Expert Advice on Personal Finance

In these turbulent times, most of us are uncertain as to what course of action to take with our personal finances. Not only do our personal issues come into play, but in some cases our actions have significant impact on others around us, especially with respect to institutions like Southeast Missouri State University, which have become more reliant on personal support as state support decreases. We recently contacted Southeast alumnus, John Ueleke, founder of Legacy Wealth Management in Memphis, Tenn., to share his input on some of the more frequently asked questions.

Question) My portfolio has declined significantly, and I need income. What are safe ways to provide that?

Answer) One of the great temptations in this market is to retreat solely to things like U.S. Treasury securities and certificates of deposit (CDs). While safety of principal is very high, there are drawbacks. Current rates on Treasuries range from slightly above zero for very short term securities to more than three percent on very long term securities. We do not view either of these as attractive unless for a very short time period. CDs can be attractive, but maturities beyond two or three years become riskier.

The FDIC insurance has been temporarily increased to $250,000 until Dec. 31, 2009, when it is scheduled to revert to $100,000. In this market it makes no sense to have more than the $100,000 limit per person in any one bank past this December. Longer maturities should be split among different banks, and many banks now have consortiums to accomplish this. Shopping the market for best rates can be helpful, but avoid any banks which are known to have major problems and are not in the Troubled Asset Relief Program (TARP), regardless of the rates offered.

High quality AA or AAA rated corporate and municipal bonds can be an attractive alternative, paying higher rates than CDs. Keep the maturities below 10 years, and stagger them so you have money coming in at different points to reduce risk and to take advantage of higher interest rates that are likely in a few years.

Watch out for maturities longer than 10 years. Even with some of the bells and whistles that issuers add to make them more attractive, they may have much greater risk. Often the more “features” an investment has, the greater the chance of disappointing results. We have seen one bond sold to senior citizens containing a “death put” so that, regardless of the value at the time of the holder’s death, it is promised to be redeemed at face value. Holders of Lehman Brothers bonds are discovering that not to be the case. Others are facing many delays in getting their money.

Our philosophy is to avoid unnecessary risk on the fixed income part of your portfolio as the market does not really compensate appropriately for that risk. It is much better to allocate a part of the portfolio to the stock market where you have a higher probability of getting paid for the risk while the rest of the portfolio is in very high quality fixed income. This should allow you to sleep better than if you have a lot of the portfolio invested in higher risk fixed income just to earn another one percent or so. Over the long term, the equity part should grow to provide the equivalent of a better return for the entire portfolio.

Q) Are commercial annuities a good option in the current economy?

A) In some cases, it may make sense to actually annuitize some of your assets as you are nearing retirement. Should you choose to do that, shop the market for the best annuity rate from the best rated companies. In essence you will be entering into a contract to exchange a fixed sum of cash for a guaranteed income and a guaranteed period, usually lifetime. You can be assured that you will not outlive that stream of income. The real risk is that a payment of $1,000 ten years from now will not buy as much as the same $1,000 does today. Putting all of your funds into an immediate annuity does not make sense, but annuitizing some assets can help to guarantee a floor for your income.

Another tempting investment area is annuities with teaser rates. Often these take the form of “bonus interest,” typically as much as 10 percent. The catch is that you agree to tie up your money for up to 20 years before it can be withdrawn without penalty. After the initial guaranty period, the rate paid by the company on your money can be anything they wish as long as it is at least equal to the guaranteed minimum in the contract. There are other “hooks” in many of these contracts. Unfortunately the annuities also carry serious tax implications and

require careful planning to avoid potentially unpleasant tax treatment when funds are withdrawn by the owner or their beneficiary. These are often overlooked in the sales process and they can change during the life of the annuity. Finally there is the question of the financial stability of the insurance company itself.

There is no equivalent to the FDIC for insurance companies. While the government bailed out AIG, one of the largest insurance companies in the country, there is no assurance that it will do so for others who might get into difficulty. Like any investment, annuities should be carefully checked out before making a commitment.

Q) Should I stay in the stock market?

A) History has shown that for longer periods of time, the stock market has been one of the best places to invest. That said, we are currently in a period of significant volatility that makes us uncomfortable. We believe that the future will provide good returns for those who stay invested. The damage done to our economy during this recession is significant and the recovery will not be rapid. Because of the depth and breadth of the stock market decline, we see many good companies whose stock price is probably lower than its true value. This is likely to spur a near-term jump in the market and then a more measured growth as corporate earnings slowly recover over the next few years. Typically the stock market has been a leading indicator of economic activity, often turning up several months before actual economic data turns positive. For that reason, we suggest that investors hold the course in the market so as to not miss the upturn which will occur at some point.

Having a balanced portfolio that is well diversified across the world is important. Last year that balance did not help much as nearly every part of the investment universe was down. Even though China and other emerging market countries are experiencing financial pain, their enormous populations and increasing standards of living will likely keep them out of recession and still at a significant growth rate when compared to the developed countries of the world. That is a bright spot in the investment world, and why we believe emerging markets should be in most portfolios in a reasonable amount.

Q) I want to continue to support Southeast and other favorite charitable causes, but in the current economic environment I am worried about over committing to these causes that I like. Is there anything I can do now without jeopardizing my financial future?

A) There is no doubt that giving in this environment is challenging. The needs of institutions like Southeast are great, yet donors’ anxiety over giving assets is high. There are several types of giving which can be effective for both sides in these times.

The simplest idea for giving today is to donate assets which have a taxable long-term capital gain associated with them and are likely to be sold anyway. By giving part or all of such an asset, the donor avoids tax on the part given and gets a deduction for the entire amount given. Careful planning with your advisor and the institution is important to maximize the deduction.

Another means of giving on a current level is the gift of a life insurance policy, either a paid-up policy or one which still has ongoing premiums. Once the policy is donated to the Southeast Missouri University Foundation, any ongoing payments are then tax-deductable based on each individual donor’s facts and circumstances. This does not provide immediate dollars for the University but does allow the charity to plan on funding in the future.

Charitable remainder unitrusts also work well if the grantor needs income today but wants the remainder after a specified term of years or after the grantor’s death to go to the Southeast Missouri University Foundation or other favorite charity. Low interest rates make this less favorable than in previous years, but it provides income now. It can be set up to provide a fixed amount of income or a fixed percentage of the fair market value of the trust each year. The income tax deduction is related to current interest rates and the level of income drawn from the portfolio.

Annuity trusts work in a similar way with the donor giving assets to the University in exchange for a lifetime income, usually at a higher rate than on the other types of trusts. This is because it is guaranteed for life, whereas the others are not, and often are for a specified term of years. There are several variations of these trusts, so it is important to work with the University or your personal advisor to understand which may be best for your situation.

Finally, charitable lead trusts work very well at this time. A donor can transfer assets to a lead trust and may or may not get a tax deduction for part of that transfer depending on the goals for the gift and the wording of the trust. The trust is for a set time period, and the income from it during that time is paid directly to the charity. At termination, the assets then go to whoever is designated in the trust. They may come back to the grantor or go to a family member. In this low interest environment, this is a very effective means of transferring assets to the next generation with little gift tax involved. Even if the grantor wished to retain the assets, it is a good way to pass the income to the charity if assets are not needed currently but will likely be needed in later years after the trust has terminated.

Each of these techniques has possibilities in today’s economic climate. Some are better than others, depending on the circumstances of each individual donor. By examining your particular needs and objectives, it is much easier to see which, if any, are suitable and logical for you. Hopefully these ideas and comments on the markets will help you make good decisions in the rest of the year ahead.