The Special Tax

April 15th is in the past. The hand wringing and sweating, while glaring glassy-eyed at Turbo Tax is over and you can all breathe a sigh of relief, unless of course you filed an extension!

There are some interesting changes to the tax code that were passed in the healthcare bill. These changes won’t take effect until 2013, so voters won’t feel the hit until after the 2012 elections. In 2013, upper incomers will pay more in Medicare taxes. First there will be 0.9% surtax on single filers that earn over $200,000. If you are happily married filing jointly, the threshold is $250,000. The EMPLOYEE will pay the whole tax.

The second issue to address for 2013 is that there will be a Special Medicare Tax of 3.8%. Singles with adjusted gross income over $200,000 and married filers with $250,000 of adjusted gross income will be affected. The adjusted gross income includes earned income, income from interest, dividends, capital gains, annuity payments, royalties and passive rental income. Still excluded from the special 3.8% tax is municipal bond interest and retirement plan payouts. There will be a few more changes to the tax code that will begin in 2013; however, we feel the Special Medicare Tax has the greatest ability to affect our clients.

The programmers at Turbo Tax will be quite busy for the next several years. Who knows — maybe they are hiring!

Gregory D. James, CFP®



227 W. Trade Street

Suite 1840

Charlotte, NC 28202

(704) 334-0894 phone

(704) 334-9323 fax

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Question: what does alpha have to do with an ox? Answer: as far as investing goes, nothing. But I did find an interesting nugget on Wikipedia when I Googled “alpha” this morning. In Moralia, Plutarch discussed why alpha should be the first letter of the Greek alphabet. The story goes that Cadmus, a Phoenician, put alpha at the beginning because it was the Phoenician word for ox, and the Phoenicians considered oxen a primary necessity. Plutarch, who was not a Phoenician, tended to side with his grandfather, who noted that the “a” sound is the easiest sound to make, and thus the first sound children make when learning to talk.

As much as I’d like to continue in this random vein, I’m afraid I must come back to investing, since this is the Parsec blog. Fortunately for me, alpha does have meaning in our world, too. Most often, it is used as a way to measure a portfolio manager’s skill – you may have heard it mentioned in conjunction with mutual fund performance. Well, here’s the Morningstar definition: “Alpha is a measure of the difference between a portfolio’s actual returns and its expected performance, given its level of risk as measured by beta.”

Crystal clear now, isn’t it? As Inigo says in The Princess Bride, let me ‘splain…no, there is too much – let me sum up. Let’s say you have a large cap mutual fund, and you want to know how it performed compared to the S&P 500 index. First, you look at the fund’s beta relative to the benchmark (the S&P, in this example). I’ve discussed beta before, so I won’t revisit the topic here, but basically if the beta is over 1 (let’s say it’s 1.10) you would expect the fund to return 10% over the S&P. If it does as expected, then the fund manager didn’t add any value – the fund performed as expected given its level of risk and its alpha is 0. However, if the fund returned 12% over the S&P, the fund’s alpha is 2%, meaning that it performed better than expected given its level of risk – the manager added value. Of course, this is assuming that the only risk is market risk (beta), and that the chosen benchmark is an accurate comparison for the fund in question.

Enough tedious financial arcana – get outside and enjoy the beautiful spring weather. Seriously, what are you doing reading this? Begone!

Sarah DerGarabedian
Research and Trading Associate

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All Things Green

Remember those “green shoots” we kept hearing about in the economy? It appears that the buds are finally breaking and spring has come. Over the past year we’ve heard that term quite a bit from economists and commentators referring to small hopeful signs of recovery from the Great Recession. Since then the news has gotten even better. No one talks of green shoots anymore, but rather full-on recovery.

In other news of things “green,” Parsec awarded the first quarter Parsec Prize to Carolina Mountain Land Conservancy and Southern Appalachian Highland Conservancy. The prize ($9,000 to each), was given to these organizations because we wanted our first quarter Parsec Prize to go toward supporting land conservancy and stewardship in North Carolina. Both CMLC and SAHC are such great organizations that we couldn’t choose between the two. Thanks in part to the work of these groups North Carolina is a beautiful place to live.

