At the risk of overdoing my seasonal metaphor, being a diversified portfolio manager, I observe that having so much cash invested in assets with miniscule returns and, in fact, losing purchasing power after the impact of inflation and taxation, is like wearing a winter coat in summer. That North Face parka is wonderful for fighting the cold winter wind in the North, but it becomes a major hindrance in July when pruning trees and working in the garden. It’s time for investors and corporations to understand that summer is coming; they need to shed the fear and parka and put some of their piles of cash to work into investments that make real profits, grow wealth and create jobs.

The unwillingness of corporations and individuals to move from cash to “riskier” assets like stocks and real estate is limiting economic recovery and muting the performance of the stock market. According to a recent Bloomberg News article titled “Record Cash Weighing on U.S. Stock Market Returns” by Roben Farzad, U.S. companies accumulated $1.84 trillion in cash on their balance sheets in the first quarter of 2010. The article further highlights that “as a percentage of company assets, cash is at its highest level in a century.” In his recent“Guide to the Markets,” Dr. David Kelly of J.P. Morgan pointed out that an individual’s portfolio of cash on the “sidelines” increased 30% from March 2007, through March 2009 and has dropped only modestly since. Now don’t get me wrong, I like cash. I remember Warren Buffett talking at a recent Berkshire Hathaway shareholder meeting about how he gets his peace of mind by having several billion dollars in cash. Currently he has about $30 billion in peace. However, as a shareholder in some of the cash: rich companies and as a capitalist, I expect more investment savvy from management than stashing away cash with no opportunity for return, like an obsessive squirrel burying more nuts that he can eat in October.

When are shareholders, hedge funds and boards of directors going to demand that management deploy some of this cash for higher returns instead of squirreling it away? When are individuals going to stop accepting negative real returns on “safe” bank assets and move to stocks? I don’t know when, but it will happen. It is irrational to accept negative returns perpetually.

How can we know when summer is coming on Wall Street? Here are three categorical indications of the potential for summer to come to Wall Street:

1. An increase in flows of money out of cash assets like money markets to equities.
2. An increase in merger and acquisition frequency.
3. An increase in the number of corporations willing to increase dividend payments to shareholders.

The facts are promising when considering the flows of money by investors in mutual fund asset categories. According to the Investment Company Institute and J.P. Morgan, the net flows of domestic and world equity funds have gone from an outflow of $233 billion in 2008 to a small inflow of $14 billion through June 30, 2010. This may be an early indication that investors are leaving cash and low yielding bonds for higher potential returns in global equities. More demand to buy equities will eventually increase stock prices.

In the merger and acquisition category, recent headlines note some indication of corporations’ willingness to invest cash by acquiring other companies. At the risk of being a bit presumptuous, a search of financial news headlines shows a trend toward an increase in merger and acquisition activity. For example, Sanofi-Aventis recently indicated an interest in an informal acquisition approach to biotechnology drug maker Genzyme Corp. I am sure Genzyme shareholders were pleased by the 15% increase in per-share value on this announcement.

A further scan of headline news illustrates the potential evidence of future increases of dividends by cash rich companies may be in play. On July 23, 2010, General Electric announced that because of a stronger than expected cash position, they were increasing their dividend 20%. GE also said they will restart a stock buyback. On the news, GE stock appreciated more than 3%.

It may still be winter on Wall Street as evidenced by high corporate and individual cash positions but there are a few early signs of investor willingness to put the cash to work. Individual and corporate investors should shed their winter parka of fear and begin allocating the piles of cash to investments that can provide good long-term investment returns. Those who see summer coming first will enjoy it the most.

Roth IRA Conversions

This year is important for Roth conversions for several reasons. Starting in 2010, income limits have been eliminated on eligibility to make a conversion to a Roth IRA. There are a variety of reasons to consider a Roth conversion, including the ability to avoid mandatory distributions from your retirement account during your lifetime as well as pass a portion of your assets tax-free to your beneficiaries. This year taxpayers also have a onetime opportunity to choose to pay taxes on the converted amount in 2010 or spread the tax payments over 2011 and 2012. An important consideration for spreading out the tax payments over 2011 and 2012, as well as for determining if a Roth conversion is right for you at all, is whether you expect your marginal tax rate will be lower in 2010, in the next two years or in the future when you would begin to take taxable distributions if you don’t convert. One thing looks likely at this time – tax rates going up next year for taxpayers in the higher tax brackets … which leads us to the next topic.

