Karl W. Blovet & Associates

Investment Planning

  1. Start now, not later.
  2. Set reasonable savings goals, and then live below your means. Being frugal is the cornerstone of wealth management.
  3. Know what to expect based on a long history of investor experiences. Look at average rates of return over long periods of time.
  4. Manage your risk – it can’t be avoided. There are two types: Volatility – actual returns vary compared to expected returns. Inflation – relates to losses in purchasing power.
  5. Diversify.
  6. Maintain a long-term perspective – the market rewards the patient investor.
  7. Do not attempt to time the market on what you or the experts expect the market to do.
  8. Know what your costs are – avoid loads, commissions, and expensive investment advice.
  9. Beware of the experts.
  10. Defer taxes unless unavoidable. Pay later than sooner.

Market conditions are compelling investors to reassess their investment strategies. Investors again value investments that emphasize capital preservation. Fortunately, there are viable alternatives when seeking safety. Because safety means lower returns, you must maintain a strict policy of minimizing investment costs. Investments with a higher degree of safety can be found in bonds and annuities. The following discussion is not intended to recommend one investment over another, but to highlight the necessity to fully analyze any investment from an integrated tax, risk, return, and cost perspective.

Debt-Based Products

Bonds can offer a higher degree of principal protection than equity securities, but they are not as readily tradable. Due to liquidity factors, obtaining reasonable pricing requires considerable effort on an investor’s part. However, this effort is well rewarded because a bond’s fixed return component means that higher fees have a significant negative impact on returns. Options range from actively “pricing out” a bond issue, buying an initial bond issuance, or purchasing a low-cost bond fund. Bonds typically have a lower return potential than equities due to enhanced safety, although one can purchase junk bonds for higher returns, but with greater risk.

Treasury Securities

Treasury securities are backed by the full faith and credit of the U.S. government. They are considered the safest investment available. The major drawback is that yields on these securities have fallen to historic lows. The prior budget surplus has reduced the offering of these securities, but they still can be purchased directly from the U.S. government (www.treasurydirect.gov/). Directly purchasing from the government is a distinct advantage in that you can obtain a market-based price without having to negotiate with a third party on pricing and/or to incur trading commissions. The Treasury now only issues notes that mature in 10 years or less (the 30-year bond is no longer issued). Treasury interest is free from state income taxation.

Treasury Inflation Protected Securities

Treasury inflation protected securities (TIPS) are a relatively new investment option whereby an investor is protected against inflation. These bonds pay a lower fixed rate, but the principal value is adjusted upward to offset inflation (based on the Consumer Price Index). In the current low interest rate environment, this feature is highly appealing if interest rates start to increase. A major drawback is that the principal adjustment is taxable as credited, but not paid until maturity. The use of a tax-deferred or tax-free account (such as a Roth IRA) would make this tax problem irrelevant.

Agency Securities

Agency securities are debt instruments issued by a governmental entity that is part of the U.S. government. Because they are typically not backed by the full faith and credit of the U.S. government (only indirectly backed), they generally pay a slightly higher rate of interest than Treasury securities.

Ginnie Maes

Ginnie Maes securities represent pools of mortgages that are backed by the full faith and credit of the U.S. government. You can purchase a Ginnie Mae directly ($25,000 minimum), but the use of a low-cost Ginnie Mae mutual fund is probably a better approach. Funds can offer greater diversification in underlying pools and professional management. The major risk is that principal is typically paid back when interest rates fall, and therefore, Ginnie Maes would tend to lose value.

Municipal Bonds

Municipal bonds have the tax advantage that their interest payments are free from the regular federal tax. However, the alternative minimum tax (AMT) can be applicable if they are “private activity bonds issued after August 7, 1986.” The AMT is affecting more taxpayers with the imposed 2001 scheduled tax rate decreases. Private activity bonds tend to offer higher yields due to this distinct tax disadvantage. Another disadvantage is that state income taxation of municipal bond interest occurs if it is not issued from the state in which the taxpayer resides. The interplay of the federal regular income tax, alternative minimum tax and state income taxation necessitates a high degree of tax planning to maximize after-tax returns.

