Disclaimer: I am not a Certified Public Accountant (CPA), tax advisor or tax lawyer. Please talk with your CPA, tax advisor, or tax lawyer before making any investment decisions that may have tax consequences for your investments. One of my investment rules is know the tax ramifications of any investment that you plan to make before you make it, and make it tax efficient, whether under current tax laws or forecasted future tax changes. Taxes and/or government fees will be increasing over the next 5 years to help pay for the federal, state and local government deficits and future government entitlement programs (for example, health care). For example, to pay for the new health care plan high income earners in 2013 will experience an increase in Medicare payroll tax (.9%) and an additional tax (3.8%) on qualified dividends and capital gains.
Former President George W. Bush’s tax cuts (BTC) were intended to expire at the end of 2010, reverting to the previous tax code for long-term capital gains and qualified dividends, reviving the estate tax and restoring the top marginal bracket of 39.6% at the beginning of 2011. On December 17, 2010 President Obama and the US Congress extended Bush’s tax cuts for another 2 years (ending January 1, 2013), made changes to the estate tax and added a 2% reduction of the payroll (social security) tax. This will be one of largest stimulus packages for the US economy ever – approaching $1 trillion US.
Long-term capital gains tax (on assets held longer than one year): The current tax rate of 0% for taxpayers in the 10% and 15% tax brackets as of 2008 and 15% for everybody else will not change for the next two years. The pre-BTC rates were 10% for the 15% tax bracket and 20% for everybody else.
Qualified dividends: Qualified dividends will continue to be taxed at a maximum rate of 15% for the next two years. The pre-BTC rate was ordinary income based on your highest tax bracket. For example if you were a high income earner and your tax bracket was 39.6% your qualified dividends would have been taxed at 39.6% (this could be as high as 43.4% in 2013).
Top income tax bracket: Bush’s tax cuts eliminated the top income tax bracket of 39.6% making the 35% the highest tax bracket and created a new 10% bracket for low income earners. Congress and President Obama extended 35% as the highest tax bracket and the 10% tax bracket for the next 2 years.
Revival of the estate tax: In 2010, as a result of several unusual circumstances, there is no limit on the size of an estate that is exempt from federal estate taxes. Starting in 2011 (and ending in 2013) the exemption will be $5 million per person and for a married couple up to $10 million will be exempt from federal and gift taxes. The top tax rate applied to the portion of estates exceeding those limits will be 35%, the lowest tax rate in 80 years.
Payroll tax decrease: Wage earners received a social security tax reduction of 2%, making the tax rate 4.2% up to the cap of $106,800 in 2011 (the cap will increase in 2012). If your wage income is at or over the cap, this will result in savings of $2,136, or about $40 per weekly paycheck. Congress did not renew the Making Work Pay tax credit of up to $400 for working individuals and up to $800 for married taxpayers filing joint returns (this was up to a maximum adjusted gross income level). Consequently, working individuals who earn less than $20,000 ($40,000 for married taxpayers filing jointly) will have less money in their paycheck starting in 2011.
The tax rate on long-term capital gains and qualified dividends which are most important to investors will stay the same for the next two years. All these tax changes will revert to their pre-BTC tax rates on January 1, 2013. With President Obama, all of the House of Representatives and 1/3 of senators up for reelection at the end of 2012, expect the US tax rates to be a major campaign issue in the 2012 election.
A good strategy is to always keep interest/ dividend-paying and non-tax efficient investments in your non-taxable accounts. Also, any investments for which there is a high degree of difficulty determining the tax liability, i.e. trading stocks, future contracts, exotic ETFs, etc., should be invested through your non-taxable accounts.
Between the extended Bush tax rates and payroll tax decreases (costing the US government almost $1 trillion in revenue over the next two years) and Quantitative Easing 2, the US government has created the largest stimulus ever in its quest to grow the economy and reduce a persistent US unemployment rate hovering close to 10%. If this stimulus does not lead to job growth and reduce the unemployment rate, the issue will become: how do you reduce structural unemployment issues which take a long time period to resolve? This will be difficult to resolve in the current US political environment which everything is short focus on the next election.
