Guarding Your Wealth - Recent Articles

Why You Shouldn't Annuitize

2008-08-21T10:27:00.000-05:00

As more companies do away with their pension programs, the insurance industry and the media are heavily promoting the use of immediate annuities to provide a dependable income stream during your retirement. But is that in your best interest? Normally, I say it is not. Read on to find out why.

An immediate annuity is one where you pay an insurance company a lump sum in return for a stream of income. You can decide if the income stream is guaranteed for a certain number of years (period certain), for a set number of years or your lifetime—whichever is greater; and whether your spouse should receive benefits for his/her lifetime after your death. Since you can receive a set payment for life and can also provide for your spouse after your death, this is seen as a ‘perfect’ pension replacement. There are four main reasons that I don’t advise this.

First, when you buy an immediate annuity you exchange a lump sum for a series of monthly payments. The lump sum is gone…forever. At that point your return is dependent on how long you and/or your spouse live (unless you chose period certain). If you live longer than the life insurance company expects then you get a higher overall return on your investment. If you die before then your return drops considerably.

For instance, Jack and Jill are both 62 and buy a joint life annuity for $250,000. In return, they’ll receive $1468 every month for the rest of their lives, regardless of who dies first. After the remaining spouse dies, that’s it. Nothing goes to your children.

Assuming their joint life expectancy is 85 years old, the internal rate of return on the annuity is about 4.6%. If they both die at 75 years old their average annual rate of return is negative 1.3%. If at least one of them lives to age 95 then the return on the investment was 6.1%. So your expected return is 4.6%, but your actual return may be more or less.

That illustrates another reason that I don’t think people should annuitize—all they are doing the first so many years is getting back THEIR money. Picture putting that same $250,000 under your mattress. Then each month you reach in and pull out $1468. You wouldn’t run out of money until 14 years later! That’s if you aren’t earning interest on it.

If you just put the money in a money market earning 3% you could keep using it until age 80. Let’s say interest rates go up (they will at some point) and a money market account pays 4.75%. Use one of those (or buy a 30-year Treasury bond) and you would cover the payments until one of you reached 86.

There are other benefits of not annuitizing. If your situation changes and you want/need access to more than the $1468 a month, you have access to the remaining principal. If you die before the money runs out the remainder can go to your children. The return you receive isn’t based on how long you live but on how it is invested.

Over time, inflation is your greatest risk. Jack and Jill’s annuity payment does not increase for inflation each year. If it did, it would be much lower to start with. Doing it yourself allows you to increase your payments over time if needed and/or based on your return.

Obviously, I feel there are better ways to invest $250,000 than putting it in a money market or CD. Over a similar period of time, a well-managed, well-diversified portfolio of stocks, bonds and real estate should average 8% or more. If so, you can meet the same income payment, adjust it for inflation and possibly never even touch your principal. Even if you end up using some principal, the chances are much greater that there will be money leftover for your heirs.

Some would rather let an insurance company bare the risks for them. There are risks to doing it yourself: interest rate risk, undisciplined spending, market risk, etc. But these are easily mitigated in a well-managed portfolio, and are far outweighed by your ability to earn a higher return while maintaining access and control of your money.

In addition to being a weekly columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. Goto www.guardingyourwealth.com for additional articles on this and other topics including investing and estate planning.

Tug of War

2008-08-13T16:38:00.002-05:00

Tug of War

A novice investor recently asked me, “Why don’t you just buy what’s going up and sell what’s going down?” If it were only that easy, we’d all be millionaires! Read on to learn a simple analogy that seeks to explain the underlying forces that move the markets.

Think of investing in the stock markets as a game of tug of war. We all remember playing this game in gym class, with people pulling on either end of a rope, with a flag tied in the middle. The goal is to get the flag to your side as quickly as possible, and of course, to embarrass the other side by your superior display of strength. Of course, it didn’t always work out that way and I have been on the side of the falling team more than once!

This is how investing works in the stock markets. We often think that the value of a stock is based on the company behind it, but that is only partly true. Think of the company as the rope in a game of tug of war. It’s not just the quality of the rope that will decide which team wins, it’s the players competing on each side.

On one side of a ‘stock’ rope, you have investors who believe the stock is going up in price. On the other side is another group of investors equally convinced the stock price will go down. The side that puts up the most money will determine the direction of the stock price.

Unlike in real tug of war, the players in the stock market can change the amount they have invested and even the side they are on at any time. Some players might change several times in a day. Others might stay on one side for years.

This switching of sides is what results in huge swings in the stock price. If one side of the rope becomes overloaded, then they have the power to quickly pull the rope their way. If you have a lot of people and money on one side it’s not going to be much of a contest.

In the real game of tug of war, the game is won once the flag moves a set distance. Then both sides quite and move on. The stock market tug of war is much more fluid. Players can come and go. Some might quickly take their profit or cut their loss short. Others may wait until it looks like one side has won before joining the game on the opposite side.

Moreover, each player may have a different strategy that determines what side they play on—or whether they play at all. Some focus on the quality of the company (the rope). Others look at the statistics of what’s happened in that tug of war in the past. And there are some that just seem to walk up and pick a side without any rhyme or reason.

Outside events also play a role in the quality of the rope and the decisions of the players. There might be a hurricane affecting the oil supply. The expected outcome of an election could impact regulation. Housing prices can go up or down.

The decisions made by professional players have a much greater impact on the outcome of the game than do those of individual investors. That’s because they have a lot more money to invest. If all the professional investors switch to the same side, the individuals on the other side are going to get embarrassed!

Looking at a single game of tug of war allows us to get a general understanding of the underlying dynamics involved in the movement of the price of a stock. The movement of a market or a market index is really the sum of all the underlying battles taking place. The S&P 500 index represents the result of the tug of war occurring in 500 specific companies. The Dow Jones Industrial Average represents 30 select companies.

Successful investing isn’t solely about choosing which rope, but also choosing the right side. And it’s vital that you take into account what the other players are or will do. You won’t always get it right (nor should you expect to), but understanding why markets move will help you make more logical and informed investment decisions.

Mr. Voudrie is a Certified Financial Planning Practitioner and provides personal, private money management services to clients nationwide. Find out more at www.guardingyourwealth.com.

Oil Barrel: Half Empty or Half Full?

2008-07-30T14:49:00.001-05:00

Every coin has two sides and so does every story. The current oil crisis is no exception. Those who wish to protect the environment at all costs have made an art of spinning every oil news story into one that discourages any additional domestic drilling. Of course those on the side of the oil industry are no dummies in the spin department, either. But here’s a recent example that shows how the spin zone works. And you can decide for yourself if the glass, or the oil barrel, is really half full or half empty.

Increasing supply is one of the many solutions being offered to solve the world’s oil crisis. Naturally this alone will not solve the problem, but with the long-term increasing demand from developing nations, obviously a growth in supply would be highly beneficial.

Recently, the US Geological Survey released a study that concerns the Arctic region’s potential supply of oil and natural gas. You can view this assessment for yourself at www.usgs.gov, but here are a few selected quotes: “The area north of the Arctic Circle has an estimated 90 billion barrels of undiscovered, technically recoverable oil, 1,670 trillion cubic feet of technically recoverable natural gas, and 44 billion barrels of technically recoverable natural gas liquids in 25 geologically defined areas thought to have potential for petroleum.”

“These resources account for about 22 percent of the undiscovered, technically recoverable resources in the world. The Arctic accounts for about 13 percent of the undiscovered oil, 30 percent of the undiscovered natural gas, and 20 percent of the undiscovered natural gas liquids in the world. About 84 percent of the estimated resources are expected to occur offshore.”

The Arctic region covers a large area, including Siberia, Greenland, Canada and upper Alaska. While we can’t influence exploration in most of those regions, we certainly can in Alaska. Arguments about opening up ANWAR to drilling have been going on for years and this report is certain to add fuel to the fire.

This is especially true since this report points out that Arctic Alaska is one of the three geological provinces that make up “more than half of the undiscovered oil resources” and “more than 70 percent of the undiscovered natural gas.” The undiscovered oil resources in Arctic Alaska are estimated to be 30 billion barrels.

Sounds like great news, doesn’t it? But not to those who oppose any and all oil drilling. They have come out with their own interpretation of the data, saying that all the oil in the Arctic would only supply the world for three years. So why put the Arctic environment at risk for such a small return?

One problem with this argument is the way in which these environmentalists came up with their three year figure. They took the world’s annual use of 30 billion barrels a year (that’s 83 million barrels a day) and divided it into the 90 billion barrels said to exist in the Arctic. But this isn’t really a valid argument. One of the main reasons that oil prices are so high right now is that there is very little margin between world demand and world supply. Any additional oil put into the supply line would lessen these margins and bring down prices.

Even the democrats in Congress are pushing for a release of petroleum from our Strategic Oil Reserve for this very reason. They know that adding some supply would put downward pressure on current oil prices. You don’t hear them explaining that the 706 million barrels in our Strategic Oil Reserve would only supply the world’s needs for 8 ½ days, so why bother tapping it at all? And yet, they argue that we shouldn’t open up new drilling in Alaska, or anywhere else where there is domestic oil, because the 30 billion barrels or more we could access wouldn’t fill the world’s demand for more than a few years. It’s hypocritical to say the least!

Increases in technology will only add to the available reserves already existing in the Arctic. And think of those 90 billion barrels this way: if the Arctic could add 2 million barrels of oil a day to the world’s supply, that oil would last 123 years. You can spin it however you want, but without increased oil supply, our oil crisis will only get worse.

Mr. Voudrie is a Certified Financial Planning Practitioner and provides personal, private money management services to clients nationwide. Find out more at www.guardingyourwealth.com.

