High-Yield Bonds: Income Potential at a Price

High-yield bonds have long been a popular source of diversification for long-term investors who seek to maximize yield and/or total return potential outside of stocks. 1 High-yield issues often move independently from more conservative U.S. government bonds as well as the stock market.

These bonds – often referred to as “junk” bonds – are a class of corporate debt instruments that are considered below investment grade, due to their issuers’ questionable financial situations. These situations can vary widely – from financially distressed firms to highly leveraged new companies simply aiming to pay off debts.

As the name “high yield” suggests, the competitive yields of these issues have helped attract assets. With yields significantly higher than elsewhere in the bond market, many investors have turned to high-yield bonds for both performance and diversification against stock market risks.

These are valid reasons for investing in high-yield bonds, especially long term. But as you read about what these issues could offer your portfolio, it’s also wise to consider how these bonds earned their nicknames.

The Risk-Return Equation

In exchange for their performance potential, high-yield bonds are very sensitive to all the risk factors affecting the general bond market. Here’s a summary of some of the most common risks.

• Credit risk: A high-yield bond’s above-average credit risk is reflected in its low credit ratings. This risk – that the bond’s issuer will default on its financial obligations to investors – means you may lose some or all of the principal amount invested, as well as any outstanding income due.

• Interest rate risk: High-yield bonds often react more dramatically than other types of debt securities to interest rate risk, or the risk that a bond’s price will drop when general interest rates rise, and vice versa.

• Liquidity risk: This is the risk that buyers will be few if and when a bond must be sold. This type of risk is exceptionally strong in the high-yield market. There’s usually a narrow market for these issues, partly because some institutional investors (such as big pension funds and life insurance companies) normally can’t place more than 5% of their assets in bonds that are below investment grade.

• Economic risk: High-yield bonds tend to react strongly to changes in the economy. In a recession, bond defaults often rise and credit quality drops, pushing down total returns on high-yield bonds. This economic sensitivity, combined with other risk factors, can trigger dramatic market upsets. For example, in 2008, the well-publicized downfall of Lehman Brothers squeezed the high-yield market’s tight liquidity even more, driving prices down and yields up.

The risk factors associated with high-yield investing make it imperative to carefully research potential purchases. Be sure to talk to your financial professional before adding them to your portfolio.

1 Diversification does not ensure a profit or protect against a loss in a declining market.
From the Financial Planning Association®

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How to Help Your Kids and/or Grand Kids Understand Investing

h2. One way is to set up a custodial account

Setting up a custodial account can be a savvy move for adults who want to either teach their kids to invest with their own money or for parents to gift their assets and help their children under the age of 18 to become financially independent.

But there are many considerations – and consequences – to weigh before opening an account.

The Account Options

The two types of accounts you can use to set up an investment account or to gift assets to your youngster are called a Uniform Gift to Minors Act (UGMA) or Uniform Transfers to Minors Act (UTMA). Which one you use will depend on your state of residence. Most states – with the exception of Vermont and South Carolina – have phased out UGMA accounts and now only offer UTMA accounts.

UTMA accounts allow the donor to gift most security types, including bank deposits, individual securities, and real estate. UGMA accounts limit gifts to bank deposits, individual securities, and insurance policies. Here are some points to consider.

1. There are no contribution limits. Parents, grandparents, other relatives, and even non-related adults can contribute any amount to an UGMA/UTMA at any time. Note that the federal gift tax exclusion is currently $14,000 per year ($28,000 for married couples). Gifts up to this limit do not reduce the $1 million federal gift tax exemption.

2. The assets gifted are irrevocable. Once you establish an UGMA or UTMA, the assets you gift cannot be retrieved. Parents can set themselves up as the account’s custodian(s), but any money they take from the account can only be used for the benefit of the custodial child. Note that basic “parental obligations,” such as food, clothing, shelter, and medical care cannot be considered as viable expenses to be deducted from the account.

3. Taxes are due – potentially for both you and your child. Some parents may initially find custodial accounts appealing to help them reduce their tax burden. But it’s not that simple. The first $1,000 of unearned income is tax exempt from the minor child. The second $1,000 of unearned income is taxable at the child’s tax rate, which could trigger the need for you to file a separate tax return for your child. Any amounts over $1,900 are taxable at either the child’s or the adult’s tax rate, whichever is higher. Note that state income taxes are also due, where applicable.

4. Your child will eventually gain complete control. Once your child reaches the age of trust termination recognized by your state of residence (usually 18 or 21), he or she will have full access to the funds in the account. Be warned that your child could have different priorities for the assets in the account than you do. Money that parents had earmarked as paying for college tuition could instead be used to purchase a sports car or fund a suspect business venture. This is where you need to make sure your child understands the account and how it works. Make them responsible for attending meetings with your adviser.

