Reuters Money

Municipal bonds: 4 rules for investors

The following article by Nanette Byrnes originally appeared in Portfolioist.

States and cities are in a world of pain at the moment as they face another year of gut wrenching (and politically unpopular) service cutbacks and layoffs. Once again, they must balance their budgets in the face of possible declines in federal funds to states and drooping real estate tax revenue.

That cold reality, combined with the prediction of influential analyst Meredith Whitney that numerous municipal bankruptcies could be coming down the pike, fueled a three-month long drop in municipal bonds. In the last two months, $25 billion has also been withdrawn from bond mutual funds.

Could this be a buying opportunity?

Municipal bonds absolutely offer good buys at current prices, say some experts. The trick: separating the good from the bad, something the municipal market is remarkably bad at, according to Rick Ashburn, chief investment officer for Creekside Partners. Says Ashburn:  “The good bonds and the bad bonds are all selling at the same price.”

Find the good, and the payoff could be sweet. With municipal bonds offering 5.5 percent and six percent yields, compared to roughly 3.4 percent for a 10-year Treasury note, Ashburn recommends clients start buying.

He’s not the only one bucking the tide and buying munis. In a December 28 interview with CNBC, famed bond investing expert Bill Gross, co-founder of bond fund giant PIMCO, explained why he’d recently put $5 million of his own money into five PIMCO muni bond funds. With some muni bonds in California, New York and elsewhere offering yields of as much as seven percent, he felt the potential reward outweighed the risk.

Is Detroit the next retirement hot spot?

Lately I’ve been thinking about retiring to Cleveland. Oh, sure, laugh, but hear me out.

Cleveland has (1) museums with parking by the front door; (2) a beautiful lake; (3) the Cleveland Clinic and other great health resources; and (4) a convenient airport. Oh, and one more thing: Cleveland has really cheap real estate. So I could take my Washington-Baltimore corridor housing money (median home value, $310,000) and trade it in for an average Cleveland house (median home value, $114,000).  And THAT would give me almost $200,000 worth of cash that I could use to fly to Key West or Cozumel for the winters, even if I didn’t downsize my house.

Yes, rust belt real estate has taken a hit, and so have some previously popular retirement spots like Phoenix and Las Vegas. That got me to thinking: How low do prices have to go before they attract new immigrants? And can you save enough by moving to one of those beaten down cities to come away with change-your-lifestyle cash?

I asked Zillow, the real estate research website, to run some numbers and provide a sanity check. “It’s an intriguing concept,” Stan Humphries, the firm’s chief economist, said tactfully. ”The savings that people could see by going to some of these cheaply priced markets do add up to real savings, and they could use the savings for travel or other discretionary items.”

Zillow crunched the numbers like this: First, they looked at all metropolitan areas that had below-average median home values. Then, they eliminated places that didn’t have convenient and busy airports, so travel wouldn’t be a problem. They ranked cities by low home values and property taxes, access to healthcare and airport size. And came up with this top ten, ranked here by their median home value.

Of course, not everyone will want to spend their golden years in Detroit or Cleveland. But for me, these cities would feel more like home than you might expect.

For starters, they both have losing football teams, too.

Obama lays down a marker on Social Security cuts

Would he or wouldn’t he?

President Obama’s deficit commission endorsed cutting Social Security benefits last month, and many wondered whether the president would endorse those cuts in his State of the Union message this week. Instead, the president reiterated the traditional Democratic position on Social Security in his address that he staked out as a candidate in 2008:

“We must [strengthen Social Security] without putting at risk current retirees, the most vulnerable, or people with disabilities; without slashing benefits for future generations; and without subjecting Americans’ guaranteed retirement income to the whims of the stock market.”

That rhetoric differs significantly from the “everything on the table” messages emanating from the White House since the National Commission on Fiscal Responsibility and Reform issued its final report. Written by commission co-chairmen Alan Simpson and Erskine Bowles, the report recommended benefit cuts via a higher retirement age, lower annual cost-of-living adjustments (COLA) and a third, somewhat technical change in the way benefits are calculated.

What happened in the weeks since the release of the commission report? A coalition of traditional Social Security backers and Democratic lawmakers seem to have convinced the White House to back away from the Simpson-Bowles recommendations. Their case had two main points — both correct:

1. Cutting benefits is bad policy. That’s because Social Security has nothing to do with the federal deficit. The program ran a $2.5 trillion surplus in 2009, a number that will hit $3.8 trillion in 2020, according to the Economic Policy Institute. The surplus has been accumulating since implementation of the last Social Security reform measures in 1983, which were implemented for the purpose of building a cushion to fund the anticipated big wave of baby boomer retirements.

