Good afternoon, and happy new year!

The US investment markets are off to a great start so far in 2013 -- up more than 2% in one week from the fiscal cliff compromise rally.  It's fun, but just like any other short-term positive or negative market fluctuation, we shouldn't get too excited about it.  We do have some excellent results to review for 2012 -- a full report on last year's investment markets is below.

Also in this month's newsletter, we have details on the fiscal cliff compromise that may affect you, resources for retirees going back to college, some perspective on the fallacy of trying to predict investment markets, and more.

If you're planning to participate in the Countdown to Retirement workshop series, I look forward to seeing you next Tuesday evening the 15th at the library in Keller (see all the details below).  As always, please don't hesitate to contact me with suggestions for newsletter articles or questions on your financial planning world.  Thanks for reading, and Live Well!

2012 Investment Year in Review

Many of you reading this will be surprised to discover that 2012 was a great year to be an investor.  Amid the unhappy headlines, anxiety over America's finances, a highly-partisan presidential election, worries about the Eurozone and the potential for recession, stocks quietly rewarded patient investors with double-digit gains.

The  Russell 3000 index, representative of the broad US stock market, rose 16.42% in 2012.

The other stock market sectors moved in a very similar pattern.  Large cap stocks, represented by the S&P 500 index gained 16% in 2012.  The Russell midcap index was up 17.28% for the year.

The Russell 2000 small-cap index gained  finished the year up 16.35%.  

Every single industry sector in the S&P 500 except utilities posted gains in calendar 2012, led by telecommunication stocks (up 12.50%), information technology (up 13.15%), consumer discretionary goods manufacturers (up 21.87%), and financial stocks (26.26% gains for the year).

Global stocks provided comparable returns.  The broad-based EAFE index of larger companies in developed economies rose 17.32% for year. The stocks across the Eurozone economies returned a robust 17.45% for the year, outpacing the Far East economies (9.11% for 2012).  The EAFE Emerging Markets index of lesser-developed economies rose 18.22% for the year.

The dark clouds were relatively small.  Commodities barely eked out positive returns, with the S&P GSCI index rising 0.08% for the year, led by agriculture (up 6.46%) and precious metals (up 6.21%).  Energy stocks were down 1.37%.

Real estate investments were among the biggest gainers, with the Wilshire REIT index posting a 17.59% gain for the year.

Investors who believed the negative headlines and pulled their money out of equities into safer havens suffered accordingly.  Treasury bonds are still mored in near-record low-return territory; if you lend the U.S. government money by purchasing a 2-year Treasury, your current coupon rate is 0.25% a year.  Five-year yields are still below 1% (0.72%), and 10-year (1.76%/year) and 30-year (2.95%) T-bonds are not in danger of enriching their purchasers.  Muni bonds are sporting aggregate yields of 0.20% (1-year), 0.29% (2-year), 0.84% (5-year) and 1.69% (10-year).  The aggregate of all AAA corporate bonds is yielding 0.72% for bonds with a five-year maturity; 1.76% if you go out ten years. 

It is helpful to remember that the year started off with dire predictions and a lot of uncertainty about the prospects for the U.S. and global economies.  The housing market was weak, unemployment was high, the Euro economies were in recession (or, in the case of Greece, bankrupt), and it was not hard to find blogs and even economic reports that predicted a catastrophic year.  Investors who ignored the gloom and doom were rewarded with returns approximately twice as high as the historical averages.

It is clear that the U.S. economy is still in a slow-growth recovery period, but there is some reason to be optimistic that 2013 could be a turning point in the long climb out of the Great Recession.  After six years of decline, the housing market appears to have finally bottomed out in 2012.  The inventory of homes on the market is down 20% or more from a year ago, and sales of existing single-family homes jumped 11% in 2012.  Bank of America Merrill Lynch economies expect at least a 3% gain from the housing sector this year, which would flip this large sector of the economy from a drag on economic growth to a boost, along the way creating construction jobs and boosting sales of appliances and other products that go with home purchases. 

At the same time, the National Association for Business Economics is forecasting a slow but steady increase in employment this year, and consumer debt is shrinking.  The still-weak global economy seems unlikely to cause gas prices to rise dramatically, and some economists have pointed to the record amount of money parked in Treasuries (hence the low rates), which, if people become more confident in the stock market, could be redeployed into equities and cause prices to rise.

Of course, we're not in the business of making predictions (more on the fallacy of predictions later in the newsletter), but the results in 2012 were a pleasant reminder that the fundamentals of a long-term, patient investment strategy still hold true.  And regardless of whether the positive economic signs materialize into profitable investor returns in 2013 and the near-term, we can remain confident that disciplined investors will continue to be compensated for taking the risk of investing over the long-term.

Adapted with permission from Financial Columnist Bob Veres.

Fiscal Cliff Compromise Details

Unless you were living on the moon this past week, you know that Washington policymakers finally reached a so-called "fiscal cliff" deal that avoids a sudden return to tax rates that are now more than a decade old.  But for some reason, news outlets have been a bit stingy about telling us exactly what's in the American Taxpayer Relief Act of 2012.

