Rancho Cordova

Wall Street‘s self-regulating agency wants to increase its power over more financial advisory firms.

Financial Industry Regulatory Authority’s (FINRA) currently performs financial regulation of member brokerage firms and their employees but now with the endorsement of politicians like Rep. Spencer Bachus it’s pushing to regulate Registered Investment Advisors (RIAs) which are currently regulated directly by the Federal and State Governments.

RIAs, which typically serve as financial advisors to individual investors, are currently required to operate under the highest standard of investor protection called the Fiduciary Standard–putting the client’s interest before their own. Most of Wall Street however operates under the Suitability Standard, which provides a much lower safeguard for investors.

FINRA oversees all the securities dealers in the country and they as a group have no desire to operate under the fiduciary standard. There is a concern that FINRA could over-regulate RIA’s and many small RIA’s would fold, which would harm the public and eliminate completion for its Securities Dealers members. FINRA’s press liaison Nancy Conrad disputes that possibility.

The National Association of Securities Dealers (NASD) a self-regulatory organization changed its name to FINRA in 2007. The change of name obscures the purpose of the organization to this writer and can confuse the public or mislead investors that FINRA is best suited to protect the public from its own members. Some believe that FINRA protecting the public is about as disastrous as the “Fox guarding the hen house”. Again FINRA spokes men states that FINRA

FINRA seems to more accurately protect the interests of the Financial Services Companies as demonstrated by:

1. FINRA’s CEO opposes the imposition of the current fiduciary standard on it’s Broker Dealer members when he said “…one-size-fits-all approach won’t work for every client, advisor and transaction.” Ms Conrad said that  ”FINRA Chairman and CEO, Rick Ketchum has long supported a fiduciary standard for both securities firms (BDs) and Investment Adviser firms.” Come on, if thats the case why don’t BD Reps operate as a fiduciary now?
2. FINRA self admits that they have done a poor job with “shortcomings in our examination program”.
3. FINRA arbitration process seemingly protects the Industry where in over 14,000 FINRA arbitration awards over a ten-year period, investors with large claims against major brokerage firms recovered only 12 percent of the amount claimed.
4. Another example is who serves on FINRA committees and Board. Bernard Madoff was on the NASD’s Board of Governors and served as Vice Chairman. Mary Schapiro the former FINRA CEO, appointed Mark Madoff, one of Bernard Madoff’s sons, to a regulatory body that reviews disciplinary decisions made by FINRA. Madoff’s niece, Shana Madoff who was a “Compliance Officer” of Madoff until the firm’s collapse was a member of a compliance advisory committee of FINRA. Conrad states that ” Our organization has demonstrated time and time again that it is not afraid to discipline firms or individuals for wrongdoing, regardless of their service on FINRA’s Board.”
5. Please see the following as to how poorly those companies who have an employee on the FINRA Board have done at regulating their own business practices and employees. Yet the public should believe by FINRA which is governed by its Board of Directors with members for these offending firms are qualified to oversee FINRA which regulates the other Securities Dealers and soon to be RIA’s?

These company violations include willful violation of State and Federal Laws, failure to supervise its own employees, lack of procedural safeguards, submitting false information to the Regulators, improper sales and on and on.

Morgan Stanley Smith Barney Violations- Board Member Gregory J. Fleming

• 2002 Illegal rewards for selling affiliated mutual funds $2.25 fine
• 2003 Conflicts of interest research analysts $75 million payment
• 2003 Inappropriate influence and improper “spinning”- $400 million fine
• 2003 Censure & penalty for illegal marketing and IPO’s $100 million
• 2004 Failure to deliver documents to investors- $13 million fine
• 2005 IPO Violations  $40 million
• 2005 Failure to disclose info to mutual fund clients $6.25 million
• 2005 Willful violation of the Advisors act of 1940 $208 million
• 2005 Failure to supervise its sales force $5 million
• 2006 Failure to maintain and enforce policies $10 million
• 2007 Failures for best execution $7 million
• 2007 Failure to supervise sales peoples deceptive actions $15 million
• 2007 Provided false information to regulators $12million
• 2007 Failure to provide customers with required information $17 million
• 2005 Improper sales of securities $8.5 million
• 2008 Inappropriate ales of auction vrate securities  $35 million
• 2008 Misled tens of thousands of investors $100 million
• 2009 Failed to supervise sales people $5.4 million

All of the above can be confirmed in greater detail here.

