Good morning, and Happy Friday!

June has been a month of many ups and downs in the investment markets, although the swings have not been as big as we experienced last August.  After all this, the S&P 500 index is up for the last month about 1% and is now up  just under 7% for the year.  Developed and emerging international markets both improved in June and are now around break-even for the year.  Bonds, as measured by the Barclays Aggregate Bond Index, are now up 2.6% for the year.

With the Supreme Court upholding the healthcare law yesterday, I am sharing information on how the new 3.8% Medicare tax works so you can begin incorporating this into your plans if it affects you.  In future issues of this newsletter, we'll focus on other aspects of the healthcare law that may be relevant to your situation.

Also in this newsletter we have practical information on employer retirement plans and two interesting perspective pieces from financial columnist Bob Veres on IPO pricing and anomalies in bond interest rates.   As always, feel free to e-mail me at [email protected] with requests for newsletter topics you'd like to see covered or to discuss concerns or questions on anything in the financial world. 

I hope you have enjoyable and safe Independence Day holiday next week.  Thanks for reading, and Live Well!

How Healthcare Law 3.8% Tax Works

This helpful explanation of the new 3.8% Medicare tax was provided on Harold Evensky's Bow Tie Blog:

The new 3.8% Medicare tax is assessed only when Adjusted Gross Income (AGI) is more than $200,000 single/$250,000 joint. AGI includes net income from interest, dividends, rents and capital gains, as well as earned compensation and several additional forms of income presented on a Form 1040 Income Tax Return.

The tax is NOT imposed on the total AGI, nor is it imposed solely on the investment income. Rather, the taxable amount will depend on the operation of a formula. The taxpayer will determine the LESSER of (1) net investment income OR (2) the excess of AGI over the $200,000/$250,000 AGI thresholds. Thus, if net investment income is the smaller amount, then the 3.8% tax is applied only to the net investment income amount. If the excess over the thresholds is the smaller amount, then the 3.8% tax would apply only to the excess amount. 

Here is an example:

If AGI for a single individual is $275,000, then the excess over $200,000 would be $75,000 ($275,000 minus $200,000). Assume that this individual's net investment income is $60,000. The new 3.8% tax applies to the smaller amount. In this example, $60,000 of net investment income is less than the $75,000 excess over the threshold. Thus, in this example, the 3.8% tax is applied to the $60,000.

In addition, this video which was prepared prior to the Supreme Court decision offers some additional details.  Click here to view the video. 

IPO Winners and Losers

This article written by Financial Columnist Bob Veres and used with permission.

The past year will be remembered for two remarkable social media initial public offerings: LinkedIn on May 19, 2011 and Facebook on May 19, 2012.  Although the dates were the same, the two offerings went very differently.  LinkedIn's share price roughly doubled immediately after the shares were purchased, from the $45 IPO price to $94.25 when the market closed that day.  The offering was widely described in the papers as a great success. 

Facebook's shares, meanwhile, were priced at $38 and finished that frenetic first trading day at roughly the IPO price--at $38.23.  You've seen the headlines ad nauseum: news reports have declared it an epic failure.

So here's the question: which IPO was actually successful, and which was a failure?

The media has had no trouble answering that question.  But if you look at the situation from the standpoint of the company bringing shares to the public (and what other standpoint really matters?) then you come to exactly the opposite conclusion.  The LinkedIn IPO would have to be judged a spectacular failure, while Facebook's IPO represents a rare example of a success.

To see why, just look at the numbers.  In all, LinkedIn raised $352.8 million on its 7.84 million shares.  Based on what investors were willing to pay on that first day of trading, the company actually had the opportunity to sell those shares to willing buyers at closer to $95, and raised a total of $700 million.  That extra $350 million could have been used to fuel its growth, develop new technologies, reach into new markets, purchase competing organizations or a million other uses. 

Where did that extra $350 million go instead?  To friends of IPO underwriters JP Morgan, Morgan Stanley and Bank of America/Merrill Lynch, who were given the sweet chance to buy at half what the market wanted to pay for the shares.

Meanwhile, Facebook, the company, got full price for the shares it sold to the public; that is, the IPO price turned out to be surprisingly close to what the market as a whole wanted to pay for shares of the social media company.  In all, the company raised $16 billion to build or enhance its franchise and acquire competitors.  The insiders who got favored access to the shares got virtually nothing when they tried to flip them on the open market.

These facts represent more than just a way to look really really smart the next time you talk with friends about the investment markets.  There's a serious issue buried in these routine mispricings, and in the way the media has been trained to think about (and cover) initial public offerings.