Lastly, today is April 1, and it appears we may have survived this gray and icy winter. The weather here in Asheville is warm and sunny and the flowers are blooming on the trees. Happy Easter, Happy Spring, and have a great weekend!

Harli L. Palme, CFP®
Financial Advisor

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Thirty Years of Progress

Parsec is celebrating its 30th anniversary this year!  It is a remarkable achievement – and we have you, our clients, to thank for it.

It is hard to believe that all this began in 1980.  I doubt many of you would pick that year as the time to start a business.  Interest rates were around 16 percent.  Unemployment was high.  The country was in the midst of a recession.

It was in this environment that Bart Boyer decided to move from Minnesota to Asheville and start an investment management firm.  Parsec’s first office was in the lower level of his home.  Now, we have expanded to every floor in the building we occupy in downtown Asheville.  We have an office in Charlotte.

I am fortunate enough to have been here for almost 18 of those years.  I have witnessed the remarkable changes and growth our firm has experienced.  In the upcoming newsletter, I will share some stories with you about our journey.  Please stay tuned!

Cristy Freeman, AAMS
Senior Operations Associate

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Asset Allocation

As our life expectancies have increased, our years in retirement have also increased. If your plan is to retire at age 62, for instance, you need to be prepared to have a portfolio that will last for your lifespan, possibly age 100. Unless you are retired from the government, pension plans are becoming a thing of the past. You will need to supplement Social Security with your own savings and retirement plans.

There is much written about asset allocation, or the mix of stocks and bonds in your portfolio. You may have read articles urging “aged based” asset allocation, or increasing your allocation to bonds as you get older. The historical ten-year equity return through 12/31/2009 is 10.3% and the bond return is 5.18%. Equities, of course, have more volatility than bonds and the last 18 months has been an equity roller coaster ride. Many investors now view the equity market with apprehension and caution, wanting an increased bond allocation. Unless you have extreme wealth, a large fixed income allocation may not be a smart strategy. A 30 year time horizon, with 30 years of inflation, means you will need enough growth to meet those challenges. Everyone has a different situation that must be evaluated before an allocation is chosen. Some investors have money they will never need, so essentially the investment is for their children or grandchildren, warranting perhaps a 100% equity allocation. If you are concerned about your allocation or would like to discuss this further, please contact your advisor.

Barbara Gray, CFP®

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Bond Market Highlights

Bond Market Highlights

Municipal Bonds

  • According to Moody’s, investment grade municipal debt had an average default rate of 0.03% from 1970 through 2009.
  • Current muni market is shaped by historically steep yield curves and historically wide quality spreads.
  • Anticipation of higher tax rates at both federal and state levels still exists.


 Corporate Bonds

  • According to Moody’s, investment grade corporate debt had an average default rate of 0.97% from 1970 through 2009.
  • Corporate spreads have narrowed considerably from a 25 year peak of 268bp to 153bp currently (AAA yields minus 1-yr Treasury yields).
  • Current corporate market is shaped by a steep yield curve and still wide quality spreads.

 High-Yield Bonds

  • In early 2009, the spread between 10-yr B-rated corporate vs. treasuries peaked at over 1,200bp.
  • At year end, spreads were around 425bp which compares favorably with the long-term average spread of approximately 250bp.
  • The amount of “distressed bonds” fell to $117 billion from $250 billion six months ago.  Distressed bonds yield at least 10 percentage points above benchmark rates.
  • Current default rate near 13% as of 3Q ’09.  Historical average is around 5%.

 International Bonds – OIBYX (4th Quarter commentary)

  • The Eurozone, particularly the export-driven economies of France and Germany, responded well to the turnaround in global manufacturing but strains within the euro family grew more prominent given the ongoing credit issues in Greece, Spain, and countries in Eastern Europe.
  • In the wake of possible higher global interest rates, the team is continuing to under-weight developed market debt and over-weight emerging market country debt.
  • Within the Developed Markets sleeve, the fund was largely able to side-step the issues surrounding Greece.  The fund’s Greek bond exposure was drawn down to zero by late November.