Corporate Bonds

Corporate bonds generally offer the highest yields but without the safety level of government-backed bonds. Additionally, they are taxable on the federal and state levels. You can obtain corporate bond pricing data from the National Association of Securities Dealers, Inc. (NASD) for approximately “500 investment-grade corporate bonds” at www.nasdbondinfo.com/asp/home.asp. One alternative is to invest in preferred and convertible preferred shares instead of corporate bonds.

Other Debt-Based Products

Other debt-based products are bank-based certificates of deposits (CDs), saving accounts, money market accounts and savings bonds. Savings bonds (HH, EE or inflation indexed) in certain circumstances are ideal investment vehicles. For the highest yielding money market funds and bank accounts, you can find yields at www.imoneynet.com and www.bankrate.com. However, a higher yield, as always, can indicate additional risks. A bank investment has the advantage of being federally insured up to $100,000. Money market funds are not insured, and losses, while infrequent, do occur.


Annuities have income tax advantages, but they typically are loaded with excessive fees. A $50,000 annuity can generate brokerage fees of up to $4,000, which virtually negates the tax advantage. Proceeds in excess of the investment are taxable as ordinary income upon withdrawal. Also, amounts withdrawn before age 59 ½ are subject to a 10-percent early withdrawal penalty. Additional complicating factors are surrender fees and annual operating fees. It is essential that you seek independent assessment prior to purchase; we can assist you in this area.

Fixed Annuities

Fixed annuities offer a high degree of payout certainty (as long as the underlying company is financially viable). However, they are typically expensive to purchase, resulting in lower overall return potential. Web sites such as www.immediateannuity.com and www.brkdirect.com can be used to obtain competing rates of return. Caution is necessary in verifying an insurance company’s financial credit worthiness. Moody’s reported that American International Group, MetLife, Aegon and Prudential Financial each had over $1 billion in credit “exposure” from bond investments in Worldcom, Enron, Qwest, Williams, TYCO, Dynegy, Global Crossing, Adelphia Communications, Kmart and Xerox. In total, life insurers “held about $23 billion” in these companies, most of which were considered “financially stable” until recent events. State guaranty plans offer only limited protection.

Variable Annuities

Variable annuities are essentially mutual funds with tax deferral. They offer a limited insurance element to qualify under the tax law. There are low expense annuity options available, but “many variable annuities carry substantial fees, as high as 4% annually.”

Dividend Paying Stocks

Dividend paying stocks are now looking much more attractive. Companies, such as Disney, even converted from the standard quarterly distribution to an annual distribution. Dividend yields had dropped to one percent, but are now above two percent. Although, there is no guarantee that any company will pay dividends.

Real Estate Investment Trusts

Real estate investment trusts (REITs) speculate in real estate properties. They typically have a high dividend yield because, in order to qualify for favorable tax treatment, they must distribute 90 percent of their income back to the shareholders. REITs have had a remarkable performance in the current market conditions, but as history shows, the best performing asset classes do not maintain their status indefinitely. REITs can be equity or mortgage based or a combination of both. Mortgage-based REITs subject investors to additional credit risks and were often considered part of the prior problem with this asset class. REITS can be issued on a variety of rental properties.

Guarantee Funds

Guarantee funds are sold on their ability to guarantee investors at least the return of their initial investment (principal). The funds have high fee structures, are limited in the assets in which they can invest and typically offer a principal guarantee only after several years. As the market falls, they are forced to sell more of their equity holdings and place the proceeds into bond-based products. In essence, you obtain an expensive balanced fund (containing both debt and equity) that will move more towards bond-based funds when the markets fall. As the funds invest in more bonds, their yearly tax effect will increase, and therefore, they are not “tax friendly.” Sales charges over five percent are not uncommon, and these funds have an average annual expense ratio of 1.5 percent.

