Personal Finance

Yearend tax tips from the experts  discussed below: Sell your stinker stocks Ponder philanthropy Size up sensible strategies Pay off credit card debt Get ready for a market rally Keeping more of your money: How to Pick the Right Investment Adviser

Is Your Sky Falling?
For most of us, investments this year were in freefall,
but capital losses can yield tax benefits for years to come


By Lawrence Bivens

Chances are that if you’re reading this story you’ve had a better year than many when it comes to matters of money. That’s because more than 90 percent of this magazine’s readers are NCCBI members, a demographic which surveys have shown are highly compensated. That you are gainfully employed is no small feat given the continuing sour economy and the accompanying high unemployment rate.

But chances also are that while your 9-to-5 habits probably haven’t changed much, your financial statements have — and for the worse — due to an unkind stock market infused with corporate scandals and threats of terrorism.

So the $32,000 question — remember when it $64,000? — is this: Is it safe to open your 401(k) statement again?

The question is one on the minds of individual investors as they close the books on another disappointing year on Wall Street and look toward 2003. As a new year beckons, questions abound on the direction of financial markets, the tax consequences of portfolio losses, asset allocation strategies, estate planning matters and more.

Prominent financial experts around the state say it’s still possible to turn recent market pain into gains, and they are encouraged about prospects for next year — assuming investors take a few of the right steps now.


Sell Your Stinker Stocks

A down market offers numerous opportunities. Some are obvious, others not so. Now, for example, is the ideal time to undergo what experienced money managers refer to as “loss harvesting” — jettisoning portfolios of disappointing holdings whose real value at this point may be in their tax relief. “Look to let go of stocks that are unlikely to come back,” suggests Arnie Morris, CPA, the director of wealth management for the Coastal Carolinas at RSM McGladrey. Capital losses from those holdings can be used to offset gains taken from other stocks, assuming there are any. If not, up to $3,000 in losses can be used to reduce taxable income from 2002. Anything beyond that amount may be carried over into the loss column of future tax years.

“Taking tax losses does have economic value,” explains Russ Kimbro, CFA, a regional portfolio manager with Wachovia Wealth Management in Winston-Salem. He suggests investors undertake some “portfolio hygiene” with the goal of salvaging cash from uglier holdings that may be used to invest in “leading economy” companies that are poised to do well as U.S. industrial growth re-emerges.

But how does the average investor identify those holdings with slim prospects of recapturing past glory? Start with those that offer little earnings visibility, Kimbro says, referring to the capacity — or, in this case, lack thereof — of firms to forecast revenue derived from their core business.

There are other relatively simply indicators to consider. Judson Russell, a principal with the global corporate and investment banking section at Bank of America, recommends a return to a pre-1990s fundamental question: “Is the company generating cash flow?” With “New Economy” firms throwing time-tested financial measures to the wind, manic investors eagerly threw cash at stocks whose promise rested in speculative returns that were, at best, years away.


Ponder Philanthropy

Holding stocks trading well off their highs present other opportunities, as well. For some investors it may be just the time to convert traditional IRAs into Roth IRAs. The latter, a relatively new retirement planning tool, offers added flexibility and future tax benefits, though there are income-based restrictions on eligibility. And, unlike their traditional counterparts, contributions to a Roth IRA are not tax-deductible.

Individuals moving assets from a traditional to a Roth IRA must pay taxes on prior year contributions, along with interest and gains, though they are given four years over which to spread their payments. With portfolio values down, those considering conversions have an ideal window through which to minimize tax consequences, planners say.

To go the Roth route is largely a question of age and proximity to retirement, explains Carlisle Whitlock, first vice president and senior portfolio manager at Central Carolina Bank (CCB) in Chapel Hill.  “Anyone younger than 50 should take a serious look at it,” he advises.

The same arithmetic applies to the practice of transferring ownership of shares to family members. “There’s an upside in gifting at a time like this,” says Jean Gordon Carter, a CPA and partner with the Raleigh law office of Hunton & Williams. A parent or grandparent, for instance, can take the opportunity to gift shares of a company trading at relatively modest values. “Three to five years from now, those shares will likely be far more valuable,” Carter explains.

Some savvy investors may be fortunate enough to hold shares trading well above their purchase price. For them, there may be justifiable reluctance in realizing their profits when doing so now means getting socked with a huge capital gains tax bill.

“They should consider donating stocks to their favorite charity instead of making their usual year-end cash contribution,” suggests RSM McGladrey’s Morris. “The charitable deduction would equal the current value of the stock, not the basis,” he says.

What’s more, they may then take the cash they would normally contribute and buy the same stock at today’s price.

Here’s an example: An investor who purchased $1,000 worth of IBM in 1992 would likely be holding shares now valued in excess of $10,000. Instead of cashing out and writing a check to Uncle Sam for the $9,000 capital gain, the investor donates the shares to his church in lieu of his usual $10,000 year-end cash gift. By doing this, he gains a $10,000 deduction from this year’s taxes and pays no capital gains taxes.

