Time to look at Corporate Bonds

Without knowing when the stock market or bond market hits bottom and a significant drop in prices, know is the time to look for bargains. One area of interest is investment grade corporate bonds. 

Over the last year, investment grade bonds (Baa-/BBB- and better) have been beaten up due to investor uncertainty of getting their money back on their bond purchases. Corporate earnings are falling, dividends are being cut, and some companies are defaulting on their loans.  Prices for bonds have adjusted accordingly and corporations have increased their cash reserves to the highest level in 15 years, $675 billion.

Year to date, iShares Investment Grade Corporate Bond (LQD) ETF is down 13.66%. Over the last 5 years it is down 18.62%. With falling bond prices comes higher yields. As of 11/24/08, LQD is yielding 7.52%.

Meanwhile, the iShares U.S. Government Treasuries 7-10 year maturity (IEF) ETF is up 8.14% year to date. Over the past 5 years it is up 10.24%. However, it is only yielding 3.75%. The iShares 1-3 year Treasuries (SHY) is yielding 1.24%.

There are advantages to buying corporate bonds over stocks. First, the corporation is paying you interest to hold their paper while you wait for the bond to appreciate in price. Also, buying corporate bonds also offers more security than buying stocks. When a company files for bankruptcy protection, bondholders will be repaid before stockholders. 

The likelihood that Treasuries will continue to outperform corporate bonds is less likely because the Government is selling more bonds to cover new debt, thereby increasing supply. Also foreign governments are less likely to buy U.S. Treasuries because they are using their money to stimulate their own economies. 

As soon as investors become more confident that the worst is over, they will start to look for higher returns than the 1% short term Treasuries offer. Look for corporate bonds to benefit from changing investor attitudes.

Lost your job? What You Should Do with Your Retirement Account

First, let me say I am sorry to hear about your job loss. I know you lost your job because you are reading about your options for your retirement plan. For further explanation or to discuss what option is best for you please contact Peterson Wealth Advisory.

Traditional 401(k). Options are listed in order most preferred to least preferred:

Rollover into IRA- This gives you the most flexibility for your investments. The advantage of rolling over your money to an IRA is that you have control over how the money is invested and have many more investment options. A rollover IRA allows you to transfer money from an employer-sponsored retirement plan without incurring any tax or early withdrawal penalties. You may have to sell some or all of the funds inside the account depending on who you roll the money over to but there will not be any penalties or taxes. Also, you have the option of transferring the money in the rollover IRA to your new employer's retirement plan provided that you do not make any contributions to your rollover IRA.

Rollover into your new company's retirement plan- You are allowed to roll over pre-tax contributions and any earnings in the fund into your new employers tax deferred retirement savings plan. You are not allowed to roll over after-tax contributions. Your new employer may require that you work for them for a specified period of time before you are eligible to contribute or receive matching contributions in their pension plan.

Keep it where it is- If you meet the criteria listed in the retirement plan document, you have the option of keeping your money in the plan. If you decide to leave your money with your former employer, you may not have the flexibility to decide what happens to that money. You may want to consider leaving the money with your former employer if you are happy with the investment vehicles you have selected and you are able to direct how your money is invested. You should consider rolling the money over if the employer limits access or restricts the plan because you are no longer an employee.

Cash out- This is a costly option because of the taxes and penalties incurred, and 45% of people choose this option. Here is why it is a bad idea. There is a 10% penalty for withdrawing money before the age of 591/2 plus payment of ordinary income taxes. Exceptions to the 10% penalty include:

• The employee's death
• The employee's total and permanent disability
• Separation from service in or after the year the employee reached age 55
• Substantially equal periodic payments under section 72(t)
• The distributions were required by a divorce decree or separation agreement 
• You paid for medical expenses exceeding 7.5% of your adjusted gross income.
  

Also remember, that a minimum amount is required to be distributed by April 1 of the year following the year the participant reaches age 70 ½.

Distribution Rules for Roth 401(k)

• 10% penalty plus income taxes on earnings (appreciation above contributions) withdrawals before age 59 1/2. Example: If you contributed $100 into the Roth 401(k) and it grew to $110, you would pay a 10% penalty plus income tax rate on $10.
• No penalty or taxes taken if distribution is after having the account for 5 years and the person is age 59 1/2 or older.

Distribution Rules for SIMPLE IRA

• A minimum amount is required to be distributed by April 1 of the year following the year the participant reaches age 70 ½.
  