MSSB has had other issues such as: race discrimination lawsuit, discrimination against women another to sex discrimination suit, and charging excessive fees to the Indiana State Teachers Association (ISTA) Insurance Trust.

Edward Jones
Violations- Board member James D. Weddle

• 1990’s Failure to disclose revenue sharing to clients $7.5 million
• 2000 Sale of unregistered stock
• 2002 Transactions without the proper registration
• 2003 Fail to disclose incentives to sell mutual funds -$75 million
• 2003 failure to supervise a financial advisor
• 2004 failed to properly deal with a complaint a complaint.
• 2008 failed to reasonably supervise the financial advisor
• 2009 failed to reasonably supervise its financial advisor
• 2010 Misappropriation of Client Funds $449,000
• 2009 Failed to supervise the activities of advisor.
• 2003 Failure to supervise a financial advisor
• 2002 Advisor recommendation of margin use to client
• 2000 Failed to supervise a financial advisor
• 2003 Improperly included its markup/markdown
• 2006 Mishandling of NAV transfer programs $25,250,000
• 2004 Willfully violated rules with sale of 529 plans
• 2008 Failed to report transactions on time
• 2006 Failing to timely deliver of official statements to clients
• 2009 Failing to establish and enforce a supervisory system, $200,000.
• 2004 Failing to establish and maintain a supervisory system, $200,000.
• 2004 Failure to achieve compliance with its Article V reporting obligations.
• 2005 Improper sales of municipal securities to clients
• 2003 Employing those that failed statutory qualification- $100,000

For the complete listing view the Form ADV.

Violations- Board member Seth H. Waugh

• 2002 Fail recordkeeping requirements of the SEC – $1,650,000.
• 2004 Research analyst conflicts of interest – $50 million,
• 2006 Engaged in market-timing and late trading of mutual funds,
• 2004 Sale of initial public offerings violations $5 million
• 2004 Research report conflict disclosures – $950,000
• 2007 Failure to ensure delivery of prospectuses – $1.25 million
• 2009 Misled customers about auction rate securities- Had to buy back ARS
• 2009 Failed to establish supervisory IPO procedures – $100,000

For more details review Deutsche Bank Securities Inc. ADV Form.

LPL Financial Violations- Board Member Mark S. Casady

• 2004 Illegal breakpoint sales – $1,116,402
• 2008 Failed to have procedures to protect customer records and $275,000
• 2011 Procedures regarding its review of e-mail-fine of $100,000
• 2011 Procedures on transmittals of cash and securities-$100,000
• 2010 Lack of supervision of variable annuity exchanges Fine $175,000
• 2008 Use of UITs, censure and fine of $125,000
• 2006 Supervision of variable annuity exchanges. Fine $300,000
• 2005 Mutual fund sales – $2,400,000
• 2005 Failure to supervise supervision wire transfers, fine $75,000
• 2005 Preferential treatment for some Mutual funds. fine $3,602,398
• 2004 FINRA reporting obligations,  a censure and fine of $450,000
• 2004 Mutual fund breakpoint discounts, censure and fine $2,232,805.

For complete information go to the firms ADV form.

Morgan Stanley is reportedly facing at least two lawsuits and a U.S. Senate Committee hearing, all stemming from the recent Facebook IPO debacle. The suits allege that analysts at Morgan Stanley (MS) had lowered their second-quarter and full-year forecasts for Facebook in the days ahead of the IPO and shared their findings via phone calls with certain institutional investors, but not with the small retail investors. Morgan Stanley’s CEO says, “we did nothing wrong.”

Why any investor would willingly do business with Morgan Stanley is hard to understand given their track record of governmental violations and questionable business operations. Could it be perhaps that investors’ opinion of MS is based primarily on the image projected through their not inconsiderable budget for public relations, marketing and advertising rather then these public facts?