Tax-Integrated Investing

Besides offering an independent assessment of investment alternatives, we can assure that the tax impact of different investments is fully and correctly integrated in financial planning. Investors and/or their advisors all too often ignore the following:

1. Tax-exempt interest considerations

  • How does the AMT affect the situation?
  • Is interest on municipal bonds taxed at the state level?

2. Treasury securities

  • Ability to defer income taxation to the next tax year
  • Advantageous avoidance of state income taxation
  • Ability to match maturity of a Treasury security with the tax obligation

3. Use of tax-deferred accounts to invest in unfriendly tax investments (interest paying, TIPS, etc.)

4. Utilization of the new capital gains rates of 18 percent and 8 percent

5. Proper use of tax losses

6. Consideration of transfer taxes and stepped-up basis issues


The current market downturn has forced investors to reassess their financial plans. Emphasis needs to be placed on investments with better return characteristics, as opposed to recommending a particular investment product. We believe that clients require unbiased information, not a sales pitch. Due to the fact that most brokers work on a commission basis, a direct conflict of interest exists between brokers and their clients. We can ensure that you are fully aware of the tax, risk, return, and cost factors of investing.

This year in particular, year end tax planning is full of uncertainties. This makes it even more difficult than previous years. If you believe that tax rates will not rise in 2011, including the 15% top rate on qualified dividends and long term capital gains, here is what most taxpayers should consider doing:

Accelerate deductions from 2011 to 2010 and defer income into early 2011 (do not jeopardize collection of the income), unless you expect to be at a higher marginal tax rate in 2011.

If you qualify to itemize deductions shift state and local income taxes into 2010. Pay your estimated tax payment s due in January, 2011 in December, 2010. This is not a strategy if you expect to be subject to the dreaded “alternative minimum tax” in 2010. Accelerate charitable contributions into 2010. If possible, make the donations using appreciated investments held more than one year. Do not donate investments that have declined in value. Pay your January, 2011 mortgage payment in December of 2010.

If you plan to do a Roth IRA conversion, converting in 2010 allows you to spread the resulting tax over 2011 and 2012. If you wait until 2011 to convert, the two year spread is not available.

Harvest capital losses, matching losses with capital gains to produce a net loss of $3,000. If you have a capital loss carry forward (from 2009 and earlier years), harvest capital gains if it fits your overall investment strategy in order to take advantage of the tax benefit.

Cashing out when changing employers: This act will cost you ordinary income taxes on your savings, as well as a 10% penalty. This should be an act of last resort only.

Doing nothing when changing employers: There are many reasons people leave their savings with former employers. Some fear of making a mistake, fear the amount of paper work involved, and some people are satisfied with the performance of their investments in their former plan. In general, by creating a new account and doing a direct transfer of your savings, you will have better investment options, you can consolidate your retirement savings accounts (easing your administrative burden), and better control the related expenses.

Not updating beneficiary designations: Because the inheritance rules regarding IRAs are so complex, it is imperative to make sure that your not creating a disaster for your loved ones by ignoring beneficiary designations.

Forgetting to invest the savings transferred: The last step is to choose the appropriate asset allocation after you have created the new account and transferred the savings. According to the Vanguard Group, many people forget to actually invest the savings once its been transferred. Instead, it sits in low-yielding money market accounts.

US Large Cap Stocks: Large US companies generate a significant portion (41% of revenues for the S & P 500 in 2005) of their revenue abroad. When the dollar is weak, international sales denominated in foreign currency translate into more revenue in dollars.

Foreign Stocks: US investors with a reasonable allocation to international stocks should get help as well. When the dollar declines in value, the value of international stocks goes up in dollar terms.

Foreign Bonds: Having a small portion of your allocation invested in bonds denominated in foreign currencies could provide a boost as well.

The key to compensating for the weak dollar is to maintain a globally well-diversified allocation. We recommend using no-load, low expense ratio index funds, or ETFs for those seeking broad international exposure.