Marginal Tax Rates

Today there are six marginal federal income tax rates. Without additional legislation these will expire at the end of 2010. The lowest 10% bracket will disappear, and the remaining brackets will return to pre-2001 levels, as shown below:

Other Key Tax Rate Changes

The tax rates that apply to long-term capital gains are changing as well. This year if you sell a capital asset (like a share of stock) that you’ve held for more than one year, the gain will generally be treated as a long-term capital gain, taxed at 15% if you are in one of the top four marginal tax brackets or 0% if you are in the 10% or 15% tax brackets.

These rates are also scheduled to expire at the end of 2010. In 2011, a 20% rate will apply, except for taxpayers in the lowest marginal tax bracket who will pay a 10% rate on long-term capital gains.

Qualifying dividends are treated similarly to long-term capital gains in 2010, taxed at 15% for the top four brackets and at 0% for taxpayers in the 10% and 15% tax brackets. In 2011, they will be taxed as ordinary income.

Of course FIM Group will continue to manage all of your accounts (taxable accounts, IRAs, etc.) to take advantage of the unique structure that each account offers in order to maximize tax efficiencies.

Looking ahead, new taxes related to the recent health care legislation will take effect in 2013. A new Medicare payroll tax of 0.9% will be assessed on wages exceeding $200,000 for individual taxpayers and on combined wages exceeding $250,000 for married couples filing jointly.

Also beginning in 2013 is a new Medicare surtax of 3.8%. Single filers with income exceeding $200,000 and joint filers with income more than $250,000 will be assessed the surtax on the lesser of: 1) net investment income, or 2) modified adjusted gross income (MAGI) in excess of the income thresholds. If either 1 or 2 is zero, there is no surtax. Net investment income includes taxable interest, dividends, capital gains, distributions from annuities, rent and royalty income, and passive-activity income. It should be noted that distributions from a traditional IRA are counted in MAGI and could trigger the surtax, whereas Roth withdrawals will not.

Estate Tax

This year we saw the temporary repeal of the federal estate tax. Many expected Congress to move quickly to reinstate the tax, but to date we are still waiting. The chart below shows a summary of the changes, and as you can see the estate tax returns in 2011 to the pre-2001 level of $1 million with a top tax rate of 55% unless additional legislation is passed.

All of this uncertainty makes it especially important to review your estate plan to ensure that it effectively carries out your wishes.

This summary covers some of the more significant federal tax opportunities, changes and uncertainties for your tax planning consideration. This is by no means an exhaustive list but rather highlights some of the changes that may affect many of our clients. The impact and applicability in individual circumstances needs to be reviewed on a case-by-case basis. Please contact your FIM Group adviser if you would like to discuss any of these matters further.

We can’t predict what Congress will do, but as in recent years it is likely we will see additional legislation between now and the end of the year making it important to stay informed.

The U.S. stock market couldn’t gain any traction in the first half of the year. And Hawaii investment experts didn’t fare any better.

Amid fears of a spreading European debt crisis, continued housing problems on the home front, and reverberations from the BP oil spill, the major indexes all hit the midyear point lower than they started in 2010.

Local stock pickers similarly struggled, with only one of four contest participants squeezing out a gain in the newly renamed Star-Advertiser’s ninth annual survey of best investment ideas.

The outlook for the remaining six months of 2010 doesn’t look much brighter, according to local stock expert Norm Caris, whose hypothetical $20,000 portfolio was up a scant 1.1 percent through the first six months.

“Stock prices show we have dodged another Depression, but toxic anti-business rhetoric and policy errors are still hurting the still-fragile recovery,” said Caris, a Kauai resident and managing director for institutional sales for Caris and Co.

He said the current tax and spending policies of federal lawmakers are counterproductive for business, investors, and market confidence.

“The market will continue to fluctuate based on legislation and how the politics turn out in November,” said Caris, whose portfolio hit the midyear point worth $20,214.20.

Still, he said stock prices have retreated to more sensitive levels and investors should be looking to increase their exposure.

In the first six months, the Dow Jones industrial average posted a 5 percent loss, which includes reinvested dividends, while the NASDAQ composite index declined 6.6 percent and the Standard & Poor’s 500 index fell 6.7 percent.

Barry Hyman, vice president-managing team for the Maui branch of FIM Group Ltd., was the only other stock expert besides Caris to trump the indexes. Hyman’s portfolio lost 3.2 percent to $19,357.81.

Rounding out the contingent of experts were Richard Dole, chief executive officer of Honolulu investment adviser Dole Capital LLC, who lost 8.2 percent to $18,362.90; and Dwight Melton, co-founder of the Hawaii Stocks and Option Group, down 18.2 percent to $16,362.93.

Caris revamped much of his portfolio for the third quarter, including closing out his short position in Honolulu-based Alexander & Baldwin following a 7 percent gain through six months.

The short position enabled Caris to profit as the stock price dropped.

