure out if they are getting a good deal, said Glenn Daily, a fee-only insurance consultant.

“You're paying the insurance company to set up and manage a portfolio of fixed-income securities and derivatives,” he said. “You don't have transparency.”

Contracts prevent canceling or surrendering for a refund of the account balance without a penalty for a set period that ranges from three to 16 years, AnnuitySpecs data show.

However, most contracts do permit 10% penalty-free withdrawals annually, according to AnnuitySpecs. Owners may incur a 10% charge from the Internal Revenue Service if distributions are made before age 591/2 because the earnings are tax-deferred.

Ms. Siswein, the retired teacher, bought her indexed annuities from Robert Calamunci of Marlboro, N.J. Mr. Calamunci, now an accountant, said that he no longer sells the products and declined to comment further.

Ms. Siswein said that she needed financial advice after her husband's death left her with more assets to manage, and Mr. Calamunci convinced her to put about $250,000 into each of four indexed annuities.

One of the indexed annuities that Ms. Siswein bought, called FlexDex Bonus, was issued by Allianz Life accompanied by a 23-page packet explaining the terms. The contract required Ms. Siswein, who was 75 at the time, to tie up most of her money until she turned 87 or pay withdrawal penalties of as much as 15%.

She canceled her policy because of lower returns than she expected and the limited access to her funds, which she said she didn't understand at the time of purchase.

Earnings were based on a portion of the average monthly performance of the S&P 500, without dividends, as calculated from her contract's anniversary July 14 to the same date the following year. The S&P 500, with dividends reinvested, returned 35% between July 14, 2003, and July 13, 2008, compared with about 15% that Ms. Siswein made over the same time period, including the surrender charge, according to her current adviser, Carolyn Walder, president of Lifetime Wealth Planning and Management.

“Up until 2008, the market had gone up dramatically,” Ms. Walder said. “She should have made a lot more money during that time.”

Without the surrender charge, an investor such as Ms. Siswein could have had a total return of nearly 30% for five years, or almost 6% a year, Laurie Bauer, a spokeswoman for Allianz Life, wrote in an e-mail.

Ms. Bauer said that she couldn't comment on Ms. Siswein's contract because the latter wouldn't sign a release. Holders of indexed-annuity contracts were protected against market declines such as the one in 2008 and lost no principal or previously credited interest, Ms. Bauer said.

Ms. Siswein said that she has joined a class action filed in 2005 against Allianz, alleging misleading sales of indexed annuities. Allianz Life denies the allegations of the case, Ms. Bauer said.

Indexed annuities have caps on returns and other terms that insurers may change annually at their discretion.

Ms. Siswein's contract with Allianz Life, for example, had a cap of 8% on how much she could receive from the S&P 500's performance in 2003. That was lowered to 6% for the policy year beginning in July 2008, according to her statements.

Altering the caps allows insurers to change how much they spend on the derivatives that fund the payouts, FBL Financial Group Inc., another company that sells indexed annuities, said in a Sept. 30 regulatory filing.

“Quite frankly, each and every quarter, we've started taking additional spreads,” which has helped increase the company's profits, chief financial officer James Brannen said in an Aug. 6 conference call with analysts.

Vincent Chiodo, a 68-year-old retired firefighter, said that he invested $113,000 in an indexed annuity issued by an FBL unit called EquiTrust Life Insurance Co. after meeting an agent at a free dinner seminar near his home in Palmetto, Fla. Dissatisfied with his returns, he said that it cost him about 20% in fees last July to get out of the contract after four years.

FBL declined to comment on Mr. Chiodo's policy.

Rick Stgeorge, the agent who sold Mr. Chiodo the annuity, said that he explained the withdrawal fees and that Mr. Chiodo made a mistake by terminating the contract when he did. Most of his clients are happy with their returns and tax benefits, he said.

Indexed annuities allow investors to defer taxes, though earnings are taxed as ordinary income when withdrawn. Capital gains from stock sales are generally taxed at a lower rate.

“There should be parades for indexed annuities,” said Mr. Stgeorge, who spells his last name as one word. Annuities earn between 3% and 8% with “no risk,” he said.

Ron Smythe, former chief executive of Meineke Car Care Centers Inc. said that he started moving money into indexed annuities about a year ago. He bought a contract issued by Allianz Life from Mr. Stgeorge because of the principal protection and potential for higher yields than other annuities.

Mr. Smythe, 76, who is retired and living in Longboat Key, Fla., said that he is unconcerned about the surrender charges for early withdrawal because he is holding them “for the long range.”

Unlike the stocks they track, fixed indexed annuities generally aren't subject to U.S. securities laws and are regulated by state insurance departments. A provision of the Dodd-Frank financial-overhaul law blocks the Securities and Exchange Commission from overseeing the market.

State insurance regulations aren't strict enough to prevent sales reps from taking advantage of the elderly with indexed annuities, said Ms. Roper, who lobbied for the products to be regulated by the SEC.

In Iowa, companies and individuals licensed to sell annuities have to gather information from buyers, such as their finances and age, to ensure that the contract is suitable, said Jim Mumford, first deputy commissioner and securities administrator for the state's insurance division. Agents who offer indexed annuities also must take at least an additional four hours of training on the products, he said.

Annuities aren't guaranteed by the Federal Deposit Insurance Corp. Insurers agree to cover losses if a company fails, up to a limit that varies by state.

An investor in Florida, for example, is covered up to $250,000 or $300,000 per company, said William Falck, executive director of the state's Life & Health Insurance Guaranty Association, a statutory body that protects clients' assets if an insurer is liquidated. Although the principal on an indexed-annuity contract may be reimbursed by the state guaranty fund, the interest may not, he said.

MetLife Inc. and Prudential, the two largest U.S. insurers, don't offer indexed annuities. MetLife allows its agents to sell indexed annuities from third parties, said company spokesman Patrick Connor.

TIAA-CREF, the retirement company that manages more than $400 billion, also doesn't offer indexed annuities.

“Very few people understand what the product is,” said Dan Keady, director of financial planning for the company.

February Newsletter

Quotable Quote:

"If the shoe fits, you're not allowing for growth." - Robert N. Coons

On nights when we can manage sometimes-ridiculous schedules to gather at the dinner table, we have a tradition of going around the table and asking three questions to all seated. One of my favorite questions is "Did you learn something today?" Our tradition gives everyone a chance to be heard, share snippets of their day, and - at least for this question - affords us a welcome break from the all-too-familiar after-school dialogue of: "What did you do at school today?" followed by the inevitable yet dreaded answer ..."Nothing..."

Here's what I learned the hard way many years ago and ultimately why I entered this profession: I believe the value proposition of most financial advisors is unsustainable and must change. A promise of consistent, above-average, long-term returns is a promise that simply cannot be kept. What, then, IS a reasonable value proposition for a financial advisory firm?

Consider this: Helping you get the most out of your life given the resources you have.

Points of Interest:

• For all those of you on the edge of your seat waiting to file your tax return, you’ll have to wait just a bit longer this year. Due to the trickle-down effect of the late passage of the tax law for 2010, the IRS has extended the delivery of 1099s until Feb 15th (the normal deadline is Jan 31st). Keep in mind that it is common for financial institutions to issue ‘corrected’ 1099s even after this deadline, so if you can hold yourself back from filing before April, you may save yourself the time and expense of an amended return.

• Passing on a legacy can take many forms. Estate attorneys busy themselves with helping you pass on your financial and physical assets – a vitally important component of your financial plan. But have you ever considered passing on your values, principles and life lessons? For those in Austin, we welcome you to attend “Tying Up Life’s Loose Ends – A Discussion about Ethical Wills” presented by Doug on Sunday, February 20th. Click here for more information about the upcoming event and here to preview the presentation.

• Ever wonder why we have never tried to sell you an annuity? Bloomberg reports this week that popular annuities are “terrible idea” for seniors. Here are a few quotes from the article: “The company is offering agents that sell at least $2.5 million of its products in the 12-month period through June 30th of this year a trip to Walt Disney World. Agents must sell an additional $600,000 of annuities to bring a child… Sales representatives are paid commissions of as much as 12%, and some are rewarded with incentives…” Enough said! See our February blog for the full article.

Feature Article:

They say a picture is worth 1000 words, so I’ll spare you a few words! Why don’t we try to time the market? Repeating what I told my elementary school students this past week, “time IN the market is more important than trying to TIME the market.”

The Markets

Mounting up: The Dow finally closed above the 12,000 mark for the first time since June 2008, and the broader Standard & Poor's 500 topped 1300. The small-cap Russell 2000 had its best week since the beginning of December, though its year-to-date gain is still only about half that of the other three domestic indexes. Optimism about economic recovery and concern about whether that would result in inflation contributed to a 32-point jump in the yield on 10-year Treasuries, which returned to a level last seen in spring 2010.

Last Week's Headlines

• The nation's unemployment rate fell to 9% in January from 9.4% in December, but the number of nonfarm payroll jobs created was a disappointing 36,000 compared to the 121,000 gained the month before. Job gains were seen in retail and manufacturing, but were offset by declines in construction, transportation, and warehousing.
• American spending rose faster than American incomes in December. The Commerce Department said consumer spending rose 0.7%--the sixth consecutive monthly increase--while incomes were up 0.4%. However, disposable personal income was 2.1% higher than the previous December, while spending was up only 1.2% from a year earlier.
• U.S. manufacturing increased in January for the 16th straight month; the Institute for Supply Management's index hit 60.8, its highest level since May 2004. The ISM's services sector gauge also rose strongly, reaching 59.4 (any figure above 50 represents growth).
• Construction spending on both private and public projects fell 2.5% in December, and was 6.4% below last December's figure.
• Oil prices retreated below the $90 per barrel level as supplies appeared to be unaffected by the political crisis in Egypt.

Eye on the Week Ahead

• A week that's light on economic data will likely be dominated by ongoing earnings reports and global events.
• Key dates and data releases: International trade (2/11).

If you need to know a financial or tax number for 2011, we think it highly likely you'll find it in this attachment! If you don't let us know, and we'll find it for you.

A few miscellaneous highlights:

• The standard mileage rate for 2011 is .51 per mile.
• Good news! Tax on long-term capital gains remains at 15% for those in tax rate brackets greater than15%. This is also true for tax on dividends.
• Your standard or Roth IRA contribution limit is the lesser of $5,000 or 100% of earned income (those 50 and younger). The "catch-up" contribution for those 50 and older remains the same as 2010 at $1,000.
• Annual gift tax exclusion is $13K; estate tax applicable exclusion amount is $5M.

January 2011 Newsletter

The days are getting longer which is good news for all those who are ready for warmer weather. This “cold(er)” season offers many people some additional time for reflection. None of us can get “there” until we have a good idea of where “there” is, so consider revisiting your short, medium, and long-term goals to make certain you are best utilizing your resources to reach your goals. Remember, your resources include all of your resources: financial capital, social capital, human capital, etc. We are happy to discuss your goal achievement with you when you are ready to take the next step. And we have a new service available that may make that next step easier than before.

Introducing the Capital Advisory Service (CAS) from Pauley Financial
This is an annual service designed to address the major areas of financial planning (goals, debt management, cash flow, employee benefits, tax planning, insurance needs, and estate planning) as well as portfolio design/management during semiannual meetings with an advisor. All areas may not be addressed at each meeting, but the focus will be on the issues of most concern to the client. To make the meetings efficient, the client will be requested to provide certain information in advance. In a nutshell, we educate you, provide advice and recommendations, and give you guidance as to how you can best implement solutions which meet your needs. The fee schedule for this service is as follows:

Capital Advisory Service

• For portfolios valued less than $500K, this is a flat-fee service of $3,000 per year. The fee is payable in full at the first semi-annual meeting each year.
• For portfolios valued greater than $500K, this service is priced annually at a rate of 0.6% of the portfolio value at the first semi-annual meeting each year. The fee is payable in full at this meeting.

Quotable Quote:
“Leadership is a Choice,Not a Position” - Stephen Covey
We can all make a difference! I am reminded of this quote as we prepare to teach classes through a local elementary school PTA program. We hope to plant seeds in these young minds about responsible borrowing and the “miracle of compound interest” as Albert Einstein was fond of referring to as the “most powerful force in the universe”.

Feature Article: Perma-Bears?
There is a video making the rounds these days which warns of all kinds of terrible economic catastrophes in a very reasonable-sounding voice, offered as a "public service" by an investment research firm that you had previously never heard of. The video narrator predicts that the very foundation of America will shake, bringing our way of life to a grinding halt. This tour of the future includes riots in the streets, arrests on an unprecedented scale, martial law, soaring prices of basic commodities, banks closing, credit cards not working, and a collapse of our monetary system.

The author purports to be the only analyst in the world who is paying close attention to the national debt, and uses the most basic scare tactics to induce people to... purchase his newsletter service. But… Porter Stansberry has been in trouble with the U.S. Securities and Exchange Commission as far back as 1993.

This is another example of a scam that is perpetrated by countless tips and toutsters -- and even some of the economists that you see on reputable financial channels. It's a variation on an old game played by tipsters at the race track. They would scurry around to different prosperous-looking individuals in the stands, and whisper in their ears a hot tip that a certain horse would win, say, the third race. If that horse lost, that was the last these people would see of the tipster. But if it did happen to win, the tipster would be back, now with a "track record" (this is the origin of the term), to ask for money in exchange for more "sure winners."