Faced with a turbulent stock market and an economy in flux, we are increasingly worried about our finances. And though investors admit to financial planners’ expertise, few consult one. So says a survey the AICPA commissioned to better understand how we manage our money.

Harris Interactive, an Internet-based market research firm, conducted the survey, “Report on America’s Financial Health,” for the AICPA. Almost all respondents (91%) said they manage their finances themselves, doing their own research, and obtaining advice from family, friends, the Internet, or a broker. The survey revealed that almost three out four respondents (71%) have been thinking more about their finances in the last three years. But only 20% thought they were very prepared for retirement. Others were uncertain about their financial future, 81% were not sure their investments were earning as much as possible and 57% were not certain they knew how to minimize their taxes through proper planning.

The survey also revealed that even individuals who felt confident about their money management skills may have been off the mark. More than half of those who believed they were maximizing savings and earnings felt this way because they had personally researched their mutual funds, understood how much investment risk they should take, had a short-term savings plan or owned real estate. But almost 90% of the respondents lost money in the last six years because of quick decisions they made about financial matters without talking to a planner.

Why didn’t more of the investors consult one? Most sought out professional advice in special situations rather than as a matter of overall strategy. For example, respondents said they would contact a financial planner if they inherited money, wanted to plan for retirement, needed estate planning advice, wanted to rollover 401(k) or IRA funds or were confused by changing tax laws.

Tips for Your Asset Allocation

There is no one-asset allocation formula suitable for all investors. You must evaluate your risk tolerance, time horizon, and rate of return requirements in order to determine how you should allocate your portfolio among the various investment categories. Consider the following:

  • The idea behind asset allocation is that different investment categories are affected differently by economic events and market factors. Some asset classes move in opposite directions (negatively correlated) while others move in the same direction (positively correlated). By investing in different types of assets, it is hoped that when one asset declines in value, other assets will increase in value.
  • Investments with higher return potential generally have higher risk and more volatility. While most investors want higher returns, they may be uncomfortable assuming higher risk levels. Asset allocation enables you to combine more aggressive investments with less aggressive ones. The combination can help reduce the overall risk in your portfolio.
  • Not only should you diversify across broad investment categories, such as equities, bonds, and money market funds, you should also diversify within the category of equities. For instance consider large-capitalization stocks, small-capitalization stocks, value stocks, growth stocks, and international stocks.
  • Determining your risk tolerance is one of the most important components of asset allocation. You are determining your emotional ability to stay with an investment when the returns are less than expected. The last two years should serve as a good framework for that assessment.
  • The longer your time horizon, the more aggressive you portfolio can be. Those with a time horizon of less than five years should not be invested heavily in equities. Look at bonds and money market funds for your short term needs. As your time horizon increases, you should have a higher percentage of equities in your portfolio.
  • Have reasonable return expectations. Basing your portfolio on a rate of return too high may cause you to increase the risk in your portfolio.
  • Rebalance your portfolio at least annually, if warranted. With time, your asset allocation percentages will change from your desired percentage as a result of varying rates of return for your different investments.
  • Be patient. The results of an investment program are best evaluated over a period of years, not days, weeks, or months.

For those of you who have procrastinated in the past about doing financial planning, Now is a “perfect time” to map out your strategy.

What follows is a brief outline of the areas you need to address:

1. Determine your spending habits.

  • Look at your expenditures from last year.
  • Break them out between necessities (food, utilities, transportation, mortgage payments, rent, etc.) and non-necessities (vacations, hobbies, entertainment, recreation etc.).
  • Make sure you have three to six months of cash available in case of an emergency, such as an unexpected job loss, in order to cover the necessity type of expenditures.
  • Also, set aside amounts for planned expenditures such as a vacation or the purchase of a new car.
  • Finally, determine if you can cut back on any of your expenses.

2. Determine your net worth.

  • Begin by adding up the value of your assets (house, car, boat, investments, 401(k), etc.).
  • Next, subtract the amount of your liabilities (mortgage balance, credit card debt, loans, etc.).
  • The result is your net worth.