He also doubled down on his positions in both Hawaiian Holdings, parent of Hawaiian Airlines, and Intel, as well as added new companies in Collective Brands, which owns Payless ShoeSource stores, and semiconductor equipment maker Novellus.

Hyman, hurt in the second quarter by a 43.5 percent decline in investment management firm U.S. Global Investors, more than doubled his position in that company for the third quarter because he sees it as a bargain.

“They specialize in natural resources, like gold, as well as emerging markets, which hold much of the world’s natural resources,” Hyman said. “At its current extremely depressed price, U.S. Global is even more undervalued relative to the price of gold and natural resources.”

Hyman sold all his holdings in Barrick Gold after the stock posted a 19 percent return in the quarter, but said gold mining stocks remain undervalued relative to the price of gold.

“Investors afraid of the stock market are buying gold bullion, coins or exchange-traded funds, but the pricing of mining stocks have not kept pace,” he said.

He added two stocks to his portfolio in the quarter. One was global telecom provider Vodaphone, which pays an approximate 7.5 percent dividend and has a consistent cash flow.

His other pick was Gaiam, a producer and marketer of lifestyle media and fitness accessories.

“While I am very cautious of many retail companies in the current environment, Gaiam is a well-managed niche company that I expect will do well despite the strapped consumer,” Hyman said.

“Through subsidiaries like Real Goods, and relations with other outlets, they focus on the consumer movement to be more energy efficient, environmentally conscious and life-quality oriented.”

Dole, who didn’t make any changes in his portfolio, said he hasn’t changed his market outlook since the beginning of the year.

At the end of the first quarter, he said the market had gotten ahead of itself based on a slow-growth environment and likely would be vulnerable to bad news.

“We certainly had a market correction, partly due to slower expected China growth and an unexpected oil spill driving down energy stocks,” Dole said.

“I continue to believe that the market will be higher by the end of the year, but we will have corrections along the way. Price-sensitive stocks suffered more than the market as a whole in the recent market downturn.”

Dole’s best performer in the quarter was Territorial Bancorp, the holding company for Honolulu-based Territorial Savings Bank, which slipped 0.2 percent.

Melton, who typically favors stocks with strong momentum, picked up a 7 percent gain from Apple in the second quarter but was stung by losses of more than 20 percent on his other three holdings, including a 32.1 percent decline by coal producer Alpha Natural Resources. Still, Melton decided not to make any changes for the third quarter in his portfolio.

“I’m cautious going forward,” he said. “For openers, housing’s pressures are mounting on both the building and sales fronts in wake of the recent expiration of tax credits for homebuyers (even though those with signed contracts now have three additional months to complete their purchase).

“Housing is not all that is restraining the upturn, though. We’re also seeing reluctance by consumers to spend, lesser contributions from fiscal stimulus, and further weakness overseas, particularly in Europe.”

I think it is helpful to first look at ourselves. Many people invested in gold and silver after their prices rose significantly during the Hunt Brothers mania in the early 1980s. Others invested in high-yield bonds in the late ’80s, Asian stocks in ‘93-’94, technology stocks in ‘97- ‘99, large caps, blue chips, passive indexes like the S&P 500 in the late ’90s, and real estate in the 2000s. A lot of those same people then sold those “investments” after they didn’t work out so well.

Unseasoned investors chase investments when the media, relatives or friends report how much money has already been made during such trends. When these same sources report things are “really bad” or “different this time” the emotional reaction is often to sell at a loss, move to cash (or other perceived “safe havens” such as gold today, after it has run up more than 300% in the past several years) and lick one’s wounds. If some of this sounds familiar based on your own or someone else’s experience, congratulations! Consider yourself normal.

Wisdom

What separates successful investors and the self-made wealthy from the common man? What is it that enabled the tremendous wealth transfer from less fortunate sellers to successful investors like Andrew Carnegie, John D. Rockefeller, J.P. Morgan, John Templeton and Warren Buffett? Along those same lines, why do you suppose it is that over long periods during which really bad things take place (including, but not limited to World Wars, the Great Depression, assassinations, terrorist attacks, natural disasters and man-made disasters, not to mention less dramatic events like recessions, inflation, deflation, stagflation, deficits, higher taxes, Democrats taking over, Republicans taking over, gridlock, etc.), markets are able to climb these “walls of worry” while apparently ignoring all this important stuff?

There is a common thread that separates investment success from mediocrity. It is the same phenomenon that propels investments themselves higher against what, on the surface, appear to be dire conditions. In a word: fundamentals. In a sentence: the ability to separate the essential from the unessential [information]. In other words, it is the ability to weigh ALL the evidence rather than reacting to a subset. The press, politicians or others often have a vested interest in what information is disseminated and what is not. Successful investing requires the discipline, skill and diligence to identify and weigh all strengths, weaknesses, opportunities and threats.