In the economic world, this game is played by people who make a living out of predicting bear markets and economic disasters. In the financial services world, we refer to them as "permabears" - that is, people who are always bearish, always warning about a market collapse, no matter how bright the economic sun might be shining. Perhaps the most famous of these is Howard Ruff, whose "Ruff Times" newsletter advised its subscribers during the 1980s and early 1990s to avoid stocks, buy Swiss francs and Kruegerrands, guns, ammunition, dried food, bottled water, and a place in the woods where all of this could be defended from the starving millions who, unprepared, would be fleeing the immanent economic collapse. Ruff's followers missed perhaps the best decade of stock returns that the world will ever see again.

How, exactly, does this game work? It's best described by a saying that goes around the investment community: "A stopped clock is always right twice a day." The tipster or economist makes dire predictions all the time, year-in, year-out, and, of course, most of the time the predictions turn out to have been way off-base. The key is to be persistent in your gloom, until you finally arrive at something like the 2008 market meltdown, when the permabears all hit the jackpot. Almost anything they said that sounded remotely dire came true, and suddenly they were geniuses, although no more than you would have been if, every morning, you yawned, stretched, looked at the sun rising in the sky, and muttered dire public prophecies of catastrophe.

Now that these permabears have a "track record" of predicting the 2008 meltdown, you can expect to hear a lot more from more of them, telling you that since they predicted that the markets would go haywire and banks would collapse, you should buy their exclusive advice and avoid the next series of terrible events that they see right around the corner. Of course, every meltdown in history has been followed by an even-more-robust recovery, so the "services" of these permabears will likely cost you not only the price of their newsletter subscription, but also the missed years of positive return and economic recovery.

As you know, our investment philosophy does not portend to be able to predict the markets. We can no more consistently predict gloom and doom than we can above average returns. We maintain our strategic asset allocation with disciplined rebalancing and a recognition that time in the market is far more important than the timing of the market. For these reasons, we believe that the value proposition of most advisors is unsustainable – promising above-average returns on investments is simply a promise that cannot be kept. There are no permabears or permabulls in our pen.

 
The Markets:
Tech fail: Last week was a split decision. After coming out of the long weekend at its highest level since August 2008, the Nasdaq plummeted more than 2%, with many tech companies being hit particularly hard. The small-cap Russell 2000, which has led for much of the multi-year rally, also got whacked, giving up all of its year-to-date gains and more. However, the Dow hit a new post-2008 high, assuming the role of year-to-date leader for domestic equities, and the S&P 500 had its eighth straight week of gains despite a midweek stumble.

Last Week's Headlines
• Building permits for December were up 16.7% for the month, though still 2.8% below the previous December. However, the Department of Housing and Urban Development said housing starts fell 4.3% from November.
• Home resales rose 12.3% in December, according to the National Association of Realtors®, though the level was still roughly 25% lower than the 2005 peak.
• According to the National Bureau of Statistics of China, the Chinese economy grew 10.3% in 2010, 1.1% higher than the previous year.
• The Conference Board's Leading Economic Indicators index rose 1% in December. It was the fourth consecutive monthly increase, and was led by improvements in housing permits, interest rate spreads, unemployment statistics, and consumer expectations.

Eye on the Week Ahead
• The Federal Reserve's Open Markets Committee (FOMC) announcement will be watched for any clues about any post-quantitative-easing plans. Friday's Gross Domestic Product (GDP) release will profile the nation's economic health. Investors also will be watching the tech sector to see if it can regain its footing, while several consumer-related companies dominate earnings announcements.
• Key dates and data releases: Home prices (1/25); new home sales, Federal Reserve announcement (1/26); durable goods orders, pending home sales (1/27); gross domestic product (GDP), labor costs (1/28).

We finally have answers…a summary of the low-down on tax cuts. It’s signed and now officially law: the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 - an $858 billion package of renewed tax cuts, unemployment benefits, and fixes to the uncertainty surrounding the estate tax and AMT. Economists expect the bill to raise U.S. economic growth by one percentage point in 2011, perhaps definitively avoiding a double-dip recession. But the bill will also raise America's $14 trillion government debt.

The bill makes tax planning a bit easier for all of us by freezing current income tax rates for the next two years. Under the EGTRRA 2001 act, taxes on dividends and capital gains were set to jump from a current 15% all the way up to 40%, and the highest ordinary income tax rates were set to rise from 35% to 39.6%--causing a lot of us to look hard at shifting capital gains and income into the 2010 tax return. Interestingly enough, after the legislation that keeps our tax status quo, U.S. tax rates are now the third-lowest of all 34 members of the Organization of Economic Cooperation and Development (OECD). (Only Mexico and Chile have lower rates; France, as you might expect, has the highest rates.)

The bill will also put money in the hands of taxpayers starting in January, when the FICA payroll tax which funds the Social Security retirement system is reduced from 6.2% to 4.2%. Of course, FICA only applies to the first $107,000 of income--and the bill provides no reduction in the matching FICA tax for employers; nor does it reduce the 2.9% (1.45% each for employer and employee) Medicare tax collected on all income. Congress also extended the $2,500 college tax credit and $1,000 child tax credit, both of which phase out at higher incomes, and the bill repeated the annual ritual of rescuing middle-class taxpayers from having to pay taxes under the alternative minimum tax.

The unemployed will receive 13 additional months of unemployment insurance benefits, and there was a grab-bag of provisions for businesses, including the ability to write off, for tax purposes, 100% of capital investments in 2011 and 2012. The research and development tax credit was extended, and so too was a tax credit for biodiesel fuel manufacturers, a higher excise tax rebate for rum distilled in Puerto Rico and the U.S. Virgin Islands, and an economic development credit to American Samoa.

One of the most complex and interesting provisions involves the estate tax. Under EGTRRA, the estate tax - which had been phased out all the way to zero in 2010 - was set to return with a vengeance in 2011: anything over $1 million left to heirs would be subject to an estate tax of up to 50% at the top marginal rate.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 sets a new exclusion amount of $5 million per spouse - $10 million for couples - and anything received by heirs above that will be taxed at 35%. The gift tax exemption has been raised from $1 million per spouse to $5 million; persons who had already given at the old limit will be able to pass on an additional $4 million, either directly or in trust.

The catch is that everything in this tax bill - all of these amounts and rates - will expire in two years, so that in 2013, unless Congress acts again, the ordinary income, dividend, capital gains, estate tax and FICA taxes will all go up to the rates they were in 2002. Between now and then, you can expect a lot of talk in Congress and from the White House about "reforming" or "simplifying" our byzantine tax system.

Eight Financial Aid Myths

Do you have a child going off to college next fall? The federal government's financial aid application (the FAFSA, which stands for Free Application for Federal Student Aid) is due as soon as possible after January 1, 2011. Here are some common myths about financial aid eligibility.

Myth #1: My child won't qualify for aid because our family makes too much money

Fact: While it's true that family income is the main factor that determines aid eligibility, it's not the only factor. The size of your family, the age of the older parent, and the number of kids you'll have in college at the same time all play into the equation. Even if you think your child won't qualify, you won't know for sure unless you apply, and it costs nothing to file the FAFSA. Besides, states and colleges typically require the FAFSA--in addition to any state and college specific forms--before they'll hand out their own aid.

Myth #2: The form is too hard to fill out

Fact: Years ago, the FAFSA was cumbersome to fill out. But ever since it went online at www.fafsa.ed.gov, it's easier than ever to submit. The online version has detailed instructions and takes you through step by step, asking only the questions that apply to you. If you need help, there are customer service representatives standing by with whom you can chat online. There is also a toll-free number you can call with questions: 1-800-4-FED-AID. All advice is free. Once you submit the form, it only takes about one week to process (compared to four to six weeks for a paper FAFSA).

Myth #3: If my child applies to a more expensive school, we'll get more aid

Fact: Not necessarily. The federal government determines your expected family contribution, or EFC, based on the income and asset information you provide on the FAFSA. Your EFC stays the same, no matter what school your child applies to. The difference between the cost of a particular college and your EFC is your child's financial need. The more expensive the college, the greater your child's financial need. But a greater financial need doesn't automatically translate into a bigger financial aid package. Colleges aren't obligated to meet 100% of your child's financial need (if they don't, you've been "gapped" in college parlance). Keep in mind, too, that there are annual borrowing limits on federal Stafford and Perkins Loans. Once your child has borrowed the maximum amount for the year, his or her only chance for more aid has to come from grants, scholarships, and/or work-study jobs.

Myth #4: My child probably won't qualify for aid because of mediocre grades

Fact: The federal government does not take grades into account when determining aid eligibility. However, colleges will consider a strong academic record when awarding certain merit scholarships.

Myth #5: A minority student has a better chance of getting aid

Fact: The federal government does not consider race when determining aid eligibility. It doesn't collect this type of information.

Myth #6: I lost my job shortly after I filed the FAFSA, but there's nothing I can do about it now

Fact: If your financial circumstances change after you file the FAFSA, you can ask the financial aid officer at your child's school to revisit your aid package; the officer has the authority to make adjustments if there have been material changes to your family's income or assets. If you have a material change that you can support with documentation, politely request a "professional judgment review" in a letter addressed to the financial aid officer. There are no guarantees, but you won't know if you don't ask.

Myth #7: We own our home, so my child won't qualify for aid

Fact: The federal formula for determining aid does not take home equity into account (it also excludes retirement accounts, cash value life insurance, and annuities from consideration). However, colleges typically consider home equity when distributing their own institutional aid.

Myth #8: Our smart/athletic/talented child will likely get a scholarship to cover most, if not all, college costs

Fact: A vast majority of financial aid officers believe that parents overestimate the amount of scholarship and grant money their children will receive. While it's true that some students end up getting a free ride (or close to it), they're in the minority. Scholarships can fill the gap, but they probably shouldn't be relied on as the main funding source.

December Newsletter

At this time of year, we are often reminded of “peace” - peace among nations, peace within, bi-partisan peace perhaps. Regardless of how or if you celebrate at this time of year, we will all be ready for some “peace and quiet” when the new year rolls in!

Quotable Quote:
“I am what survives of me.” – Erik Erikson

With awareness of tools to pass on your values and principles, as well as last instructions, you can provide your loved ones gifts beyond your physical assets. See http://pauleyfinancial.publishpath.com/pfsi-seminar-series for an outline of “Tying Up Life’s Loose Ends”, a powerful, concise presentation on writing ethical wills and letters of instruction.

Focus Items:
1. Thank you to all those whom have provided information for the end-of-year tax analysis.
2. Tax ‘deals’ are being made in Congress – we are carefully watching and looking for opportunities the new legislation provides.
3. As always, we encourage you to periodically review your short, medium and long-term goals with us.

Feature Article: Compromise on Taxes?
You've no doubt heard stories that the Obama Administration and Republican leaders have negotiated an end-of-year tax deal which will, among other things, extend the current income tax rates for the next two years for all Americans. Capital gains and dividends would also be taxed at the current preferred (lower) tax rates.

According to published reports, the compromise measure would also reinstitute the estate tax, with a $5 million exemption ($10 million for a married couple), and a top estate tax rate of 35% for amounts above the exemption threshold.

If this estate tax measure is passed, it would fix a major source of estate planning confusion for planning professionals and our clients. As you know, there is no estate tax for persons who die in 2010; instead, heirs inherit the tax basis of the assets that they receive, which can create some extremely messy tax calculations going forward. In 2011, if no new law were passed, the estate tax exemption would have reverted to $1 million and the top estate tax rate would have moved up to 55%. The top estate tax rate would be 35%.

In addition, unemployment benefits would be extended.

From a budget standpoint, the deal will add an estimated $314.9 billion to the U.S. government's deficit over the next two years.

We should know a great deal more in the next few weeks, as Congress hammers out the final details. Obviously, this last-minute tax measure makes precise tax planning a bit difficult. But we'll stay on top of developments, and keep you posted when we know more.

 
The Markets:

Domestic equities managed to shrug off Friday's disappointing unemployment figure, buoyed by back-to-back triple-digit midweek gains. However, bond prices took a hit as the 10-year Treasury yield returned to last summer's levels. Investment Company Institute data showed that investors pulled money out of municipal bond funds for the third week in a row, as they have been doing with domestic equity mutual funds since May.

Last Week's Headlines
• After idling at 9.6% for the previous three months, unemployment rose to 9.8% in November, while nonfarm payrolls remained static. Despite the onset of holiday shopping, retail businesses had job losses, though there were gains in temporary help and healthcare. People unemployed for more than 27 weeks represented almost 42% of the 15 million people without jobs.
• The manufacturing sector in the U.S. expanded in November for the 15th straight month. The 56.6 reading on the Institute for Supply Management's manufacturing index was the second fastest rate of growth in the last six months. The ISM's November reading on the services sector also increased slightly, with retail trade leading the way.
• European leaders said they would continue to buy bonds to help support troubled sovereign debt there, and the head of the European Central Bank assured investors that his organization will take whatever steps are necessary to protect the euro.
• Preliminary indications from post-Thanksgiving shopping were strong, according to the National Retail Federation, which reported Black Friday sales that were higher than the previous year and an increased volume of shoppers.
• The bipartisan National Commission on Fiscal Responsibility and Reform failed to muster enough votes to send its proposals for cutting the national deficit to Congress.

Eye on the Week Ahead
With few economic data releases scheduled for the week, eyes will be on Washington for any sign of a decision on tax cut extensions, and on Irish leaders who will vote on a new budget needed to implement the country's recent bailout.
Key dates and data releases: International trade (12/10).