De-Stressing the Markets

2008-07-16T13:46:00.002-05:00

For the first in time in about seven years, we find ourselves in a true bear market. The problems in the financial sector, pervasive gloom and doom forecasts and ever increasing oil prices have combined to create one of the most tumultuous financial climates of recent history. Inflation fears, the credit crisis, mortgage foreclosures, tension with Iran, recession woes: it’s enough to give even the most seasoned investor sweaty palms. How can you navigate these tough times without losing your cool?

There are two levels where you can de-stress the influences of the market. The first is in your own portfolio. No matter how your portfolio is structured, there are several key points to remember. Most important, is that you cannot control the market and shouldn’t act hastily. Any portfolio adjustments should be well reasoned. Some investors make the mistake of knee-jerk reactions when markets turn sour and make mistakes that cost them thousands of dollars down the road.

The second thing to remember is that you need to focus on minimizing loss, but recognize that you cannot eliminate it. Some people want to turn to all fixed investments during hard times, thinking they are ‘safe.’ But today, what used to be some of the most conservative investments are becoming some of the most risky. Financial stocks are the perfect example.

To avoid loss completely, some investors are tempted to liquidate all equity holdings and move 100% into cash. You might gain some temporary peace of mind, but you end up costing yourself in the end. Another common mistake during difficult markets is for investors to fall for all-encompassing products that appear to promise them market gains without any risk of loss. These include variable annuities with their guaranteed income riders and equity indexed annuities. If you are tempted to purchase either one of these products, please take the time to do your research and at least read some of my past articles on the subject!

Here’s what I’m doing for my clients. I have their portfolios well diversified between a number of holdings, across a broad range of sectors and strategies. This includes a division between short term and longer term holdings. My shorter term holdings have more trades, to take advantage of trends and special opportunities. I am apt to move these holdings to cash more quickly as the markets turn down.

My longer term holdings include those with long term growth potential and stocks purchased for their high dividend yields. When markets are trending up, I’ll have more money in these longer-term holdings than in shorter term ones. But when markets are trending down like they are now, buy and hold strategies get hammered. So I am more weighted in shorter term holdings, where I move a higher percentage into cash as necessary. However, I’m not as quick to liquidate my high-dividend holdings, since they’re paying us along the way.

If you have most of your money in mutual funds, I certainly wouldn’t leave it up to the fund money managers to decide what is in your best interest. Look at how your money is divided and make sure you aren’t over exposed in one area. Some investors think they are well diversified because they own several funds, not realizing that all of those funds are basically investing in the same pool of stocks.

For mutual fund investors, pre-determine how much loss you are willing to tolerate. Based on that, you may decide that if Fund A drops 10% that you’ll liquidate 25%, etc. That way you are limiting the downside risk but still in a position to benefit should the market turn around..

The second area where you need to de-stress is on the personal side. Keeping the right perspective can make all the difference. As bad as times seem to be, they are temporary. Remember all that we have come through before: wars, the inflation of the 70s, the terrorist attacks of 9/11, etc. We will see our way through today’s challenges as well.

If you find yourself losing sleep, maybe you should take a break from the news coverage for a bit. Focus on what really matters: your family, your faith, your friends. Those are the things that will outlast high gas prices and inflation, and are what make life worth living in the first place. After you’ve relaxed, re-visit portfolio decisions.

Mr. Voudrie is a Certified Financial Planning Practitioner and provides personal, private money management services to clients nationwide. Find out more at www.guardingyourwealth.com.

Going Green, Part 2

2008-07-14T11:53:00.002-05:00

As the summer heats up, so does the rhetoric about the energy crisis. The presidential candidates are taking political shots at each other’s solutions to the problems, while everyone else in Washington is playing the blame game. Even OPEC is washing their hands of the matter, blaming ‘speculators’ for the current crisis.

As investors, all the arguments and finger pointing do nothing to help our bottom line. If we wait for our own government or powers abroad to take action to benefit us, I’m afraid we’ll be waiting a very long time.

But the good news is that you aren’t at the mercy of feuding politicians or oil-producing nations. There are steps you can take to protect your nest egg and your standard of living.

One important factor to understand so that you can navigate these turbulent times is that the issue isn’t just the price of oil. The supply/demand problem we discussed last week is occurring across the board with all natural resources. Just as China and India are increasing their demand for oil, they’re also increasing the demand for food products, such as soy beans, corn, and wheat.

As supplies tighten and demand increases, we’re seeing a world-wide increase in food costs. Ethanol production and drought conditions in some wheat-growing areas like Australia are only adding to the problem. The recent floods in the Midwest have also destroyed many acres of grain crops. All of this means that consumers shouldn’t expect to see relief at the checkout any time soon.

Since consumers world wide have to spend more of their money on food, we see two obvious results. First, they are less optimistic about their financial situation, and second, because food and fuel is consuming a larger percentage of their disposable income, they are cutting back their spending in other areas. We’ve already seen this here in the United States, where one large home improvement chain recently reported a decrease in big ticket purchases and a sharp increase in repair items.

When consumers are feeling the pinch, it’s usually a hard time for the stock market. The temptation might be to pull out of equities all together and head for the ‘safety’ of cash, bonds or CDs, but these investments have their own set of risks. Interest rates are quite low and these investments give you no protection from inflation.

Real estate often performs well in an inflationary environment, but we are still feeling the effects of the real estate bubble and sub-prime mess. Savvy investors can take advantage of the situation, but if you don’t know what you’re doing, you can certainly get burned.

In these uncertain times, investors can make an even more costly mistake: believing the hype about ‘miracle’ investments that promise to solve all your problems. These products are promoted as ways to protect your money and give you a bonus for investing, but instead they lock up your money for years, give below-average returns, and provide a handsome payday for the advisor.

If ever there was a time to keep control, access and flexibility over your money, it’s now. In these difficult markets, you must be able to take quick action to protect your money and have the flexibility to take advantage of changing opportunities.

The good news for investors is that you can be in control of your financial future. You don’t just have to sit back and take what the markets give you. Yes, you will need to tread cautiously and be highly selective in the sectors and countries in which you choose to invest. But you don’t have to be at the mercy of pre-packaged, mass-marketed products that do little to help you meet your financial goals.

There are times you might need to ‘stand aside’ and let the markets work through an issue. Remember, all the money managers are seeing the same trends and what used to take several days to play out is now happening in a single day. This is increasing volatility.

Don’t let the current energy crisis turn into a financial one for you. Maintain control, access and flexibility over your money and keep a close eye on your investments. This isn’t the time to simply buy an investment and hope it does OK over the long-term. Instead, opportunities and risks must be closely managed—something few advisors do.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. For more information go to www.guardingyourwealth.com.

Going Green

2008-06-19T07:16:00.002-05:00

Going Green

Everyone is feeling the pinch at the pump. And just about everywhere else it seems. No matter where you look: the grocery store, utility bills or airline tickets; prices are going up. We all hope these increases are just a temporary road bump, on the financial landscape, but unfortunately, I believe we'll be experiencing the effects of the energy crisis for years to come.

With all the talk about going green, for the environment, it's time for investors to go green, with their portfolio. And I don't mean investing only in earth-friendly, companies (though you certainly can.) What I mean is positioning your portfolio so that you add enough green, to your bottom line to allow you to weather the effects of inflation and without lowering your standard of living.

First, let's take a closer look at the current energy crisis. To make a long story short, the problem is based mainly on supply and demand. As the standard of living has been rising around the globe, and particularly in large Asian nations such as China and India, the demand for oil has exploded. And this trend will only continue.

While demand has risen, supply has not. Non-OPEC countries are actually seeing supply decrease, while our domestic exploration has been hindered by environmental concerns. So while China can drill off the coast of Cuba, we aren't tapping new oil off our own coast or in ANWAR. While it is true our known reserves would not solve the current crisis, they would certainly lessen our energy dependence and help keep prices in check.

There are only three ways to solve a supply and demand issue: reduce demand, increase supply, or do both. On the demand side, there is no way we can simply conserve, our way out of this mess. Any oil we conserve in our nation will be more than offset by rising demand globally. That's not to say that hybrids, carpooling and alternative energy sources are bad ideas, just that they aren't enough.

Take wind farms for instance. They work great, as long as the wind is blowing. But the power grid must have a constant flow of energy into it. And because wind energy flow isn't constant, traditional power plants have to be constructed to cover the energy needs when the wind farm isn't generating power.

On the demand side, we need to open up more drilling and exploration. Environmentalists will resist this move, but the fact remains that currently there is no viable substitute for oil. The world will continue to depend on oil to survive for years to come, even with all the research going on in alternative fuels. We can't go back to horse and buggy days while waiting on a miracle solution.

Ethanol, bio diesel and other sources won't make the problem go away, either. And they each have their own issues to contend with. Take ethanol for example. Increased production has caused corn prices to rise, affecting food costs across the board, not to mention the energy it takes to produce it.

To combat the energy crisis, we will need to pursue all means available to both reduce demand and increase supply. This will be a herculean task to accomplish, but a lesson from history can give us hope. My youngest daughter and I have been watching a new television series on the early days of the space program that put man on the moon. Our country had the will, determination and desire to accomplish the impossible. And we did it. It took the hard work, ingenuity and creativity of a multitude of motivated people. It also took a large investment of time and money to bring about. But in the end, a giant leap for mankind touched not only America, but the entire world.

And we can do it again. As prices continue to rise at the pump, I am optimistic that we as a nation will gain the political grit to do what it takes to attack this issue head on. We still have some of the brightest minds on the planet, and if we could put a man on the moon, surely we can find a way to solve the energy crisis.

Next week, we'll look at how you can add some green, to your bottom line and avoid turning the energy crisis into a financial one.

Death and Taxes

2008-06-11T18:49:00.001-05:00

The old saying is that there are only two certainties in life, death and taxes. Now that we know who the two nominees are for this year's presidential election, it's time to take a look at what might happen regarding taxes and how we should adjust our portfolios.