Please chime in with your comments on 2011 tax rates, tax efficient investments, or anything else.
© 2010
Paul Cusick
Tuesday, December 28, 2010
Sunday, December 19, 2010
Quantitative Easing 2 (QE 2) Update and Analysis
On November 3, 2010 the US Fed (Federal Reserve) announced the policy of Quantitative Easing (QE) 2. The stated goal of the policy was to decrease interest rates in order to jump start the economy and reduce the US’s persistent unemployment rate of just under 10%. The major side effects of QE 2 are that it would devalue the US currency and make commodities more expensive since they are valued in US dollars. At the same it would make US manufactured goods cheaper for companies and customers outside the US which should lead to an increase in US exports, at the same time making imports more expensive thus decreasing imports.
After six weeks (as of December 18, 2010), what has been the effect of QE 2?
US Treasury interest rates - The interest rate yield has increased on the 10, 20 and 30 year treasury bonds. The 10 year has increased 33%, the 20 year has increased 16% and the 30 year has increased 9%. Mortgage rates track the yields on the 10-year Treasury note. For example, if you add 150 (1.5%) Basis Points (BPS) to 160 BPS you will get the 30 year fix mortgage rate. The current national 30 year fixed rate is 4.83%; on November 5, 2010 it was 4.24% (an increase of almost 60 BPS). With the increased cost of borrowing for companies and consumers, it will reduce their spending on goods and resources. This will have the effect of decreasing economic growth.
US unemployment rate - The November 2010 (December rate will be announced January 7, 2011) unemployment rate was 9.8%. I will need to review the unemployment rate over the next 6 months.
Commodities prices - Almost all commodities prices have continued to increase after the announcement of QE 2. For example, the US national gasoline price has increased over $.17, oil (Brent) has increased $5 a barrel, copper increased 9% and wheat has increased 9%. This increase in commodity prices will increase the price of goods, food for example, and decrease companies’ and consumers’ ability to spend more on goods and services. It could also lead to inflation.
US real GDP (Gross Domestic Product) - The real GDP rate for the third quarter was 2.5%. I will continue to check back on the real GDP rate over the next 6 months.
US imports / exports – The August 2010 US 12 month trade balance was negative $621.4 billion. I will review the 12 month trade balance periodically over the next 6 months.
US dollar - The US dollar has decreased by 5% compared to the Euro and 4% compared to the Japanese Yen. This should increase US exports (they will be cheaper) and decrease imports (they will be more expensive).
Currently the primary issue with QE 2 is that interest rates are increasing, which leads to increased cost of financing which could in turn slow the growth of the economy, counter to the intent of QE 2. This should, however, be neutralized by the large tax decrease and stimulus approved by Congress and President Obama on December 17, 2010.
© 2010 Paul Cusick
Paul
After six weeks (as of December 18, 2010), what has been the effect of QE 2?
US Treasury interest rates - The interest rate yield has increased on the 10, 20 and 30 year treasury bonds. The 10 year has increased 33%, the 20 year has increased 16% and the 30 year has increased 9%. Mortgage rates track the yields on the 10-year Treasury note. For example, if you add 150 (1.5%) Basis Points (BPS) to 160 BPS you will get the 30 year fix mortgage rate. The current national 30 year fixed rate is 4.83%; on November 5, 2010 it was 4.24% (an increase of almost 60 BPS). With the increased cost of borrowing for companies and consumers, it will reduce their spending on goods and resources. This will have the effect of decreasing economic growth.
US unemployment rate - The November 2010 (December rate will be announced January 7, 2011) unemployment rate was 9.8%. I will need to review the unemployment rate over the next 6 months.
Commodities prices - Almost all commodities prices have continued to increase after the announcement of QE 2. For example, the US national gasoline price has increased over $.17, oil (Brent) has increased $5 a barrel, copper increased 9% and wheat has increased 9%. This increase in commodity prices will increase the price of goods, food for example, and decrease companies’ and consumers’ ability to spend more on goods and services. It could also lead to inflation.
US real GDP (Gross Domestic Product) - The real GDP rate for the third quarter was 2.5%. I will continue to check back on the real GDP rate over the next 6 months.