Warm wishes for a “peaceful” December.

Let us know how we can help…

November 2010 Newsletter

At this time of year, perhaps more than any other, we are mindful of how many things we have to be thankful for. We wish you a Thanksgiving filled with gratitude and peace.

Among the many things that we have to be grateful for, our relationships with our family, friends, clients and colleagues are at the very top of the list. And this month, we are especially grateful to our graphic designer as we introduce our new logo (below). We hope it portrays pictorially what we are all about. As always, we welcome your feedback.

Chances are, you know someone that is planning on attending college. Our Feature Article this month provides updates on the new costs of that privilege. Bad news rarely gets better with age! In this case, the continued sky-rocketing cost of higher education certainly does not benefit from the “ostrich” approach. Educating families on the reality of these rising costs will help parents provide for their children without sacrificing their own long-term goals and financial independence. If you know someone who is trying to find that balance (or needs to be) in their own lives, we’d welcome the opportunity to help.

Quotable Quote…

People who don’t consciously renounce unneeded, unloved purchases end up with STUFF – piles of mediocre, creeping stuff that actually decreases their quality of life. – Martha Beck

Focus Items…

• 2010 Year-End Planning Checklist - While some items carry over into next year, there are others which must be accomplished before the clock strikes midnight on 12/31/10 - - access the checklist here.
• Tax planning season is upon us as well. Clients, please review your individual Tax Planning Package emailed to you on 11/5/2010 so that we may discuss planning opportunities that you may take advantage of now. For our non-clients who subscribe to this newsletter, a completed sample of the Tax Planning Package can be found here. This is just one more way we’re adding value to our client experience.

Feature Article: College Board Releases New College Cost Figures

On October 28, 2010, the College Board released college cost figures for the 2010/2011 academic year in its annual Trends in College Pricing report.

To view the Trends in College Pricing 2010 report, click here.
To view the companion Trends in Student Aid 2010 report, click here.

Here are the highlights:

Four-year public colleges (in-state students):
• Tuition and fees increased an average of 7.9% to $7,605
• Room and board increased an average of 4.6% to $8,535
• Total average cost* for 2010/2011: $20,339

Four-year public colleges (out-of-state students):
• Tuition and fees increased an average of 6.0% to $19,595
• Room and board increased an average of 4.6% to $8,535
• Total average cost* for 2010/2011: $32,329

Four-year private colleges:
• Tuition and fees increased an average of 4.5% to $27,293
• Room and board increased an average of 3.9% to $9,700
• Total average cost* for 2009/2010: $40,476

*"Total average cost" includes tuition and fees, room and board, books and supplies, transportation, and other miscellaneous costs.

The Markets…

Whether prompted by the Fed's launch of QE2, the midterm election results (and the end of all those political ads), or some combination, the animal spirits on Wall Street soared last week. The S&P 500 surpassed its April 23 high of 1217, and the Dow hit a level not seen since September 2008 before the fall of Lehman Bros. As the Fed's decision raised concerns about the potential for future inflation, the dollar suffered, while gold rose sharply to just under $1,400 an ounce.

Last Week's Headlines

Disappointed with the pace of economic recovery, the Federal Reserve will try to help it along by cranking up the printing presses and buying $600 billion of long-term government bonds between now and next June. The Fed hopes the second round of quantitative easing--so-called QE2--coupled with reinvestment of the proceeds from existing holdings that are maturing will hold down long-term interest rates.

The private sector added a net 151,000 jobs in October; even with the loss of 8,000 government jobs, the figure represents the first monthly gain since May. Retail, temp jobs, and health care led the way. However, the unemployment rate remained at 9.6%.

U.S. manufacturers saw their 15th straight month of growth in October. The Institute for Supply Management's index rose to 56.9% from September's 54.4% (any number over 50 indicates growth). The ISM's services sector index also rose to 54.3% from 53.2%.

After increasing all summer, American incomes fell by 0.1% in September (after inflation and taxes, they were down 0.3%). According to the Bureau of Economic Analysis, the decline was partly the result of higher unemployment benefits during the previous month. People also were saving slightly less (5.3% of income rather than August's 5.6%). And while personal spending showed signs of slowing, it was still up 0.2% from August.

General Motors announced details of its pending initial public offering (IPO), which is tentatively scheduled for later this month and would be one of the largest IPOs in U.S. history. The IPO would enable the Treasury Department to begin selling its roughly 60% stake in the company.

Eye on the Week Ahead

In a week that's light on data and shortened by Veterans' Day on Thursday, investors will likely watch for any smoke signals out of Washington that suggest what might happen on tax cut extensions when the lame-duck session of Congress reconvenes the following week.
Key dates and data releases: Balance of trade (11/10); consumer sentiment (11/12).

What’s New at PFSI…

• Our logo! As we look to provide deeper and better service to each of our clients, we took the opportunity to further define our vision for the firm. The updated logo, we believe, reflects our values and commitment to YOU.
• New to our Video Library – Small Business Jobs Act of 2010
• Facebook – we continue to use our Facebook page to provide timely bits of news, reminders, and links to articles we’ve culled through which we hope you find value. We currently have 53 people who “like” us. We’re shooting for 100 by New Year’s Day – would you help us out and “like” us and/or recommend others?
• We continue to receive wonderful feedback on our MONEY MATTERS4U! classes. It is a rewarding experience for us and we believe it benefits our community as well. If you have an organization or group that is looking for a speaker, take a look at our topic offerings. We can also custom tailor a class to meet your group’s needs.

Some common strategies for minimizing taxes are discussed briefly below, but remember, none of these strategies are without drawbacks. Before you act, consult a tax professional as well as your estate planning attorney.

Gifting or bequeathing your interest outright

If you don't need continued income from the business and you don't want to retain some control, you can simply give the business to your children outright. To minimize the gift tax consequences, you can first use your $1 million lifetime exemption. Then, you can begin a systematic program of making annual gifts to your children in amounts that equal the annual gift tax exclusion (currently $13,000 per year per recipient). By transferring your interest in this manner, you may be able to transfer all or a significant portion of the business free from federal gift tax (although these transfers may still be subject to state gift tax). The disadvantage here is the amount of time that may be needed to transfer your entire interest.
If you can wait and transfer your business at your death, Section 6166 of the Internal Revenue Code allows any estate taxes incurred because of the inclusion of your family business in your estate to be deferred for 5 years (with interest-only payments for the first 4 years and interest plus principal due in the fifth year), and then paid in annual installments over a period of up to 10 years. This will allow your beneficiaries more time to raise sufficient funds to pay the taxes or obtain more favorable interest rates if they need to borrow the money. Be aware that the business must exceed 35% of your gross estate and other requirements must be met.

 
Selling your interest outright

If you need income from your business, you can sell your business interest (for full fair market value) to your children. This will avoid gift and estate taxes, but you may owe capital gains taxes. Long-term capital gains tax rates, however, are currently lower than gift and estate tax rates.

Using a buy-sell agreement

If you want to sell your business interest to your children but retain control over the business for a while, consider using a buy-sell agreement. This is a legal contract that prearranges the sale to happen when a specific event occurs, such as your retirement, disability, divorce, or death. When the triggering event occurs, the children will be obligated to buy your interest from you or your estate. The price and sale terms will have been predetermined. Remember, however, that you will be bound under a buy-sell agreement: you won't be able to sell or give your business to anyone except the buyers named in the agreement (unless they consent).

Using a grantor retained annuity trust (GRAT)

A GRAT is a trust into which you would transfer your business interest. The value of the gift is determined using the IRS's current interest rate (published monthly by the IRS). The trust must terminate at a specified time (e.g., 10 years). You receive annuity payments during the term of the trust, and at the end, your children will receive the business. Hopefully, the business will have appreciated beyond the IRS's interest rate, allowing the excess to pass tax free. Be aware however, that if you die during the GRAT term, your entire business interest will be included in your gross estate for federal estate tax purposes. You will have failed to transfer your business interest and lost the tax advantages of the GRAT, and you will have incurred the costs of creating and maintaining the GRAT for nothing, so structure your GRAT carefully.

With a GRAT, you receive a fixed dollar amount that does not change even if the value of the trust property (corpus) increases or decreases. You may, alternatively, retain the right to receive a fixed percentage of the trust corpus, determined annually. That type of trust is called a grantor retained unitrust (GRUT).

A rolling or cascading GRAT is a technique that involves creating a series of short-term GRATs (typically two or three years) with each successive GRAT being funded by the annuity payments from the previous ones. This technique can minimize the risk of the grantor dying during the GRAT term, and can also minimize interest rate risk.

Creating a family limited partnership (FLP)

An FLP is a type of business entity. First, you establish a partnership with both general and limited partnership interests. Then, you transfer the business to this partnership. You retain the general partnership interest for yourself, allowing you to maintain control over the day-to-day operation of the business. Over time, you gift the limited partnership interests to your children, leveraging your lifetime gift tax exemption and the annual gift tax exclusion. You also save taxes because the value of the gifts may be eligible for valuation discounts, such as the minority interest and lack of marketability discounts.

October 2010 Newsletter

We are having a spectacular fall in Texas! Hope it’s the same for you wherever you are.

The last tax return deadline for 2010 is now upon us – October 15th. We know you will be glad to get beyond it, but it is already time to start looking forward to closing out 2010 and making sure we’ve addressed all possible needs before the clock strikes midnight on 12/31.
Let us know how we can help you…

Quotable Quote…

You will get all you want in life if you help enough other people get what they want.
- Zig Ziglar

 
Planning Items…

• 2009 Income Tax Return (last chance!) – October 15th is the deadline.
• 2009 SEP-IRA Contribution (last chance!) – If you are on extension, you can still make a SEP-IRA contribution for self-employment income at the time of your ultimate tax filing – not later than October 15th.
• 2010 Year-End Planning Checklist - While some items carry over into next year, there are others which must be accomplished before the clock strikes midnight on 12/31/10 - - access the checklist here.

Feature Article… One Economist’s View on The State of the Economy

The question on the mind of many investors has to be: where is the U.S. and world economy headed? Are we moving toward a double-dip recession, or is the economy in the early stages of a long-term recovery?

At a recent industry conference in San Diego, Todd Buchholz, former White House director of economic policy and, before that, economics professor at Harvard University presented an extremely candid report describing the 2008-2009 economic meltdown as "the most tumultuous economic times any of us have ever been through."

Buchholz said that if you aren't sure what's going on, you aren't alone. Economists are discovering that their economic models have grown increasingly out of touch with the realities of the marketplace. One big reason is that the world has changed dramatically. "When the Berlin Wall was pulled to the ground, millions of workers who had been trapped on the other side were suddenly free to compete against you, me, somebody writing software in San Diego or assembling textiles in North Carolina," Buchholz told the audience. "When you add in India and China, you have billions of new workers in the global workforce, which pushes down labor rates and inflationary forces here at home."

Today, the American worker is caught between two negative forces. It's hard to negotiate for higher wages when more than a billion workers are competing for his/her job. At the same time, newly-industrializing nations like India and China are clamoring for commodities, which raises the world price of everyday items like gasoline, cotton, cement, metals, food and whatever is made from those things.

So where do we stand today? Buchholz applauded the fact that the Federal Reserve Board has taken interest rates to zero and (as he put it) "stomped on the money supply accelerator." He doesn't expect this to lead to high inflation down the road because wages will be kept low by global competition for jobs, and because the new money is actually offsetting the 2008-2009 destruction of value in the real estate markets and the private sector. Unlike some economists, Buchholz believes the fact that housing inventories and home starts are going down is a good thing, because it means that home prices will be primed to rise again.

Jobs? Buchholz conceded that the job market is brutal right now, but he thinks this is normal at this stage of a downturn. "Whenever you have a recession, companies fire people and cut costs," he said. "When business picks up again, as it has in the U.S., they don't immediately call them back. Instead, they say, hey, Bill, can you stay an extra hour? Or: hey, Joe, come in a bit early tomorrow morning?" Recent rises in temporary worker hiring and overtime may be a precursor to hiring back full-time employees.

The bottom line? Buchholz doesn't expect to see a double-dip recession. "Consumers are showing more resilience and more composure than most professional economists anticipated," he said. "This is not a rip-roaring recovery, by any means. But earnings are better than expected, corporate cash on hand is greater than expected. Instead of a recovery that would grow the economy at 4-5% a year, we could see 2-3% growth for a while."

Is there a danger to this cautiously positive vision? Buchholz said that what worries him most is a backlash against capitalism in the U.S. Congress, which might impose trade barriers to protect U.S. industries. "There were three terrible policy mistakes that the government made which caused the Great Depression," he told the group. Two of them are unlikely to be repeated: the Federal Reserve allowed the money supply to collapse by 30%--the opposite of what the Fed is doing today--and Congress raised taxes dramatically across the board. But the third mistake was passing significant tariffs, triggering retaliation from other companies--and suddenly world trade fell by 40%. "I am very concerned today about trade tensions brewing around the world," said Buchholz, "even among friendly countries with the U.S."

At the end, Buchholz said that the most pressing issue, in his mind, is getting our educational system back into the global top tier. He said that increasingly, wealth is measured by the application of education and intelligence, and the world is catching up to the U.S. "Whoever harnesses intelligence most," he told the group, "will prosper most in the 21st century."