The brokerage companies that underwrite IPOs are paid handsomely for selling a company's first publicly-traded shares to the investment world--roughly 7.5% of the money raised, or about $1.3 billion on these two IPO deals alone. The firm is supposed to be working purely for the benefit of the company whose shares it is selling, and the only goal that makes sense is to raise as much money as possible for that company so its executives can deploy the capital and grow its business and shareholder value. 

But in fact, in the real world that we happen to live in, the brokerage underwriters have actually made a practice of deliberately undervaluing shares when they bring them to market.  They then dole out the underpriced IPO shares to their best customers, who can flip them for an immediate profit.  Some of those big customers are, themselves, the people who make decisions about which company will be given the lucrative contract to sell their own company's shares on the open market.  If this looks to you like a way to bribe people to bring you business, then you are reading carefully and correctly.

The difference between the initial share price and the higher price you see in a lot of IPOs directly benefits the brokerage firm itself.  These deliberate underpricings have become a clever, perfectly legal way for the brokerage firm to reward the very customers who pay (or will someday pay) these firms ginormous fees for their own IPO.  In legal terms, this is a huge conflict of interest, and it is interesting that our media reports favorably, with breathtaking excitement, whenever these large institutions visibly take advantage of the firms they supposedly work for to the tune of hundreds of millions of dollars.  And the media gives us an endless stream of negative headlines in cases like Facebook where, apparently by accident, the brokerage underwriters do their job well.

Bond Anomalies

This article written by Financial Columnist Bob Veres and used by permission. 

Here's a trivia question to startle your friends with.  According to International Monetary Fund statistics, what country has the highest government debt levels, compared with its economic output, in the world?

You might be inclined to guess troubled or developing nations like the African nation of Eritrea (134% of its 2011 GDP), Lebanon (136%), or Jamaica (139%)--or, if you were aware that it existed, the sovereign nation of Saint Kitts and Nevis (153%), a former British colony is located in the beautiful Caribbean Leeward Islands north of Venezuela. 

After reading so many headlines, you might guess that Greece (161%) is in the deepest debt hole, or perhaps the United States (103%).

As it happens, none of these countries is even close to the runaway leader in government debt as a percentage of its economic output: Japan, which is paying interest on bonds whose face value equals more than 229% of Japan's GDP.

Perhaps the most interesting thing about this bit of trivia is that bond traders don't seem to be worried about Japan's ability or willingness to pay back its creditors.  As you've probably seen from the headlines, when investors are worried about a country's soaring debt levels, they will often demand higher rates--so the rate that a country pays is a pretty good proxy for how concerned (or not) investors are about the country's solvency.  With that in mind, look at the little table below, which shows the debt to GDP levels of various countries next to their 10-year bond rates.  Think of it as a comparison between how much global bond investors SHOULD be alarmed vs. how alarmed they actually are.

Country     10-Yr Bond Rates    2011 Debt/GDP

Greece                28.66%                160.61

Pakistan              13.37%                  60.12

Brazil                  12.55%                  66.18

Portugal              11.36%                 106.79

India                     8.35%                   68.05

Hungary               8.28%                   80.45

Ireland                  8.21%                 104.95

South Africa         8.20%                   37.88

Colombia             7.60%                    34.67

Peru                      6.76%                   21.64

Indonesia              6.47%                   25.03

Spain                    6.09%                   68.47

Russia                  6.00%                     9.60

Mexico                 5.92%                   43.81

Italy                      5.70%                 120.11

Poland                  5.35%                   55.39

Israel                    4.41%                   74.34

South Korea         3.65%                   34.14

Thailand               3.64%                   41.69

Malaysia               3.51%                  52.56

China                    3.38%                  25.84

New Zealand        3.30%                  37.04

Czech Republic    3.25%                  41.46

Australia               3.09%                  22.86

Belgium                3.00%                  98.51

France                   2.57%                  86.26

Norway                 2.38%                  49.61

Austria                  2.24%                  72.20

Netherlands          1.84%                  66.23

Canada                 1.83%                  84.95

United Kingdom  1.72%                  82.50

Finland                 1.69%                  48.56

United States        1.65%               102.94

Sweden                 1.48%                 37.44

Singapore             1.44%                100.79

Germany              1.38%                  81.51

Hong Kong          0.96%                  33.86

Japan                    0.88%                229.77

Switzerland          0.65%                  48.65

Comparing the right-hand column with the one in the middle, you see some head-scratching anomalies.  Greece, which has the second-highest debt-to-GDP level in the world, pays by far the world's highest interest rates on its debt, which seems appropriate.  But Italy, which is not far behind on the debt list, is paying interest rates somewhere near the middle of the pack, and the U.S. and Singapore, which have significant debt levels compared with the rest of the world, are paying almost nothing for the privilege of borrowing from global investors.  Meanwhile, relatively thrifty countries like Colombia, Peru and Indonesia are paying much higher yields than debt-burdened Belgium, France and Singapore.