The bottom line is that regardless of who wins the White House, our taxes are going to go up. That is going to impact the money that we have to spend at the shopping center. The result is that we may see U.S. economic growth continue to lag.

Let's look at the candidate's position on capital gains, income, payroll, and estate taxes. This information is derived from analysis of comments made by the candidates themselves and from interviews with campaign advisors.

The issue that has the greatest potential of affecting those who are retired or near retirement is capital gains. We know that President Bush reduced the dividend and capital gains tax rates to a maximum of 15% and that those cuts are set to expire in 2010. That means that unless new legislation is drafted extending them (or making them permanent) that capital gains tax rates will go up.

Senator McCain has stated that he wants to make the current capital gains rate permanent. Senator Obama favors increasing the capital gains rate to 20-25%. Many retirees rely on dividends and capital gains to supplement their Social Security, so increasing the capital gains tax rate will directly affect them. Also, increasing the capital gains tax rate on dividends may negatively affect the share prices of stocks in general.

Regarding estate taxes; currently there is an exemption of $2 million dollars per person with a top estate tax rate of 45%. The personal exemption is set to rise to $3.5 million in 2009. In 2010, there isn't any estate tax, but then in 2011 the personal exemption goes back to $1 million dollars. It's amazing what they can come up with in Washington!

Senator McCain proposes an exemption on estates less than $10 million with the highest tax rate on estates larger than that being 15%. Senator Obama proposes exempting estates less than $10.5 million, but has a sliding tax rate that tops out at 45%.

On the positive side, the expiration of the existing estate tax rates has made long-term estate planning very difficult. Getting a new plan in place will allow that planning to be done much easier.

Positions on income taxes differ between candidates as well. Senator McCain wants to maintain the current maximum of 35% and Senator Obama may potentially move the maximum rate from 35% to 52%. I haven't been able to find out each candidate's position on the Alternative Minimum Tax (AMT). The AMT, which isn't indexed to inflation, is resulting in many middle-income Americans paying a much higher tax rate, so whether or not this is changed is just as important as what the maximum tax rate will be.

Lastly, Senator Obama advocates removing the OEcap, on earnings subject to FICA (Social Security) tax. Self-employed individuals currently pay a 12.4% FICA tax on their wages. Employees of companies pay half that while the employer pays the other half. Currently, FICA tax is only paid on wages up to $102,000. Senator Obama has stated that he wants to remove the cap for those earning $200,000 or more per year. I don't know Senator McCain's position on payroll taxes.

Keep in mind that small business owners have their profits taxed as wages, so that is really a tax on small business. Remember also, that employment growth the past several years hasn't come from major corporations but small businesses. So this additional tax has the potential to affect employment.

Should democrats control the Congress, the chances of the current tax rates becoming permanent are low. If Senator Obama wins the election, the likelihood of passing higher taxes is high. All indications are that the democrats will control Congress.

From an investment standpoint, I am concerned about the impact higher taxes will have on our economy. Moreover, higher taxes won't be used to pay down our nation's debt but to fund additional programs. The effect of taxes, inflation, and the decline of the Dollar causes me to favor foreign investments. As always, selection and proper management is tantamount.

Reader Questions Advisor Recommendation

2008-06-04T13:33:00.002-05:00

I recently received a question from a reader in Florida who is taking an early retirement. Like many investors, he was confused after meeting with a couple advisors. My advice to him might save you from making a wrong decision, too.

"Phil" (not his real name), has the option of taking either a lump sum payment or a monthly pension from his employer. He goes on to detail his financial situation: 401k, money market accounts, house paid for, no debt, low monthly expenses. Phil has lived beneath his means, saved his money and achieved financial freedom.

Phil writes: "I met informally with 2 CFP's. They are working with people at [my company]...but they seem to only push annuities. After reading your articles on annuities I am cautious...I have always been conservative with my finances, but I realize that to retire at 55 I might have to expose myself to the equity markets. I would like to talk with an advisor who will show me multiple options and talk straight, with no fluff."

Here's a shortened version of my actual response:

"You are in one of the most important times of your life, and are facing what may be your biggest financial decision. Whatever you do, be careful.

It looks like one of your initial questions is whether you should take a lump sum. Generally speaking, I feel that people should take the lump sum because it gives them greater control, flexibility and access. It also becomes an asset that can increase in value and be passed on at death to your heirs.

There is risk in doing so, though. Many retirees have been duped by advisors into investments that weren't in their best interest and ended up losing large portions of it as a result. You have to be willing to invest some time and energy finding the advisor that is right for you. Even then, you will want to keep track of what is going on at least on a monthly/quarterly basis, so you can alert the advisor if you become concerned.

There are several things to keep in mind regarding choosing an advisor.

First, you aren't going to know if the advisor (or investments) you've chosen is the right one for you until probably 6-12 months down the road. Commission-based salespeople with their packaged products needlessly force you to make a 7-10 year time commitment. That's why it is VITAL that you not be in a situation where it will cost you thousands and thousands of dollars to make a change.

On the other hand, fee-based advisors like me only get paid for the time you use our services. There's no commission, no time commitment and no automatic surrender penalty. This gives you significant control and flexibility. You remain the boss. If I don't keep you satisfied then I'm not going to keep you as a client.

Second, beware of the advisor that promotes buy and hold. They're the ones that tell you to "just hang in there" while they watch your account drop in value--and do nothing. The diversification I use combined with the technological safeguards I've created result in my clients being comfortable going for the growth because they know I'll take action should things not go as expected.

Third, don't feel pressured by anybody to make a decision. There's no investment so great that you need to rush into it. You can take your time to find someone you feel comfortable with. Talk to their references (existing clients). Even then, only start with a portion of your nest egg and let the advisor prove him/herself."

As with Phil, you too need to beware of financial salespeople pushing pre-packaged solutions. If it's designed for the masses it's not designed for you. Don't give in to sales pressure. Take your time--this may be the biggest financial decision of your life. A wrong move is costly.

Just because someone has the right initials behind his or her name doesn't mean they will act in your best interest. Most won't. Be very skeptical. Do some independent research.

It didn't cost Phil a penny to get my opinion. It won't cost you anything either. If an investment is being recommended that you aren't sure about, I'll be happy to provide a second expert's opinion. Go to www.guardingyourwealth.com and click on Ask Jeff.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Advisor Commissions Revealed

2008-05-29T04:26:00.002-05:00

Most investors have absolutely no idea how much money advisors earn from their investments. There's certainly nothing wrong with advisors being compensated for their work. The problem arises when there is a lack of transparency in the advisor/client relationship. You should know exactly how much you are paying, for the investments and services you receive. Only then can you make an informed decision on whether or not you are receiving a good value for your money.

I can't tell you how many times people have told me, "Oh, I didn't pay my advisor anything. The insurance company paid him, not me." Or I'll hear, "Commission? What commission? I just bought a muni bond, not a stock." The problem with commissions is that you don't always see them. But trust me, there is no such thing as a free lunch. You are paying something, whether you realize it or not.

On some investments, the commission is quite obvious. On others, you have to dig a little deeper to uncover the charge. In an effort to level the playing field, I'm going to reveal the typical commissions paid on a variety of investments. Be aware that these commissions can vary between different providers.

Let's start with one of the most popular investments; mutual funds. No load funds charge no up front commission, but do have a yearly management fee that can range from .25% to 2% per year. Load mutual funds, the kind you would buy from a commission-based advisor, can top out at 5.75% for equity funds, and 4.5% for bond funds. But breakpoints can greatly decrease the commission you pay. So the more you invest, the less commission you pay.

The commission paid on individual stocks can be as low as $10 a trade. Because there is so much competition in both stock trading and mutual funds, commissions on both are dramatically less than they used to be.

The commission on individual bonds is much harder to see, because it is built into the price. Commissions increase with the bond's maturity length, usually topping out around 3%. But the only way you'll know for sure is to try to get a price for the same bond from a discount house.

Now we'll get into the higher commission products where the fees are especially tricky for the investor to uncover. For example, variable annuities typically pay the broker between 6% and 7%, yet most investors think they're not paying anything when they buy them. If they ask their advisor about it, they're often told that the insurance company pays the advisor, not the investor. But it's amazing how the surrender penalty amount closely resembles the amount the agent received in commission.

Investors may not realize that no-load annuities are available. These "plain vanilla" products lack some of the flashy features of their high-cost cousins, but they deliver the same basic result at a dramatically lower cost.

Commissions are considerably higher for equity-indexed annuities. Rates of 10% or more are common, with some charging less. But these are by far the highest commissions charged in the financial services industry. Is it any wonder that these are promoted so heavily?

One of the main problems with commissions on insurance products is that the insurance companies realize their real client is the agent, not the investor. If they don't pay a high enough commission, an agent will simply sell an annuity from another company. And since the commission isn't clearly understood by the investor, sky-high commissions are the result.

Agents will argue that the additional features of these annuities are worth the money paid. But I disagree. If it were such a good deal, then why not use these high fees as a selling point, instead of hiding them in pages of fine print?

Here's the commission the advisor receives if you move a $500,000 IRA or 401k into each product: Mutual Fund - $12,500, Individual long-term bond - $15,000, Variable annuity - $30,000 and $50,000 for an equity-indexed annuity. How many months/years did it take you to save the amount the advisor will be getting?

I feel there is a conflict of interest when these details aren't disclosed. How can you make an informed decision unless you know what the advisor is making? How can you compare various options? Frankly, you can't.

Do You Need A Trust Or Foundation?

2008-05-07T11:35:00.001-05:00

Trusts and private foundations aren't just for the rich and famous like Warren Buffet or Bill Gates. Nowadays, even people of modest means are realizing the great benefits trust and foundations can provide. Read on to see what they can do for you.