Should he remain interested in owning shares of Big Blue, he can purchase $10,000 worth, now at a higher basis, with the cash that he would normally have given the church.


Size Up Sensible Strategies

After betting all or much of the farm — and losing — on high-flying technology and telecommunications stocks over the past two and a half years, many investors are returning to more sensible asset allocation strategies, divvying up their portfolios across an array of individual stocks, mutual funds, bonds, cash and other instruments. “One of the things we’ve been stressing is diversification,” says Morris. Asset allocation begins with a sober assessment of risk tolerance and time horizons, he says. “In the 1990s, people moved out of their risk tolerance zone.”

At the heart of gauging risk tolerance is determining when — in some cases, whether — you’ll need your principal. Saving for the college tuition of a high school sophomore dictates a more conservative approach than, say, investing for a retirement that may be three decades away. “If you don’t have at least a three-to-five year time horizon, maybe it’s wrong to be in the stock market,” says CCB’s Whitlock.

Assuming stocks are the appropriate option, there is the question of purchasing individual shares vs. selecting a stock mutual fund. Owning individual stocks offers investors more flexibility and control, while mutual funds provide broad diversification and professional management.

Morris suggests investors with less than $2 million think about sticking with mutual funds, though it’s important to select the right funds for the right reasons. “Look for funds with low costs and management fees,” he says. He looks for funds with expenses that amount to about 0.70 percent, although in the case of an international stock fund or one that invests solely in small companies, it is not unreasonable to see management fees in the 1.25 percentage point range.

And he encourages mutual fund investors to look at owning fund shares in various fund families. “There’s no one family of funds that does well in every asset category,” says Morris, who adds that fee-based planners can sniff out the best funds with the lowest costs.

Bank of America’s Russell advises small investors to divide their portfolio roughly in half, putting some assets in a “passively managed” mutual fund, such as a broadly based index fund, which should offer an adequate return at a low cost.

“Investors should then look around to find an investment they may know something about,” he says. A computer expert can invest in what he thinks are promising technology companies, for example. Those knowledgeable about medicine may compile a list of pharmaceutical companies. “It might even be antiques, if that’s something that a person is really familiar with,” Russell says.


Pay Off Credit Card Debt

As with the end of any year, it is prime time to look at 401(k) and other employer-sponsored retirement savings programs, making sure that tax-protected contributions and provisions for employer matching have each been maximized. “Put as much into these plans as you can afford,” suggests Russell.

Current economic and market conditions also present opportunities in the area of debt management. With investors jittery about war, terrorism, corporate accounting chicanery and lackluster economic growth, it may be a good time to pay down outstanding loans instead of sending more cash to Wall Street.

Rock bottom mortgage rates have homeowners scurrying to re-finance. McGladrey’s Morris suggests plowing that extra savings into the loan’s principal. “Pre-paying” the mortgage, he says, enables them to own the house free and clear sooner and save thousands in interest payments. Those with extensive credit card debt or outstanding car loans should consider using a home equity line-of-credit or second mortgage to pay them off, Morris says.

“They can not only get a better rate that way, but interest payments on those types of financing are tax-deductible.”

Morris and other professional planners also urge clients to look at estate planning issues this time of year. “December is a good time to discuss needs with the family,” says Hunton & Williams’ Jean Carter. Time at home with family members is an opportunity to put such matters as wills, living wills and healthcare powers-of–attorney on the table.

And it is more important this year than before to consider key changes to estate tax exemptions enacted by Congress in 2001. “A lot of people have planning documents that are based on old tax laws,” Carter says.

While it’s often an awkward subject to broach, parents and their adult children should seize the opportunity to talk about their wishes regarding end-of-life care. “One of the biggest favors a parent can do for their child is to discuss getting a healthcare power-of-attorney,” believes Carter.

She recently saw firsthand the importance of such instruments when she was dealing with the final weeks of care for her terminally ill father. While such documents are vital for older people, they’re worth serious consideration at any age, Carter says.


Get Ready for a Market Rally

After three straight down years, most who follow the markets professionally expect the coming year to offer a welcome move to the upside. “In my view, the market is poised for a rally due to a combination of fiscal and monetary stimulus,” says Bank of America’s Russell.

While he has placed the bulk of his personal assets in bonds over the past two years, he is now beginning to look at equities again. Among the sectors Russell is considering: battered technology and telecommunications stocks. The latter group, he suspects, will likely begin undergoing consolidation in 2003.

Wachovia’s Kimbro is also optimistic about stocks. Prospects for a prompt conclusion to any war with Iraq, along with newly minted corporate disclosure rules, are likely to boost consumer confidence, he says. Add to that the fact that currently relaxing on the sidelines is an estimated $5 trillion in cash awaiting a return to the market.