By far the biggest outlier on the table, however, is Japan, with debt-to-GDP levels more than twice as high as the U.S., paying rates lower than anybody on the table but Switzerland.  How can that be?  Because more than 90% (some estimates say more than 95%) of Japan's government bonds are owned by Japanese citizens, compared with an estimated 57% in Italy, and 54% in the U.S.  In other words, the global bond markets cannot demand higher interest rates on yen-denominated government bonds because they don't own Japanese debt; global investors are looking for more return on their money than Japan is currently offering.

Sources for the article can be found at:

 http://en.wikipedia.org/wiki/List_of_countries_by_public_debt 

 http://www.tradingeconomics.com/bonds-list-by-country

When an Employer Goes Out of Business

You may be wondering what happens to your employer retirement plan if your employer goes out of business.  When that happens, any retirement plan your employer sponsored will be terminated. 

If the plan is a 401(k) or other defined contribution plan, your benefits are held in trust, apart from your employer's assets, and are not subject to the company's creditors.  You'll generally be entitled to receive your full account balance in a lump sum and can roll your payout into an IRA or another employer's plan.

 If your employer sponsors a defined benefit plan, it gets a little more complicated. A defined benefit plan promises to pay you a specific monthly benefit at retirement. While defined benefit plan assets are also held in trust (or insurance contracts), apart from your employer's assets, whether a particular plan has enough cash to pay promised benefits depends on your employer's contributions and the plan's investment earnings and actuarial experience.

When a defined benefit plan is about to terminate, the Pension Benefit Guaranty Corporation (PBGC), a federal agency created specifically to protect employees covered by these plans, is notified. If the plan has enough money to cover all benefits that participants have accrued up to the plan termination date, then the PBGC will permit a "standard termination," and your employer will either purchase an annuity from an insurance company (which will provide lifetime benefits when you retire) or, if your plan permits, let you choose a lump-sum equivalent.

If the plan doesn't have enough money to pay all promised benefits earned up until plan termination (that is, the plan is "underfunded"), the PBGC will take over the plan as trustee in a "distress termination," and assume the obligation to pay basic plan benefits up to legal limits. For plans ending in 2012, the maximum annual benefit (payable as a single life annuity) is $55,840 for a worker who retires at age 65. If you begin receiving payments before age 65, or if your pension includes benefits for a survivor or other beneficiary, or if your plan was adopted (or amended to increase benefits) within five years of the termination, the maximum amount is lower. According to the PBGC, only 16% of retirees in recent years have seen their benefit reduced because of the annual dollar limits.

What to do if automatically enrolled in your 401k

When you start a new job, you may now find yourself automatically enrolled in the company 401(k) plan.   Auto-enrollment is designed to increase participation and overall retirement savings, but it's a mistake to assume that the investment decisions your employer has made on your behalf are right for you. Instead, take charge of your own retirement savings right now by following these four steps.

Step 1: Get the facts

Your employer will typically enroll you based on a default contribution percentage deducted from your paycheck and a standard investment option.  You have the option to increase or decrease your contribution rate, move money from one investment option to another, or even opt out of the plan altogether.   Your employer is required to send you information about the plan provisions and your investment options, along with specific instructions on how to make changes or opt out.

Step 2: Consider your contribution rate

Like many people, you may be tempted to stick with the contribution rate your employer has chosen for you. But this contribution rate (typically 3 percent) may be less than you need to contribute to target your retirement savings goal. Find out what company match your plan provides, and contribute at least enough to receive the full match if possible.   If you're under 50, you can contribute up to a max of $17,000 this year; those 50+ can contribute up to $22,500.

Step 3: Review your investment options

The most common default investment options chosen by employers are money market funds, stable value funds, and target retirement date funds.  Money market and stable value funds are conservative and designed to not lose money.  Target retirement funds vary based on your age.  Depending on how much you need to save for retirement, how far away you are from retirement, your tolerance for risk, and your investments outside your 401k, you may want to redirect some of your contributions into other investment investments.

Step 4: Check up on your plan at least once a year

Even if you've decided to stick with your company's default options for now, review your investment options and contribution rates at least once a year.  This is also a good time to rebalance your account back to your target allocation.

As you make decisions, think about your overall retirement plan, including where your retirement money will come, the major expenses you might have (e.g., housing, medical care), and the lifestyle you hope to lead (e.g., traveling frequently, owning a second home).

Personal Finance Workshops at the Keller Public Library resume in September.  If you have requests for upcoming topics, please let me know!