The American Taxpayer Relief Act of 2012 (ATRA) permanently extends a number of major tax provisions and temporarily extends many others. Here are the basics.

For most individuals, the legislation permanently extends the lower federal income tax rates that have existed for the last decade. That means most taxpayers will continue to pay tax according to the same six tax brackets (10%, 15%, 25%, 28%, 33%, and 35%) that applied for 2012. The top federal income tax rate, however, will increase to 39.6% beginning in 2013 for individuals with income that exceeds $400,000 ($450,000 for married couples filing joint returns).

Generally, lower tax rates that applied to long-term capital gain and qualifying dividends have been permanently extended for most individuals as well. If you're in the 10% or 15% marginal income tax bracket, a special 0% rate generally applies. If you are in the 25%, 28%, 33%, or 35% tax brackets, a 15% maximum rate will generally apply. Beginning in 2013, however, those who pay tax at the higher 39.6% federal income tax rate (i.e., individuals with income that exceeds $400,000, or married couples filing jointly with income that exceeds $450,000) will be subject to a maximum rate of 20% for long-term capital gain and qualifying dividends.

The two percentage point reduction in the Social Security payroll tax--a stimulus measure enacted in 2010--was also eliminated, which is likely to be the biggest impact of the legislation on most taxpayers.  The payroll tax rises from 4.2% last year to 6.2% this year.

• "Marriage penalty" relief in the form of an increased standard deduction amount for married couples and expanded 15% federal income tax bracket
• Expanded tax credit provisions relating to the dependent care tax credit, the adoption tax credit, and the child tax credit
• Higher limits and more generous rules of application relating to certain education provisions, including Coverdell education savings accounts, employer-provided education assistance, and the student loan interest deduction

• Provisions relating to increased earned income tax credit amounts for families with three or more children are extended through 2017
• American Opportunity credit provisions relating to maximum credit amount, refundability, and phaseout limits are extended through 2017
• The $250 above-the-line tax deduction for educator classroom expenses, the limited ability to deduct mortgage insurance premiums as qualified residence interest, the ability to deduct state and local sales tax in lieu of the itemized deduction for state and local income tax, and the deduction for qualified higher education expenses are all extended through 2013
• Charitable IRA distributions (IRA holders over age 70� are able to exclude from income up to $100,000 in qualified distributions made to charitable organizations) are extended through 2013; special rules apply for the 2012 tax year
• Exclusion of qualified mortgage debt forgiveness from income provisions extended through 2013
• Exclusion of 100% of the capital gain from the sale of qualified small business stock extended to apply to stock acquired before January 1, 2014
• 50% bonus depreciation and expanded Section 179 expense limits extended through 2013
• Allow individuals to convert their existing 401(k) plan to a Roth 401(k) plan, if the employer offers designated Roth accounts under the plan, regardless of whether the individual is allowed to take a distribution out of the plan.  

Spending and Moving Forward

Finally, the new tax law makes $24 billion in federal spending cuts, while giving Congress two additional months to decide what to do about $109 billion of automatic spending cuts that were scheduled to begin taking effect at the start of this year.

You can expect those two additional months to be spent in partisan wrangling over where, exactly, federal expenses should be cut, and news outlets have been repeating over and over the fact that March 1 also happens to be the next time that Congress has to vote to raise the debt ceiling.  We don't know whether that next debate will spill over into tax rates once again, but we will be paying attention and will keep you posted.

Adapted with permission from Financial Columnist Bob Veres and Broadridge Investor Communication Solutions, Inc. 

The Fallacy of Predictions

One of the more interesting myths in the investment world is that large financial institutions, with their access to mountains of data pored over by teams of staff economists, can determine where the markets are going and profit accordingly.  Gullible investors believe this even though, every year, we can go back to the confident predictions of brokerage firm leaders and leading hedge fund managers and see a hard-to-explain gulf between expectation and reality.

This past 12 months, the broad U.S. markets delivered roughly a 16% return, depending on which of the indices you're measuring--a good year by any standard.  So let's jump into a time machine and see whether the brokerage firms were telling us to go all-in on stocks and take full advantage of this nice little bull market run.

They weren't.  Not to pick on anyone in particular, but looking at some specific examples helps to highlight the point.

Adam Parker, who serves as the U.S. equity strategist for the mighty Morgan Stanley organization, boldly predicted that the S&P 500 index would fall 7.2% in 2012.  He recently said that he underestimated the impact of central bank stimulus.

Credit Suisse's "strategist" Andrew Garthwaite, Wells Fargo "strategist" Gina Martin Adams and Bank of America/Merrill Lynch "strategist" Savita Subramanian forecast essentially flat returns for U.S. equities,

David Kostin of Goldman Sachs, meanwhile, predicted that the S&P 500 would drop 25% in the midst of a Euro collapse, and boldly predicted that Europe's sovereign debt crisis would worsen "almost daily."  John Paulson, founder of what may be the most famous global hedge fund, based in NY, told clients in April that he was wagering heavily against European sovereign bonds.  UBS economist Jonathan Golub forecast struggling equities in the face of European recession.