In the case of the movement of broad investment market trends, contrary to what the financial media might have us believe, the common thread that has separated periods of rising prices from those of falling prices has had very little correlation to inflation, economic growth or exogenous events like the headwinds described above. For example, from 1933 through 1936, the Dow Jones Industrial Average rose 200% despite the country being mired in the depths of the Great Depression. From early 1942 through early 1946, the Dow rose more than 130% despite the attack on Pearl Harbor and the U.S. being drawn into WWII. More recently, from 1982 to 1999, the Dow rose an incredible 1,214% despite stagflation, inflation, the price of gold soaring tenfold then collapsing, a stock market crash (October 1987), the Exxon Valdez disaster, the largest earthquake since 1908, the first Gulf War, the junk bond crisis, the savings and loan crisis and a recession. (Worth noting is that all of these advances were solely the prices of the Dow stocks and did not include the very significant contribution of dividends provided to investors.)

The single common thread present at the beginning of every period of extended stock market advance was historically low starting prices of stocks relative to their measures of valuation, such as their earnings or sales at the beginning of each period. For example, the P/E ratio (price-to-earnings ratio) of the stocks in the Dow average began those three periods at 11, 9 and 7 respectively, the low end of their historic range. The reverse situation describes the worst bear markets of the past 100-plus years. That is, at the beginning of the worst periods for the U.S. stock market, such as 1929 to 1932, 1937 to 1941, 1966 to 1982 and 2000 to 2009, the P/E of the Dow began at 28, 18, 21 and 42, the high end of their range. (Source: www.crestmontresearch.com)

Model Investors

In the case of uber-successful investors, they also had a similar common thread. They, too, obeyed fundamentals and weighed all the evidence.

Carnegie attained his wealth initially by investing his meager Pennsylvania Railroad wages in the stocks of companies with which the company he worked for did business. Out of the ashes of the Civil War, the success of his investments in the railroad businesses, integral in the rebuilding of America, began what eventually grew to be one of the greatest amounts of wealth an individual had ever amassed. Where others saw destruction and devastation, Carnegie saw opportunity.

Morgan, who came from a completely opposite upper-crust background, increased his family fortune though many endeavors, including helping finance the government during the Panic of 1893 and the banking system in the Panic of 1907. He was rich before these crises and did not need to risk his capital. But he, too, saw opportunity embedded in crises.

Rockefeller was, like Carnegie, born of modest means. He was a self-made businessman and amassed his great wealth in a fashion similar to Buffett. Rockefeller formed a fledgling oil company then began buying out competitors, improving their efficiencies and leveraging his growing empire to get favorable pricing from vendors. Admittedly ruthless, his tactics were similar to Buffett’s in that he purchased companies at prices that were low relative to the earnings he expected them to be able to generate regardless of the obstacles emanating from the press, regulators or competitors.

Five Losing Years

FIM Group’s mentors, include Benjamin Graham, Sir John Templeton and Warren Buffett, because they are the past century’s most notable fundamental stocks and bonds investors. They did not fear volatility, but rather saw volatility as an opportunity to buy assets from frightened people who had little understanding of the value of their holdings. Through each of their disciplined value approaches, they were all massively successful investors even across vast periods of difficult investment terrain. For example, from 1966 through 1982, a period during which the Dow Jones Industrial Average began at 1,000 and ended at 1,000, Templeton earned himself, as well as investors upon whose behalf he invested, more than 1,100%. Within that 16-year period, he had five losing years, but his losses were not permanent because he ignored the fear, embraced volatility and had conviction in the value of his holdings despite the folly of “the markets.”

When prices of such investments are pressured down, savvy investors take advantage of such opportunities. None of these great investors sold because so-called pundits said the market was going down or the world was in trouble. Instead, each of them took advantage of such behavior to transfer great wealth from weaker investors to themselves. What is it that prevents common investors from having similar success? Paul Sutherland terms it “The Poisons of Investing.” These behaviors include placing too much emphasis on current news, holding investments that are no longer good values, panic-selling, inflexibility/stubbornness, etc… Again, the short answer to a lack of investor success is the inability to weigh all the evidence and invest accordingly.

The Rest of the Story

Let’s examine the world’s current state of affairs. The bad stuff includes huge debt, bailouts, deficits, higher taxes, health care reform, 9% unemployment, a falling dollar (until 11/09) followed by a rising dollar, similar problems in Greece, Portugal, Spain and Italy, a collapsing Euro, a terrible oil spill and conflicts in Iraq, Afghanistan and Korea. The politicians are saying we are doomed unless we follow their agenda. The financial press is saying we are doomed in order to keep people glued to the tube, papers or other form of media. Yet, for each of these conditions, there are both historical precedents and current balancing factors.