There are many different kinds of trusts and foundations, but they all share a common element; control. Using them, you can control what happens to your assets while you are alive, in the event of incapacity, and for generations to come.

For instance, a trust is highly recommended if you and your spouse each have children from a previous marriage and you want to avoid any conflict when one of you passes away or becomes incapacitated. A trust can be just the thing if you are concerned about a child losing their inheritance in a divorce. And, in today's litigious society, trusts can be used to shield assets from lawsuits. A trust can be as simple or as complicated as you need it to be.

Foundations have many similarities to a trust. The main difference, though, is that foundations are designed specifically for charitable, religious, educational, scientific or literary purposes. Like a trust, a foundation allows you to control how the assets are invested, who they are distributed to, and when. Plus, there are tax benefits for transferring assets into a foundation, that aren't available with most trusts.

If you expect to leave several hundred thousand dollars in assets to charity, a foundation may be right for you. That's especially true if you want the assets to be invested and each year's earnings distributed to a special cause.

There's more involved in setting up a foundation as compared to a trust. They also require more work. Accurate records must be kept and informational tax returns must be filed. For those with much smaller contributions, it may be easier to donate the money or assets to an existing organization, as opposed to forming your own.

Still, it may be easier to donate a significant amount than you think. You might have had a life insurance policy for years and you no longer need it. Instead of canceling it, you can name your foundation as the beneficiary. In fact, life insurance is a great way to not only provide the initial funding for a foundation, but also to help it increase in size over time.

I mentioned tax incentives. Appreciated assets like real estate or stocks can be transferred into a foundation (and certain charitable trusts). That way, capital gains taxes don't have to be paid, and you still get a tax deduction for the contribution. The result is that your charity receives more money than if you sold the asset, paid the taxes and donated the remainder.

There are different versions of charitable trusts. Some allow you to donate an appreciated asset, get a tax deduction, and receive an income stream for life. When you die, the remainder can be used by your favorite charity. Another version is similar, but the charity receives the income stream during your life, and your heirs receive the remainder at your death. This can be beneficial if you have investment property that has greatly appreciated, you need income and you don't want to pay all the taxes.

In can cost thousands of dollars to set up a trust that allows you to avoid probate and protect your child's inheritance from a lawsuit. Foundations can be even more expensive. But they don't have to be.

If you are comfortable doing research on your own and are willing to take the time, you can set up a trust and/or foundation on your own very inexpensively. Legally, you can serve as your own attorney and draft your own estate documents. There are many sources that provide templates. If your situation is straightforward, all you have to do is fill in the blanks.

For those with more involved situations an experienced attorney is recommended. Even if you do it yourself, it's not a bad idea to have an attorney review it. Lastly, a trust does nothing for you unless you transfer assets into it. Don't forget that step, or all your work will have been for naught.

Why Investors Lose Money on Wall Street

2008-04-30T12:06:00.003-05:00

Investors fear losing money, but they are almost as afraid of losing out, of not making money when they could have. This is referred to as the fear and greed cycle and is one reason the Wall Street pros make money while the individual investor often loses it.

Here's what typically happens. Let’s use a hypothetical investor named Sam. Sam hears about how much money his buddies are making in the stock market. So, Sam decides to invest his retirement money in the market. He goes to his local advisor who promptly throws his money into the market, while Sam imagines all the money he's going to make.

Well before long, the market starts to go down, maybe it loses 3%. (By the way, there will always be times when the markets go down.) Sam figures the market will turn around in a few days, and often it does.

But this is one of those times when the market continues to go down. Now Sam thinks, "What if this keeps dropping? I'm losing money, not making it!" So Sam calls his advisor, and inevitably the advisor tells him to just hang in there, it will come back.

But this isn't a normal correction and the market continues to decline. It's up one day and down the next, but it's down more than it's up. This goes on for days and then for weeks. Before Sam knows it, his account is down 7-8%.

Sam is really getting nervous at this point. Everything he hears tells him that the market and the economy are in terrible shape. And now, the thought of losing even more money is keeping him up at night. (By the way, Sam hasn't heard from his advisor all during this time.)

The next morning he can't take it any more. He calls his advisor and tells the advisor to sell everything! The problem, though, is that there are millions of “Sams” out there and they are all calling their advisors and saying the same thing. You can imagine what the markets do that week! When there are more sellers than buyers the prices drop, and drop quickly.

In the end, Sam loses around 10% and vows to never invest in the stock market again, or at least to wait until things turn around. Soon, sometimes within days, the markets start going back up. Sam hears about it on the news, but the pundits are still saying that the economy is in terrible shape. So he decides it isn’t time to get back in.

After a while, the markets are up so much that everyone on the news is talking about how great the markets are. Those same experts that were saying the economy was so bad are now saying the crisis is over and that the markets will continue to go up and up.

At last, Sam thinks the danger is past. He calls his advisor and moves his money back into the market. Remember, there are millions of “Sams” out there and they are all calling their advisors and saying the same thing. The markets may continue to go up for a while, but before long they will start to correct.

I think you get the picture. It seems like all that Sam does is lose money. Why? Because, he's acting just like everyone else. And that's the problem. To make money in the markets you need to buy before everyone else buys and you need to sell before everyone else sells. Professionals call this the fear and greed cycle. Professionals are well aware of what the Sams of the investing world are thinking and the actions they will take.

Investing in the stock market is a zero sum game. What that means is that every time one person is making a dollar, someone else is losing one. Whenever you buy a stock there is someone selling it to you and vice versa. Who do you think was buying Sam's stock when the markets were down 10%? It's the professionals. Who do you think was selling that same stock back to Sam later when the market was up 10-15%? That's right, the professionals.

That's why it's the professionals that make money on Wall Street and not the individual investors that are following the advice of their traditional just hang in there, advisors.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. Read more of Jeff's financial and investing articles or ask Jeff a financial question.

The Wolf Among the Lambs

2008-04-23T17:04:00.003-05:00

For years, I've been warning seniors about the dangers of equity indexed annuities. And I've taken quite a bit of heat over it from those in the insurance industry. While many agents, and some readers, have discounted my views, the uproar against equity-indexed annuities, and the tactics used to sell them, is growing louder and louder. And now the national media has entered the fray.

On Sunday, April 13th, 2008, Dateline NBC aired a hidden-camera investigative report titled "Tricks of the Trade" with reporter Chris Hanson. They recorded actual insurance agents selling equity-indexed annuities to seniors, went to their seminars, and even attended training sessions for agents.

Agents might dismiss my claims when I say that equity-indexed annuities are a horrible investment, but it's hard to disqualify the comments of Joseph Borg, the Alabama Securities Commissioner. When asked by Mr. Hanson if he would recommend an equity indexed annuity to his own mother, Mr. Borg responds, "I wouldn't. I wouldn't recommend them to anybody."

Mr. Hanson also talks to the Minnesota Attorney General Lori Swanson about the sales tactics agents use to convince seniors to buy these investments. She says, "What is tragic about it is when those agents go into the seniors' homes, it is literally the wolf among the lambs. It's happening all around the country and it's happening on large scales and these insurance companies need to knock it off."

These comments come, not from other financial advisors like myself, but from public servants entrusted to protect the citizens of their states. And these aren't the only public officials who feel this way. Many states are taking action against the insurance industry and the tactics used by agents selling these products.

One of the biggest bones of contention is the common sales tactic of gaining credibility with the investor through the use of deceptive credentials. Often, those selling these products are life insurance salesmen who have little if any training, background and experience in investing. In fact, for most it is against the law for them to render financial advice. But isn't that exactly what they are doing?

Dateline showed this scheme in great detail when they secretly attended Annuity University, a training seminar for agents selling equity indexed annuities. They discovered, that for the right price, an agent can make it appear they've written books, magazine articles, and have been interviewed by a national radio show. You can even have your name and face on a magazine cover that contains a large picture of Federal Reserve Chairman Ben Bernanke.

All of this is designed to make the insurance agent sound more qualified than they might otherwise be. And it works. Many seniors follow the agent's advice because of these credentials. Minnesota Attorney General Lori Swanson is not amused with these tactics and doesn't pull any punches in her response. She says it's like "handing them [the agents] loaded guns so they can walk into the senior's home and rip them off."

Ms. Swanson goes on to say that "this is part of the marketing ploy, build trust, show you're reputable." Dateline reporter Chris Hanson, who is not an agent, was able to get his own picture and name on a magazine for $1,500. "That's terrible, and you've captured it right on tape," responds Ms. Swanson, "what we're hearing in all of these cases and investigations that we're bringing [is] that these agents are not telling the truth."

Speaking of not telling the truth, Dateline captured instructors at Annuity University training agents to frighten seniors by telling them that their money isn't safe at the local bank, because the FDIC is insolvent. This simply is not true and there has never been a single instance when the FDIC has failed to pay out on a valid claim.

Ms. Swanson also believes agents aren't being truthful when discussing surrender penalties with potential investors. After viewing the typical sales pitch caught on hidden camera, she replies, "It's absolutely misleading. I mean really, they need to deal with these seniors straight."

So don't just take my word for it. Be very careful when considering any investment. Do your own research. Read the contracts and the fine print. If you can't understand it then don't invest.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. Find more articles about annuities or investing or ask Jeff's advice about your personal financial situation.

Harmed Investor Gets Justice

2008-04-16T11:56:00.001-05:00

Countless investors have lost large portions of their investments. Some have been in investments where they lost everything. But investors looking for help in recouping losses often find there are few places to turn for assistance. Read on to learn about one investor that finally got justice.

Many an investor has been harmed by their advisor's inaction or being put in unsuitable investments. It's natural that those feeling wronged seek retribution. So, where do investors turn if they need justice?