The Markets…

By last week's end, the Dow was above 11,000 for the first time since before the May 6 flash crash, and even the Global Dow reached positive territory for 2010. Meanwhile, 10-year Treasury yields hit a new low for the year.

Last Week's Headlines

- Though private-sector payrolls continued to improve, adding 64,000 new jobs in September, the Bureau of Labor Statistics said the loss of 159,000 local and federal government jobs kept the unemployment rate at 9.6%. Including people working part-time involuntarily and discouraged workers who have stopped looking, the unemployment rate was 17.1%, the highest in a year.

- Eleven of the fourteen industries in the Institute for Supply Management's index of the U.S. services sector rose in September. The index's 53.2% reading, up from August's 51.5%, represents the ninth straight month of growth. In manufacturing, the Commerce Department said new orders for non-transportation manufactured goods increased 0.9% in August. However, a drop in aircraft orders resulted in a 0.5% decline in overall durable goods orders--the third decline in the last four months.

- Slow and low: To try to stimulate its economy, the Japanese central bank cut its 0.1% interest rate--yes, that's one-tenth of a percent--to "virtually zero." It also said it would set up a fund to buy bonds issued by the Japanese government and other entities, and to make loans collateralized by similar assets.

- The International Monetary Fund (IMF) forecasts slow growth in 2011: a 2.3% rate for the U.S.--lower than this year's 2.6% estimate--and 4.2% globally. Even China's 8.4% forecast is lower than the 2010 estimate. The IMF also warned about potential damage to the global economy from countries competing to increase exports by devaluing their currencies.

- After joining several major lenders in freezing foreclosures that are being challenged in 23 states because of faulty mortgage processing, Bank of America became the first to halt all foreclosures nationwide while the situation is being investigated.

Eye on the Week Ahead

Several large tech firms are on deck to announce third-quarter earnings, and retail sales data will shed light on consumer spending. The potential for a second round of bond-buying by the Fed to support the economy--so-called "quantitative easing" or QE2--could be a significant influence this week, with Tuesday's release of the latest Fed meeting minutes and inflation numbers later in the week. Finally, any additional foreclosure turmoil could have an impact.

Key dates and data releases: Wholesale inflation, international trade (10/14); consumer inflation, retail sales, options expiration (10/15).

What’s New at PFSI…

Doug is scheduling year-end planning meetings with clients and their tax preparers.

Kimberly has just finished a major project to help automate the reports we provide clients (and their tax preparers) – one version for the fall planning meeting and another for February. Her next project is assimilating a new aggregation tool to help us with your non-TD Ameritrade Institutional account reporting.

Kerri just finished helping clients with Required Minimum Distributions (RMDs) from their IRAs. Her next major project is to pull and assimilate the myriad pieces of the tax report Kimberly designed in order to get that information out to our clients by 11/8. We’re looking forward to getting this important information out to our clients.

Our custodian, TD Ameritrade Institutional, just announced a great new value for our clients. They now have 100 ETFs we can trade without a transaction fee (typically $9.99 or $16.99 depending upon the amount held there). As a result, Doug updated our recommended investment list, noting which funds it would now be most beneficial to our clients to use. While there aren’t appropriate investments in each of the asset classes we use for client portfolios, there are a good number of these no-transaction fee ETFs we will be able to use. We feel fortunate to have such a terrific custodian which is on the leading edge of helping us serve our clients better.

New to our Video Library – Considerations in Claiming Social Security Retirement Benefits

MONEY MATTERS 4U! If you belong to a group or organization which needs speakers, we’d love to help out! We can structure any of the MONEY MATTERS 4U! classes to be suitable for your audience. Check out the different offerings at the MONEY MATTERS page on our website.

Thank you...

We hope you find our newsletters helpful. If you have suggestions for improvement (or items you’d like us to address, please let us know).

We are extremely grateful to you who for providing introductions to family, friends, and colleagues who have important life choices they’re struggling with. Our practice is built on the generosity of your introductions – we can only help if others if they know about us or we know about them. And, helping is our passion!

Please be assured all of your confidential information will remain private when you provide an introduction. We view these introductions as an honor and will treat them with absolute respect and courtesy. Depending upon how you and the other person may want to handle it, we can call/email them or vice versa and then proceed as shown below…

We recognize we are not the right planners for everyone, but we are happy to help point anyone in the right direction if our services do not match up well with their needs. Having made the step to contact us, we do not want to be the obstacle to them moving forward.

As “life happens” to you, your family, your friends and colleagues, we would be honored if you’d keep us in mind. We’re happy to help serve as guides along the journey.

Let us know how we can help you…

R. Douglas Pauley, MBA, CFP®, AIF®

In General

• Re-examine the adequacy and liquidity of your emergency fund. Remember, the emergency fund is the “buffer” which prevents you from carrying credit card debt. When expenses exceed income, you dip into the emergency fund to avoid carrying a balance on your credit cards. Then, focus your savings effort to replenish the emergency fund so it is there the next time you need it. If you have to dip into the emergency fund too often and aren’t replenishing it, it is a sure sign that your cash flow plan needs review.
• Plan holiday spending to keep in line with budgeted amount - travel, entertainment, gifts, etc. Consider “acts of kindness” and “gifts of time” instead of spending money on more “things.” Unplanned spending leads to carrying balances on your credit cards – very expensive because of the high interest rates!
• Update your home inventory (actually, best done after the holiday giving season). Be sure to include: item, cost/value, date and place purchased. File receipts with home inventory. It's also a good idea to photograph or video items so your insurance company has the best information available should you need to file a claim. Store photos, video tape and inventory away from home.
• If making year-end gifts, the annual exclusion amount that can be given by each individual to any number of individuals for 2010 is $13,000/person. If a gift exceeds the annual exclusion amount, then you must file a gift tax return (IRS Form 709) even though you will not owe gift tax on the first $1,000,000 gifted.
• The estate tax exclusion amount for 2010 is currently unlimited unless Congress acts before year-end. In 2011, the estate tax re-appears with an exclusion amount of only $1,000,000 unless Congress agrees to a new plan. A properly structured estate plan will enable a married couple to protect twice the amount of the exclusion amount.

Year	2009	2010	2011
Estate tax exclusion	$3.5 Million	N/A	$1 Million
Top estate tax rate	45%	No tax	55%

• Review your credit report for inaccuracies and accounts that should be closed but which remain open. All US citizens are eligible for a free credit report from each of the three reporting agencies annually – www.annualcreditreport.com.

Investments

• Non-retirement accounts. Be cautious about making additional contributions before mutual funds distribute their capital gains and dividends near year-end. Check with the fund as to when the distribution may be and how much it is anticipated to be. This will keep you from investing money and then having it returned to you in short order, only to be taxed on the latter (yet again!).
• Required minimum distributions (RMDs) are back for 2010. The requirement to take minimum distributions from IRAs and defined contribution plans was temporarily suspended for 2009; minimum distribution requirements are once again in effect for 2010. Failure to make your RMD results in a 50% penalty.
• Convert your Traditional IRA to a Roth IRA? This year there is no income limit; so, everyone with a Traditional IRA is eligible. But, is it a good choice? The cost is that you’ll have to pay the tax now on any pre-tax contributions (and growth) being converted. The benefit of converting is that you change an asset that would be taxed as ordinary income (high rate) when you take the proceeds out into an asset where the proceeds will come out tax-free. There are a number of factors which impact this decision. We’re happy to help you sort through them.
• IRA 2010: Make 2010 contribution of $5000 ($6000 if age 50 or older) before April 15th, 2011.
  Which IRA should I contribute to – Roth or Traditional?
  Preference would be to make a Roth IRA contribution providing you’re eligible - AGI < $105k if single, < $167k if married filing jointly.
  If not eligible, then consider a Traditional IRA contribution.
  Be sure that you are completing your IRS Form 8606 (in conjunction with your tax return) each year that you make a nondeductible contribution so you can track your cost basis in your IRA – Roth or Traditional.
• Verify that your IRA and retirement plan beneficiary designations and account titling support your formal estate plan. Errors here can cause assets to flow in ways you didn’t intend.
• Coverdell Savings Account (formerly known as the Education IRA ) – contribution of $2000 can be made up until 4/15/11, providing your AGI is less than $110k for singles, $220k for MFJs. You can contribute to both a Coverdell Savings Account and a Section 529 plan in the same year, but be cautious of the annual gift limit.
• Have you set up an automatic investment plan? The best way to save is to create an “automatic” plan just as with your 401(k). Have a specified amount pulled each month from your checking account and invested for you. This helps fulfill the “pay yourself first” principle rather than saving “what’s left.” I’ve found very few clients are capable of achieving their stated goals if they aren’t saving at least 20% of their gross income.
• Trusts. If the trust tax year is the calendar year, consider paying trustee fees and any necessary distributions before year-end.

Medical

• If you’ve already met your insurance deductible for the year, schedule needed and/or elective medical work to be done before year-end to help delay the time until you have to pay your deductible next year.
• Use any funds remaining in this year's Flexible Spending Account. You now have the first quarter of next year to use this year’s flex dollars.
  File claims for current year’s Flexible Spending Account.
• Make an estimate for the amount to be withdrawn from your check for your employer's Flexible Spending Account for next year. Because of the extra quarter you now have to spend your flex-dollars (providing your employer’s plan permits), you don’t have to be as conservative in your planning. Using pre-tax dollars to pay for these items is a huge benefit, be sure to take advantage of these opportunities for both medical and dependent care.
• Health Savings Accounts. If you are covered under a high deductible health insurance plan, you can contribute $3050 for self-only coverage and $6,150 for family coverage. The deductible minimum for self-only coverage is $1,200 and $2400 for family coverage. The out-of-pocket limits are $5,950 for self-only and $11,900 for family coverage.

Taxes

• Consider a year-end planning meeting with your tax advisor and your financial advisor to make an estimate of your likely tax situation and be able to take advantage of any planning opportunities before year-end. This is also a good time to determine if an estimated tax payment is needed on January 15th; and, if so, how much.
• Update files to be ready for tax return preparation early next year.
• Dependency exemption. If you pay for more than half of the support for another, you may be able to claim them as a dependent. This includes parents or others. If you claim them, they cannot claim themselves on their return.
• Consider bunching deductions every other year (this works especially well if you don’t have a mortgage payment). Bunching enables you to maximize your deductions in one year and then get the “free” standard deduction the next. Over a two-year time period, this will reduce your taxes. Keep track of whether you are an odd- or even-year “buncher.” Note: The standard deduction for 2010 for singles is $5,700; for those filing as married, it is $11,400; and, it is $8400 for head of household filers.
• Try to maximize the allowable contribution to your employer's retirement plan. This reduces your reportable income, lowers your taxes, and adds to your savings! Minimally, contribute up to the amount that the employer matches – this is free money!
• If taxable income is nearing a higher bracket, consider deferring income, to the extent permissible, until succeeding year, e.g. bonus or self-employed payments. Currently, there are six marginal federal income tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%.

2010 Income Tax Brackets - Married Filing Jointly

Taxable Income	Marginal Tax Rate
Not over $16,750	10%
Over $16,750 to $68,000	15%
Over $68,000 to $137,300	25%
Over $137,300 to $209,250	28%
Over $209,250 to $373,650	33%
Over $373,650	35%

• These brackets--the result of 2001 tax legislation--expire at the end of 2010. As things stand now, in 2011 the 10% bracket disappears, and the remaining brackets return to their pre-2001 levels: 15%, 28%, 31%, 36%, and 39.6%. Though it would take action by Congress, the president has indicated that he would like to permanently extend the 2010 rates for individuals earning less than $200,000 and married couples earning less than $250,000 (these dollar benchmarks would be reduced by an amount that reflected the standard deduction and exemption amounts), but allow the two highest brackets to return to 36% and 39.6% for higher earners.
• Currently, long-term capital gains are generally taxed at a maximum rate of 15%. If you're in the 10% or 15% marginal income tax bracket in 2010, though, a special 0% rate applies (in other words, you owe no tax on any long-term capital gain). The same rates apply to qualified dividends received in 2010. These rates also expire at the end of the year. The maximum rate on long-term capital gain in 2011 will generally increase to 20%, with a 10% rate applying to individuals in the lowest tax bracket (special rules would apply to qualifying property held for five years or more). Qualifying dividends will be taxed as ordinary income. The president has proposed to permanently extend the 0% and 15% rates, with a new 20% rate applying to high-income individuals (those in the 36% and 39.6% tax brackets). Again, though, that all depends on what Congress does in the next few months.
• If enough income tax withholding has not been made to meet your anticipated current year's tax liability (or to garner protection of the “safe harbor” provision), consider increasing the amount withheld from pay late in the year by adjusting W-4 with employer and/or making a larger estimated tax payment on January 15th to avoid unnecessary penalties and interest.
• If a change in filing status (as a result of marriage, divorce, death) is expected in the succeeding year, consider deferring current income and accelerating deductions if the change in status will lower tax rates. If higher rates are expected, reverse the strategy.
• If your child has earned income (as opposed to investment income), consider setting up a Roth IRA and/or SEP-IRA for them. They can fund it with their income or you can fund it for them up to the amount they grossed for the Roth and approximately 20% of their net income for the SEP-IRA.
• In tax year 2011, the “marriage penalty” returns, reducing the standard deduction for married couples to less than two times what a single person gets. Additionally, higher tax rates will apply at lower income levels than less than twice that of those that are filing single.