Morgan Stanley’s governmental investment violations with fines and/or restitution or penalties

• 2002 Illegal rewards for selling affiliated mutual funds $2.25 million
• 2003 Conflicts of interest research analysts $75 million
• 2003 Inappropriate influence and improper “spinning” $400 million
• 2003 Censure and penalty for illegal marketing of IPOs $100 million
• 2004 Failure to deliver documents to investors $13 million
• 2005 IPO Violations $40 million
• 2005 Failure to disclose info to mutual fund clients $6.25 million
• 2005 Willful violation of the Advisors Act of 1940 $208 million
• 2005 Failure to supervise its sales force $5 million
• 2006 Failure to maintain and enforce policies $10 million
• 2007 Failures for best execution $7 million
• 2007 Failure to supervise sales peoples deceptive actions $15 million
• 2007 Provided false information to regulators $12 million
• 2007 Failure to provide customers with required information $17 million
• 2005 Improper sales of securities $8.5 million
• 2008 Inappropriate sales of auction rate securities $35 million
• 2008 Misled tens of thousands of investors $100 million
• 2009 Failed to supervise sales people $5.4 million

All of the above can be confirmed in greater detail here.

Other Illegal Practices

In addition to violations of governmental investment regulations, Morgan Stanley has a history of violating the rights of women, minorities, teachers and others.

Morgan Stanley was sued for having engaged in a pattern of discrimination against women. In one case, Morgan Stanley agreed to pay $54 million to settle a sex discrimination suit, while a second sex-discrimination lawsuit was settled for $46 million.

In a national, class-action race discrimination lawsuit, Morgan Stanley was charged with engaging in race discrimination and paid $16 million.

The Missouri Department of Insurance filed a lawsuit alleging that Morgan Stanley had conflicts of interest that damaged the value of an insurance holding company. Morgan Stanley agreed to pay $95 million to settle fraud charges from its role in the company’s collapse.

Morgan Stanly was accused of fraudulently inducing bond insurer MBIA Inc (MBI.N) to insure $223.2 million of risky mortgage debt. Morgan Stanley reached a settlement with MBIA to resolve the litigation between the two companies.

In another case, Morgan Stanley was charged with excessive fees to the Indiana State Teachers Association.

What to do if you invest with Morgan Stanley

If you are an investor with Morgan Stanley and are uncertain as to how you are or will be treated, print this oath and ask your Morgan Stanley sales associate to sign it. If he or she refuses, now you know why.

Most investors are familiar with open-ended mutual funds, which are bought and sold at the end of the day based on the Net Asset Value (NAV) of the fund’s holdings. As new money comes into these open-ended funds, more shares are issued by the mutual fund company.

But too few investors have ever heard of a Closed End Mutual Fund (CEF), which is unfortunate since they can be a beneficial investment option for some investors.

CEFs are similar to open-ended Mutual Funds in that they own a collection of investments (stocks, bonds, REITs, etc.), however the number of shares do not increase or decrease based on demand. CEFs start with a fixed pool of dollars with which a fixed number of shares are issued, and that number does not change over time.

Because the numbers of shares are fixed, CEF shares are bought and sold in a manner similar to a share of regular stock. One main advantage of this structure is that the price of the CEF is determined by the market, not the value of the underlying investments. This means, essentially, that it is possible to buy a collection of stocks or bonds at a discount to NAV, and to sell them at a premium to NAV.  Prices for shares of conventional open-ended Mutual Funds always track exactly to the NAV.

Adding CEFs to a diversified portfolio could provide increased tax-free income with a leveraged muni bond fund (ex. AKP, VCV, NAC), enhanced dividend yields with a covered call or preferred stock CEF (ex. FVT, PDT, JGV). A CEF can also provide exposure to alternative asset classes in an actively managed fund that can be purchased at a discount to the NAV.

Gary Cohen, a Financial Planner and Investment Fiduciary in CA, has personally invested in CEF’s for some time and has the following insights.

CEF advantages include:

1. No big inflows of cash chasing performance or redemptions when investors begin jumping ship due to a poorly performing fund.
2. Stays fully invested during market cycles since no cash is needed to redeem shares.
3. Can purchase and redeem CEFs throughout the trading day.

CEF disadvantages include:

1. Typically, a very small number of shares trade in a given day, meaning large orders can affect prices.
2. Wider bid/ask spreads than is typical for mutual funds.
3. Possible higher expense ratios due to the smaller capital pool being managed.
4. Some CEFs are somewhat more expensive versions of conventional mutual funds, but others use the inherent CEF structure to provide distinct advantages which could include:
   • Leverage:  CEFs can borrow against their holdings to increase returns (and concurrently increase risk).  Typically, CEF bond funds will leverage 20-40%, boosting yields by 1% or 2% over conventional funds.
   • Covered call writing:  Some CEFs use a covered-call strategy to boost yields and income, trading capital appreciation for current income.
   • Preferred stock investing: Some CEFs can arbitrage among preferred stocks, bonds and common stock to increase current income and provide capital appreciation.
   • Investing in alternative assets like REITs, commodities, floating rate notes or other “exotic” investment classes.