For securities investments such as stocks, bonds, mutual funds and variable annuities, it's to the National Association of Securities Dealers (NASD). The NASD is a self-regulatory organization created by the securities industry, not a government agency.

In 1987, the Supreme Court ruled that investors can be required to waive their right to sue in court in order to open a brokerage account. Now all grievances with a brokerage firm must first go through arbitration.

Fifty-five percent of arbitration cases rule in the investor's favor. But the average settlement is about 12 cents on the dollar. It so happens that the judges (even those deemed to be independent) are from the securities industry! No wonder brokerage firms prefer arbitration!

It is a long, expensive process to pursue arbitration on an individual basis. When you look at the average settlement, you will be lucky to cover your legal expenses. Your chances can be greatly improved, though, if you are one of many members in a group that had similar experiences with the same broker or firm. Think of it as class-action arbitration.

That's how Bob finally got justice. He invested $750,000 in a variable annuity recommended by an advisor in 2000. Three years later Bob's investment was only worth $350,000. When Bob became my client in November of 2002, there was little recourse he could take.

About a year later, though, he saw an advertisement in the local newspaper about a seminar just for those retirees of his company. It was put on by an out-of-state attorney that specialized in handling arbitration cases.

It turns out Bob, wasn't the only victim. Many of his fellow retirees used the same advisor that he did. Almost all had virtually the same experience. Collectively, they were able to get more of the attention they deserved during arbitration.

After 3 long years, Bob has received a settlement check for $166,000. It doesn't make Bob whole, but it sure helps ease the pain. Bob was one of the lucky ones.

Guess what happened to the broker? Not much. There won't even be any hint of the problems he caused on his permanent record. That means other investors will never know what this advisor did to Bob, and his fellow retirees. That means it can happen to them, too.

You see, the advisor you use could have lost investors hundreds of thousands of dollars and you will never know about it. There's no way to know if your advisor has had cases go to arbitration in the past. There's no way to know if he/she has any current cases in arbitration.

So what can you do to protect yourself?

First, ask your advisor if they have ever had any written complaints and/or cases that went to arbitration. You should also do a broker check at www.nasd.com.

Second, find out how the advisor will monitor and manage your investments on a day-to-day basis. Beware of the advisor that does nothing. Look for an advisor that has specific procedures in place to monitor and manage your account. Few do.

Third, make sure you have the ability to make changes should something go wrong. That's why I am so adamantly opposed to investments that have long-time commitments or big surrender penalties. They limit your options, making it expensive to switch investments down the road.

Fourth, if you've been wronged, try to see if there are others in the same boat. Search the internet for existing class-action lawsuits and see if you can join.

Typically, the problem is the advisor, not the type of investment. Use an advisor that will prevent a significant loss from happening in the first place. Bob was able to recover a portion of his loss. Justice was served, at least partially. Of course, the best strategy is to do your research before you invest your hard-earned money.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. Find more articles or ask Jeff a financial question at www.guardingyourwealth.com.

Special Announcement: Dateline on Equity-Indexed Annuities

2008-04-12T16:17:00.002-05:00

Dateline will be airing a hidden-camera investigation segment this Sunday that focuses on how Seniors across the nation are being taken advantage of by unscrupulous insurance agents selling a product called an Equity-Indexed or Fixed Index annuity.

I have been writing a weekly financial advice column for over 4 years and have consistently warned investors about the hidden dangers of these products. I have been contacted by so many investors across the nation that I wrote two, in-depth Special Reports that focus solely on helping the investor understand how these products actually work so they can make an informed decision before buying one. I've been contacted by attorneys nationwide as a result of those reports and asked to serve as an expert witness.

You can find my in-depth Special Reports (provided to investors free of charge) at these URLs:

www.guardingyourwealth.com/SpecialReports/Allianz.htm

www.guardingyourwealth.com/SpecialReports/GeneralEIA.htm

Always At Your Service,

Jeffrey D. Voudrie, CFP President

The Three Risks You Must Avoid

2008-04-09T11:42:00.001-05:00

There are many financial risks that investors want to protect themselves from (inflation risk, interest rate risk, market risk, etc). But there are three risks that most investors don't take into account and I believe not doing so can quickly get them into trouble. I call them control risk, access risk and flexibility risk. Let me explain.

When I refer to control risk, I'm talking about your ability to exert control over your money. Since you are the one that will have to reduce your standard of living if something happens to your nest egg, it's vital that you retain control over it. The problem with annuities, life insurance and other packaged products is that you immediately lose control over your money. You are ceding control to someone else. They are the ones in the position of power because they get to decide what is done with your money. They use contracts that specifically limit your control and give it to them. Why would you ever want to surrender control over the most important financial asset you will ever have? It doesn't make sense!

The second risk that people fail to think about is access risk. Whose money is it? It's YOUR money. If you own something, shouldn't you be able to access it any time you want? You own your home and you can use it whenever you want. Imagine giving your home to someone else where they control what happens to it and you can only access it when THEY allow you to. That doesn't make any sense, yet that is exactly what happens when you buy many of these packaged products.

There's no way to know what life is going to be like tomorrow. Few could have imagined the terrorist attack of 9/11. Few expect to be in a car accident. No one thinks that they will have a heart attack today, but there's no way to know.

Let me tell you a true story that just happened. My neighbor had some friends stop by yesterday. These snowbirds, were driving their motor home from Arizona back to the Northeast. As they were driving across the barren roads of west Texas, they didn't realize that there had been an auto accident up ahead. The accident had happened on the other side of the Interstate, but a highway patrolman had stopped traffic in their lane and a single car had come to a complete stop. For some reason, the patrolman's car had no flashing lights to get their attention.

You probably know what happened. The speed limit was 75 mph there and although the motor home wasn't going that fast, it takes a long time to get one stopped. He didn't see the stopped car until it was too late. He swerved around it, barely missing it, but the truck he was towing clipped the back end of the stopped car, totaling their truck. But it gets worse. As he swerved around the stopped car, the patrolman stepped out right in front of their path. The impact threw him onto their windshield then dumped him onto the grassy median. The officer ended up being air-lifted to the hospital.

This retired couple is still waiting to see if charges are going to be brought against them. And they most likely will. Their lives changed dramatically that instant, something they couldn't have foreseen. Imagine how you'd feel if that happened to you!

They could easily end up spending tens of thousands of dollars in legal fees. This is just one of many true examples that illustrate why free and complete access to your money is critical.

The third risk is Flexibility Risk. This is closely related to control and access risk. Basically, since it's your money you should have the flexibility to do whatever you want with it. You should be able to make changes to the way that it's invested. You should be able to move it from one place to another without having to pay a penalty. You should be able to pull it out and use it to help a loved one or just to take that dream vacation. But flexibility is just one more thing you lose when you buy a packaged product.

These three risks are difficult to place a dollar value on until you are affected by them. Then they are priceless.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide. Find all his articles at www.guardingyourwealth.com.

House of Cards Part 2

2008-04-02T12:24:00.005-05:00

Last week, I talked about how the current credit crises evolved. This crisis is the result of mistakes made by the homeowner, the mortgage company, the investment banks and the rating agencies. This week, you'll see what caused the House of Cards to fall and will learn how this example can keep you from making a financial mistake.

Leverage was used at each stage of the mortgage-chain. Leverage is when money is borrowed so that additional investments can be made. The idea is that more can be earned on the investment than has to be paid in interest on the loan. So the homeowner borrows the full value of the home, the investment banks borrow money so they can buy more loans, etc. While leverage can increase returns, it also exacerbates a decline.

For example, a popular concept these days is to borrow the equity from your home and invest it in life insurance (one that I don't agree with). Perhaps both spouses work and their income easily covers the additional mortgage payment. The couple only sees the potential profit and doesn't realize if things don't work out, this transaction can be very costly to unwind.

Suppose one spouse loses their job and their income falls short of covering the mortgage payment. Or maybe their mortgage payment increases because of interest rates. Unless the spouse can find another job, the couple will be faced with having to sell their home quickly to pay back the mortgage company. If there are lots of other people in the situation, all trying to sell their homes at the same time, the value of a home is going to drop quickly.

Taking this example a step further, if home prices in general have declined 20%, then those who had 20% equity in their home suddenly have none. Now their home is only worth what they owe. Or, they may have a home equity line of credit. The bank is going to reduce the line of credit based on the decreased amount of equity.

That's basically what has occurred on a national scale at every point in the mortgage-chain. If a portfolio of mortgages is used as collateral and it's suddenly worth 50% less, the lender is going to want their money.

What should we learn from this? First, examine why so many homes are in foreclosure. Is it because the borrower wasn't informed about the details of the loan? No, the bank or mortgage company provided lots of fine print for homeowners to sign, explaining every aspect of their loans, including how interest rates would increase payments in the future.

Did banks or mortgage companies illegally provide mortgages to consumers who weren't qualified? No, not really. Obviously, the mortgage lenders wanted to sell as many mortgages as possible because that's how they made money. It wasn't their job to protect the borrower.

It's the same in the world of investing. You can't expect the one selling you a product like a mutual fund or annuity to be the one to watch out for your best interests. As a consumer, it is your responsibility to do the research, read the fine print and thoroughly understand any financial contract you sign. A financial advisor isn't going to say to you, "Hey, this might not be the best investment for you. Your money is going to be locked up for 15 years and the only way you can tap it is by paying a big penalty. Besides, you can earn even more using a balanced portfolio of quality investments."

Believe it or not, a commission-based broker or agent is NOT legally obligated to do what is in your best interest. They only have to offer investments that are suitable. They don't have to make sure you understand the fine print you sign. They don't have to go over all the future consequences of your financial decisions. They don't have to sort through all your investment options and find the one that fits you perfectly. That's not their job!