Schedule A

• As previously discussed, consider bunching deductions in alternating years.
• If you've had an expensive medical year and are nearing the amount necessary to make your medical expenses deductible on Schedule A of your taxes (greater than 7.5% of your Adjusted Gross Income), consider buying medication and scheduling appointments for check-ups and/or elective procedures before the end of the year.
• Consider making year-end charitable contributions of personal property such as clothing and furniture. Be sure to make a good inventory and get a receipt for the donation. The charity won’t assign an amount – you’ll have to do that which is why you need a good inventory.
• Consider making a charitable contribution of appreciated securities. Using appreciated securities enables you to avoid paying capital gains tax on long-term, built-in capital gains and to get the charitable deduction – a double tax benefit! But, be wary of possible adverse alternative minimum tax consequences.
• Consider bunching miscellaneous expenses, including professional dues, tax preparation fees, investment advisory fees, job search costs, safety deposit box fee, and un-reimbursed employee business expenses, into the current year so that the total exceeds 2% of adjusted gross income (AGI). If the 2% threshold will not be exceeded even through bunching, consider postponing as many of these expenses as possible until next year when it might be easier to hit the 2% threshold.

Schedule C

• If there is any income from self-employment, consider setting up a retirement plan (such as a SEP-IRA) to sock away pre-tax dollars and lower your tax bill.

Schedule D

• Consider matching gains and losses in existing investments to reposition your portfolio tax-neutrally if you need to rebalance to meet your target asset allocation.
• Consider tax loss harvesting – you can use existing losses to offset capital gains plus up to $3000 of capital losses to offset ordinary income. If you don’t use all your losses this year, you can carry them forward for use in future years when you are harvesting gains. Believe it or not, a tax loss is a usable asset!
• If you think capital gains rates are likely to increase next year, you may be better off taking gains this year.
  Use installment sales method to defer capital gain recognition on real property, particularly if it is likely that you will be in a lower tax bracket in later years.

Alternative Minimum Tax

• Determine AMT liability and shift itemized deductions that are treated as exclusion items for AMT purposes into years in which no AMT liability will be incurred. These include personal interest, state and local taxes, and most miscellaneous itemized deductions.

September 2010 Newsletter

Fall is officially here… so, it is time to ramp up for year-end!  We sent our 2010 End of Year Checklist out earlier this month, and we hope it is proving to be a useful tool for you. We’re happy to help you work through it. Please feel free to share it with others as it is just another way for us to give back. If you don’t have the email, you can access the checklist here. 

Quotable Quote…

It's good to have money and the things that money can buy, but it's good, too, to check up once in a while and make sure you haven't lost the things that money can't buy.
-George Horace Lorimer

Focus Items…

• 2009 Income Tax Return (last chance!) – October 15th is the deadline. Let us know if we can help.
• 2009 SEP-IRA Contribution (last chance!) – If you are on extension, you can still make a SEP-IRA contribution for self-employment income at the time of your ultimate tax filing – not later than October 15th.
• 2010 Year-End Planning. While some items carry over into next year, there are others which must be accomplished before the clock strikes midnight on 12/31/10.

Feature Article… FDIC Coverage

Last year, 140 banks shut their doors; as of the beginning of September this year, the number of bank closings is already up to 125. That's compared with three bank closings in the more normal economic times of 2007. At last count (June 30 of this year), 829 other banks were on the Federal Deposit Insurance Corp.'s "Problem Bank List," meaning they have weak capital positions that could lead to failure.

Last year, 140 banks shut their doors; as of the beginning of September this year, the number of bank closings is already up to 125. That's compared with three bank closings in the more normal economic times of 2007. At last count (June 30 of this year), 829 other banks were on the Federal Deposit Insurance Corp.'s "Problem Bank List," meaning they have weak capital positions that could lead to failure.

But if you have substantial assets on deposit at a lending institution, you do have some protection against losing money in a failure, and a way to check how much. The FDIC provides government-backed insurance for your deposits, and the new financial reform bill permanently raised this amount to $250,000 per depositor.

As it happens, you probably have more protection than you think. The FDIC has created a web calculator called EDIE (https://www.fdic.gov/edie/calculator.html), which lets you input the name of your lending institution, the value of your deposit, personal, business or trust accounts, and it will tell you how much of your money at that institution is insured. A quick run through the site shows that if a husband and wife have a joint deposit account worth $500,000, then the total amount is insured - $250,000 each. Suppose one of them also has a business checking account as a sole proprietor? That, too, is insured up to $250,000. A trust with beneficiaries is also protected, with the amount of coverage going up the more beneficiaries there are. A tutorial on the site gives the example of a $1.2 million trust co-owned by a husband and wife who have three named beneficiaries (their children). The way the math works, the full amount is insured; each child counts for $200,000 of FDIC insurance with the father and for the same amount with the mother.

Before you go to the web site, however, you might first want to check and make sure that your lending institution is a member of the FDIC. Most member banks have official FDIC signs prominently displayed at the teller windows, but you can also check online at the FDIC web site's "bank find" feature: http://www2.fdic.gov/idasp/main_bankfind.asp.

And finally, understand that stocks, bonds, mutual funds, annuities or other investments don't qualify for FDIC coverage. Only CDs, checking accounts and deposits are FDIC insured.

Looking Ahead…

• September 30th – End of 3rd Quarter
• October 15th – Tax returns and SEP-IRA contributions due for those who filed extensions
• October 31st – Halloween!

The Markets…

For the third consecutive week, domestic equity markets continued their surprising September rally, returning both the Nasdaq and Standard & Poor's 500 to positive territory for the year. The S&P 500 is now down just 7.5% from its 2010 high this spring.

For the third consecutive week, domestic equity markets continued their surprising September rally, returning both the Nasdaq and Standard & Poor's 500 to positive territory for the year. The S&P 500 is now down just 7.5% from its 2010 high this spring. 

Index	2009 Close	As of 9/17	YTD Change
DJIA	10428.05	10607.85	1.72%
NASDAQ	2269.15	2315.61	2.05%
S&P 500	1115.10	1125.59	.94%
Russell 2000	625.39	651.44	4.17%
Global Dow	1984.48	1904.55	-4.03%
Fed. Funds	.25%	.25%	0 bps
10 Yr Treasuries	3.85%	2.75%	-110 bps

Shoppers filled up the gas tank and bought back-to-school clothes in August, helping to push retail sales up by 0.4%. According to the Commerce Department, it was the second consecutive month of retail gains and was helped along by sales tax holidays in several states.
Concerned about the rising value of the yen, the Japanese government threw currency markets a curve by selling yen to try to prevent the currency's strength from hampering the country's exports. It also said it is prepared to intervene again if necessary to support the nation's economy.

Deflation seemed to be a nonissue for wholesalers in August. Led by higher energy costs, prices at the wholesale level were up by 0.4%.That's the second consecutive month of increases, and it put the annual inflation rate for wholesale goods at 3.1%, lower than July's 4.2% annual rate. Industrial production rose in August for the second month in a row, and is up 6.2% from last August.
Consumer inflation rose 0.3% in August, but the increase was largely the result of energy costs. Core inflation, which excludes volatile food and energy costs, showed no change in prices from July after three months of increases.

What’s New at PFSI…

Our clients will see a new Short- and Medium-Term section to their quarterly reports coming out in early October. We think this improved report component will better help us tag a funding mechanism against its corresponding goal and its funding means.
New to our Video Library – Financial Reform: What Is It and Why It Matters to You.

MONEY MATTERS 4U! If you belong to a group or organization which needs speakers, we’d love to help out. We can structure any of the MONEY MATTERS 4U! classes to be suitable for your audience. Check out the different offerings at the MONEY MATTERS page on our website.

As “life happens” to you, your family, your colleagues and friends, we would be honored if you’d keep us in mind. We’re happy to help serve as guides along the journey.

R. Douglas Pauley, MBA, CFP®, AIF®

....by Paul Merriman

Lesson One: Happiness in later life is not a direct function of how much money somebody has.
This is hard for many folks to accept, but it is never a surprise to the smartest people I know. Happiness depends much more on attitudes and behavior than on the numbers in somebody else’s computers. In today’s world, essentially that’s what money is: numbers in distant computers.

Lesson Two: Wealth comes from choices people make, not chances they take.
Smart people do not wait for luck to make them wealthy. Every day, they cultivate habits and follow rules that others don’t. Live below your means if you want to be wealthy. Pay yourself first and build wealth, not a lifestyle that saddles you with expenses. When you save and invest, make your money work hard for you. My new book contains eight chapters that tell exactly how to do that.

Lesson Three: Those who plan also prosper.
Smart people plan for retirement – in writing. I know a written plan has no magic of its own. People who are serious enough to put their plans in writing are likely to identify where they are, where they want to go and what they must do to get there.

Lesson Four: Don’t wait to start saving.
Smart people learn early in life how to defer gratification. If you are in your 20s, retirement seems pretty remote, but time gives you an opportunity to do a lot, for a little. A one-time investment of $5,000 when you are 25 will grow (at 10 percent) to $140,512 by the time you are 60. If you wait until you are 45, you need to invest $33,638 to get the same result.

Lesson Five: Retirement belongs to those who are still with us.
Smart people take care of their health. If you want to retire rich, you need to live long enough to retire and be healthy enough to live it up. Smart people see their doctors periodically and follow the doctor's advice. They do not neglect their mental health, either.

Lesson Six: The quality of your life is shaped by the quality of the people in your life.
The happiest people I know seem to have many favorite people in their lives – including some who are younger than they are. At the end, life can sweep our dignity and money away, but if we have friends with whom we can share joy, pain and respect, we are blessed.

Lesson Seven: We older folks could learn some common sense from high school students.
That may surprise you, but it should not. Every year I speak to high school students. I ask them if they had money to invest, would they invest like millionaires or like poor people. They never get this wrong, but I’m continually amazed why so many of their parents continue to invest like poor people. In a nutshell, here’s the difference:
If you invest like a millionaire, you carefully choose an advisor who has no conflict of interest with you. You invest in hundreds or even thousands of stocks. You take a long-term view, and you keep your costs low and your expectations realistic.
There are many ways to invest like a poor person. One popular route is going to a broker and buying some “hot” individual stocks, hoping to get rich by exploiting insight and knowledge that you believe you or your broker have, and everybody else on Wall Street is too dumb to recognize. Yeah, right!

Lesson Eight: Active trumps lazy, every time.
Smart people of all ages keep themselves active mentally as well as physically. People who regularly challenge their brains live longer than those who get intellectually lazy. Do you want to have a long, happy retirement? Then do stimulating things like reading, crossword puzzles, taking a class or teaching one. If you can, travel to unfamiliar places and try new things.

Lesson Nine: Smart people do not wait around for “real life” to start.
The happiest people I know, whether retired or still working, would have no trouble making a list of 100 things they would love to do if they had the time. Places to go. People to see. Books to read. Golf courses to master. Smart people know that all the tomorrows we assume are ours can be snatched away in an instant. They identify their passions, their dreams and their goals, and then find ways to make those dreams reality, starting now.

Lesson Ten: The very best investment you can ever make does not cost a dime.
This is not news to the smartest people I know. Every person who reads this article has something valuable to give which they have not given, yet. It might be money. It might be time or volunteer work. It might be a helping hand. It might be as simple as the gift of listening.
If you take the time to discover what this gift is for you, and you give it generously, two things will happen: Your life will be richer and more satisfying, and you will make the world a little better place. You might be surprised by how few people purposely and consciously live their lives this way.

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PFSI August Newsletter 

The equity markets have continued their volatile ways while many are out enjoying their summer vacations. Good run-up in July… Some pullback already in August.

We hope you are getting a chance to take a break with family and/or friends to regenerate and prepare for the fall. For those of us with school-age kids, it’s the last hurrah before school starts again.

Quotable Quote…

We frequently tell our children that the most precious things in life are our relationships with others – family, friends, and clients. And, we believe we “walk the walk” on that as well. Money provides for the basics as well as an ability to provide experiences/opportunities. We hope they will keep this in mind as we prepare them for adulthood…

Ordinary riches can be stolen; real riches cannot. In your soul are infinitely precious things that cannot be taken from you.
 - Oscar Wilde

Focus Items…

Beneficiary Designations – When was the last time you checked yours? Are they up to date on all your IRAs, 401(k)s, 403(b)s, retirement plans, and insurance policies? Most importantly, do they support your current estate planning documents? We’d be happy to help you check!

2009 SEP-IRA Contributions – If you are on extension, you can still make a SEP-IRA contribution for self-employment income at the time of your ultimate tax filing – not later than October 15th.

Roth Conversions – If we haven’t discussed this with you yet, please ask. There are a few “no-brainer” situations, but most require some analysis.

Feature Article… Understanding Both of Your Brains

Have you ever felt anxious about your investment portfolio? Who hasn't? A recent presentation at one of our professional conferences pointed out that five out of every six years will produce a stock market return sequence that either triggers anxiety or smacks your portfolio so hard that you wonder why you ever trusted the markets to begin with.

This is normal. Many people simply cannot handle stock market volatility, which is why the people who DO have, historically, tended to make more, over multiple ups and downs, than the people who kept all their money stashed away in Treasury bonds.

The question is: is there better way to handle the inevitable anxiety that comes with buying stocks?