US imports / exports – The August 2010 US 12 month trade balance was negative $621.4 billion. I will review the 12 month trade balance periodically over the next 6 months.
US dollar - The US dollar has decreased by 5% compared to the Euro and 4% compared to the Japanese Yen. This should increase US exports (they will be cheaper) and decrease imports (they will be more expensive).
Currently the primary issue with QE 2 is that interest rates are increasing, which leads to increased cost of financing which could in turn slow the growth of the economy, counter to the intent of QE 2. This should, however, be neutralized by the large tax decrease and stimulus approved by Congress and President Obama on December 17, 2010.
© 2010 Paul Cusick
Paul
Saturday, December 4, 2010
Best Investment Strategies for Quantitative Easing (QE2)
On November 3, 2010 the US Federal Reserve announced its second round of Quantitative Easing (QE 2), a program through which it intends to buy an additional $600 billion of longer-term treasury securities by mid 2011. This equates to $70 billion per month. In this week’s blog I will be discussing what investments are best for the QE 2 environment, focusing on commodities, precious metals, gold and US companies that export.
The major impact of QE2 is that it will inject $600 billion directly (by printing money) into the economy. Theoretically this will facilitate the Fed’s stated policy to grow the economy and increase job growth. It will have the outcome (if everything goes according to plan) of decreasing interest rates and devaluing the dollar, which will have the following effect on investments:
· Since most commodities are valued in $US QE2 will drive up the cost of commodities.
· QE2 will have the positive effect of making US exports cheaper (it is a positive for companies that export and should help their stock price) for companies or consumers outside the US. It will have the opposite effect with imports which will become more expensive for US companies or consumers to buy.
· Interest rates may decrease which will in theory help to grow the economy. For example, for REIT companies that need to refinance their properties every 5 to 7 years this will lower their interest costs.
As for myself, I don’t tie my whole portfolio to my macroeconomic forecast or the forecasted economic environment. I could be wrong, so I tilt some of my portfolio (10 - 20%) to take advantage of the QE2 economic situation and the rest elsewhere. It helps to hedge so that, if my forecast is wrong, I am not forced to sell assets that have lost value. Today many people are finding themselves in the unfortunate position of needing to sell their houses to raise cash to pay debt and living expenses. You never want to be forced to sell an asset that has lost value. A well-diversified portfolio is key – you never put all your eggs in one basket.
As routine due diligence I will review all of my investments against the current economic conditions to determine whether any are no-no’s for the forecasted economic environment. For example, if I was invested in a company that used commodities for the majority of their products, and it is not possible for the company to raise their prices, I will decrease or eliminate my investment in that company.
Also, always understand the tax consequences of your investments, how the investment works and what your exit strategy will be.
The following are methods for investing in commodities, precious metals, gold and companies that export:
1. Commodity producing companies. Examples of commodity producing companies are coal and Natural Gas (NG) producer Consol Energy Inc. (CNX) and gold, silver and copper producer Goldcorp Inc. (GG). Consol Energy is the biggest coal exporter to China for steel production. Canada Goldcorp is one of the largest gold producers in the world. I own the following commodity producing companies:
Lundin Mining Compnay - LUNMF.PK
Advantage Oil and Gas Ltd. - AAV
Pegrowth Engery - PGH
Penn West Engery - PWE
2. Future Based Commodity ETFs. Before you buy future based commodity ETFs you may want to read the following article “Commodities are a Rock in a Hard Place”: http://www.morningstaradvisor.com/articles/article.asp?docId=17924.
Before buying a future based commodity or commodity index you need to understand the contango and backwardation effects (you should also understand the tax consequences of a taxable account). Two famous future based commodity ETFs are States Oil (USO) and United States Natural Gas (UNG). These funds have been influenced by the contango effect in the future energy market. UNG lost over 50% of its stock value in the last year. A worthwhile article on the contango effect on UNG is “What’s Wrong With UNG?” http: http://etfdb.com/2009/whats-wrong-with-ung/.
3. Exchange Traded Funds (ETFs) or Mutual Funds (MF) index of commodity producing companies. For a very good article on ETFs of commodity producing companies indexes see
http://seekingalpha.com/article/195688-the-benefits-of-equity-commodity-etfs.