Some guidelines for investing in CEFs:

1. Buy at a discount or even at par, but never at a premium.
2. Always buy and sell in small quantities using limit orders. Never buy or sell more than 1,000 shares at a time. Plan to buy or sell over a number of days to minimize the effect on prices.
3. Use leverage wisely; leverage low risk investments (e.g. AAA muni bonds or blue chip stocks) but not speculative investments.
4. Understand that most CEFs provide higher levels of current income but that often comes at the expense of long term capital gains.
5. Avoid investing in CEFs that have been returning capital and not earning their distributions via investments or trading activities.
6. Do not automatically invest dividends and capital gains distributions.  The purchase of CEFs should be a conscious decision, not automatic, since their prices can move significantly.

As people approach retirement, they often take a look at their projected retirement income and the expenses, scrutinize their findings, and then heave a sigh of relief. Unfortunately, all they have really gotten from that exercise is a false sense of security. While at first blush, it looks like they will have enough income to enjoy a comfortable retirement, in reality they may not, because most folks greatly underestimate two important factors!

INFLATION

Overall inflation usually runs at about 3.5% over long periods of time. Yes, we are in a low inflation period now but that can and probably will change. Let’s say that a decade ago you went to the store and spent $100 on basic groceries. Now those same groceries would cost you $141 and in 20 years they’d cost you $280.

Groceries are one thing but in retirement, health care costs are a more major concern since we need more care for several reasons. The first is that medical care inflation often is more like 6% – noticeably higher than general inflation. More procedures may be needed and new medications may be prescribed to control more health issues, etc.  Let’s say that a doctor was $100 ten years ago. That same procedure would be $171 today and in ten years would be $574.

Inflation of retirement income is often much less then the inflation of expenses. Even if a person is fortunate enough to have a pension, many pension plans do not have a Cost of Living Adjustment (COLA) provision, so purchasing power goes down each year.  That would mean if you spend $100 for groceries out of your pension today and you have no COLA for your retirement income, in 10 years you will only be able to buy $70 worth of food and in 20 years it would be only $49.

For many Americans, Social Security (SS) is a major source of retirement income. SS does have a COLA provision most years, but it is often reduced due to increases in Medicare premiums. The result is shrinking purchase power of SS dollars over time.

INCREASED LONGEVITY

In the early 1900’s most people would not live to see age 70. Today, financial planners project people living well into their 90s.

As people age, they cannot do as much for themselves as when they were younger. Older folks need to hire people to do the yard work, clean the gutters on the house, and maybe even drive them around. These extra but often necessary services will be an additional cost in the retirement budget.

Also as we age, there is an increased probability of needing personal care for the activities of daily living. I did not say Long Term Care (LTC) since few ever think they will need that type of care but in reality many eventually will and it is very very costly.

Let’s say you are age 65 and about to retire. The current cost of 2.5 years of LTC is about $220,000. But most peoples do not need LTC at 65. More often, that need comes at an older age, let’s say age 85. If the person that retired today needed LTC at age 85, the inflated cost would be closer to $586,000.

What am I suggesting as a solution? Since projecting retirement income and expenses is not as easy as it may appear, consider sitting down with a financial planner and going over your retirement plan.

It may turn out that you do have adequate resources saved to supplement other retirement income, but it also may be that you do not. Perhaps you’ll need to change the investment allocation of your portfolio to increase or decrease risk and return. In any case, the sooner you have a clear picture of your retirement future, the better.

To find a financial planner now you can go to the website for the National Association of Personal Financial Advisors (NAPFA) on the web at http://findanadvisor.napfa.org/Home.aspx or to The Garrett Planning Network on the web at http://www.garrettplanningnetwork.com/map.html.

Last week’s op-ed piece by Greg Smith regarding his former employer, Goldman Sachs, was another example of a large financial services company being incentivized to make as much profit as possible at the expense of the client.

But I think that, perhaps, the key reason is that most investors fail to understand the inherent conflict of interest when using a Broker-Dealer (B-D) like Goldman, Merrill Lynch, Edward Jones or Smith Barney.

Much has been written about the higher level of legal protection that comes from the fiduciary standard when using the investment services of a Registered Investment Advisor (RIA), who operate as a “fee only advisor.”