For example, the debt on the U.S. government’s balance sheet is around $9 trillion (Source: Bloomberg). Not to downplay this debt as a good thing by any means and the fact that U.S. government debt has ballooned by $3 trillion in the past two years is certainly nothing to sneeze at. But looking at the debt alone ignores several important balancing factors. First, the vast majority of it was used to purchase assets (ownership in financial and auto companies as well as mortgages and other depressed collateralized loans). It is conveniently left out that the values of most of those assets have risen, some dramatically, since the government’s investments were made, thus earning taxpayers significant profits. It is also not mentioned that, according to calculations from First Trust Advisors, the assets on the government’s balance sheet exceed $150 trillion. If that ratio of debts to assets were the balance sheet of a company (minus a few zeros naturally), or of an individual (minus a few more zeros), they would be considered incredibly strong financially. However, the press and politicians get no benefit from highlighting the facts they conveniently leave out.

Successful investors seek out “the rest of the story” rather than merely reacting emotionally to the hype or headlines. The current environment is one in which billions of dollars of wealth will likely transfer from investors not prepared or able to defy their emotions to those who are.

Patrick, my two-year-old, shrieks so loudly when he wants mine or my wife’s attention that we sometimes keep our windows closed. He indeed triggers an emotional response just as readily as today’s writers, idea evangelists and marketers desire to get our attention, grab headlines and sell people on their ideas. For Patrick, however, it’s gummy bears or playing basketball with his 15-year-old brother, Keeston, even though it’s bedtime. What’s interesting about the emotional “fear-greed” paradigm that we have been seeing so much of lately is that we are all still raw from the crisis of a few years ago and still see little in the way of “fixes” from our leaders. In times of crises, many governments seem to default to taking a shortsighted, myopic, easy path and “just say yes” to things like bailouts, dishonesty, and self-dealing by firms and individuals, and enact irresponsible policies that are just as unhelpful in the long term as saying yes to gummies or basketball. Any parent, adult or common sense-infused sibling knows that to say “yes” to Patrick’s rants is a short-term gain that sets us up for extreme long-term pain. Because Patrick is my third child, I have the sensibility to let him shriek till dawn rather than give in to his demands. Governments, too, should have the sensibility to impose more austere measures regardless of the populist shrieking.

Feeding our fear at this moment in time are the now well-documented, sound byte-grabbing “three Gs”: 1) Gulf (oil spill), 2) Greece (Euro breaking down) and 3) Goldman (ethics and excess). Each of these is a real threat, and politicians and the press have an unrelenting desire to feed our emotions with fear, greed and lust-caused actions. So again people are selling, but really there is no sell without a buy. When someone sells a German bond, Swiss holding company, Hong Kong conglomerate, Spanish utility or French energy company, they’re likely saying, “I like a U.S. money market instrument better.” But on the other side of the transaction, another investor is buying the security and taking advantage of the emotional behavior of the seller. The question, however, in any buy, sell or hold decision is, “What was the logical thought map of the decision?” Was this the best financial advice? Was it logical in the long term or just a quick emotional response to the market’s and media’s shrieks? The world’s government experts, our representatives, heads of state and their advisers seem to have forgotten to think long term with their decisions and are responding to the shrieks of their constituents. Years ago a mentor told me, “Paul, before you can teach well, you need to be a good parent, husband and businessperson. Once you have mastered those skills, then you can teach.” Our representatives need to learn a thing or two. Fortunately, history tells us that while many mistakes are likely to be made, the entrepreneurial spirit of capitalism will prevail, and we will muddle through and fix our problems.

The Greatest Generation

My wife, Amy, and I had the privilege of hearing Tom Brokaw, author of The Greatest Generation, speak and field questions when he came to Traverse City. His thoughtful answers were inspiring and filled me with a hope that only rational analysis could bring. When asked about today’s political, economic and polarized world, he smiled and chatted about Watergate, the Kennedy assassinations, Oswald, Martin Luther King, Agnew, Vietnam and the economic mess that we pulled out of in the ’80s. Also with a smile and a wise demeanor that only someone who had “been there – done that” could have, he talked about what he called “the greatest generation”– those who survived the Great Depression only to find themselves in two major wars, a Holocaust and the devastation of most of the world (except the U.S.). He did not want to trivialize today’s problems, but when he compared them to the world’s scenario during the ’60s and ’70s, we had to feel like our current situation was not something unmanageable. Things are not as bad as they seem in the political arena … just like in the investment arena. As part of our disciplined approach to looking at companies, I often use SWOT (strengths, weaknesses, opportunities and threats) analysis – the same method I used when working toward my MBA. I got to thinking about the world’s economy and we have reason to be either optimistic or negative – it’s our choice.