Pay less to the IRS with tax-managed mutual funds

Werner Renberg is a writer and author based in Chappaqua, N.Y. He is the author of four books, including All About Bond Funds: A Complete Guide for Today’s Investors. The opinions expressed are his own.

If you own equity or mixed-asset mutual funds in taxable accounts, one thing is certain: Whatever the top income tax rate on capital gains that President Barack Obama and Congress will agree on for 2013 and beyond, it will continue to hit you in two ways — and possibly even a third:

1. You, of course, will owe income tax when you sell mutual funds’ shares out of taxable accounts if your capital gains exceed your capital losses.

2. You also will owe income tax when funds sell securities and have net capital gains at year’s end, requiring them to credit you with your portions of the taxable distributions even if you didn’t sell one share — and even if your funds values dropped.

3. You would suffer a third strike if all your net capital gains and capital gains distributions lift your adjusted gross income (IRS Form 1040’s Line 37) enough to put you into a higher tax bracket.

Can you do anything to have more of your taxable retirement portfolio continue to work for you and pay less to the IRS? Perhaps. You could move money into one or more tax-managed equity or mixed-asset funds. Such funds tend to have two goals:

•  Maximizing after-tax returns by (a) offsetting capital gains with capital losses to reduce, if not to avoid, long-term capital gains distributions and (b) using other tactics, such as keeping stocks targeted for sale for a year until they become long-term holdings to avoid highly taxed short-term capital gains distributions. For income, these funds prefer stocks that pay lower-taxed qualified dividends and may also invest in federally tax-free municipal bonds.

Gray divorce: The question of alimony

There’s probably no great time to dissolve your marriage, but recent dips in the economy have especially played havoc on so-called “Gray Divorces” — break-ups between older people who have been married for decades.

Garbrielle Clemens, a Massachusetts attorney who specializes in the financial elements of divorce, says now that the economy is starting to improve she’s seeing increased filings for gray divorces from couples previously stuck in a holding pattern. And the one trend she’s seeing is women forgoing alimony in order to front-load money in case their ex-spouse can’t come up with the payments down the line.

“I’m finding a lot of women are not interested in alimony,” she says. “They don’t want to be subject to them every month being late or not paying what they should. So I’m seeing a lot of people saying ‘Give me an unequal amount of the property division and I’ll figure it out myself.’ And that’s been working basically well.”

Two of Clemens’s clients offer good case studies. Nancy Colgan, 64, wanted to avoid alimony in her split with her spouse of 38 years because she wanted to cut ties and her ex’s employment status seemed shaky. “I didn’t want him to try to get alimony from me,” she says. In fact, her husband did lose his job after their settlement went through, and she’s glad she set herself up as she did. But, she says, “The judge didn’t like it.” During the proceedings the judge told her she was making a mistake and wouldn’t put the settlement through until the next day so she could think about it some more. She doesn’t regret her decision.

Clemens notes: “You can put anything you want in an agreement but the question is, down the road can you enforce it?”

That rings true with her client Linda Powers. Powers decided to forgo alimony and just do a straight-up division of assets. But in this economy, even that kind of deal can be troublesome. She says her husband got the house and was supposed to pay her $50,000 a year for ten years to compensate her for her portion of the property. But, Powers says her ex-husband was employed in real estate and his income tanked; he started drawing on the equity in the house and stopped paying her completely. “That was supposed to be my income,” she says. Their fight continues in court. Her advice? “Settle your divorce as fast as you can. If your income is tied to your ex-husband, it’s still like you’re married to them.”

Justin A. Reckers, managing director of Pacific Divorce Management in San Diego, says the non-alimony route is uncommon in California, and it’s something that should be handled with great care based on the laws in your state. In Colgan’s case, he notes: “The court retains jurisdiction here forever, unless you tell them otherwise. Attorneys here think that the judge can always come back and modify a spousal support agreement. So, if that case happened in California, there’s a very good chance that her ex could come after her for spousal support.”