• A withdrawal is taxable in the year received.  
• If a participant makes a withdrawal before he or she attains age 59 ½, generally a 10% additional tax applies.  
• If this withdrawal occurs within the first 2 years of participation, the 10% tax is increased to 25%.
• SIMPLE IRA contributions and earnings may be rolled over tax-free from one SIMPLE IRA to another.  
• A tax-free rollover may also be made from a SIMPLE IRA to an IRA that is not a SIMPLE IRA, but only after 2 years of participation in the SIMPLE IRA plan. 
  

Plan Now for the Turnaround

What should you be doing now to your portfolio? 

Here is a checklist of things to evaluate right now:

1. Costs- Evaluate the internal costs of the funds you use. Depending on the share class, actively managed funds have internal expenses ranging from 0.75% to 2.35%. What do they provide for the cost? Underperforming funds. Over the past 5 years, 74% of actively managed funds underperformed their benchmark index.* I advocate the use of index funds (ETF's or Mutual Funds) with low expenses 0.3% or less. Part of the money you save from your investments can be used to employ an independent financial planner who will get to know you, understand your goals, and create a plan to meet those goals.
2. Taxes- This is the time of year where actively managed mutual funds distribute capital gains to shareholders based on the buying and selling inside the fund. The amount that is distributed reduces the overall price of the fund and you are taxed on the amount distributed. This is unfortunate because in all likely hood you will be paying taxes when your fund has lost money. Avoid taxes by buying index funds which rarely distribute capital gains because the stocks inside the index rarely change.
3. Revisit the goals of your plan- How has your portfolio performed in this market? Have you lost more than you feel comfortable losing? Will you be delaying retirement? How has your situation changed?
4. Reallocate- With all the movement in the market most asset allocations are out of whack. After you determine your updated goals and risk profile, look at your current allocations and make adjustments. This can be done in two ways: When new money is brought in buy assets that you want  more of. Or sell the asset you want less of and buy the asset you want more of. Be aware of tax consequences when doing selling.
5. Set up a dollar cost averaging plan- There are huge sales on stocks and certain bonds. This is a huge opportunity that disciplined people will take advantage of. Sure, times are bad and a turnaround does not seem on the horizon but we will come out of this. And it probably will happen without anyone knowing. Don't try to time the bottom. Buy in pre-determined increments of diversified assets. The adage is buy low sell high. Well, it looks like things are low to me.

Be patient, save as much as you can, and and have someone like me, a fee only, independent investment advisor help you.

*http://biz.yahoo.com/prnews/081113/ny45959.html?.v=1

Grasshoppers didn't prepare

Yesterday, I thought of an old fable, The Grasshopper and the Ant, and its relevance to today's economic problems. Aesop's story has become a cliche but in times of uncertainty, it helps to go back to basics and think in simple, understandable terms. 

The Grasshopper and the Ant 

The Grasshopper, so blithe and so gay,

Sang the summer time away.

Pinched and poor the spendthrift grew,

When the sour north-easter blew.

In her larder not a scrap,

Bread to taste, nor drink to lap.

To the Ant, her neighbor, she

Went to moan her penury,

Praying for a loan of wheat,

Just to make a loaf to eat,

Till the sunshine came again.

"All I say is fair and plain,

I will pay you every grain,

Principal and interest too,

Before harvest, I tell  you,

On my honer - every pound.

Ere a single sheaf is bound."

The Ant's a very prudent friend,

Never much disposed to lend;

Virtues great and failings small,

this her failing least of all,

Quoth she, "How  spent you the summer?"

"Night and day to each new comer

I sang gaily, by your leave;

Singing, singing, morn and eve."

"You sang? I see it at a glance.

Well, then, now's the time to dance."

We can debate whether or not the grasshopper should be helped. It is compassionate to offer a helping hand to the grasshopper. However, if you provide help with no consequences, what incentive is there to change. This story is analogous to so many situations right now: government spending, individual spending, corporate spending, corporations asking the government for money, individuals asking the government for money, the government TAKING more money.

Learn from these times. 

• Create a "rainy day fund" with at least 6 months of cash/Certificates of Deposit. 
• Buy more stocks NOW. If you bought the S&P 500 at the end of 1932 during the Great Depression, 5 years later you gained 86%; in 10 years 120%; in 20 years 926%.*
• With prices of goods expected to continue falling, the money you save now will buy more next year.
• Stop asking and expecting the government to help you. 
• If you ask the government for anything ask them to lower your taxes. 
• But only if you actually pay taxes.

You will be so much happier when you rely on yourself and control your own path.

*Data from WSJ article by James B. Stewart October 29th, 2008