Lunch in the USA

I had lunch today with a Zambian born immigrant, and we chatted about Africa, where 30,000 of its citizens die of starvation and preventable deaths every day. He is hopeful about Africa’s fixes, but sad that corruption, “live only for today” mentality, aid that causes dependence and its fear-based system seem to bog down any progress. Throughout U.S. history, we have had men and women rise from obscurity to be leaders at times when they were needed most. When I think of how lucky we are, and how events from 234-plus years ago shaped our nation, I can see only reason to be optimistic. This young Zambian’s father worked in the copper belt and spent his meager mineworker’s income to educate his children. That was his only priority. That was his only goal. I’m becoming more and more optimistic that Africa will figure it out, too. When we look at Singapore, China, Brazil and scores of other countries and the progress they’ve made, it is so easy to be rationally optimistic. When the likes of George Washington, Mahatma Gandhi and Nelson Mandela appear when their citizens need them most, it is easy to be optimistic. The Fourth of July is just around the corner, and I am so proud that I was born in the U.S. I am most proud of the fact not that we have fought and won wars and overcome the Great Depression, but that we have fought against complacency, negative attitudes, laziness, despair and had little tolerance for mediocrity throughout our history. We Americans have “good bones” and a great legacy. In a few years, we will look back on the three Gs as an interesting footnote in history. Life goes on, and I am optimistic, because when I perform a SWOT analysis on the U.S., I see the opportunities and strengths boxes filled to the brim and the threats and weaknesses boxes chock full of opportunities to fix.

Types of Annuities

There are various types of annuities, each with different benefits, depending upon where the assets are invested and when payments begin. A “fixed” annuity, for example, provides a specified rate of interest for a period of time, while a “variable” annuity offers greater opportunity for growth but also comes with higher risks. Other types include “indexed” annuities, “deferred” annuities, “single premium” annuities and “flexible premium” annuities. Keep in mind that the cost of these products often is directly proportional to their complexity – the more complex, the more money someone will pay for the product and, typically, as happens with complex products, the less a customer will understand what he or she is buying.

I’m not generally a big fan of annuities, mainly because they are expensive, have potential negative tax consequences, and are complex and confusing. For clients who come to us already owing an annuity, I’ve often asked them general questions about it, and they looked at me with glassy eyes and said they hoped I’d tell them. Without getting into to all the details and nuances of the different types of annuities, the following are some of the pros and cons of owning them in your portfolio.

Pros to owning annuities:

• An immediate lifetime annuity contract can guarantee periodic payments for life (main risks are inflation and the credit-worthiness of the company)
• Provide an option – compared to CDs – for those who are risk-averse and don’t want to risk losing part of the savings (fixed annuities still have credit and inflation risk)
• Provide a steady source of income
• Allow investments to grow tax-deferred (qualified and non-qualified annuities)
• No restrictions on who can invest (anyone can purchase a nonqualified annuity)
• Can be customized to fit your needs
• The sum value of some annuities are guaranteed to be at par or greater than the value of the amount invested (variable annuities – this benefit usually comes at a very high cost)
• Are backed (in some cases) by state guarantee funds, so if the company cannot pay, investments may not be lost (vary by state)

Cons to owning annuities:

• They are very expensive! I haven’t found one client who wasn’t completely shocked when we pointed out the fact they were paying (in most cases) between 2.5% and3.5% per year for their product
• Offer (mediocre) insurance coverage (one of the biggest selling points)
• Investment options are restrictive to mutual fund subaccounts that are often very expensive on their own (variable annuities)
• A big selling point is the tax-deferred savings, yet I find other retirement plans (especially employer-sponsored 401(k) plans) a much more attractive, less costly, less complex, simpler means of funding for retirement
• Lack of liquidity – funds are often tied up for six to eight years and are subject to a sizeable “surrender charge” if withdrawn early

For retirees, an annuity offers an assurance of a stream of income for life or for a specified period of time. For those who fear the potential loss of their money due to poor investment choices, that “guarantee” can be attractive. Keep in mind that that while the annuity income can look big, a good portion of the annuity’s income is a return of principal. The problem with buying into this (and paying too much for that guarantee, in my opinion) is that there are numerous other options that are typically more flexible and suitable that should be explored. But in the end, if having an annuity will help someone sleep better at night and bring them peace of mind, then a diversified portfolio manager at FIM Group can help find low-cost/low-load products that do not, for example, charge surrender fees or have very low expense charges. There are a handful of good products on the market, and we can help provide the due diligence before buying.