Psychologist Ken Haman says that the key is to stay rational. He points to studies of the human brain which shows that all of us actually have two brains. One is the neocortex, where all of your higher thought processes take place. Below the neocortex is a primitive brain which is about as smart as an alligator, and this lower brain happens to be where all of our survival instincts are housed. Whenever you experience panic, the primitive brain immediately takes over and shuts down the neocortex--which allows you to respond/react instantly (rather than thoughtfully) on those many occasions when large black bear is running in your direction.

So when the markets have spent the past quarter giving up all the gains they generated in the previous quarter, what do you do? As Stephen Covey recommends, hit the “pause” button on your “primitive” brain. Try not to react/respond immediately. Instead, pause to give your neocortex time to take over from your primitive brain which is programmed to react to the perceived “threat.”

What else can you do to help engage your neocortex? You’re welcome to call us – that’s what we’re here for. When we see market volatility that stokes our primitive brain, we usually try to send out an email or call our clients to help them engage at a higher level of thinking. Instead of reacting, we encourage them to pause and to reflect on the strategy and their long-term goals. Doing so enables them to engage their more rational brain and avoid making costly, knee-jerk reactions to short-term market volatility.

People who can handle the stock market roller coaster without getting sick seem to have an unfair advantage over everybody else in the investment world. It seems to depend on which part of your brain you allow to control your actions.

Looking Ahead…

September 6th – Labor Day
September 15th – 3rd Quarter estimated tax payments are due
September 30th – End of 3rd Quarter
October 15th – Tax returns due for those who filed extensions
October 31st – Halloween!

The Markets…

Domestic equities markets spent July recuperating from damage done during the second quarter. After starting the month at their year-to-date lows, the major indexes rebounded strongly despite a few days of triple-digit head fakes both ways in the Dow Industrials. The S&P 500 rose almost 7% to top 1100--just barely--once again. Generally strong corporate earnings for the second quarter also helped push the Nasdaq and the small-cap Russell 2000 up almost 7%. The S&P has now regained 41% of its losses since its most recent high three months ago, and the Nasdaq and Russell aren't far behind. The Dow has done even better, rising just over 7% in July and regaining roughly 51% of its losses since late April. And as European tensions eased, the Global Dow rose almost 8.5%.

Treasury bond yields continued to slide. Investors who had fled to gold in recent months backed off a bit. The dollar, which had been benefitting from anxiety about European sovereign debt, weakened against the euro.

Market/Index 2009 Close Prior Month As of 7/30 Month Change YTD Change

• DJIA 10428.05 9774.02 10465.94 7.08% .36%
• NASDAQ 2269.15 2109.24 2254.70 6.90% -.64%
• S&P 500 1115.10 1030.71 1101.60 6.88% -1.21%
• Russell 2000 625.39 609.49 650.89 6.79% 4.08%
• 10-year Treasuries 3.85% 2.97% 2.94% -3 bps -91 bps

Last Month’s Headlines

• President Obama signed into law what is being called the most sweeping financial reform since the Great Depression. The legislation is designed to help prevent (or at least better manage) a recurrence of problems that contributed to the 2008 financial crisis. Much of the law's impact will be determined by regulations that will be developed over the next year or so. The law's provisions are designed to revise credit and lending practices; increase transparency and accountability for investors; limit risky banking practices; and set up a process for monitoring system-wide risks and managing the dissolution of systemically important financial institutions.

• Sales of existing homes fell by 5.1% in June, according to the National Association of Realtors®, though they were 9.8% higher than a year ago. The Census Bureau said residential housing starts also were down 5% in June, and 5.8% lower than June a year ago. Even the good news about the housing market wasn't great. After plunging in May in the wake of the qualifying deadline for the first-time homebuyer's tax credit, new-home sales surged in June by 23.6%. However, according to the Census Bureau, that only brought sales to a level that's almost 17% below last June.

• Treasury Secretary Timothy Geithner said tax cuts for top earners will be allowed to expire on schedule at the end of 2010 as part of the Obama administration's effort to bring down the budget deficit.

• All but seven of 91 European banks that underwent stress tests to determine their vulnerability passed the tests, indicating that they had access to enough capital to weather harsher economic conditions. The Committee of European Bank Supervisors said five of the seven that failed were in Spain.

• The country's manufacturing and services companies continued to expand, but at a slower pace, according to the Institute for Supply Management. However, they still weren't hiring. Even though the unemployment rate fell to 9.5%, the Bureau of Labor Statistics said the drop resulted not from the addition of new jobs but from people leaving the workforce.

• Also more sluggish was second-quarter Gross Domestic Product (GDP). Though the Bureau of Economic Analysis said the economy grew at an annual rate of 2.4%, that was slower than the first quarter's 3.7%.

• Both consumer and wholesale inflation continued to fall, according to the Bureau of Labor Statistics. The Consumer Price Index is now at an annual rate of 1.1%, largely because of lower energy costs.

Eye on the Month Ahead

During the dog days of summer, often a sluggish time on Wall Street, investors will be assessing any rallies or downturns in terms of their breadth and trading volume, trying to determine what market movements might suggest about the second half of the year. Housing stats will increasingly reveal whether the housing market can revive without life support from the federal homebuyer's tax credit.

Key data releases: U.S. manufacturing (8/2); personal income/spending, pending home sales (8/3); unemployment/payrolls (8/6); Federal Reserve Board announcement, productivity/labor costs (8/10); international trade (8/11); consumer inflation, retail sales (8/13); international capital flows (8/16); housing starts, wholesale inflation, industrial production (8/17); options expiration (8/20); home resales (8/24); durable goods orders, new-home sales (8/25); second estimate Q2 GDP (8/27); personal income/spending (8/30); home prices (8/31).

What’s New at PFSI…

We’re enjoying our family vacation in Estes Park, Colorado – truly a spectacular place! It is a great bonding experience for our family as cell phone coverage is almost non-existent and we get to spend big blocks of uninterrupted time together hiking, cooking, fishing, learning archery, horseback riding, etc. We are staying at the YMCA in Estes Park and we are enjoying so many new wonderful experiences!

A multitude of thanks to Kerri Russ for handling all she has to make our trip so enjoyable by taking care of client management issues while we’ve been gone.

As we told you last month, we’ve added a Video Library to our website. Be sure to check it out. We added a clip on College Planning Basics recently.

MONEY MATTERS 4U! If you belong to a group or organization that needs speakers, we’d love to help out – let us know! We can structure any of the MONEY MATTERS 4U! classes to be suitable for your audience. Check out the different offerings at the MONEY MATTERS page on our website.

As “life happens” to you, your family, your colleagues and friends, we would be honored if you’d keep us in mind. We’re happy to help serves as guides along the journey.

Warm regards,

R. Douglas Pauley, MBA, CFP®, AIF®

As “life happens,” we appreciate the opportunity to work with you to help you adjust to the new choices you may face. Birth, death, divorce, job change, career change, retirement, and the other big life events can be navigated more easily with the help of experienced guides. While we are called “financial planners,” we see ourselves as much more than that. Knowing you, understanding your values and goals, and helping you contend with life as it “happens” is what drives us. So, let us know when “life happens” to you, your family, your friends, or your colleagues and let us help. It makes the journey easier.

Quotable Quote…

One of my favorite lines is that “wisdom only comes with age and experience.” This quote by Tom Wilson helps validate that age alone isn’t enough…

Wisdom doesn't necessarily come with age. Sometimes age just shows up all by itself.

Focus Items…

Beneficiary Designations – When was the last time you checked yours? Are they up to date on all your IRAs, 401(k)s, 403(b)s, retirement plans, and insurance policies? Most importantly, do they support your current estate planning documents?

2009 SEP-IRA Contributions – If you are on extension, you can still make a SEP-IRA contribution for self-employment income at the time of your ultimate tax filing – not later than October 15th.

Roth Conversions – If we haven’t discussed this with you yet, please ask. There are a few “no-brainer” situations, but most require some analysis.

Feature Article… 15 Ways to Tell if You are Ready to Retire

by Emily Brandon, US News & World Report, Tuesday, June 29, 2010

I saw this article by Ms. Brandon and thought it was particularly well done with a good checklist of things to consider whether you’re planning to retire or you’re already there. I hope you find it beneficial as well. If you need help thinking through this large life choice, we’d be happy to assist.

It can be difficult to determine if you are prepared to permanently exit the workforce. You need to save enough to last the rest of your life--and you'll need to manage that money to beat inflation and minimize taxes. Retirees should also have a plan for remaining connected to others and staying relevant in this new life stage. Here's how to tell if you are ready to retire.

Establish a Retirement Budget
Retirees no longer have to pay for professional work clothes or transportation to the office. But unless you enter retirement newly mortgage-free, most of your other expenses are likely to remain the same after you leave your job. "I don't find that people's expenses go down in retirement," says Leisa Brown Aiken, a certified financial planner for Veo Financial Counsel in Chicago. "You're probably going to spend as much or more as you spend now." If you plan to travel or take up new hobbies, your expenses could even increase in retirement.

Examine Your Cash Flow
Most retirees receive income from several sources, including Social Security, pensions, investments, and increasingly, a part-time job. You need to make sure you will receive enough income from these or other sources to pay all of your monthly bills. Less common sources of retirement income include home equity, annuities, insurance, royalties, and rental income.

Size Up Your Nest Egg
How much you need to save for retirement depends on what your retirement expenses are and how much income you have coming in from other sources. Your savings needs to fill in the gap between your monthly living costs and your Social Security, pension, and other guaranteed sources of income. Retirement savers should estimate how long they will live and take steps to protect that money from inflation. Donald Duncan, a certified financial planner for D3 Financial Counselors in Downers Grove, Ill., says healthy baby boomers should plan as if they will live until at least age 90, and perhaps 100.

Develop a Withdrawal Strategy
Retirees need a plan for drawing down their assets. Most financial advisers say that you can safely spend 4 percent of your nest egg each year. Withdrawals from tax-deferred retirement accounts become required after age 70 1/2. The withdrawal amount is calculated by dividing your IRA and 401(k) account balances by the Internal Revenue Service's estimate of your life expectancy. The penalty for failing to take out the correct amount is 50 percent of the amount that should have been withdrawn, in addition to regular income tax.

Minimize Taxes
Your entire nest egg isn't available for spending in retirement. When you take money out of tax deferred 401(k)'s and IRAs in retirement, regular income tax is due on the withdrawals. If your tax bracket fluctuates from year to year, you can time your retirement account withdrawals to minimize taxes. "Do withdrawals or convert to a Roth when you are in a low tax bracket and, if you can, withdraw less when you are in a higher tax bracket," advises Aiken.

Maximize Social Security
Retirees can sign up for Social Security beginning three months before their 62nd birthday. But annual payments increase for each year you delay claiming until age 70. Seniors who sign up at age 62 get smaller payments over a longer period of time. But retirees who delay claiming will get higher payments in old age when they are less able to work and more likely to develop health problems.

Get Health Care Coverage
Many people delay retirement until they become eligible for Medicare at age 65. Sign up right away to avoid a Medicare Part B premium increase of 10 percent for each 12-month period of delayed enrollment. You'll also need to shop around for the Medicare Part D plan that best meets your prescription drug needs. Those who retire before age 65 need to have a plan to purchase health insurance. Consider whether your employer provides health coverage to retirees, you are eligible for COBRA coverage, or will need to purchase your own individual policy. Health insurance exchanges will become operational in 2014.

Prepare for Long-Term Care
Retirees need to consider the possibility that they might need long-term care. Medicare pays for up to 100 days of nursing home care, but a prolonged illness or chronic condition could require care for a longer period of time. Purchasing a long-term care insurance policy is one way to shield yourself from high chronic care costs, but these often expensive policies are not appropriate for all retirees. The health reform bill created a voluntary government long-term care insurance program, Community Living Assistance Services and Supports (CLASS), which will begin in January 2011.

Consider New Activities
Plan to embrace a new activity in retirement. "You have to be mentally ready to not go into the office anymore," says Duncan. "You need to have something to replace the time that you spent working such as a hobby or travel." Consider volunteer work, taking a class at a local college, or a part-time job.

Join a Social Circle
When you leave your job, work-related social functions and lunches with coworkers often stop. "If your whole social life is tied up in your work life, it is a difficult transition," says Warren Ward, a certified financial planner for Warren Ward Associates in Columbus, Ind. Try to make friends or join a social circle outside of your company before you retire. "Very often, people will find a hobby or two, volunteer at the library, or become a boy scout leader because it introduces you to a new social circle," says Ward.

Coordinate With Your Spouse
Retirement may change your relationship with your spouse. Perhaps one spouse is ready to retire and the other wants to continue working. Even if you retire together, you may have to renegotiate responsibilities and boundaries. "The act of retirement itself can put a strain on a marriage because they were both working or one was working and one was home and now they are both home at the same time all day, " says John Migliaccio, director of research for MetLife's Mature Market Institute. "Negotiating retirement with your spouse is very important." Sure, you'll be able to take lingering walks on the beach in retirement, but you also need to decide who mows the lawn and who unloads the dishwasher now that neither of you is working.

Pick Out a Place
Once you're no longer tied to your job, you're free to move anywhere you wish. Frugal retirees can downsize into a smaller home or condo or relocate to a low cost area of the country (college towns often offer a low cost of living and plenty of amenities.) Many seniors move to sunnier climates and never shovel snow again, and some choose to move closer to their grandchildren.

