Welcome to the latest edition of the Brighton Bulletin. We've had quite an active market in March and I'll provide our thoughts on why. I'll also cover custodial 529 plans and discuss new comparability profit sharing plans. Also, I'm interested in starting a Q&A section and, therefore, welcome any financial related questions you may have. Finally, please stop by my blog - Brighton Perspective for daily commentary on financial issues. |
Bull Market or Bear Rally?
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 As the old saying goes March came in like a lamb and left like a lion. Entering the month, the equity markets were steadily falling with no end apparent. Then, early in the month, roughly around March 6, good news began to emerge. Modest as it was, Citigroup, Bank of America and Goldman Sachs all announced that the first two months were better than expected, financials rallied and the rest of the market followed.
The question remains as to whether this is a nascent recovery or just a bear market rally. A bear market rally is a short-term rally that fades away as investors come to recognize the negative drivers causing the bear market are still present. Here, I think we're more likely in the early stages of a recovery that won't quite be a full on bull market but isn't a bear rally (but don't be surprised by a short-term pull-back in mid to late April if bank earnings negatively surprise investors). Historically, equity markets have started to recover roughly 6 months prior to the economic trough. So, markets are recovering when the news seems bleakest. That certainly fits the current environment. However, we have significant crosswinds. From one direction, we have monetary policy flooding the economy with currency. The monetary policy appears to be having a positive impact - commercial paper markets are working again, mortgage rates are at or near historical lows, and corporations are returning to the convertible bond markets. Alll are good indications of market recovery. We're also seeing modest improvements in various economic indicators.
Countering the good news is the bad news. Unemployment continues to rise, inventories continue to be higher than they should be, capacity utilization is below average, and the "stimulus plan" has yet to kick in. Concerns remain as to whether the stimulus plan will be, in fact, stimulatory or just inflationary. The increase in national debt, lack of immediate projects and the focus on programs that can create entitlements suggests to many, myself included, that the prospect of higher taxes, lower growth and inflation exists in the near future. I expect we'll see an increase in inflation 18-24 months out and increasing from there. The issue is the inability of the government to pull back on the stimulus if the economy is showing signs of recovery. Injecting enormous liquidity into an already growing economy is bad news. Finally, we've yet to see concrete evidence that the financial institutions have turned the corner and are getting healthier. Data is mixed at this point, for example, banks are holding lots of cash on their balance sheets, but can't adequately price or sell poor quality assets. So the cash is nice but its effectively just collateralizing bad assets and is, consequently, not productive.
The bottom line is we're seeing good signs mixed with bad, which is actually better than 6 months ago. All of the news was bad then. If you're in equities already, stay the course. Returns are asymetric at this point - there's more upside than downside exposure if you're holding equities. If you sold your equity holdings and are in cash, it may be time to start dollar-cost-averaging back into equities. Focus on stocks of companies with easy to understand balance sheets, strong cash flow (net of pension expense) and strong brands in their industries. If you're using funds, favor funds with manager tenure, lower fees, lower turnover and lower volatility than their asset class peers. If you'd prefer, you can have someone else manage the portfolio for you as well. As always, caveats apply. Consider your financial situation first and discuss any change in strategy with your advisors. I do think we're seeing early signs of recovery and think some equity exposure is warranted. However, hedging that exposure by focusing on quality is beneficial. As the year progresses, you can gradually increase your exposure to equities to a level that makes sense for you.
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Custodial 529s
More beneficial than UTMAs
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Section 529 college savings plans gained prominence in 2001 with the
passing of the Economic Growth and Tax Relief Reconciliation Act of
2001. Prior to 2001, many parents with the foresight to think about
funding college expenses had used established Uniform Transfer to
Minors Accounts (UTMA) or Uniform Gifts to Minors Accounts (UGMA).
These accounts were established with good intents but, today, have
become problematic for many families. Two significant reasons for this
are:
1) the assets in the UTMA or UGMA belong to the child.
Thus when the child reaches the designated age, the assets can be
claimed by said child and used for any purpose they wish. So that
college fund just became the travel around the world fund and the
parents can't do anything about it.
2) the assets in these
accounts are included as student income and assets when completing the
FAFSA and PROFILE forms for financial aid. The student is expected to
contribute a larger portion of his/her assets and income to fund
college expenses. Thus, these accounts, in effect, penalize families
for saving for college.
One partial solution is to establish
custodial 529 accounts. It's a partial solution because it doesn't
remove the child as the owner of the account. However, it does enable
the account to grow on a tax-deferred basis (as long as assets are used
to fund college expenses). It also changes the FAFSA calculation as the
custodial 529 is treated as an asset of the parents rather than the
student. Since parents are expected to contribute a smaller percentage
of their assets and income it can improve the chance for an aid
package.
There are tax issues to consider (aren't there always
tax issues to consider?). 529s can only be funded with cash. Thus, if
the UTMA or UGMA account has other types of holdings, these will need
to be sold and taxes paid on the disposition. The timing might be good,
though, in 2009 since market conditions over the past 12 months have
been very poor. There may be losses generated which can be used to
offset potential gains generated.
So, if you have UTMA or UGMA
accounts, it is worth examining the potential advantages and
disadvantages of established custodial 529s for these accounts. As
always, talk with your financial advisor and your accountant before
making a final decision. Final thought - establish a traditional 529 at
the same time you establish the custodial 529 and fund traditional 529 going
forward. The traditional 529 enables you to change the beneficiary so
you can continue to save for college and still maintain control of the
assets.
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I hope you found this month's Bulletin informative and beneficial. If yes, please feel free to forward to anyone you think might be interested in its content. If I can be of service in any way don't hesitate to contact me.
Sincerely,
John P. Middleton, CFA, CAIA
Brighton Financial Planning, Inc. |
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Spotlight
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Many readers are small business owners who have or might be considering a retirement plan. The challenge for small business owners is setting up a plan that provides adequate benefits for the owner, who is typically the only highly compensated employee of the organization. As such, the amount allocated to the owner is typically constrained by the amounts allocated to non-highly compensated employees. The new comparability plan is a profit-sharing plan that addresses this deficiency of other profit-sharing plans. Under this plan, employees are grouped into categories. Each category receives an allocation percentage. This plan is well suited for business owners who are, typically, older than their employees, want the flexibility of a profit-sharing plan, want to reward key employees yet still retain the highest amount possible for themselves. It is a popular choice for small professional services firms such as consultants, law practices and medical practices.
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