3. Prepare a credit plan.

  • As a result of determining your net worth, you know the exact amount and nature of your debt.
  • Begin by checking your credit score report (www.myfico.com).
  • If you have too much credit card debt, create a realistic pay-down plan.
  • Find a credit card company that offers the most favorable terms on balance transfers, and use the new account to consolidate your debt balances, but consider any negative impact on your FICO score first.
  • Make sure that you stick with your pay-down plan.

4. Determine your philosophy relative to investing.

  • Write down your long term and short-term goals (why you are investing).
  • Determine you risk tolerance (what mix of investments will allow you to sleep at night).
  • Consider your tax situation and how often you want to rebalance your mix of investments.
  • Remember, investments are only a vehicle to help you attain your goals and objectives.

5. Do tax planning throughout the entire year.

  • Maintain good records. Keep receipts.
  • Analyze your current social security statement for accuracy.
  • Consider the tax implications of any major expenditure.
  • Review your prior year tax returns to become more familiar with the type of income and deductions you typically incur.
  • Educate yourself relative to the tax nuances for your income and deductions.

6. Make sure you have adequate insurance (property, health, life and disability).

  • Appropriate insurance coverage is critical to any financial plan. This is not area where you want to skimp.
  • Make a list of all coverages.
  • Determine your deductibles, over all limits, co-payments, premiums, etc.
  • This should be reviewed annually and discussed with your insurance agent.

7. And finally, resolve to save more.

Asset allocation is your target mix of stocks, bonds, and cash. Without periodic monitoring, your allocations may stray considerably from your target allocation.

For you to maintain your asset allocation and risk-control strategies, you should:

  • Check your asset class weightings semi-annually, or minimally annually.
  • Rebalance whenever any asset class has strayed more than 5% from your target allocation.
  • Time your rebalancing to coincide with a memorable date, such as a birthday or an anniversary.

It is best to rebalance tax-deferred accounts (401(k) or IRAs) first, since there are no tax consequences. Also, you should determine the amount of any related transaction costs.

By now you should have received your stockbroker’s Form 1099-B. This form is also sent to the IRS and indicates the dollar value of the stock you sold last year. We use this as the minimum amount that is reported on your Form 1040. Any amount less, may generate an IRS Notice. Depending on the broker, the information contained with the 1099-B may be all we need to prepare your tax return. Many brokers are now including not only the proceeds from the sale of stock, but also the basis (cost of your stock) in the stock sold. Unfortunately, they do not always include the basis. As a result, you need to provide us with the information. When you provide your basis, it makes our job easier and less expensive for you. Here are some rules in determining your basis:

  • With regard to mutual fund shares, the most common method in determining basis in your shares is the “average cost” method. This means you take the cost of all your shares purchased, including dividend reinvestments, and divide the total by the number of shares on the date of sale. The result is the average cost of shares (your basis). Alternatively, you can use the double-category method, whereby you total the cost of shares held more than one year and total the cost of shares held one year or less. You then figure the average cost per share for each group.
  • Under the specific identification method, you specify which shares have been sold. Your basis is what you paid for those shares when you acquired them. In order to use this method you must give written notification to the fund as to which shares you are selling
  • If you do not specify a method for calculating basis, the IRS assumes that you use the FIFO method, where the shares sold are the ones you have held the longest, which usually results in the largest capital gain.
  • With regard to individual stocks, you may also use the specific identification method and you also must give written notification to your broker to identify the shares that you are selling.
  • As with mutual fund shares, if you do not identify the shares sold, the IRS assumes that you use the FIFO method.

These are just a few of the complex rules with regard to purchasing and selling securities. If you have any questions, please call.

A study of 17,000 stock mutual fund share classes by Standard & Poor’s, determined that fund expenses are a critical factor in fund performance.

The study found that over a ten-year period, stock funds with lower than average expense ratios performed better than funds with higher than average expense ratios in all investment style categories except one. The exception was the mid-cap blend category.

It is important for you to keep fund expenses in the forefront of your analysis when selecting funds for your portfolio.