Keep Your Emergency Fund
Although the fear of losing your job disappears when you retire, the need for an emergency fund doesn't. Retirees still get leaky roofs, broken-down cars, and other large and sudden expenses. "It makes sense for retirees to have a fund of cash of some kind, one to three years' worth of money that they will need in addition to Social Security, and keep that in something really safe," says Aiken. "It's your short-term spending money." Keeping your emergency fund in an FDIC-insured account will allow you to delay withdrawals from investment accounts in years when the stock market performs poorly.

Pay Off All Debts
Pay off as much debt as you can before you retire. "In general, people should have all their debts paid off when they retire," says Aiken. "If you have no mortgage you have more flexibility when things happen."

Take a Practice Retirement
One way to tell if you will enjoy retirement is to test it out by taking an extended vacation or leave of absence from your job. "Very often, people who are used to working really hard are just lost when they don't have some place to go," says Ward. "Their value in their own mind is being part of the workforce and going in and solving problems for people every day." Find out if you will enjoy hours of free time and lingering lunches or if you'll crave work to structure your days. "We encourage people to take a leave as an alternative to retirement as a chance to sample it," says Ward. "Consider what you want to do next and what you are going to give up."

Looking Ahead…

September 6th – Labor Day
September 15th – 3rd quarter estimated tax payments are due
September 30th – End of 3rd Quarter
October 15th – Tax returns due for those who filed extensions

The Markets…

Short but sweet: There may have been only four trading days last week, but they represented the best week for the Dow since roughly the same time last year. Last Tuesday was a mirror image of the previous Tuesday, with the Dow soaring 275 points up instead of down and bouncing above the 10,000 mark yet again. The small-cap Russell 2000 managed to squeak back into positive territory (barely) for the year, even though the week's gains couldn't match those of the Dow or the broader S&P 500.

Last Week's Headlines
• Service industries in the U.S. grew in June for the sixth consecutive month, though at a slightly slower pace. According to the Institute for Supply Management, only two categories--finance/insurance and miscellaneous--reported contraction, while real estate/rental/leasing showed the most growth.

• Consumer borrowing fell in May at an annual rate of 4.5%, according to the Federal Reserve Board. It's the fourth consecutive monthly decline. Revolving debt (credit cards) was down even more, at an annual rate of 10.5%.

• European banking supervisors will assess the resilience of 91 banks there by administering stress tests similar to the ones performed on U.S. banks more than a year ago, and will make the results public.

Eye on the Week Ahead
With Congress coming back from its July 4 recess, the fate of financial reform is once again on the table. Monday's Alcoa announcement is the traditional kickoff of the second-quarter earnings season.

What’s New at PFSI…

When we upgraded the website recently, we added a Video Library. As with our newsletters and Facebook postings, we try to serve as a filter for all the info available today and call your attention to items we think are most relevant/valuable to you. If you find something you think we should share, please pass it along. And, please share our info with others as well – it’s free!

MONEY MATTERS 4U! Our June class was one of my favorites – Tying up Life’s Loose Ends… This is a presentation I put together not long after my father passed away to help us all think about how we could ease the burden to our families at our death by writing a Letter of Instructions and an ethical will (www.ethicalwill.com). For our September class, we’re planning a session on attending college and what that entails. See our website for program details – www.moneymatters4u.org. If you belong to a group or organization that needs speakers, we’d love to help out – let us know! We can structure any of the MONEY MATTERS 4U! classes to any audience.

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Ways to Cut College Costs-

Here's a new twist on an old saying - There are three things in life that are certain: death, taxes, and college costs that go up every year, even during a recession. How can students and parents avoid the "extreme borrowing" phenomenon that can lead to years of burdensome loan payments? They can start by looking for ways to trim college costs so they won't have to borrow and/or pay as much in the first place. Here are some ideas.

Pick a college with a lower sticker price
Pricey private colleges often like to point out that the majority of their students don't pay the full "sticker price." The problem is, you never quite know how much, exactly, their students are paying. Every student's aid package is different, and the presence of merit aid awards makes the picture even murkier. Private colleges with the biggest endowments can afford to be the most generous (replacing loans with grants in aid packages, for example, or guaranteeing merit aid for all four years), but not every private college can do this. Even if a college takes $15,000 or $20,000 off its sticker price, that may still leave $30,000 or more to pay each year.
In the past few years, enrollment at public colleges has soared due to their lower sticker prices--public colleges are typically half the cost of private colleges and, for in-state residents, the savings can be even greater. Education experts often debate the benefits of spending more money to attend a well-known, more prestigious private college vs. a public college. But it's generally agreed that motivated, bright students can succeed anywhere, and that after a certain period of time, job experience matters more than where you went to college. For those parents sending their kids to a state school, although the percentages vary, the conservative number is less than 40% of kids that attend a public school graduate in 4 years, so keep that in mind when you figure the price of a public school vs a private school.

Consider taking a year off
The number of students taking time off between high school and college is growing in a measurable way. This period, commonly referred to as a "gap year," is typically spent volunteering, traveling, working, and/or interning. One of the main benefits of a gap year is the increased maturity and focus that comes from engaging in new experiences. These traits can help students get their money's worth in college by sharpening study habits and career goals. Another benefit is the potential to earn money to pay for college. For example, working full-time for 42 weeks (10 months) at the federal minimum wage of $7.25 per hour equals about $12,180 before taxes. Or, for the volunteer-minded, the AmeriCorps program currently provides a modest living allowance and a stipend in 2010 of $5,350 in exchange for service work (future stipends will be tied to the maximum federal Pell Grant). And more than 80 colleges now offer matching grants to students who earn an AmeriCorps stipend (see www.americorps.gov for more information).

Tweak the typical four-year experience
If your child doesn't mind forgoing the typical four-year college experience, here are some ways to trim costs:
• Attend a community college for one or two years, then transfer to a four-year institution
• Take AP high school courses to earn college credit and reduce the time in college
• Look at colleges that offer three-year accelerated degree programs
• Consider living at home and commuting to school to save on room-and-board costs
• Research online education options (check out www.distance-education.org)

Research scholarships
After your child fills out the federal government's financial aid application (the FAFSA) and the college's financial aid application (the standard PROFILE application or the college's own form), he or she should set aside as much time as possible to research and apply for scholarships. With online searches, students can easily input their talents and background and get a filtered list of relevant scholarships (try www.fastweb.com or www.collegeboard.com). Also, don't forget to check with your employer and the local chamber of commerce for scholarships.

Budget well during college
Encourage your child to look for deals on mandatory items like books, supplies, and other personal dorm room items. For discretionary items, establish guidelines for a reasonable amount of monthly spending money, but build in flexibility. If you do co-sign a credit card application with your child (a co-signer is now required in most cases for applicants under 21), make sure your child doesn't succumb to the temptation of easy money. According to a study last year by Sallie Mae, the average college student has $3,200 in credit card debt. Discuss your expectations of credit card usage and make sure your child understands how interest accumulates on unpaid monthly balances.

Wishing you a GREAT summer of terrific life experiences!

At your service,

R. Douglas Pauley, MBA, CFP®, AIF®

The biggest problem with investment returns is that they're posted daily - or, in the case of the recent "flash crash" - every hour or so.

Why is this a problem? Because it implies that what happened yesterday or the day before is meaningful to your financial life, and is important information for future investment decisions. People all over the world struggle with figuring out the relevance of last week's or last month's or last quarter's investment returns, and the cable investing channels and newspapers feed the confusion by trying to explain yesterday's downturn in terms of housing or unemployment data, and project tomorrow's returns based on interest rates and earnings reports.

If you're one of those people who checks the market regularly and can't quite find the meaning of all this short-term information, then this is a good time to relax. Because there IS no meaning to be found there.

At all times, there are three forces guiding the markets. The first is long-term economic growth. Global businesses are gradually expanding their operations, opening up new markets, learning to manufacture and service their customers more efficiently, creating new products. With billions of new customers emerging in India, China, Indonesia, and elsewhere, and new technology improving the efficiency of building, tracking, servicing, managing, and everything else, this trend has been generally upward since people first squatted in caves around a wonderful new invention called the campfire.

The industrial revolution, the information revolution, and whatever new revolution the Internet and iPhone are a part of are accelerating this long-term business trend, which is invisibly making you money in your portfolio every day you stay invested.

The second force is the economic cycle, which moves from robust growth back to recession back to robust growth in a round-trip gyration which can last anywhere from months to years. Economists have felled whole forests trying to explain the hows and whys of these fluctuations, but most of us instinctively understand what it means to become overextended, pulling back, tightening our belts, and then moving forward again. No human activity can be graphed as a flat line.

The only important thing to realize about economic cycles is that they are generally subservient to the longer-term cycle. Throughout all the ups and downs and sideways, the world economy has experienced net long-term growth ever since those first campfires.

The third force is investor emotions, which are by far the most volatile element of investment returns, and can change hourly, daily, weekly, monthly. You know these on a personal level; it's what you feel when you see the market go into the "flash crash" freefall, or a year and a half ago when the markets suddenly realized that the demise of Lehman Brothers - a company which helped finance the Civil War - was a scary event. That urge you feel to sell everything and make the anxiety go away is shared by roughly a billion other investors around the globe, who conspire, unconsciously but powerfully, to rock the markets like the ocean waves in a storm. Even on good days, these waves are rolling around powerfully enough to make TV analysts think they can find meaning in them.

But that's the point: studying the waves, studying what happened yesterday or last quarter, tells you nothing at all about the long-term viability, health or growth of the companies in your investment portfolio - despite what Jim Cramer happens to be screaming today. You might get equally-valid information looking at the patterns of tea leaves or the markings on the back of tortoise shells.

That doesn't mean the waves have no impact on investments, however. The great investors, like Warren Buffett, look for those times when a billion investors are pushing the panic button, and take advantage of stocks selling at bargain prices. Thousands, perhaps millions of investors had to sell during a lot of panics to make Warren Buffett a billionaire, and in his annual shareholder meetings, he acknowledges this. The waves go in the opposite direction as well, taking prices well out of the bargain zone.

Through it all, the long-term trend is quietly making you money, moving us toward a future day when people will look back at us the way we look back at people who lived at the dawn of the Industrial Revolution. They will wonder how we could get so excited about (or scream on TV about) all these little ups and downs while the economy was steadily, visibly, reliably carrying us to a better place.

June 2010 - News You Can Use!

As bad as the market has felt, the drop in stocks recently has been nowhere near as big as the rise in volatility. It's not clear where the market is headed next in the short-term--up or down. Based upon history, we know the long-term trend has been up! But what is clear is that whatever direction we are headed, the captain has put on the “Fasten Your Seat Belt” sign! Fortunately, our strategy of protecting the funds needed for the short- and medium-term will make the ride less bumpy.
To provide some perspective, the markets do tend to be more volatile (wider swings high and low) during the summer, providing us opportunities to capture the gains and harvest the tax losses. Just not as many folks “manning the fort” as traders, market makers, and the like are also trying to take vacations.

The habit of saving money is itself an education. It fosters every virtue, teaches self-denial, cultivates the sense of order, trains to forethought, and so broadens the mind.
Thornton T. Munger

Focus Items…

Beneficiary Designations – When was the last time you checked yours? Are they up to date on all your IRAs, 401(k)s, 403(b)s, retirement plans, and insurance policies? Most importantly, do they support your current estate planning documents? We’d be happy to help you check!
2009 SEP-IRA Contributions – If you are on extension, you can still make a SEP-IRA contribution for self-employment income at the time of your ultimate tax filing.
Roth Conversions – If we haven’t discussed this with you yet, please ask. There are a few “no-brainer” situations, but most require some analysis.

Feature Article… What Did We (Re)Learn?

One of the biggest take-aways from the recent market meltdown, for many people, was the rediscovery of many kinds of fun that don't cost money--a lot of the things that people did years ago before the advent of 3D movies, gourmet restaurants, traveling soccer teams and endless consumerism.

In fact, one financial planning firm took a poll of its clients, asking them what kinds of fun things they had rediscovered while they were tightening their belts. What they found was that many people were having MORE fun with less money, simply by being creative.

Other advisors are asking similar questions, and reporting the answers so that everybody can see what their friends and neighbors have discovered/rediscovered. They received answers like: working jigsaw puzzles as a family, or playing board games (like Parcheesi or Scrabble) in the evening, inviting friends over to play cards, taking walks, creating a new flower garden (or, in one case, turning the entire front lawn into a flower garden of spectacular beauty), hiking in the local state park, attending a variety of free seminars, getting more involved in community meetings, having group cookouts where everybody shares the cooking or brings dishes, joining a book club--the original advisory firm now has several hundred suggestions, and counting.

Of course, the lesson is something that we somehow manage to forget from time to time: that the world is full of endless possibilities for fun and pleasure and satisfaction and beauty, and some of the most interesting cost us nothing. In fact, the shared togetherness of many of the "rediscovered" activities makes them superior to how many people were spending their time before the market dropped.

It would be a shame if we learned these important lessons and then let our rediscoveries slip away now that people are feeling a bit wealthier again. They call these the "simple" pleasures, but there's nothing simple about being creative and really looking at the beauty and possibilities of the world around us. It's possible that we can be thriftier AND enjoy life more if we use our minds and hearts and each other to bring pleasure and fun into our lives.