Actively managed ETFs and other wrinkles

The following is an edited excerpt from Never Buy Another Stock Again: The Investing Portfolio that Will Preserve Your Wealth and Your Sanity, written by David Gaffen, who is the Reuters markets editor. It was printed with permission of FT Press, an imprint of Pearson.

One of the biggest growth industries in finance right now is in exchange-traded funds, and further growth in ETFs appears likely to come from several places.

Sector or country-specific ETFs and actively managed ETFs are likely to continue to be a growth area, along with perhaps a combination of the two (an actively managed ETF focusing on small-cap stocks, for instance).

The most popular sector ETFs are in natural resources and technology, although State Street, which sponsors the SPDRs ETF, has S&P sector ETFs for nine of the ten S&P sectors (telecommunications is the lone exception—it’s folded into another area); new ones continue to crop up.

For professional investors attempting to beat the market, they’re an ideal vehicle because they carry a relatively low cost and have tax efficiency, as David Kotok of Cumberland Advisors has pointed out. But John Bogle, in his book “The Little Book of Common-Sense Investing,” quoted (anonymously) a chief investment officer at an ETF company cautioning against “pin-pointed” bets on sectors, because they “still involve nearly as much risk as concentrated stock picks.” But that doesn’t mean they’re going to stop growing.

Like mutual funds, tech stocks, tech funds, and other hot investments that dominated the landscape for a time, the ETF world is turning into its own “app economy,” as Nicholas Colas, chief market strategist at BNY ConvergEx Group, puts it. This, by itself, is not necessarily a bad thing, but with more choices comes more confusion.

Another area where one can expect a growth spurt is in actively managed ETFs, first introduced by investor Harry Dent with his Dent Fund through AdvisorShares, which is now marketing other new actively managed exchange-traded funds. And so ETFs are starting to come full circle: While this is still designed for the same kind of tax efficiency and liquidity offered as most ETFs, now investors have the (supposed) benefit of active management—but the higher expenses to boot.

Wary Americans lose their risk appetite: study

Call it another by-product of the recession: Americans have lost their risk mojo and are slow to return to financial markets after taking a beating in the 2008-09 recession, according to a risk tolerance January 2011 survey released by TD Ameritrade.

The findings also show Americans would rather forgo an up day in the market than risk losing money in a slight market decline.

“More than half of investors think that being invested in a 10-percent market decline is a worse scenario than missing a 10-percent market increase. That’s a real change in attitude,” said Stuart Rubinstein, managing director of client engagement for TD Ameritrade.

Of those surveyed, 28 percent reported moving more money into bonds or certificates of deposit in order to avoid exposure to risk in the market while 23 percent moved money into managed investment products like mutual funds.

Baby boomers remain the most wary about returning to the market, while younger investors, who are using cash for emergency funds, savings and large purchases, are returning to the market in larger droves.

Generation Y seems to be rebounding a little bit faster: 34 percent of Gen Y investors surveyed report investing new money in the stock market compared to 14 percent for Gen X and 15 percent from baby boomers. Rubinstein says this could also mean Gen Y investors are “nimbler.”

“When we ask older generations the most important financial advice they can give to younger generations, 77 percent said live within your means, 67 percent said start saving for retirement earlier and 47 percent said learn all you can about proper money management,” he says.

Reverse mortgage defaults prompt changes to counseling services

Federal regulators and lenders are moving to address a growing problem with defaults on reverse mortgages. Last week, I detailed how defaults can happen on these loans to seniors, and a new initiative by the U.S. Department of Housing and Urban Development (HUD) to beef up counseling services as part of a broader effort to deal with non-performing loans.

The new HUD initiative comes in the wake of criticism of the reverse mortgage industry’s marketing and consumer counseling practices. While it’s impossible to make a direct connection between the criticisms and the growing number of defaults, advocates argue that aggressive marketing has resulted in reverse mortgage sales in situations where the loans may not have been a good fit.

A June 2009 report by the U.S. Government Accountability Office (GAO) uncovered misleading advertising claims by lenders, including ads that implied HUD’s Home Equity Conversion Mortgage (HECM) is a government benefit (it’s not – HUD only regulates and insures the loans); that borrowers can never lose their homes; and that borrowers can never owe more than the value of their homes.

“There are some benefits to a suitable reverse mortgage,” says Norma Garcia, senior attorney at Consumers Union and co-author of a recent study critical of reverse mortgage lending practices. “But it’s for a very particular need and the industry has been marketing them as though they are good for everyone.”