This Forbes blog, “The Fee-Only Planner,” frequently posts  about the benefits of this fiduciary approach. It is unfortunate that those shocked by the Times article had not been reading the Forbes.com column.

An RIA is legally required to always act in the best interests of the client. A Broker-Dealer representative is not. B-D sales people are held to a lower “suitability standard” and are contractually required do only what is in the best interest of their employer.

A primary reason for the failure of the public to recognize the inherent difference between the RIA and the B-D representative is likely due to the Broker-Dealers’ use of titles for their sales people.

A Broker-Dealer rep is merely a sales rep, not an adviser. The B-D rep does not get paid to give advice and is not licensed to provide advice so they really cannot be called an “adviser.” The B-D reps get paid a commission when they sell a particular financial services product, the same way as, say, a car or insurance salesperson.

It is clear that when Broker-Dealers refer to their salespeople as “financial advisers” or “vice president,” the intent is to mislead the public as to their true purpose. The public would be less confused if the B-D rep’s title included the key word “sales;” call a B-D rep a “Financial Services Sales Representative” or “Branch Office Head of Sales” or “Assistant to the Chief Salesman,” and there would be much less confusion for the public.

But of course, confusion is what they are relying on. When salespeople are referred to as “advisers” or as official-sounding “Vice President” of this, that or the other thing, then the public is led into thinking they are being told or sold what is best for them. In fact, in the majority of cases involved in a commission-driven transaction, the client comes out on the short end of the “conflict of interest” stick.

In the case of Goldman Sachs, there are reportedly 33,000 employees, of which 12,000 of those are Vice Presidents. That would presume that there is 1 Vice President to manage every 2 other employees. Really? I suppose that some of them could be the actual, managerial type of Vice Presidents (though they probably call them something else). But I suspect that the vast majority of them are not. And the real reason for so many is because Goldman’s intent is to confuse the clients as to the real purpose of those Vice Presidents in generating income on behalf of Goldman’s bottom line. This scenario would seem to fit into the “toxic environment” mentioned in Smith’s Times piece.

The public is further confused when large Broker-Dealer affiliated companies are also registered as RIA’s and their B-D reps are registered both ways. With this dual registration, how would a client know if the representative was wearing the RIA hat and giving advice in the client’s best interest, or the B-D hat and selling a product for the company’s bottom line? The simple answer is that they cannot.

So, what can a smart consumer do to get real advice when it comes to investments, instead of being on the receiving end of a sales pitch? Here are some guidelines.

1. Ask your advisor (or potential advisor) if they are a Registered Investment Advisor, or a representative of an RIA.
2. Ask to see their Office Brochure or ADV form. This will outline their business methodologies and reveal any past regulatory problems. (Goldman Sachs has had many.)
3. Ask if the individual is a representative of a Broker-Dealer. If so, know that they receive commissions, rebates, and/or kickbacks when they sell a product to you. To remove any uncertainty, it is best that you not use this person and subject yourself to this conflict of interest environment.
4. Ask if the individual is dually registered as an RIA and a representative of the Broker-Dealer. If the answer is yes, you are unfortunately placed in the difficult position of never truly knowing which set of “legal standards” you are protected by, i.e., the “suitability standard” of a Broker-Dealer or the fiduciary standard of an RIA.
5. Ask what professional designations they are qualified to use. CFP® and CFA® have some of the highest standards and ethics.
6. Ask about affiliations. National Association of Personal Financial Advisors (NAPFA) and Garrett Planning Network are the two premier associations of fee-only advisors. (NAPFA sponsors this column, along with Forbes.com)

For the many readers of the Forbes.com “The Fee-Only Planner,” the article by Greg Smith was probably shocking, but not surprisingly so since these readers are well aware of the benefits of using an investment advisor who only operates as a fiduciary and who is legally required to do what is in the client’s best interest. It is truly unfortunate that so many investors learn about the conflict of interest when sales are involved, the hard way.

In these crazy times of volatile stock prices, low interest and changing economics, making good financial decisions is not easy. Using the services of a financial advisor can greatly help but finding a great advisor is not easy. Knowing what to ask of a perspective advisor is often helpful. However, all published advice is not accurate.

In the July 2011 edition of Money Magazine (page 69), senior writer George Mannes suggests that as part of the vetting process for selecting a perspective “trusted” financial advisor or planner, you ask for some names of clients that you can talk to about the advisor. The Wall Street Journal, CNN Money, and even Liz Davidson and Susan Bradley, who are contributors to Forbes.com, also make this suggestion.

