The Market

Obviously, we are going through a difficult time – again – in the market and investors fear there will be another drop similar to the last one. I read the following in an AP article on the web this morning: “Don’t panic. Think long-term. Corrections are normal.”

The idea to get out of the market when it starts to go down and get back in when it goes up just does not work. The reason it doesn’t work is that despite all the predictions you read and hear out there, no one knows when the market hits the bottom or when it will turn around. Long term investors should not be concerned about short term volatility. You should always keep enough cash for emergencies and have the proper allocation for your situation. You need a long-term plan and you also need to resist the temptation to succumb to the fear that the media generates.

I received a newsletter this week where the title concerned another bubble that is about to explode. They predict that the average $100,000 portfolio will be worth $48,000 at the end. However, if you would only take the bold steps outlined in the report you could turn that $100,000 into $2.4 million. The report is 20 pages long and outlines some compelling evidence and I can see why people would be influenced by reports such as this. If it was so easy to make so much money why is the author writing a newsletter? There are also books – that are best sellers – that are predicting dire things for the economy. There are also books that give a more balanced historical perspective, such as “Manias, Panics, and Crashes” (fifth edition) by Charles Kindleberger and Robert Aliber. While we usually hear “this time is different” the truth is that every time is different, yet surprisingly the same.

Barbara Gray, CFP®
Partner

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How to Save Millions in Two Seconds!

I love headlines like that. Tightening our belts is the topic du jour during this economic disaster. While the leading indicators show an improvement, I am sure you know people who are still unemployed, have lost their homes, or are in serious financial straits. We are hardly out of the woods yet. So, I have compiled a list of my favorite tips for saving money:

Protect your credit score. Why?

o You qualify for better interest rates when your credit score is good, which saves you money in the long run.
o Your credit score impacts your property insurance rates.
o A prospective employer may want to check your credit. A bad score could hurt your chances, depending upon the employer.

Everyone knows you should get the free, annual credit report offered through AnnualCreditReport.com. Identity theft is not the only danger, though. Excessive debt and late payments or defaults can damage your score. All your sacrifices and stringent budgeting can be undone by a lousy credit score.

Be thoughtful about all purchases, not just the big ones. I am not talking about your daily Starbucks habit, although that can add up too. A lot of purchases are driven by a perceived need, rather than an actual need.

Don’t fall victim to the “it’s on sale” syndrome. You are not saving money if you really had no intention of buying the item in the first place.

The Internet is a fabulous tool. You can comparison shop without having to leave the comfort of your home.

Tip if you are considering an appliance purchase: Go to energystar.gov. Look for the Energy Star Appliance Rebate Program button. The “cash for clunkers” program is being offered for certain appliances this year. Each state has a different budget and rollout date. Our dishwasher died here at Parsec about three weeks ago. We waited for this program to start in North Carolina and saved over $100.

Ask about discounts. Some people will give you a discount, but you have to ask. My vet will match heartworm medicine prices offered by a national catalog retailer. I saved about $50.

Yes, it takes extra work to stretch your dollar these days. Hopefully, these tips can assist you in that task.

Cristy Freeman, AAMS
Senior Operations Associate

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How to Make a Little More Money on Your Excess Cash (with a Bit of Work on Your Part):

With short-term interest rates at very low levels, many are wondering if there is any way to earn a higher return on their cash balances. We generally recommend that clients maintain an emergency reserve of 3-12 months worth of after-tax living expenses. The specific amount varies by client and depends on a number of factors such as the level and predictability of your income as well as your personal preference. Many clients choose to meet their liquidity needs by keeping a home equity line of credit available, and keeping their cash invested with a long-term focus at their desired asset allocation.

This column will focus on how to get a little more yield on an existing cash balance. Currently, money market rates at Fidelity and Schwab are almost zero. As of last week, the national average for a 1-year certificate of deposit was 0.72%. One thing to consider for small cash balances is Series I Savings Bonds issued by the U.S. Government, which are currently earning an annual rate of 3.36% for the next 6 months.

The earnings rate for Series I Savings Bonds is a combination of a fixed rate, which applies for the life of the bond, and the semiannual inflation rate (think “I” as in “inflation”). The 3.36% earnings rate for I Bonds purchased through April 30, 2010 will apply for their first six months after issue. The earnings rate combines a 0.30% fixed rate of return with the 3.06% annualized rate of inflation as measured by the Consumer Price Index for all Urban Consumers (CPI-U). The inflation rate changes every 6 months, so your earnings rate will increase with increases in inflation. The fixed rate applies for the 30-year life of I bonds purchased during each six-month period. The bonds cannot be redeemed for 12 months after issuance, and there is a penalty of 3 months’ interest if they are redeemed before 5 years. Purchases are limited to $5,000 per Social Security Number in electronic bonds and $5,000 in paper bonds, so a couple could purchase up to $20,000 annually.

So why would you want to invest a portion of your liquid cash in something that carries a penalty for 5 years? Because if you act by April 30, you are in effect creating a 1 year CD with a yield of about 2.45%.

Here’s how it works:

You go to your bank and buy a series of $1,000 I Bonds. For the next six months, these bonds will earn interest at an annual rate of 3.36%. The rate will then reset, but we already know what the inflation component will be since CPI-U has already been published. We just don’t know the fixed rate, which is set every six months by the Treasury. If the fixed rate stays the same at 0.30%, the earnings rate for the next 6 months will be an annual rate of 1.84%. So you could reasonably expect a return of at least 2.45% over the next year versus 0.72% in a bank CD.

What if there is an emergency and you need the money? You cannot redeem the bonds for 12 months, so you need to leave some liquid cash on hand. After 12 months, just pay the penalty and you are still ahead of where you would have been (say 1.77% yield if you cashed the bond in after 12 months and one day, versus 0.72% in a bank CD).

You can then repeat this process to create a ladder of bonds maturing at different points, say every 3-6 months. You can set up an electronic account at www.treasurydirect.gov and manage this process from the comfort of your couch. You can just deposit any paper bonds that you buy into your account and convert them to electronic form.

All I Bonds that are outstanding have the same inflation component, currently 3.06% annualized. The only difference is in the fixed rate that each bond offers. If the fixed rate increases significantly, just redeem some bonds and pay the penalty. Then buy some new bonds with the higher fixed rate (but remember the $10,000 annual limit on purchases for each Social Security Number).

Some other benefits of I Bonds include:

–Interest is exempt from state income tax;
–If you buy the bonds on the last day of the month, you still get interest for the full month;
–You don’t have to worry about FDIC insurance or shopping around to different banks for the best rate. I Bonds are direct obligations of the government, whereas FDIC insurance is a fund consisting of a small percentage of deposits that are covered.

Bill Hansen, CFA
April 23, 2010

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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®

Partner

ParsecFinancial

227 W. Trade Street

Suite 1840

Charlotte, NC 28202

(704) 334-0894 phone

(704) 334-9323 fax

www.parsecfinancial.com

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Alpha

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®
Partner

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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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