Under federal law, potential HECM borrowers are required to go through pre-loan counseling sessions intended to make sure they understand HECMs and their risks. But the GAO study pointed to inadequacies in the counseling process, citing instances it uncovered where federal standards for pre-loan counseling were not met. GAO found instances of counselors who failed to discuss other lower-cost options available to potential borrowers outside of HECMs, and the financial implications of an HECM.

The report also found instances of inappropriate (and now illegal) cross-marketing of financial products such as deferred annuities or other insurance products alongside HECMs.

A spokeswoman for HUD notes that new counseling standards have been implemented since the GAO report. And earlier this month, HUD announced $3 million in new funding to housing counseling agencies to help them provide guidance to borrowers facing default. And the FHA recently beefed up the financial education required under the counseling program.

Fire your financial adviser, unless they are a fiduciary

If you have a conventional stock broker or agent acting as a financial adviser working on commission, fire them.

Now that the SEC has endorsed a “uniform fiduciary standard of conduct” for brokers and investment advisers, there’s no reason to settle for anything less. This is a financial professional who, by law, must put your interests first.

In the past, the SEC did little to protect you from the ravages of a commission-driven world. Few knew the difference between a “financial consultant” (a broker) or a “certified financial planner” or “registered investment adviser.” The latter two are fiduciaries.

Having a fiduciary is one of the best investor protections around. If they wrong you, you can sue them. As a requirement of the Dodd-Frank financial reform law, the SEC needs to write the rules codifying this key investor protection and Congress needs to rubber stamp it.

It’s also time to move on to fix the broken system that deals with investor disputes. With brokers and agents, you typically sign away your right to sue. You are then subject to inadequate “suitability” standards that don’t offer much protection at all. Not only is it extremely difficult to sue, you are forced to settle most disputes in an industry-run arbitration system.

Countless investors are cowed by the process of proving that they were sold inappropriate investments by brokers. Although the industry doesn’t release the numbers — they should — most investor arbitration lawyers say that about 80 percent of wronged investors settle with brokerage firms for a fraction of what they are owed rather than go through arbitration.

Not surprisingly, investors don’t like the fact that even if they choose the arbitration process — which is billed as a cheaper alternative to litigation — it will cost them thousands in an attempt to get their money back and will face at least one industry member on a three-person arbitration panel. It’s like having a lawyer being the foreman of a jury in a legal malpractice trial.

IRA-to-charity rollovers are a smart move for retirees

Since 2006, a popular tax rule had permitted those aged 70-and-a-half or older to donate up to $100,000 from their Individual Retirement Accounts to charity. Last year, as the tax flux dragged on, no one knew whether this provision would stay or go.

At the 11th hour, the December tax legislation gave it the okay: The provision was both extended through the end of 2011 and permitted retroactively for 2010. Given the delays, the deadline to do this and have it count for 2010 has been pushed out till Jan. 31. If you’ve got the funds and it makes financial sense, you could make two IRA-to-charity rollovers this year, counting one donation for 2010 and one for 2011.

For last year’s contribution, unfortunately, you need to have forgone your required minimum distributions (RMDs) for the year. If you already took them, sorry, you’re out of luck: The Internal Revenue Service won’t let you return those payments in order to take advantage of this charitable rollover for 2010.

“It’s a hot topic here,” says Craig Richards,” director of tax services at Fiduciary Trust International. “Unfortunately, none of our clients so far have been able to take advantage of it for 2010 because we got such late tax legislation.”

But even if that’s the case, it’s worth considering for 2011. And that’s the case even if your retirement funds, and your charitable donations, are relatively modest.

What’s the big deal? For those who don’t need all their RMDs for living expenses — or for those who were going to give money to charity, anyway — this can be a very savvy financial play. That’s because the charitable rollover can count toward the RMD amount, but is not taxed as a regular distribution would be. While you don’t get the charitable tax break, it’s a better deal than taking the RMD, paying tax, and then giving the money to charity.

Consider a simplified example: If you gave $100,000 from your IRA to charity through this rollover, the charity would get $100,000 and you’d pay no tax. If you took the $100,000 as an RMD and paid tax on it at the 35 percent tax bracket, you’d have only $65,000 left to give to charity. You’d get a tax benefit of $22,750 for donating that smaller amount. But overall, you’d end up with a net tax payment of $12,250 on a much-lower charitable donation.