If you currently own an annuity, or are interested in learning more about these products, please feel free to call one of FIM Group’s advisors. We’d be happy to explore whether or not an annuity may be appropriate for you.

Protecting Your Assets

The majority of FIM Group accounts are held with Charles Schwab and Co., Inc., our main custodian, we feel that now is an appropriate time to remind our clients about the internal protective practices and stringent standards taken by Schwab that are designed to ensure the safety and security of your hardearned assets:

• Keeping Client Securities Separate from Broker-Dealer Securities – Client securities – such as stocks and bonds that are fully paid for or excess margin securities – are segregated from broker-dealer securities, in compliance with the SEC’s customer protection rule. In the unlikely event of insolvency of a broker-dealer, these segregated assets are not available to general creditors and are protected against creditors’ claims. This is a legal requirement for all broker-dealers.
• Account Protection by the SIPC and Lloyd’s of London – Schwab’s asset security measures offer protection for securities and cash by the Securities Investor Protection Corporation (SIPC). All Schwab accounts are insured by SIPC for securities and cash in the event a broker-dealer fails financially.Additional brokerage insurance is provided through underwriters at Lloyd’s of London. This additional protection becomes available in the event that SIPC limits are exhausted and there are no additional funds available from the estate of the failed brokerage firm.
• FDIC Coverage – The Federal Deposit Insurance Corporation (FDIC) is a U.S. federal agency that protects investors against the loss of their deposit accounts (such as checking and savings) in the event of the failure of an FDIC-insured bank. All deposit accounts held at Schwab Bank, including the Schwab Bank High Yield Investor Checking® account and the Schwab Bank High Yield Investor Savings™ account, are FDIC-insured.
• Information Security Measures – In addition to protecting clients’ assets, Schwab is committed to protecting client privacy and safeguarding information. – To learn how Schwab protects client privacy, visit >www.schwab.com/privacy – To learn how Schwab keeps client personal and financial information safe online, visit www.schwab.com/schwabsafe – To learn how Schwab plans to provide continued client service in the event of disruption to normal business operations, please visit www.schwab.com/businesscontinuity.

Invest with a margin of safety

Recently several FIM Group managers presented a webinar in which we discussed the markets, economy, investments and Roth IRAs. One of the topics we touched upon involved giving investments a margin of safety. Great investors are naturally disciplined toward investing with a margin of safety. Investing icons like Sir John Templeton and Warren Buffett, for example, talk about importance of discipline and a process of evaluation to ensure that a significant margin of safety exists for every investment made. For many investors, price is the best safety enhancer. For example, if you buy a dollar bill for 50 cents, you have less risk than if you paid $2.00. What a company is worth, of course, lies in the details and complexities of the “What is it worth?” decision. You need to evaluate if you are paying less than what it’s worth with a degree of safety that compensates you for the risk and possibility of making a poor investment choice.

At FIM Group we use both soft and hard – qualitative and quantitative – techniques when making the “What is it worth?” decision. Since the numbers are the easy part, as they are the known variables, we spend a lot of time on variables such as management, ethics, industry, product and product strategy analyses. All of this bakes into a decision that potentially involves hundreds of decision tree branches.

Based on past participation, the most popular webinar we’ve conducted to-date is titled “What’s in My Portfolio and Why?” FIM Group will continue to host webinars on relevant investment topics. Visit www. fimg.net for the most up-to-date webinar information, and be on the lookout for e-mail alerts announcing upcoming webinars. If you prefer, or if it’s easier than accessing an online webinar, you may contact any FIM Group representative, and he or she will send you a CD that you can review anytime.

What gives an investment a margin of safety?

• Sort through Millions of Opportunities
  (50,000+ stocks)
• Good Management
  (If Steve Jobs Took Over GM)
• Good Industries
  (Health Care, Food, Energy, Entertainment)
• Good Ethical Values
  (Transparency is Reality)
• Good Companies
  (Fad or Needed Goods & Services)
• Good Products and/or Services
  (Make Great Companies)
• Good Balance Sheet
  (Little Leverage)
• Free Cash Flow/Income
  (Cash to Reinvest or Pay Dividends)
• Skin in the Game
  (Insider/Family Ownership)

KEY

Buy and sell at the right price.

BOTTOM LINE

Prices fluctuate due to the liquidity of the markets, instant emotional responses and crowd behavior.

Volatility is a friend of the wealth-creating investor.