While these credible sources are all well meaning, they are missing the boat by suggesting that a financial advisor or financial planner give the shopper some names of current or past clients for at least 3 reasons:

1. First, and for simple common sense reasons, the process is unreliable and can be very misleading. Let’s say that the advisor had worked with 100 clients. 97 of the clients felt the advisor was terrible. Three of the clients thought the advisor was great. The advisor would obviously know the feelings of the clients and would only give out the contact information for the three happy clients. This would be misleading which is why the SEC prohibits testimonials.
2. The Security and Exchange Commission (SEC) prohibits the use of testimonials since it is felt they can be misleading. SEC Rule 206(4)-(1)(a)(1) in general states that it is fraudulent, deceptive, or a manipulative act, for any Registered Investment Adviser (RIA) to directly or indirectly, publish, circulate, or distribute any testimonial of any kind concerning the investment adviser. On the other hand, stockbrokers and insurance agents can give out names of clients because they are not RIAs who are held to the higher standard.
3. Most RIAs have a Privacy Policy Statement for their office, which states that the office does not release information about its clients for any reason. Not abiding by the privacy policy statement would contradict form ADV and would be a violation of either state or federal law.

It is for these reasons and possibly others that the following organizations do not recommend asking for references: Forbes.com, Kiplinger, CFP® Board of Standards, NAPFA, Garrett Planning Network, and About.com.

Many organizations and writers suggest asking the following meaningful questions of a would-be advisor:

1. Are you a Fiduciary, and do you accept fiduciary responsibility in writing? (This is what you want)
2. Do you sell clients products such as insurance and investments? (If they say yes, how will you know that their advice is in your best interest — or that of the seller who gets the commission? Avoid sales people.)
3. What is your training and Certifications? (CFP®, CFA® AIF® are some of the best.)
4. How long have you been working as a financial Advisor/Planner? (The longer the better.)
5. Do you have any financial ethics violations?
6. What are the services that you offer? (Make sure the planner provides what you are looking for.)
7. What is the age range and economic situation of your clients, and what is your ideal client? (They should be people like you.)
8. The field of financial planning is broad. What are your strong points and what do you refer out to others most often?
9. How long do you plan to be in business and what is your exit strategy? (It is not wise to start the process with someone who is planning to retire in 1 year.)
10. Will you give a written fee estimate for the services requested? (This should be “yes”!)

To find perspective financial advisors near you, go to the National Association of Personal Financial Advisors NAPFA.org or GarretPlanningNetwork.com

As a teenager I worked in an ice cream store. There were 31 flavors, so I think you know which store in which I worked. My problem with ice cream is I like all the flavors. That is not the case with the different flavors of income tax.

The most common flavor of income tax is Fully Taxable. The sources of income subject to full tax are wages, bonus, business income, partnership income, bank account interest, alimony, pensions and rent that you might receive. The tax rates are 10%, 15%, 25%, 28%, 33% and 35% depending on your total income. With the current financial status of this country, it’s pretty clear that these income tax rates will be going up at some point in the future.

The second flavor of income tax that’s better than the full tax flavor is deferred tax. This includes traditional IRA’s, 401K, 403B 457 and a few others. It depends on the type of employer as to which type plan is offered but regardless to the plan they all provide the same feature. They allow employees to defer income until the retirement years when you might be in a lower bracket. With this flavor of tax you don’t pay now you pay later when you take the money out.

The third tax flavor is preferred tax status. Many of you who are retired do have this preferred tax on your Social Security benefits. If you’re in a low income tax bracket you pay no tax on your Social Security benefits. If you have some additional income you could tax on up to 85% of your benefits. Some of you might be old enough to remember the government’s previous promise never to tax Social Security benefits.

Another type of preferred flavor is that of long-term capital gains. If you invest in stocks or other types of investments and hold it for longer than one year, sell the item and reap a profit, you pay less than ordinary income. If you are in a low tax bracket would pay zero tax and in higher brackets long-term tax rates are 15% which is honestly preferred to the higher rate of fully taxable.

A perpetual tax flavor favorite is tax-free. The income from municipal bonds is what most people think of when they think of tax-free income. There are however many other sources of tax-free money. When someone gives you a gift, there is no tax due. If you receive an inheritance, there is no tax due. Life insurance payouts are income tax-free. When a couple sells their home, there is no income tax up to $500,000. Child support is tax free to the recipient. Roth IRA withdrawals are tax-free. Health Savings Account withdrawals are income tax free as long as you use it for a qualified expense. 529 plan with drawls for college education are tax-free when the proceeds are spent on qualified expenses.