Don't let fear or greed cause you to defy common sense when it comes to investing. Do independent research, read and carefully parse the fine print and if you can't understand it then you shouldn't buy the investment. Don't let a smooth-talking advisor cause you to skip any of these important steps.

Nationally-syndicated financial columnist and Certified Financial Planner(R) Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA.

Read more or ask Jeff a financial question at www.guardingyourwealth.com.

A House of Cards: Part 1

2008-03-26T14:03:00.007-05:00

The current credit crisis has impacted multiple sectors of our financial economy. Home foreclosures are on the rise. Credit-worthy consumers struggle to secure mortgages. Investment banks are brought to their knees. Foreign and domestic stock markets experience gut-wrenching volatility. The Federal Reserve is forced to take historical steps to maintain liquidity. And the list goes on....

In an effort to help the ordinary investor make sense of it all, here's the first part of a simplified explanation of the credit crisis that has overtaken our economy. Hopefully you'll come away with a better understanding of the situation, along with some lessons you can apply to your own personal finances.

As with all true disasters, a series of mistakes are made that culminate into a full-fledged crisis. History provides us with many examples, including the sinking of the Titanic, the stock market crash of the 1920s, and more recently, 9/11 and Hurricane Katrina. In each case, a series of circumstances, along with multiple human errors, combined to bring about a true disaster.

Such is the case here. We can't just blame the banks, or the mortgage companies or the housing market or the Federal Government. This was a real group effort and there's plenty of blame to go around in this chain of events.

Let's start the story at the beginning of the chain, with the American home-buyer. We all know how to buy a home. If your income and credit score are high enough, and your outstanding debts are low enough, you can get home loan from a bank or mortgage company. And many people do. But as home prices continue to rise and the supply of credit-worthy consumers dwindles, a way has to be found to keep the mortgage profits flowing.

So loan requirements are relaxed. Adjustable rate mortgages, with low initial teaser rates, are introduced. Down payments are lowered or eliminated altogether. Documents proving credit worthiness, like income tax returns, are no longer required. Loans for more than the price of the house are given. Suddenly almost anyone can get a loan for more house than they can really afford. But that's no problem, certainly not in the middle of one of the hottest housing markets in recent memory. House prices are going up like a rocket and everyone wants to go along for the ride.

Once a bank or mortgage company gets a loan, they turn around and sell it to investment banks, freeing up capital so they can loan even more money. The investment banks, believing that these mortgages have been given to credit-worthy consumers, in turn sell groups of mortgages to shell companies they create. This way these mortgage loan assets are off their books, freeing up capital they can reinvest to earn even more profits.

The shell-companies don't have the capital requirements that banks do, so they can leverage these loans even more by issuing short-term commercial loans to institutional buyers and hedge funds. They are earning more off the mortgages than they are paying on the commercial loans, so they make a profit. The rates offered on the commercial loans aren't high because the mortgage bonds collateralizing them are AAA rated.

The institutional buyers like the AAA ratings of the underlying bonds, and buy large amounts of the short-term loans they're based on as a secure source of income. Everyone believes that these groups of mortgages are well diversified and are from credit-worthy consumers, hence the AAA rating. As long as house prices keep climbing, everyone is happy and keeps making money.

So far, our chain of events is all about leverage. The home-buyer leverages a small (or no) down payment and monthly house payments to fund a substantial mortgage. The bank or mortgage company leverages the profits from these loans to loan even more money. The investment banks that purchase these mortgages from the original lenders are able to move them off their balance sheets and into shell companies they create, leveraging them even further. The shell companies leverage them yet again, allowing them to make even more loans and helping institutional investors increase profits.

In our next article, we'll see the tragic consequences when all this leverage is turned on its head and the house of cards based on a booming housing markets collapses.

Sticker Shock

2008-03-19T12:16:00.000-05:00

It can be difficult for someone in the financial services industry to know how the investor feels, especially when first choosing which advisor to work with. I recently had an experience that put me in your shoes for a change.

A couple of mornings ago, my teeth began hurting for a short time after I brushed them. It had been awhile (too long) since they were cleaned so I decided to go to the dentist for a cleaning and check-up...

I only have one set of teeth and I know that they need to take care of me for the rest of my life. Unless I want to exist on soft food, it's vital that I take care of them. Likewise, someone retiring only has one nest egg and their lifestyle and ability to remain retired will depend on what happens to it. Make a mistake and you can lose a good portion of it.

How do you choose an advisor? How do you choose a dentist? I could look in the phone book and I can ask people that I know whether they are pleased with their dentist. Still, how do I know if their experience with a dentist is going to be the same as mine? It's not like you can interview a dentist, get a price list and an extensive list of references!

Worse, the reason I was looking for a new dentist was because I wasn't pleased with the dentists I'd used in the past. Surely this time I would find one that I would like! So I called a dentist that seemed to do a good job for another family member and I set an appointment.

A red flag went up during the first call. I asked for an appointment after the stock market was closed for the day and amazingly, they just happened to have had a cancellation and I could get in that very day! Having a sales background, I know that's a common tactic to use because you don't want to give the impression that you aren't busy.

Another red flag was raised as soon as I walked into the office. There was leather furniture, a cafe and a plasma screen television. The coffee table featured literature on various cosmetic improvements. The plasma TV, it turned out, was just playing a loop designed to sell those improvements. I never realized that having whiter teeth would have such a positive impact on my entire life!

The phone sales tactic I picked up on was confirmed when I heard the receptionist say the same thing to others that were calling in. In the financial services industry, these are seen as harmless statements. "It's no big deal, they'll never know," the advisor might explain to the assistant. Maybe I'm old fashioned, but I don't want to be treated that way and neither do my clients.

Soon, I was ushered into the chair where I thought I was going to have my teeth cleaned. After a few pleasantries, the dental assistant said that she needed to take some x-rays and that they recommended the 360 degree one. "It is $199 for both sets, is that OK?"

While examining my gums she mentioned that oral cancer was very hard to detect and affected many people. They had a test that would screen for it and it only cost $49 would I be interested? No.

My appointment was for a cleaning. But all I received was the x-rays and the initial consultation‚. It's possible‚ I have a cavity under one of my existing fillings and the dentist recommended it be fixed, not with a traditional filling but with a new crown that would be much better.

I left feeling like I paid $200 for some x-rays and a sales pitch. The full cleaning, it turns out, will cost over $500! That partial crown would only be $850! For comparison I called another dentist. This one seemed to be more old school. His cost for a cleaning? $110.

Have you ever felt like I did after going to an investment advisor? Undoubtedly, some of you have and I am ashamed to say that it is becoming more common. There are advisors out there, though, that are more focused on your needs than their own. Trust your red flag indicator, don't move quickly, and do extensive research on any recommended products.

Read more or ask Jeff a question at www.guardingyourwealth.com.

An Ounce of Prevention

2008-03-13T12:32:00.000-05:00

We've all heard the old adage that an ounce of prevention is worth a pound of cure. This applies to many areas of life, but perhaps none better than in the area of long term care. Nobody likes to think about the possibility of needing this kind of care and, as a result, many people put off preparing for it until it is too late. Here's a real life story that will hopefully motivate any procrastinators out there into action.

A dear friend of ours, whom we'll call April, has been helping her 88 year old mother recover from some fractures in her spine caused by osteoporosis. After living independently and refusing any kind of assistance for years, she has now decided she does not want to go back home from the rehab hospital, but would rather go straight to a nursing home facility.

As often happens with the elderly, declines in health and mental attitude can come on quickly and such is the case here. April's mother has been a widow for several years and did not even want her own children dropping by to help her with housekeeping. But when her severe back pain turned out to be three fractured vertebrae requiring surgery, she had a sudden change of heart. Now, she would rather have others care for her and not have to deal with keeping up a home.

Fortunately, 18 years ago when April's mother was 70 years old, she purchased a long-term care insurance policy. While it only covered nursing home care and not assisted living, it promised that premiums would not increase over the life of the policy. Her premiums were $1,800 a year, which seemed like quite a sum to her and her husband back in 1990. But given the longevity on her side of the family, they felt it was a wise decision.

They didn't buy a similar policy for April's father, because he was a World War II veteran. In those days veterans knew that they could live out their days in a V. A. nursing home should the need arise. As the years went by, the couple remained in relatively good health. When a letter from the V. A. arrived years later, he didn't understand exactly what it said and didn't realize that the once-promised nursing home benefits for veterans had drastically changed.

His family didn't realize this either, until the father developed severe Alzheimer's a few years ago. That's when they discovered that the V. A. would only cover nursing home care for the first 90 days. After that, you were on your own. Unfortunately for him, his ability to swallow went away quickly and he died soon after. Had his illness progressed more slowly, his condition would have financially devastated his wife's financial security.

But because of the policy bought 18 years ago, April's mom will be well cared for. While $1,800 a year seemed so expensive back in 1990, today it's an absolute bargain. With nursing home care in our area costing about $175 a day, the $32,400 she's paid in premiums will be recovered in less than 6 months. Think about that. She's paid premiums for 18 YEARS and will get it all back with only 6 months care.

It's true that if she recovers well enough to handle most activities of daily living and goes into an assisted living facility instead, she will have to pay for it. But given her age and current condition, even if that is the case, most likely the need for nursing home would simply be a matter of time. But her policy gives her options she would not have otherwise and will allow her to choose a quality facility without having to consume her nest egg.

There are several lessons we can all learn from this story. While we can't predict our future, the increasing of life spans and medical advances means most of us can expect a longer life than our parents, increasing the likelihood of needing some kind of long term care. Medical costs continue to outpace inflation. If you wait too long to apply for long term care, you may have developed conditions that will medically disqualify you for it.

So don't put off this very important aspect of your financial plan. An ounce of prevention is certainly worth a pound of cure.