You can buy selector based ETFs, for example metals and mining (XME), global coal (PKOL), steel (SLX), etc.
4. ETFs index of commodities. Before you buy a commodities index ETF in your taxable account you should read the following article about tax consequences of ETFs:
http://www.investopedia.com/articles/exchangetradedfunds/08/etf-taxes-introduction.asp.
The following are 2 examples of commodities index ETFs:
Powershare DB Commodity Index Tracking Fund - DBC
Dow Jones AIG Commondity Index Fund - DJP
These ETFs have about 20 commodities in the index. They include, for example, oil, NG, heating oil, gold, corn, wheat, etc. These ETFs have large total assets of over $2 billion and at the same time large bid / ask spreads (also very high fees for ETFs). These funds all use future contracts and may also be affected by contango.
5. ETFs or MFs index of commodity producing countries. These also have currencies implications. I own the following ETFs and MFs indices of commodity producing countries (each of these funds has about 50% commodity stocks within its index):
S & P BRIC 40 SPDRS - BIK
Claymore/BNY BRIC - EEB
DWS Latin America - SLA
6. Real commodity assets (owning a forest or mine). If you have a lot of money like the Yale Endowment Fund (http://www.yale.edu/investments/Yale_Endowment_09.pdf) you may want to buy real assets such as a forest, large commercial building, or oil or natural gas fields. The Yale portfolio manager, David Swensen, one of the top investors in the world for the last 25 years, has been increasing his holdings in real assets over the last 3 years. It is an investment category through which you can take advantage of pricing efficiencies. One of the best ways for the average investor to buy real assets is by buying Real Estate Investment Trust (REIT) companies. For example, timberland has been one of the best investments for the last 20 years. Its return during the past two decades has been 12.8%. There are a number of timberland REIT companies that own extensive timberland acres. For example, Plum Creek (PCL) owns over 7 million acres and has a yield of 4.3%.
7. Companies that export a majority of their sales from the US. QE2 should have a positive effect on US companies that export a majority of their products. Their products should cost less and be more competitive in the world marketplace. This should increase their revenue and profit and should have the effect of increasing their stock price. This will not work if the products they sell have a large component of commodities (since commodity prices will be increasing).
Please chime in with comments about the QE 2 investment strategy. What investments do you are think best for QE 2? Future blogs that I will be writing:
Income generating bucket of money
Investing in possible buyout companies
Investing in Brazil
Using Fisher’s 15 points for researching companies to evaluate one company
Reviewing 2011 tax changes
© 2010 Paul Cusick
Paul
The major impact of QE2 is that it will inject $600 billion directly (by printing money) into the economy. Theoretically this will facilitate the Fed’s stated policy to grow the economy and increase job growth. It will have the outcome (if everything goes according to plan) of decreasing interest rates and devaluing the dollar, which will have the following effect on investments:
· Since most commodities are valued in $US QE2 will drive up the cost of commodities.
· QE2 will have the positive effect of making US exports cheaper (it is a positive for companies that export and should help their stock price) for companies or consumers outside the US. It will have the opposite effect with imports which will become more expensive for US companies or consumers to buy.
· Interest rates may decrease which will in theory help to grow the economy. For example, for REIT companies that need to refinance their properties every 5 to 7 years this will lower their interest costs.
As for myself, I don’t tie my whole portfolio to my macroeconomic forecast or the forecasted economic environment. I could be wrong, so I tilt some of my portfolio (10 - 20%) to take advantage of the QE2 economic situation and the rest elsewhere. It helps to hedge so that, if my forecast is wrong, I am not forced to sell assets that have lost value. Today many people are finding themselves in the unfortunate position of needing to sell their houses to raise cash to pay debt and living expenses. You never want to be forced to sell an asset that has lost value. A well-diversified portfolio is key – you never put all your eggs in one basket.
As routine due diligence I will review all of my investments against the current economic conditions to determine whether any are no-no’s for the forecasted economic environment. For example, if I was invested in a company that used commodities for the majority of their products, and it is not possible for the company to raise their prices, I will decrease or eliminate my investment in that company.