The fifth flavor is not bad but is not great. It is when there is no tax due because the income is below the taxable threshold. On one hand its good because no tax is due. Yet it is not so desirable in that there may not be adequate resource to fund current needs and save for the future.

The last flavor of tax is the Alternative Minimum Tax. The Federal government invented this particular flavor years ago for the purpose of making sure the “wealthy” pay their “fair share”. When the legislature wrote this rule they did not index the law for inflation. As a result, years later, it is impacting many middle-income taxpayers. Unfortunately, our lawmakers don’t have the time to eliminate this flavor from our ice cream shop oh I mean tax code.

As a financial planner as well as a taxpayer, my favorite flavor is tax-free, followed by tax preferred then tax-deferred. I have to put up with fully taxable but I personally have never had to taste Alternative Minimum tax. What are your favorites, if any?

Recently in a social situation, I was introduced to a physician. In the course of the conversation she realized I was a financial planner and investment fiduciary and she asked the common question “What would a be a good investment for me in these turbulent economic times?”

The physician appeared to be somewhat taken back when I answered “I have no idea what would be a good investment for you.” Her question would be like me asking her, “What would be a good drug for me to take?”

A doctor would not prescribe a medication without taking a case history, performing tests, making a diagnosis and consider the treatment options in light of other medications.

A financial planner or investment advisor should go through a series of similar steps before making an investment recommendation. The following is an outline of the steps.

1. Understanding the client
   The advisor must understand the client’s current financial situation including liabilities and income, as well as their goals, aspirations and dreams. The financial capacity for risk as well as the clients’ mental outlook for risk needs to be understood by the advisor and the client.
2. Analysis of current investments
   The next step would be to the current asset allocation and the investments in each category. Appropriate investments should be retained while others may need to be liquidated taking taxes into consideration. If a client had 80% of their assets in growth equities adding Netflix, Apple, Google, Microsoft or even Wal-Mart Stores or would not be appropriate since the portfolio is already grossly out of balance.
3. Investments going forward
   First a determination of appropriate asset classes for the individual is made. As an example with a low interest rate environment adding long bonds may not be appropriate when interest rates go up. The appropriate mix of these different asset classes is then determined. Sometimes an optimization program is utilized to determine which mix of asset classes gives the highest projected return for the minimum risk taken. A plan should be developed and expressed in what is known as an Investment Policy Statement.

When picking the funds that go into the different asset classes, many investors fail to heed the SEC’s warning published in all prospectuses, which states, “Past performance is not a good indicator of future performance.”

Selecting investments should be based on Generally Accepted Investment Principles. These would include: an investor cannot pick the return but can only choose the level of risk, One cannot accurately predict the market, Diversification lowers risk, Invest to be on the Efficient Frontier and low cost investments can improve performance vs. high costs.

The take away for the Dr. and for the public in general is that there is no one HOT investment that is right for every one and that an appropriate investment recommendation is not made lightly.

Michael Chamberlain CFP® AIF®
Sacramento/Santa Cruz/Campbell

It is all too common: an insurance salesperson who comes to your home after you attend a free seminar or a bank employee recommends that you cash out some or all of your stocks, bonds, or mutual funds and purchase an annuity. In doing so, they have broken the law and may not even be aware of it.

The Investment Advisers Act of 1940 is a United States federal law that was created to regulate the actions of those giving investment advice for compensation as means to protect the public.

The Act defines an “investment adviser” as anyone who, for compensation engages in the business of advising others about the value of securities or the advisability of investing in, purchasing, or selling securities.

Therefore, when an insurance salesperson or bank employee suggests that you sell some of your investments to buy their annuity, they are technically giving investment advice, and are required to be licensed to provide that advice.

Recommending that you buy the annuity is not illegal under the Act because fixed annuities and indexed annuities are not considered investments. They are insurance contracts. It is the suggestion or advice to sell your stocks or mutual funds that is the illegal act.

To give investment advice, one needs to be licensed as a Registered Investment Advisors. RIA’s have a legal obligation to always recommend what is in the best interest of the client, disclose all relevant details, and avoid conflict of interest. This is the fiduciary standard.