Read more or ask Jeff a question at www.guardingyourwealth.com.

A House Divided

2008-03-05T14:18:00.002-05:00

One of the biggest issues seniors face as they get older is how to preserve an inheritance for their children. Their biggest fear is spending all of that money on assisted living and/or nursing home care. As each family situation is different, so is each solution. Perhaps you can learn something from the experience of one of my clients.

Here's their situation in their own words, with their names changed, of course:

"Tom's mom has decided that she wants to move to a retirement home while she can make her own decisions about where and when to go. She's on the waiting list at one that's so nice I may go too!"

"Anyway, we are looking at options of what to do with her house. She's always wanted the house to go to Tom and his brother Les even if she has to use up every other asset she has."

"Les is disabled and on Social Security Disability Income. Mom sends Les about $150.00 a month to help out. Her first thought was to sell the house and divide the proceeds now. Tom thought it might be better for her to lease it and then she could still send Les money each month."

"Also, if she were to sell, we think she should keep the money in case she ends up needing it to live on. I know there are tax limits on gifts of money, (and not sure what all that would do to Les's assistance eligibility). Maybe she could sell, give each $10,000 and keep the rest for her future living expenses. Anyway, I think she could well be heading toward some mental issues (lots of forgetfulness, etc.) so we need to make the right decision."

"What say you, Mr. Financial Guy?"

These are difficult situations. First, you need to make sure that you have the appropriate legal documents in place to handle any incapacity that may/may not occur. There should be Powers of Attorney for Assets and Healthcare and/or a Living Trust. There should be a Living Will. If she doesn't have a Living Trust you will want to make sure that her Will is up to date.

There are issues relating to Les receiving an inheritance in that it might disqualify him from SSDI. It's important that any inheritance he receives go to a Special Needs Trust. Otherwise, the government might take the money as pay back for what they've spent. Be sure and consult a qualified attorney for this kind of trust.

Depending on her income, she may need the money to cover her assisted living and/or future nursing home care. Some want to leave an inheritance and try to get the government to pay for their care. That is done through Medicaid. To qualify, one has to be indigent--having less than $2k in assets.

So if she sells the home and uses the money for her care, she will need to spend it down to $2k before qualifying for Medicaid. There is a 5-year look back period when someone applies for Medicaid. If they have gifted money within that period, they will be denied benefits for the amount of time that money would have otherwise covered.

There are really two unknowns here. First, whether mom will need all her money for her care and, second, whether that will occur within 5 years. If she sells the house, she can gift all the money to her sons now without having to worry about Federal Gift Taxes (other than filing a form). She should check to see if there will be any state gift taxes.

As long as her other money lasts for 5 years the gift wouldn't impact future Medicaid eligibility. Another option is for her to consider long term care insurance. She has to medically qualify and her memory issues may keep that from happening.

In short, Mom should make sure she has enough money to cover her expenses for the next five years. She might need some of the house proceeds to cover this. Then she could go ahead and gift the remaining house proceeds to her sons. If she qualifies, long term care insurance could help cover future health care expenses. And you're right to not put off these kinds of difficult decisions. Deal with it now, before it's too late.

Read more or ask him a question at www.guardingyourwealth.com.

Pulling Back The Curtain On Reverse Mortgages

2008-02-27T21:56:00.004-05:00

Last week's article on reverse mortgages generated a very interesting response from one reader. Unfortunately, due to his choice of vocabulary, I can't print his response here. Suffice it to say that this advisor doesn't want me saying anything negative about his chief source of revenue. This week I'd like to pull back the curtain on the real reason reverse mortgages have become so heavily marketed and what you need to do as a consumer to protect yourself.

In my previous article, I mentioned an elderly couple from Florida who were considering a reverse mortgage as the answer to their financial crisis. Over the course of a year, they attended two different seminars presented by their bank. This couple was living beyond their means and saw tapping their home equity as a way to keep making credit card payments. A reverse mortgage would have given them access to a $38,000 line of credit, but would have cost them almost half that much in fees.

Fortunately, they shared their plans with their son. They were scheduled to sign the papers in a week. That's when he called me. He gave them my advice and took the time to help them look at all the options available. More on their decision later; the issue I really want to explore is why are conservative banking institutions and mortgage brokers pushing these mortgages so heavily?

The answer is simple and obvious: the collapse of the housing bubble. Home values are declining, credit is drying up, and fewer homes are being bought or sold. Mortgage departments are a huge source of revenue for a bank. Over the last 5 years, the mortgage department has been generating huge profits. Suddenly, that has all changed.

Enter the reverse mortgage. These have been available for some time, but when a loan officer was so busy writing traditional mortgages, there wasn't a reason to focus on them. With some spare time on their hands, mortgage brokers need to find a way to feed their families. And from their point of view, the reverse mortgage is the perfect product for a variety of reasons.

For one thing, reverse mortgages are government guaranteed so the bank doesn't have to worry about losing money in a foreclosure. This is especially important when home values have plummeted 10% or more. In other words, there is very little risk for the bank.

It also helps that the fees on reverse mortgages are amazingly high. That means that the mortgage brokers, if they are successful pushing reverse mortgages, can continue to make money. The bank likes it because the mortgage department continues to add to the bottom line.

A third reason why reverse mortgages are so popular is because the market for them is far larger than the traditional mortgage market. Most people only buy/sell a home every 5-10 years. Think of how many seniors are sitting in homes with huge amounts of equity! Instead of chasing a limited market of home buyers who can afford large down payments, mortgage brokers can tap a larger, ever expanding senior market.

It isn't that banks and brokers shouldn't make money. They should. My primary concern isn't the bank, though. It is you. I want you to understand the motivations of those involved. You should research any large financial decision you make. Get all the facts so you can make an informed decision. It's the same when considering a reverse mortgage.

There are certain situations when a reverse mortgage can make sense, but I expect that there are many, many reverse mortgages done in situations where there were better alternatives. It was never intended as an easy way to pay for dream vacations.

What about my friend's elderly parents? Given all the facts, they chose credit counseling instead. They consolidated their credit card debt while reducing their interest rates. They also decided to sell their home and use their equity to relocate closer to family. Besides leaving a hurricane zone, they'll be moving to a more temperate climate with a much lower cost of living.

Don't blindly fall for the reverse mortgage sales pitch. Explore all the options and make sure youâre making the choice that is best for you. I also suggest you get your children involved as well. You could just sell the house and move in with them (just kidding)!

Should Seniors Use Reverse Mortgages?

2008-02-20T13:28:00.001-05:00

Some of the most popular products being pitched to seniors today are reverse mortgages. Everywhere you turn there are free seminars, free reports and free DVDs, all touting the amazing benefits these loans offer. Are reverse mortgages the answer to seniors‚ prayers, or are they too good to be true?

It all sounds so wonderful: easy access to your home's equity, no monthly payments, and all without having to sell your house or move. You can have a guaranteed income for the rest of your life! I feel that the sales pitches for these products do a disservice to seniors and, in some cases, can do irreparable damage.

All of us are familiar with a traditional mortgage. You borrow money from the bank using the home for collateral. You are then charged interest on that loan and have to make monthly payments. The larger your mortgage is compared to the value of your home, the less equity (or wealth) has been accumulated.

A reverse mortgage is just like it sounds. You are still borrowing money from the bank and using your home as collateral. The only difference is that you don't have to make monthly payments on what you borrowed. Instead, the interest just builds up. So every month you go further and further into debt and have less wealth.

You don't have to pay off the loan unless you sell the home or no longer live there. Another advantage of a reverse mortgage is that you don't have to have any income to qualify and there are no restrictions on how you use your proceeds.

While these mortgages can be helpful to seniors truly struggling to cover the basics, many seniors see reverse mortgages as free money‚ that can allow them boost their standard of living. Some providers are promoting reverse mortgages as an easy way to pay for that dream vacation or expensive new car. For those with considerable home equity, such possibilities are indeed tempting.

A reverse mortgage is probably the most expensive loan available today. The up-front fees can be astronomical. Here's a real life example. A friend of mine asked me to check out a reverse mortgage being pitched to his elderly parents. The proposal given to them by the bank showed that in order to access $33,000 in equity, they would be charged almost $18,000 in fees! That's over 50%.

His parents had a home worth $230,000 and a $100,000 mortgage. They needed $33,000 and didn't qualify for any other loan. A reverse mortgage has to be the primary loan on the home so enough had to be borrowed to pay off the existing mortgage. So they were paying fees on a loan of $133,000 instead of just the $33,000 they needed.

The lender has to know that they will be able to sell the house for more than you owe on it. That's why they will only lend around 65% of the home's value depending on your age. In some situations, if the home value doesn't appreciate significantly over the years, you could see your equity dwindle away to nothing. You have the miracle of compounded interest working against you month after month.

His parents weren't concerned about the fees because they didn't see it as costing them anything. But it does. That money took decades of making monthly payments to accumulate. It looks just like some numbers on paper, but it can have a very real impact on their future.

The money spent in fees is money that they won't be able to spend on food, medicine or personal care. It's money they won‚t be able to use to fix the roof or get a new water heater. And if they don't maintain the home, the lender can step in and take it away.

For those who receive a set monthly payment from their reverse mortgage, it's true that they won't run out‚ of money. That doesn‚t mean there isn't any risk. The monthly payment doesn't increase from year to year, but the price of everything else does. What will you do if that set payment is no longer enough to meet your expenses, and you've lost much of your home's equity to high fees and interest costs?

A reverse mortgage may be right in special situations, but it's anything but free money.

Read more at www.guardingyourwealth.com or visit the website and ask Jeff a question.