Looking Ahead…

June 15th – 2nd quarter estimated tax payments are due
June 30th – end of the second calendar quarter
July 4th – we celebrate our independence from the rule of King George III
September 15th – 3rd quarter estimated tax payments are due

The Markets…

The waves of global fear sent investors to seek the comfort of Treasuries; prices rose as the yield on the 10-year note dropped sharply, and the euro hit its lowest level against the dollar in 14 months. Oil also fell below $75 on concerns that European banks might stop lending, thus slowing global economic recovery. However, eurozone finance ministers agreed in an emergency weekend session to a massive $955 billion bailout package of loans and loan guarantees designed to be a firewall against the need to restructure sovereign debt across the European Union (EU). Still most markets for the year are hovering near even.

Market/Index 2009 Close As of 5/7 YTD Change

DJIA 10428.05 10380.43 -.46%
NASDAQ 2269.15 2265.64 -.15%
S&P 500 1115.10 1110.88 -.38%
Russell 2000 625.39 653.00 4.41%
Global Dow 1984.48 1823.64 -8.10%
Fed. Funds .25% .25% 0 bps
10-year Treasuries 3.85% 3.45% -40 bps

Last Week's Headlines

Nonfarm payrolls saw their biggest increase in four years: 290,000 jobs were created in April, and only 66,000 were temporary census workers. However, the new hiring wasn't strong enough to absorb the 805,000 job seekers entering or re-entering the labor market on signs of recovery, according to the Bureau of Labor Statistics. As a result, the unemployment rate went from 9.7% to 9.9%.

In addition to the EU bailout agreement, the European Central Bank reversed a decision earlier in the week and announced it will buy government and private bonds. The program, intended to backstop European banks and bond markets, is similar to moves adopted by the Federal Reserve in 2008 to combat the credit crisis here.

American incomes as a whole rose in March, but American spending rose almost twice as fast. According to the Bureau of Labor Statistics, incomes were up 0.3%, while spending increased by 0.6%. And saving? Down 0.8%, to an annual rate of 2.7% of income.

April was the U.S. manufacturing sector's best month since June 2004, expanding for the ninth straight month. The Department of Commerce said construction spending in March also was up by 0.2%, mostly on nonresidential public projects such as roads.

Productivity rose during the first three months of 2010, though the 3.6% productivity gain was less than the previous quarter's 6.3%. The productivity gain more than offset a 1.9% increase in hourly compensation, according to the Bureau of Labor Statistics. As a result, unit labor costs for nonfarm businesses--one indicator of whether inflation is heating up--declined 1.6%.

What’s New at PFSI…

We released our new website a couple of weeks ago. If you haven’t had a chance to check it out, please do - www.pauleyfinancial.com. We’d love your feedback!

Part of our compliance requirements is to notify you when there is a change of ownership. For reasons you all recognize, Kimberly Pauley is now my co-owner of Pauley Financial Services, Inc. It is truly a blessing to have a life partner who is also a business partner.

MONEY MATTERS 4U! Our May car classes were a hit with our audiences. We looked at ALL of the costs of owning a vehicle. Naturally, many of our young teenagers had not given them much consideration, but we provided an eye-opening experience for them - and some good discussion points to address with their parents. Who pays for what? What are the expectations for getting (and keeping) car driving privileges?

This month we’re doing one of my favorites – Tying up Life’s Loose Ends… This is a presentation I put together not long after my father passed away to help us all think about how we could lift the burden by writing a Letter of Instructions and an ethical will (www.ethicalwill.com). See our website for program details – www.moneymatters4u.org.

Wishing you a GREAT summer of terrific life experiences!   Please let us know how else we can help.

R. Douglas Pauley, MBA, CFP®, AIF®

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"Four Keys" Article Summary by Bob Veres;  Investment Advisor, June 2010

Patton says that when he worked as a broker at the "largest wirehouse," and at one of America's largest banks, he consistently found it difficult to serve the client. One of the great benefits of independence, he says, is the freedom to be creative--no longer bound by "the more narrow-minded focus often found in larger firms." He says that the larger firms' focus is the production of revenue; you're torn between the desire to serve the client's best interest and the pressure to produce. Later, the article says that asset preservation should be your primary objective, and still later: "an independent firm does not have to pander to shareholders or adopt a culture of sales where production of revenue trumps all.

But (I still hear brokers argue) hey; we're all fiduciaries, right? Patton says that the firms whose focus is squarely on production are not following a sustainable business model, and predicts that the industry will lose trust and "die on the vine."

As published at :  http://www.fa-mag.com/component/content/article/7-news/5109.html?Itemid=44

(Dow Jones) If the high number of phone calls to mutual-fund firms and the comments posted to articles on the subject are any sign, savers are showing a lot of interest in converting their traditional individual retirement accounts into Roth IRAs, but they and their advisor should be wary about acting on that desire too hastily because some expensive traps are waiting for the ill-informed.

"Roth conversions can trigger unintended tax traps and financial problems that are not being addressed in the mounds of 2010 Roth conversion information that currently dominates the media," Ed Slott wrote recently in his newsletter, "Ed Slott's IRA Advisor."

These traps may make you reconsider when to convert, how much to convert, or even if you should convert at all. Here are some of the traps that Slott says await the uninformed.

1. On a 2010 conversion, the income is split, not the tax

"While the income limitations for Roth conversions are repealed for 2010 and all subsequent years, 2010 is the only year that will allow taxpayers a special break on paying the conversion taxes," Slott wrote.

"Taxpayers who convert in 2010 won't have to include any conversion income on their 2010 tax return, and instead will include half the income from the conversion on their 2011 return and half the income on their 2012 return," he said. "But just because you evenly split the income over two years doesn't necessarily mean you evenly split the tax as well. In fact, that would be highly unlikely."

The total tax bill is going to depend on a number of factors, some totally outside a person's control, including tax rates and overall income.

2. 60-day rollover mistakes

The best way to move money from an IRA to a Roth IRA is by trustee-to-trustee transfer—a direct rollover. But some company plans or IRA custodians don't offer this type of transfer, Slott said. Instead, the firms will simply write a check to you, the account owner, and send you on your way.

In such cases, you have 60 days to place these funds into another qualifying retirement account, including a Roth IRA. And if you don't make the deadline? "If the 60 days pass without the funds being re-contributed to another retirement account, the funds become taxable and are no longer eligible for rollover," Slott wrote.

The only fix for this is a private letter ruling, he said. PLRs, as retirement experts call them, can be costly and time consuming—and there's no guarantee the IRS will rule in your favor.

3. Medicare costs and Social Security taxation

You might have to pay higher Medicare premiums or have your Social Security payments taxed if you do a Roth IRA conversion. That can happen if you are receiving these benefits and do a Roth conversion, Slott said.

"In general, Social Security benefits are excluded from the gross income of a taxpayer and are therefore not taxed," he said. "However, depending on how much other income an individual has, anywhere from 50% all the way up to 85% of their Social Security income can be included in gross income, resulting in a higher tax bill for that year."

What's more, he said, "Medicare Part B premiums are based on income. For 2010, joint taxpayers will remain at the lowest premium levels as long as they have income of $170,000 or less ($85,000 for those filing single). From there, premiums progressively increase until joint taxpayers have above $428,000 in income ($214,000 for those filing single). Conversion of a large IRA or plan balance could move you into a higher premium bracket, potentially costing a couple around $6,000 extra in Medicare premiums for 2010."

4. Financial aid loss

Most schools exclude a parent's retirement assets when considering a college student's eligibility for financial aid. "Income, on the other hand, is one item schools tend to look at intensely," Slott said. "And that's exactly what a Roth conversion creates. A Roth conversion will cause a spike in income for the year or years where the income is included. While this additional income is an aberration and does not represent typical income levels, it can cause a loss of valuable financial aid."

5. New Roth accounts need new beneficiary forms

The beneficiary form, according to Slott, is the most important estate-planning document when it comes to IRAs and Roth IRAs. It controls who ultimately gets the money in the account when you, the account owner, dies. Each custodian will have procedures in place for the conversion, but each new account you open will need to have the beneficiary forms completed properly and submitted.

6. Partial conversions involving after-tax money

When you have after-tax money in an IRA, you can't isolate the after-tax amounts and convert them tax-free while keeping the remaining pre-tax dollars in the traditional IRA, Slott wrote.

"That would be like trying to separate the cream from your coffee after pouring it in—it just can't be done," he said. "Instead, when a partial conversion of IRA assets is done, a pro-rated amount of after-tax money, or basis, is included with each dollar converted."

The formula for calculating this amount is this: Total basis in all IRAs divided by the total value of all IRAs times the amount converted.

7. Rolling to an IRA mid-year

If you plan to roll your 401(k) into an IRA in the same year that you do the conversion, be sure to avoid this trap. "When an IRA is converted, only IRA assets are taken into consideration for the pro-rata rule," said Slott. "Plan assets have no effect."

For example, consider the case where someone has an IRA worth $50,000, of which $25,000 is non-deductible contributions and $25,000 is earnings, said Slott. This hypothetical person also has a 401(k) worth $450,000, all of which is pre-tax. If the person converts the entire IRA, he will owe tax only on $25,000 since the plan assets are excluded from the pro-rata formula.

8. RMDs must be taken first

Just when you thought you could get rid of required minimum distributions (RMDs) forever, this trap comes along. Yes, many IRA owners were waiting, breath bated, for 2010 so they could convert and stop taking those tax-causing RMDs. Well, 2010 has arrived, but those IRA owners have to be careful not to act too quickly.

"In their haste to convert, some IRA owners might convert their entire account balance not knowing that their RMDs cannot be converted to a Roth IRA," Slott said.

"Individuals who are 70 1/2 or older in 2010 must first take their 2010 RMDs if they plan to convert all their IRAs to Roth IRAs. The first dollars withdrawn from the IRA are deemed to be the RMD until that amount is satisfied. Once the RMD is withdrawn, then the remaining IRA balance can be converted," he said.

9. Some funds are not eligible for conversion or contribution

You might think you can convert anything into a Roth IRA, but you'd be wrong.

"The tax code allows only eligible rollover distributions to be converted to Roth IRAs," Slott wrote.

Besides RMDs, there are a number of other items that can't be converted, including 72(t) payments, hardship distributions, corrective distributions of excess deferrals, deemed distributions, and dividends from employer securities.

10. Non-spouse beneficiaries can't convert inherited IRAs

Besides the aforementioned, Slott said there's one type of account not eligible for conversion that merits special attention.

"Any non-spouse beneficiary who inherits a qualified plan is eligible to convert that plan to an inherited Roth IRA, and the plan must allow this transfer," he said.

"This conversion must be done by a direct transfer as non-spouse beneficiaries can never do a 60-day rollover. But, while a non-spouse beneficiary who inherits a qualified plan can convert to an inherited Roth IRA, if the same beneficiary inherits an IRA they cannot convert it to an inherited Roth IRA."

11. The SIMPLE IRA 25% penalty

All IRAs, including SEP IRAs and SIMPLE IRAs, are eligible for conversion to a Roth IRA. But unlike a traditional IRA or SEP IRA that can be converted anytime without penalty, SIMPLE IRAs present a dangerous trap, Slott noted. "SIMPLE IRAs have a two-year holding period. The two-year clock is unique to each participant and starts once they have made their first contribution," he said. "Funds that leave a SIMPLE in the first two years are treated as a taxable distribution that is not eligible for rollover other than to another SIMPLE IRA. They cannot be converted to a Roth IRA."

12. The 10% penalty trap

There's a 10% early withdrawal penalty when funds are withdrawn from an IRA before age 59 1/2, but the Roth conversion is an exception, Slott said. "IRA or plan funds withdrawn at any age are not subject to the 10% penalty if those funds are converted to a Roth IRA."

However, two tax traps can still trigger the 10% penalty, he said. One of these traps is if some (or all) of the funds withdrawn are used to pay the conversion tax. Since funds used to pay the conversion tax are not actually converted to the Roth, they are subject to the 10% penalty and income tax.

Does Diversification Still Work?

Looking back at the major market correction of 2008-2009, many wonder if diversification still works… that is, holding different kinds of assets in a portfolio to smooth out the ride. In 2008, the indexes representing U.S. and international stocks, commodities and real estate all went down. In 2009, they all went up. The idea that some assets zig while others zag--leveling out the rollercoaster ride of market ups and downs--seems to be broken.

But is it? In a recent interview in Investment Advisor magazine, Yale University finance professor Roger Ibbotson pointed out that in 2008, about 25% of U.S.-listed stocks lost at least 75% of their value. But only four of the more than 6,600 open-ended mutual funds that invest in U.S. stocks lost more than 75% in 2008. Holding a variety of stocks--diversification--cushioned the impact, which could have been quite severe if your entire portfolio had consisted of one of more than 1,000 stocks that went into free-fall. So, diversification within asset classes still worked. Diversification across asset classes didn’t work as well as we would have like. Even though “everything” was down in 2008, wasn’t down at the same rate or hitting asset class bottoms all at the same time. The fact that asset classes don’t exactly coincide with the cycle of other classes still provided a modest diversification benefit.

Meanwhile, the May 1-2 issue of the Wall Street Journal, in the Weekend Investor section, reports that investors who held small company stocks as well as large ones didn't suffer quite as badly through the so-called "lost decade" of stock market returns. For the full decade beginning January 1, 2000, the large-cap S&P 500 index fell nearly 18%, a loss of almost 2% a year. Over the same ten-year time period, the small-cap S&P 600 index gained nearly 100%, producing an annualized return of 7.1% a year. Nobody could have predicted that small cap stocks would do so well or that large caps would do so badly. Investors who owned both escaped some of the pain; for them, the "lost decade" wasn't a total loss after all.

Please contact us if you’d like help looking at your situation.