The article described how some investment firms have fee structures that incentivize advisers to steer their clients to riskier, more expensive products (e.g., hedge funds, structured products, annuities, etc.), rather than acting in their clients’ best interests. The article also pointed out how one adviser had identified 17 different ways firms earn revenues, which often include fees, commissions and expenses that were neither transparent nor disclosed to their clients. Clients were often not aware of the substantial conflicts of interest that can exist, for example, between brokerage firms, trust companies and private banks. Firms, of course, receive investment management fees, which most often are all that a client will see. The client may not realize, however, that their adviser might also receive transaction commissions, trustee fees, accounting fees, fee-sharing, front-end/backend commissions or 12b-1 fees from mutual funds, annuities and such. Expenses can be very substantial, and of course it is hard for a consumer to analyze the cost-benefit-value equation in the complex world of investing.

Unlike some of the practices described above, FIM Group does not charge more for “growth” accounts or less for “yield income accounts,” so there is no incentive or benefit to placing a client in a higher-risk investment category. In fact, our fee structure is the same across all four of our main investment strategies. Plus, we not only fully disclose all costs to our clients in a transparent and straightforward way, we are committed to controlling expenses and minimizing the erosive influence that high commissions, hidden fees and expenses can have on a portfolio. FIM Group is a fee-only weatlth management adviser – which means we cannot receive commissions, fee-sharing payments, or referral fees from trust companies, brokers, banks or any entity or person. None. Nada. Zip. Zero! We only receive the fees that our clients pay, which are fully disclosed and detailed on each monthly and quarterly statement. Through our flexible, global strategy we do invest from time to time in closed-end funds (CEFs) and holding companies that may receive a management fee, but FIM Group is neither incentivized nor compensated when we carefully select investments for our clients. Our job is to seek out the best value and build our portfolios one security at a time, taking into consideration the full investment process.

Doing the Right Thing

We have a huge incentive to control expenses for our clients. Why? Because it’s the right thing to do. We believe that there should be no other reason to do something with integrity and virtue than simply because it is the right thing. If Wall Street had done the right thing and operated with virtue rather than greed, they probably could have completely avoided the problems they experienced in the last couple of years. But as the saying goes, “You can’t regulate morality.”

So is managing a company based on principals and virtue “Pollyanna pie-inthe-sky idealism” or raw and uncooked wisdom? I don’t know really – especially when I see Wall Street executives and brokers make hundreds of millions selling junk that they know is junk by misleading or obscuring the reality to unsuspecting or even “sophisticated” investors.

Virtue vs. Greed

I think it is logical to think about the “virtue vs. greed” equation when investing for clients. Should we invest in questionable businesses no matter how profitable the outcome? Should investors hire managers with legacies that show a trail of woe to its shareholders, clients and rank-andfile employees (while these managers and their kin are often well-rewarded with bonuses made on the short-term speculation)? Should investors be values-neutral in their investing? The tsunami of 2008 and the aftershocks we see today tell us it is a loser’s game to invest with those that are values-neutral and that lack an ethical, sustainable, virtuous business philosophy. So I believe defaulting to doing the right thing – the virtuous thing – is the proper course for investors.

Little by Little…

At its roots you’ll find that consistent, positive compounding performance comes from many little “right decisions.” Decisions about controlling fees, for example, add up over time, as does making quality decisions about investing. It all adds up over time … a little bit here and a little bit there. FIM Group is proud of our track record. If you would ever like to compare your FIM Group performance against another manager, index, benchmark mutual fund, entity, inflation, money market or your Mom’s investment club’s performance, we’d be happy to run the numbers for you. We are committed to integrity, transparency, virtue and performance. If you have any ideas on ways we can improve, no matter how big or small, feel free to let us know by e-mail, phone, snail mail or in person.

Politics and Bailouts

Sadly, taxes, politics and bailouts are part of this value conversation. FIM Group manages all of our taxable portfolios to maximize after-tax returns. Politics will have an effect on tax laws and capital flows because of incentives and bailouts, which seemed to have upset “economic natural order” in the U.S. and overseas. Countries have in some cases allowed risks to be borne by society (bailouts) and rewards to be kept by the taxpayer. Foolish, arbitrary politics creates a moral hazard when risk management and prudent business strategies are trumped by recklessness reinforced by taxpayers’ bailouts. When bad decisions by businesses cause no pain, then a reinforcement loop happens that continues until something changes. Things are a changing in Washington, but right now for business it seems like we are playing a game where the rules keep changing. Things, however, will stabilize as they always do. The new normal, for awhile at least, will be more bone-headed regulations, harder-to-understand tax laws, new layers of incentives and disincentives, and a Congress and White House ill-equipped to say “no” to anything that has to do with spending. I am not melancholy in this assessment. Democracies are reactive systems, so things will need to get overregulated and Congress will have to say “yes” one too many times before voters say “enough,” and the dismantling cycle starts once again. Any student of American history knows this. Any student of world history knows this. And for that we have lots to be grateful for and reason to be optimistic.