Also, always understand the tax consequences of your investments, how the investment works and what your exit strategy will be.
The following are methods for investing in commodities, precious metals, gold and companies that export:
1. Commodity producing companies. Examples of commodity producing companies are coal and Natural Gas (NG) producer Consol Energy Inc. (CNX) and gold, silver and copper producer Goldcorp Inc. (GG). Consol Energy is the biggest coal exporter to China for steel production. Canada Goldcorp is one of the largest gold producers in the world. I own the following commodity producing companies:
Lundin Mining Compnay - LUNMF.PK
Advantage Oil and Gas Ltd. - AAV
Pegrowth Engery - PGH
Penn West Engery - PWE
2. Future Based Commodity ETFs. Before you buy future based commodity ETFs you may want to read the following article “Commodities are a Rock in a Hard Place”: http://www.morningstaradvisor.com/articles/article.asp?docId=17924.
Before buying a future based commodity or commodity index you need to understand the contango and backwardation effects (you should also understand the tax consequences of a taxable account). Two famous future based commodity ETFs are States Oil (USO) and United States Natural Gas (UNG). These funds have been influenced by the contango effect in the future energy market. UNG lost over 50% of its stock value in the last year. A worthwhile article on the contango effect on UNG is “What’s Wrong With UNG?” http: http://etfdb.com/2009/whats-wrong-with-ung/.
3. Exchange Traded Funds (ETFs) or Mutual Funds (MF) index of commodity producing companies. For a very good article on ETFs of commodity producing companies indexes see
http://seekingalpha.com/article/195688-the-benefits-of-equity-commodity-etfs.
You can buy selector based ETFs, for example metals and mining (XME), global coal (PKOL), steel (SLX), etc.
4. ETFs index of commodities. Before you buy a commodities index ETF in your taxable account you should read the following article about tax consequences of ETFs:
http://www.investopedia.com/articles/exchangetradedfunds/08/etf-taxes-introduction.asp.
The following are 2 examples of commodities index ETFs:
Powershare DB Commodity Index Tracking Fund - DBC
Dow Jones AIG Commondity Index Fund - DJP
These ETFs have about 20 commodities in the index. They include, for example, oil, NG, heating oil, gold, corn, wheat, etc. These ETFs have large total assets of over $2 billion and at the same time large bid / ask spreads (also very high fees for ETFs). These funds all use future contracts and may also be affected by contango.
5. ETFs or MFs index of commodity producing countries. These also have currencies implications. I own the following ETFs and MFs indices of commodity producing countries (each of these funds has about 50% commodity stocks within its index):
S & P BRIC 40 SPDRS - BIK
Claymore/BNY BRIC - EEB
DWS Latin America - SLA
6. Real commodity assets (owning a forest or mine). If you have a lot of money like the Yale Endowment Fund (http://www.yale.edu/investments/Yale_Endowment_09.pdf) you may want to buy real assets such as a forest, large commercial building, or oil or natural gas fields. The Yale portfolio manager, David Swensen, one of the top investors in the world for the last 25 years, has been increasing his holdings in real assets over the last 3 years. It is an investment category through which you can take advantage of pricing efficiencies. One of the best ways for the average investor to buy real assets is by buying Real Estate Investment Trust (REIT) companies. For example, timberland has been one of the best investments for the last 20 years. Its return during the past two decades has been 12.8%. There are a number of timberland REIT companies that own extensive timberland acres. For example, Plum Creek (PCL) owns over 7 million acres and has a yield of 4.3%.
7. Companies that export a majority of their sales from the US. QE2 should have a positive effect on US companies that export a majority of their products. Their products should cost less and be more competitive in the world marketplace. This should increase their revenue and profit and should have the effect of increasing their stock price. This will not work if the products they sell have a large component of commodities (since commodity prices will be increasing).
Please chime in with comments about the QE 2 investment strategy. What investments do you are think best for QE 2? Future blogs that I will be writing:
Income generating bucket of money
Investing in possible buyout companies
Investing in Brazil
Using Fisher’s 15 points for researching companies to evaluate one company
Reviewing 2011 tax changes
© 2010 Paul Cusick
Paul
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