Charting a Course for Emerging Markets

2008-02-14T01:02:00.003-05:00

Investors dissatisfied with domestic returns have been seeking greater growth in foreign markets. As noted in last week’s article, the growth of emerging markets is not a short-term fad, but a long-term trend that will affect global markets for years to come. The question then, is how you can take advantage of this opportunity without losing your shirt. Read on to find out.

The returns of foreign emerging markets are truly impressive—-20%-100% a year or more isn’t uncommon. Who wouldn’t want to earn 83% in one year like the China index FXI did? Or the 58% it did in 2007! These dramatic returns have caused some investors to throw caution to the wind. They’ve moved significant portions of their portfolios to these markets only to suffer devastating losses.

That’s not what I want for my clients, nor do I want it to happen to you. While the returns are much higher, the risk is also much greater. Unless you have carefully planned how to control that risk then you should leave these markets to the professionals.

Here’s the real question. Are you willing to endure losses of 20-50% that can last for months in order to achieve those stellar returns? Most are not. They jump into these markets only to get discouraged and sell after a big decline. The China index (FXI) is down over 30% since its peak in October of 2007. Would you still be hanging on to it?

Daily swings of 5% to 8% are not uncommon for large-cap Chinese stocks. Newer markets, like those in Vietnam, can take huge dives very quickly. Governments, along with their financial regulations, can change overnight. Growing pains are common for developing markets and those with the stomach to handle the wild ride can be richly rewarded. Clearly, investors have to match their foreign exposure to their appetite for risk.

Investing in emerging markets is not for the faint of heart. That doesn’t mean that you shouldn’t do it. Start small by only investing a couple of percent of your overall portfolio. Then you need to decide the method of investing that is best for you.

There are several ways you can invest in foreign and emerging markets. You can buy individual stocks on the foreign exchange. You can buy foreign companies that are listed on U.S. exchanges. There are exchange-traded funds (ETFs) for just about every country and/or region. There are mutual funds. You can buy bonds as well as stocks.

I only recommend buying stocks on a foreign exchange for advanced, sophisticated investors. This isn’t as hard as it used to be thanks to online brokerage firms, but is still pretty involved. First, the markets like the Hong Kong exchange are located half-way around the world. That means their market is open while it’s nighttime here. Second, you have to convert your money to the local currency prior to making a purchase.

It’s much easier to buy large foreign companies that trade on U.S. exchanges. Doing so isn’t any different than buying any other U.S. stock. Some of these companies trade on the pink sheets. If you go this route, beware of the daily trading volume and the spread (the difference between the bid and ask price).

Good quality mutual funds are perhaps the most popular way to invest outside the United States. There are too many choices to list here and doing your research before you invest is crucial. Some have active management, while others are more passive. Some focus on specific markets while others are more general in nature. Fees can vary widely as well.

No matter how you invest, one major risk to consider is currency risk. When the U.S. dollar is falling, foreign returns benefit. When the dollar is rising, however, foreign returns suffer. This means your return can either be wiped out or greatly boosted, depending on what the currency markets are doing.

While the superlative performance of emerging markets is long term trend, many tactical decisions will need to be made along the way. There are simply too many changes in the governments, rules and regulations and the economies themselves to just set it and forget it. Professional management can add significant value and help you take full advantage of the opportunities that are available.

Nationally-syndicated financial columnist and Certified Financial Planner® Jeffrey Voudrie provides personal, in-depth money management services and advice to select private clients throughout the USA.

Read more at www.guardingyourwealth.com or stop by the website to ask Jeff a financial question.

Can Emerging Market Growth Continue?

2008-02-06T12:37:00.001-05:00

We've all heard about the amazing growth taking place in developing countries and how the global economy will never be the same again. But countries like China, India and Vietnam seem so far away. It can be hard to understand how those marketplaces can affect the individual investor here in the U.S.A. After my recent trip to Cambodia, I'm here to tell you that emerging markets aren't some short-lived fad. We've only begun to see the impact they will have in the financial markets.

My wife and I had visited Cambodia last March, but this time was different. Besides having our four children along for the experience, the signs of a growing economy were everywhere. Construction was taking place all around Phnom Penh, the nation's capital. A new 42 story office building had broken ground, the country's first skyscraper. It's being financed by a South Korean company. A huge new complex of shops and office buildings were coming up on old rice fields north of town in a special economic zone.

Masses of new apartment buildings were being constructed. The prices of these condo/apartments continue to increase. Those that were $40,000 when construction started are now $100,000. Land values continue to soar exponentially. More people can afford cars. Everyone has a cell phone. Universities and schools teaching everything from nursing to English classes to management and computer skills are popping up on every corner. And the schools are packed.

The city continues to improve its infrastructure with the paving of roads and improvement of their drainage system, which is important during the monsoon season. Internet access is growing as is the availability of cable television. But there's much work to be done. Power outages occur almost daily. The municipal water isn't potable. The sewer system has a very limited reach. There is no mass public transportation service in a city of well over 1 million. There's little garbage collection.

Just outside of town, the picture is even starker. When you travel out to the provinces, it's like stepping back in time. Once you get off the main highway, there are no paved roads. Many homes are simple wooden shacks with thatch roofs. Naked children play with sticks in the road next to ditches that are little more than open sewers. Electricity comes from generators that operate a few hours a day. Health care is almost non-existent. The rice grown in the fields hardly supplies enough grain for each family's yearly needs.

Not all provincial families live in dire poverty. But the majority do. The young people don't want the same life their parents have. They want more. And they're willing to work for it. Many of them turn to the garment factories, where by working six to seven days a week, ten to twelve hours a day, they can make $100 a month. In country where unemployment can reach 50%, that's a nice sum of money. But it's not much of a life.

Others realize that education is their ticket to a better future. The church we visited and were working with offers free English and computer classes. Over 200 students jam every available room of the building four nights a week. In addition, all of these kids attend either high school or university during the day. Many of them came from the provinces and plan to send money they earn back home to help support their families.

So if you think the emerging markets‚ is just the latest financial talk point, think again. The story in Cambodia is the same story all over Asia. These people want a better life. They want a higher standard of living. They are becoming educated. Their countries are only beginning to improve their infrastructure. Astute companies from around the world are investing big bucks into these economies. And the growth is only going to increase.

This isn't a five year fad. It will take decades for these countries to grow into modern nations. But there's no going back. The young people we met are determined and focused. This generation will do what it takes to succeed.

Your generation worked very hard to achieve financial security. In today's changing global marketplace, you'll have to invest smarter in order to maintain it. In next week's article, I'll give you practical steps to take advantage of the opportunities these emerging markets provide.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.

Do You Owe Taxes On That Gift?

2008-01-30T12:50:00.001-05:00

As a Certified Financial Planner, I'm often asked about issues regarding inheritance, gifting and the resulting taxes. Here's a classic example of just how complicated these situations can be, using a question from a reader in Michigan we'll call Bob.

Bob writes: I have a question about my mom's home that I inherited. Before my mom died she put her real estate into joint ownership between her and my sister. It was supposed to help make settling her estate easier. Before mom passed away, my sister died. After my sister died, mom placed the real estate jointly between herself and me. Mom passed away over a year ago and I am now contemplating the sale of her house. After mom's death I had the home transferred to my and my wife's names.

What are my capital gains liabilities on the sale of the house? Do I pay capital gains on the whole sale, half the sale, or none of the sale?

Bob's lack of knowledge is nothing out of the ordinary. Few people are aware of the tax implications and needlessly end up creating a tax headache for themselves and their loved ones.

Let's explain what an inheritance is and how it differs from a gift. An inheritance is money, property, or another asset of value that is transferred after death. A gift occurs when money, property or other assets are transferred before death. An inheritance and a gift are handled very differently from a tax standpoint.

Each of us can give gifts up to $12,000 per year to any person we want without any Federal tax implications. (There may be some state gift tax implications so check with an accountant.)

Inheritances aren't subject to Federal Estate Tax unless the estate's value is over a certain amount, which is currently two million dollars. Because all assets owned by the deceased are included in the estate's valuation (i.e. retirement accounts, annuities, life insurance, etc.), reaching that two million dollar limit is easier than you think.

Even if there is no gift or estate tax when the assets are transferred, there can be capital gain taxes when the assets are sold. The trick is determining the asset's original value, or cost basis, and that depends on whether the asset was a gift or an inheritance.

When you receive a gift, you also receive the cost basis the person giving the gift had. So, if a parent paid $10,000 for a home and it was worth $100,000 when it was gifted to the child, the child now has a cost basis of $10,000. If the house is sold 5 years later for $125,000, the child will owe taxes on a gain of $115,000.

If the house was instead inherited by the child, the cost basis is the value of the house at the time of inheritance, which in our example would be $100,000. So when the house is sold 5 years later for $125,000, the child only owes taxes on the gain of $25,000. In tax parlance, the house received a step-up in basis when transferred after death. It doesn't receive a step-up if transferred prior to death.

Let's apply this to Bob's situation. When Mom added Sister's name to the deed, it was a gift to the sister of 50% of the value of the home and Sister's cost basis was 50% of Mom's cost basis.

When Sister died and the house transferred back to Mom, it was considered an inheritance. So Mom's cost basis on the 50% she inherited was the market value at the time she inherited it back. So 50% of Mom's ownership is based on her original cost basis and the cost basis of the other 50% is the value at Sister's death.

When Mom then adds Bob's name to the property, it's another gift. So Bob will inherit 50% of Mom's new, adjusted cost basis. When Mom dies and the other 50% is transferred to Mr. K, his cost basis in that 50% is the value at the time of Mom's death. Now you know why accountants make all that money!

If Mom had used a Living Trust instead, there would have been no need to add names to her house and her heirs would have 100% of stepped up cost basis, saving thousands of dollars in taxes.

In addition to being a nationally syndicated columnist and Certified Financial Planning Practitioner, Mr. Voudrie provides personal, private money management services to clients nationwide.