Wachovia bank economists are forecasting GDP growth in 2003 to take place at a healthy 3.5 percent clip, which is likely to give corporate earnings — and thus share prices — a needed shot in the arm.

“With the economy improving modestly in 2003, we’ll likely see the broader indexes increase by five to seven percent,” according to Michael Walden, William Neal Reynolds Distinguished Professor of Agricultural and Resource Economics at North Carolina State University.

Even though the nation’s recession ended in 2001, equity markets have struggled to decipher just how firm the economy will be. “There was the assumption that we would pick up where we left off in the late 1990s, and now the markets have determined that growth will be slower over the next few years.”

Only a few years from retirement, Walden says he is moving his portfolio into more conservative investment instruments such as U.S. Treasuries and corporate bonds. He expects interest rates will rise next year, a move that will impact certain industry groups. “I’d be cautious about investing in durable retail such as home appliances or automobiles because of rising interest rates,” he says.

Others have delved into market history and find reasons to be upbeat about 2003. “We know the market rebounds nicely in the six months following a mid-term election,” explains John Baber, a lecturer in finance at the University of North Carolina at Charlotte’s Belk College of Business Administration.

Historical evidence suggests that over the years, stocks continue to provide better returns than any other vehicle. “In the long haul, you’re still a whale of a lot better off than with CDs or money market accounts,” says Baber.

That’s a perspective that may be worth remembering when it comes time to tear open that 401(k) statement.



You Do Background Checks on New Employees,
Why Not on the Person Handling Your Investments?

During the heady bull market of the late 1990s, nearly any investor could be a hero. But the past two years have taught many that seeking paid advice from a qualified professional is an appealing alternative to the painful losses most average investors have seen. Picking winners in such a merciless market environment, many have concluded, requires more than basic financial literacy and a daily scan of the financial pages.

But where can already squeamish investors turn to make sure the advice they’re getting is sound and the people they’re getting from are on the up-and-up?

“It’s a subject that we come in contact with daily,” says David Massey, director of the securities division at the North Carolina Secretary of State’s Office. Legislation passed in the late 1980s has added some clarity to the often hazy lineup of planners, advisers, agents and representatives. Today, anyone charging a fee for their work must register themselves with Massey’s office. Consider any arrangement with a financial professional a business relationship that requires attention from both sides, Massey says. “As with any business relationship, you have the responsibility to look out for yourself.” Investors should take time to ponder their goals before speaking to any professional. “You’ve got to have some idea of what you expect out of the relationship,” he adds.

One central question worth getting on the table early involves how the professional is compensated. Some advisers are paid a percentage of the account’s assets — typically between one and two percent. Others charge a flat fee unrelated to the account’s performance. But Massey says other compensation sources should be checked out. Some “soft-dollar arrangements” involve investment advisers channeling their clients’ business to a particular securities dealer in return for research and other useful information. “The client should really know about this,” Massey says. “If not, they are operating in the dark.”

It’s also worth asking advisers how long they’ve been in the business and how many different firms they’ve been with over their careers. Educational background, specialized training and certifications can also be good indicators. “Credentials can be very helpful,” says Arnie Morris, director of wealth management at RSM McGladrey in Raleigh. Designations such as Certified Public Accountant (CPA), Certified Financial Planner (CFP) or Chartered Financial Analyst (CFA) are indications the individual has completed extensive rounds of specialized training and successfully passed rigorous exams. “But there are other things that are important,” Morris adds. He advises finding out what percentage of the professional’s time is actually spent providing investment advice. “You want an individual who is dedicated to this field — not a part-timer,” Morris says.

It’s also worth knowing what return a prospective adviser has earned for existing clients. “You want to look at their record,” suggests Carlisle Whitlock, first vice president and senior portfolio manager at Central Carolina Bank in Chapel Hill. Whitlock says it is also crucial to get a sense of the adviser’s style. Does it mesh with your style? He also recommends people ask for and check the references of professionals. “There’s nothing better than getting to talk to a satisfied, or unsatisfied, customer,” Whitlock says.

The Internet is a convenient mechanism for checking into would-be advisers. The Secretary of State’s web site (www.sosnc.com) offers a broad array of resources to assist investors, including access to two searchable national databases of brokers and financial advisers. The site has links to useful financial information, as well as a helpful “Smart Investor Notepad” to track conversations about investments.

“People realize now that successful investing does require due diligence,” says Secretary of State Elaine Marshall, who has made financial literacy a priority for her department. She says most of the problems that crop up between investors and their advisers could be avoided if people took the time to check with her office about whether investment professionals and their products are actually registered. Beware especially of people who claim they don’t need a license to sell their services, Marshall says. In addition to its web site, the Secretary of State’s office maintains a toll-free telephone number (800-688-4507) that consumers may use to verify credentials.  -- Lawrence Bivins

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