 US Treasuries

  • The break-even rate between yields on 10-yr Treasuries and TIPS, a measure of the outlook for consumer prices, has widened from 0.12% to 2.15% at the end of February.
  • A newer gauge of investor expectations for inflation rose to 3.27% in early January, approaching the high of 3.36% reached in May ’04.  This gauge, called the five year/five year forward break-even rate, was created by a Federal Reserve Bank insider.
  • A survey of 80 financial services firms forecast CPI of 2.15% in 2010, 2.00% in 2011, and 2.30% in 2012.

 Mark Lewis

Research & Trading Associate

March 2, 2010

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The Importance of Dividends–Part 2

In an earlier column, I discussed some of our philosophy regarding dividends.  This week, I would like to expand on that somewhat as well as give a quick update regarding taxation of dividends in the President’s budget proposal.

Modern financial theory holds that the value of any investment is the sum of the present value of its future cash flows.  This logic applies whether the investment is a publicly traded stock, a piece of commercial real estate or a hot dog stand.  With a dividend-paying stock, you are getting a return on your initial investment each quarter rather than relying purely on future earnings growth to make a profit. While short-term volatility can be considerable, over longer time periods stock prices follow rising earnings and dividends.

As part of our investment process, we compare the current market price of a stock to its theoretical value using a dividend discount model.  The output indicates whether the company is overvalued (expensive) or undervalued (on sale) based on certain assumptions. All else equal, a company that does not pay a dividend must have a higher expected growth rate than a dividend-paying stock to command the same valuation.  Part of our job is to analyze whether the model’s assumptions regarding dividend growth, the sensitivity of a stock to movements in the overall market, and other factors are reasonable. 

The dividend payout ratio is the proportion of a company’s earnings that are paid out as dividends to shareholders. If a company earned $1.00 per share for a year and paid a $0.40 dividend during that time, the dividend payout ratio would be 40%.  The traditional theory taught in universities and graduate schools all over the world used to be that the lower the dividend payout ratio, the higher the earnings growth rate in subsequent periods.  Recent studies have demonstrated exactly the opposite, that is, that higher dividend payouts actually resulted in higher future earnings growth.  This relationship was shown to hold true across a number of different countries and time periods.  If this theory continues to hold true, it would be a double win for investors, since they would capture both a higher current dividend as well as higher future earnings growth by investing in dividend-paying stocks.  (If you are asking yourself why we don’t invest exclusively in dividend-paying stocks, please see my November 25, 2009 Blog entry). 

Currently, qualified dividends are taxed at the same rate as long-term capital gains, at a maximum rate of 15%.  If the Bush tax cuts currently expire at the end of 2010 as scheduled, dividends would be taxed at higher ordinary income rates for 2011 and beyond. Tax brackets are scheduled to increase, with the top bracket rising back to 39.6% from the current 35% level.  However, President Obama’s budget proposal that was recently submitted to Congress has a maximum 20% tax rate on qualified dividends for single taxpayers earning over $200,000 and couples earning over $250,000.  For those earning less, the qualified dividend tax rate would remain at 15%.  While an increase in taxes on qualified dividends from 15% to 20% is not anyone’s first choice, it is a lot better than going from 15% to 28% or 39.6% as many feared.  It is too early to say whether this portion of the budget proposal will pass, but I believe that the result is unlikely to be significantly worse.

Bill Hansen, CFA

February 26, 2010

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Let’s Make Like BRK.B and Split

In late January, the financial world was abuzz with the news that Kim Kardashian’s shoe rental company launched its first retail kiosk at an L.A. mall! No, wait, wrong headline – Warren Buffett’s Berkshire Hathaway B shares underwent a 50-for-1 split! The shares, which had been trading just below the $3500 mark, split on January 21 and began trading around $70. Wow, seems like a great deal, doesn’t it? In the sense that a single share seems more affordable, yes. The operative word there is “seems.” Stock splits don’t affect the value of the company or its market cap (and if you’ll notice, 3500/50 = 70). To borrow an analogy from a coworker, think of the company as a pie. You could divide the pie into 4 quarters and charge $10 per quarter. Now, I don’t know about you, but when I go to a bakery or a coffee shop for a piece of pie, I am not interested in shelling out $10 for 1/4th of a pie. I also don’t know of many places that will sell you a fractional piece of a menu item. So, the shop owner would do much better to slice the pie into 8ths or 16ths, and offer each piece for $5 or $2.50, respectively. The smaller, more affordable quantity is more appealing to the vast majority of people, but the overall value of the pie hasn’t changed – all the pieces together still add up to $40.