Investment advice can be provided by a non-RIA’s under two exemptions:

1. Advice associated with offering investments for sale can be given via a Broker Dealer representative. However, these sales folks currently operate under the “suitability standard” which does not have the same legal safeguards that you have when using a RIA.
2. CPAs and attorneys are exempt when providing advice in the normal course of their work and do not hold themselves out as an Investment Advisor.

Please note that an insurance license DOES NOT allow for any advice to by given to buy, sell or hold a stock, bond, mutual fund or ETF under any circumstances.

Unfortunately, seniors are often the victims of this illegal investment advice. The result can be increased income taxes from the sale of highly appreciated investments, being locked into an annuity contract for a long period of time, having to pay a penalty to get all of your money back, or having a contract that fails to live up to the sales pitch.

Getting help when you are a victim of illegal investment advice can be difficult. Some governmental agencies are strapped for resources and never properly investigate a complaint. Police may not understand the significance of the 1940 Act. Many folks do not know where to go for help.

Complaints can be sent to the Securities and Exchange Commission but many times are a matter for a State agency. Another alternative is to talk to an attorney who specializes in senior abuse or security law violations.

Many financial services companies have been sued for questionable annuity sales including LPL Financial, AIG and Washington Mutual, Allianz, Bank of America, National Western Life Ins. Co.,

If you, a parent, or friend had an insurance salesman recommend that stocks, bonds, or mutual funds be sold to buy their annuity or indexed annuity, there can be legal recourse against the agent and the insurance company. One client that I referred to an attorney, received a $50,000 settlement as a result of an improper annuity sale.

Additional information on avoiding financial abuse with annuity sales may be viewed here.

Michael Chamberlain CFP® AIF®

Millions of households have received or will be receiving income tax refund checks from both the state and federal governments. What will you do with your refund check?

Good ways to spend the tax refund

Pay down credit card debt. It’s been a few tough years and maybe you, like many people, have used the credit card to get through difficult times. With credit card interest rates often exceeding 20%, the carrying costs can devastate a monthly budget. Paying off credit card debt with these high rates is like having an investment with an equivalent rate of return.

Set up a rainy day fund. Unexpected expenses or disruptions of income frequently occur. Having a stash of cash is a good idea. Capital One, ING Direct, American Express, and Ally Bank have money market accounts currently paying over 1% interest. These accounts typically beat the interest rate at local banks.

Get financial planning advice. Financial planning can help you in three areas: 1) the areas where you know you need help, 2) areas of opportunity you may not be aware of, 3) the areas you think you understand but may not be right about. Be sure to go to a fee-only planner who will not sell you products but rather give you unbiased advice. Go to www.garrettplanningnetwork.com or www.NAPFA.org to find a planner near you.

Establish estate planning documents. One never knows when disability or death may occur. Being prepared can help safeguard you and your family, and your desires as to what happens with your assets. Always consult an attorney who specializes in estate planning for the preparation of these very important documents. Be sure to include powers of attorney to administer your affairs if you’re incapacitated, and provide instructions regarding: health and healthcare, who should care for your minor children, and how your assets are to be distributed. These laws vary from state to state. Note: do not trust online services or CDs from Susie Orman.

Fund retirement plans more fully. Sticking the tax refund into an IRA or an equivalent amount into a 401(k), 403B or 457 will not only provide tax-deferred growth for retirement but gives you an immediate tax break for next year.

Investing in yourself. Taking a course or class to improve your job skills or qualify for you a new job can provide a high return on the investment.

Bad ways to spend your tax refund

Splurge on things that make you feel better. It is very common for people to buy things to make themselves feel better. It may be clothes, a bigger television, or going out to fancy dinners. Unfortunately these better feelings dissipate quickly and people are left in no better position than when they started.

Taking a “great” vacation. It is somewhat natural after working hard all year to think that we “deserve” a vacation and use the tax refund to pay for it. Taking a break and relaxing for a while to recharge the batteries is a good idea, but resist using the tax refund to splurge on a vacation. Take satisfaction in making a more prudent decision about the use of these funds.

Using the refund as a down payment. It is very tempting to buy things over time by financing the purchase. Having the down payment is only the start of many payments to come. It is far wiser to save the money so that you can purchase the item out right. The exception of course would be a house or car. Don’t finance anything unless you’re certain you can meet the monthly payments thereafter without impacting other obligations or your ability to fund other short-term and long-term goals.