In fact, the Eurozone became practically the epicenter of bad Wall Street predictions; crafty traders watched in dismay as Greek bonds surged in value in 2012, and the Euro itself strengthened about 9.4% from its July 24 low against the dollar.  Germany's DAX Index managed to survive the predicted freefall by returning 29% to investors who ignored their brokers and stayed the course in Europe.  The most dire predictions came from Citigroup economist Willem Buiter in London, who told reporters last February that there was a 50% chance Greece would leave the euro within 18 months.  In May, he raised the risk to 75%, and cited a 90% chance of departure in July--and said he was assuming that there would be an exit by January 1.

2012 is not an isolated incident; in fact, last year a company called CXO Advisory Group--which tracks more than 60 market "gurus" (the company's term)--calculated that the average Wall Street expert forecaster had been accurate only 48% of the time over the long term.  Translated, that means that a coin flip is a slightly more accurate predictor of the future than the experts you see on cable's financial TV channels.

But of course this is the season when, once again, the experts, economists and visionaries put on their gypsy shawls, get out their crystal balls, and tell you with calm certainty where the markets are going in 2013.  You are about to be deluged with confident predictions from Wall Street, along with Money Magazine telling you "the smart place to put your money now," and once again it will all sound believable.  Perhaps the best advice is to imagine, as these gurus come on the tube, that they are wearing tall, floppy wizard hats with a bright crescent moon inscribed on the front. Or you can turn off the TV and pull out a more reliable guide to the future: any one of the coins in your pocket that happens to have a head and a tails.

And while you're enjoying this humorous image, pat yourself on the back because you know that we don't have to predict market movements to be successful investors.  Maintaining a disciplined, diversified, low cost investing strategy doesn't require a crystal ball to help us meet our goals.

Article adapted with permission of Financial Columnist Bob Veres.

Economics of Borrowing from Your 401k

When times are tough, the money sitting in your 401(k) plan account may start to look attractive. But before you decide to take a plan loan, be sure you understand the financial impact. It's not something to do lightly.

The basics of borrowing

A 401(k) plan will usually let you borrow as much as 50% of your vested account balance, up to $50,000.  You pay the loan back, with interest, from your paycheck. Generally, you have up to five years to repay your loan, longer if you use the loan to purchase your principal residence.

You pay the interest to yourself, but...

When you make payments of principal and interest on the loan, the plan generally deposits those payments back into your individual plan account.  This means that you're not only receiving back your loan principal, but you're also paying the loan interest to yourself instead of to a financial institution. However, the benefits of paying interest to yourself are somewhat illusory. Here's why:

To pay interest on a plan loan, you first need to earn money and pay income tax on those earnings. With what's left over after taxes, you pay the interest on your loan. That interest is treated as earnings in your 401(k) plan account. When you later withdraw those dollars from the plan (at retirement, for example), they're taxed again because plan distributions are treated as taxable income. In effect, you're paying income tax twice on the funds you use to pay interest on the loan. (This doesn't apply to a Roth 401k.)

...consider the opportunity cost

When you take a loan from your 401(k) plan, the funds you borrow are removed from your plan account until you repay the loan. While removed from your account, the funds aren't continuing to grow within the plan. So the economics of a plan loan depend in part on how much those borrowed funds would have earned if they were still inside the plan, compared to the amount of interest you're paying yourself. This is known as the opportunity cost of a plan loan, because by borrowing you may miss out on the opportunity for additional tax-deferred investment earnings.

Other factors

If you take a loan, will you be able to afford to pay it back and continue to contribute to the plan at the same time? If not, borrowing may be a very bad idea in the long run, especially if you'll wind up losing your employer's matching contribution.

Also, if you leave your job, many plans provide that your loan becomes immediately payable. If you don't have the funds to pay it off, the outstanding balance will be taxed as if you received a distribution from the plan including any penalties.

Plan loans may make sense in certain rare cases (for example, to pay off high-interest credit card debt or to purchase a home). But make sure you compare the cost of borrowing from your plan with other financing options, including loans from banks, credit unions, friends, and family.   The 401k should be a last resort, not the first-stop piggy bank.

Some material adapted with permission of Broadridge Investor Communication Solutions Inc.

Here's the schedule for my first quarter 2013 Keller Personal Finance Workshops.    The series is entitled Countdown to Retirement and is designed for individuals and couples within 5 - 10 years of retirement

 January 15, Part I: Creating your Retirement Plan

This session will cover how to maximize tax-efficiency in saving for retirement, assessing when it's time to retire, building a retirement budget, and making decisions on possible long term care funding needs.

February, Part II: Maximizing your Social Security Benefit

Attendees will learn how to increase their retirement income by making smart decisions on social security benefits.  We'll cover how to decide when to file, filing strategies for couples, and how to plan for taxes on your social security benefit.

March, Part III: Investing in Retirement

Attendees will learn how to adjust their portfolio to shift from accumulation to distribution and steps they can take to minimize the effect of a market downturn on their retirement plans.  We'll also cover the basics of how to build a low-cost retirement portfolio.

Cost: Free

Time: 6:30 pm, 3rd Tuesday of the month

Location: Keller Public Library, 640 Johnson Rd

RSVP: Please RSVP to [email protected]