So it is with a stock split. Investor perception is that $20 to $80 is a reasonable price to pay for a share of stock, so sometimes companies will split the shares when the price has risen above these levels. In Berkshire’s case, the split was due in part to the acquisition of Burlington Northern Santa Fe. In order for Berkshire to be able to offer shares of BRK.B in exchange for shares of BNI, they had to reduce the share price. Why? If BNI is trading around $100, and you own 20 shares, your investment is worth $2000, which is less than BRK.B’s per-share price of $3500. In the same way that you can’t order half of a menu item, you can’t trade fractional shares of stock, only whole shares.

To sum up, I will quote John Ogg from 24/, “A split is technically a non-event on true fundamentals. But at this point it has finally become a stock that the public can own.” It’s the same pie, just divided into smaller pieces.

Sarah DerGarabedian, Research and Trading Associate

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Somebody’s Economy is Doing OK

The Wall Street Journal recently reported that a bronze statue just sold at Sotheby’s auction for $104.3 million.  “It must be an ancient relic,” I said.  Nope – it was cast in 1960.  “It must be by Leonardo da Vinci,” my colleague said.  Nope – it was created by Alberto Giocometti.  “The person who would spend $104.3 million on that must have a lot of other money,” another colleague said.  Yes, probably.

Meanwhile, jobless claims moved higher.  The four-week moving average of new jobless claims ticked up from 456,000 to 468,000.   The unemployment rate is a lagging indicator of the near-term direction of the economy, but the initial jobless claims report is a leading indicator.  Some fear that the economy will “double dip,” meaning, take another leg down before a sustained recovery. 

Though having higher jobless claims is certainly not good, other leading indicators are pointing to the economic recovery.  The Conference Board measures an index of 10 leading indicators such as yield spread (the difference between the overnight bank lending rate and the 10-year Treasury), building permits, and the stock market.  The Conference Board recently reported that the index of leading indicators jumped 1.1% in December.  This is on the heels of a 1% increase in November. 

We take this as a good show of economic recovery (not to mention the recent report of 2009 4th quarter GDP of 5.7 %!).  Joblessness is painful to those experiencing it.  You can’t write off this reality because of other improving leading indicators.  However, the economy has to improve before job growth can resume.  In the mean time, we will save our cash and hold off on that $104 million dollar statue purchase.

Harli L. Palme, CFP®

Financial Advisor

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To Die or Not to Die in 2010

Since 2001 we have had a stable estate tax with gradually increasing estate tax exemptions.


2002-2003          $1,000,000

2004-2005          $1,500,000

2006-2008          $2,000,000

2009                          $3,500,000

2010                          $0 ???

For now in 2010 there is no federal tax on estates.  Of course nobody believes this will last.  The House and Senate will most likely come to an agreement to bring back the $3,500,000 exemption.  This is what the House tried to pass before 2009 ended.  The Senate was too busy with healthcare, so no fix was passed. The Senate I believe is pushing for a higher exemption and doubling the amount for married couples which will eliminate the need for a by-pass trust.  In other words, if an estate was valued at $7,000,000 the assets would not need to be split for each spouse to receive the full exemption. In either case, when they do decide it will most likely be retroactive to January 1, 2010.  If you die before they decide your estate may have to litigate to keep the zero tax.  One drawback to not having an estate tax is your heirs would inherit your cost basis on assets.  This could cause your heirs to pay hefty capital gain taxes if they liquidate assets after your death.  In prior years assets inherited qualified for a step-up in cost basis, using the value on the date of death for the new cost basis.  An estate will have the ability to increase the tax cost basis by $1.3 million plus an additional $3 million for transfers to a surviving spouse. This caveat is still uncertain as to whether or not it will go back to the old way of a full step up in cost basis.

We will keep you informed as to the outcome.  In the mean time keep on living and enjoy the economic come back, and the future market growth we are certain to experience in the years ahead.

Gregory D. James, CFP®

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