5. It could impact financial aid considerations. For financial aid purposes, custodial assets are considered the assets of the student. If the assets in the account could jeopardize your child’s chances of receiving financial aid, speak to your tax and/or financial professional. One of your options could involve liquidating the UGMA/UTMA and establishing a 529 account.

Before making any decisions about establishing a custodial account, be sure to talk to your tax and financial professionals.

This communication is not intended to be tax advice and should not be treated as such. Each individual’s tax situation is different. You should contact your tax professional to discuss your personal situation.

3 Diversification Mistakes that cause Dysfunction

Every adviser talks about diversification. Basically having your investments spread across a variety of asset classes, such as large companies, small companies, international, etc… The weightings assigned to each asset class mainly depends on your time horizon, goals, and risk tolerance.

One of the largest mistakes investors make is thinking they are diversifying their portfolio by diversifying the advisers or companies managing their money. Having your assets spread across companies may seem diversified but actually can be destructive to your goals.

When one person isn’t seeing the whole picture, advice becomes centralized on what they know. The more spread out you are, the narrower the scope of the advice. Be open with your advisers about what you have, and where.

The second mistake is concentrating on one asset, gold comes to mind. Whenever anyone wants “to sell everything and buy gold.” it usually sends chills down my spine. The whole point of diversifying is making sure you are not relying on one asset to fund your goals.

Every asset class has bad years and good years. No one can accurately predict the ups and downs. When everyone invests in the same asset a bubble can occur when emotion trumps fundamentals. Remember when people say real estate “always goes up”? Or technology can only go higher? Beware of concentrating money in only one area.

The last diversification issue is diversifying your taxes. Not only do you have options on where and how you are taxed, most people forget to think about it as they plan for retirement. Tax deferred and tax free can be the difference in a few hundred dollars a month in income. Although the tax situation is still uncertain right now, it’s not a bad idea to explore Roth IRA‘s and whether you should hold growth stocks in a taxable account or not.

Remember an IRA is great for tax deferral but eventually you will pay income tax on every dollar coming out when you begin receiving distributions.

The Sticker Shock of Medicare Part D – Why you should shop around

The enrollment season for Medicare prescription drug Part D and Medicare Advantage Part C runs from October 15th through December 7th. Reevaluating coverage annually can make the difference of hundreds of dollars in your pocketbook.

The suprise is that you may be facing double-digit premium increases if you stay with your current plan.

So start with your statement, review the annual notice of change that you should have received in September. This will explain any basic benefit changes for 2013.

Dig deeper, if you are currently taking any prescription drugs look for statements that the insurance company has the right to ask the ordering physician about cheaper alternatives, this could delay prescription drug fulfillment. Also pay attention to how much the plan charges for the drugs you need.

The doughnut hole is shrinking. Good news for those caught in the middle of spending $2,970 – $6,733. Enrollees will receive discounts on brand name drugs and a higher discount on generics.

Many plans are moving to a “preferred delivery network”. That means you must agree to receive your drugs through a specific retail or online pharmacy network. Make sure it works for you.

For those of you still working be aware of the high income surcharges on Medicare. This year the surcharges affect individuals with annual income starting at $85,000 (single filers) or $170,000 (joint filers), and move up from there. And there is a two year lag in income reporting so your 2012 surcharges are based on your 2010 tax returns.

The best online tool is the Medicare Plan Finder on the Medicare website. Fill in your medicare number and drugs you are using to find the right plan. Another site for one on one help is medicare counseling, a network of non-profit Medicare counseling services. And if you prefer to talk to someone on the pone there is the Medicare Rights Center offering free counseling by phone at 1-800-333-4114.

The Two Things You Can Depend On? Death and Taxes

First taxes, I discovered a website that is interesting and interactive. Just enter your income to see how your income is affected by the different tax proposals. The nonpartisan Tax Foundation provides an interactive calculator that can estimate your federal tax burden. It also shows you state taxes, so if you are looking to retire or move to a different state you can see what the tax rates are. I just finished a projection for a couple thinking of moving to San Diego, which showed what the effect of a pay raise in California has on the bottom line. We determined the pay raise was enough to make the move, and projected the cash flow needed to live.

Taxes have a large impact on your ability to spend and save. That’s why it is important to review your tax situation with your planner and tax preparer. If you do your own taxes, check in with a professional to make sure you are maximizing your deductions. If you are changing jobs, got a raise, or aren’t sure what percentage you are putting in retirement, a review can help you make better decisions. A recent couple came to me and although they knew what percentage of wages was going into their retirement plans, we discovered it was much less than they thought. By underestimating the percentage, they were missing out on the matching funds from the employer. Plus the additional savings into the plan also lowered their taxable income, thus enabling them to pay themselves more in the future.

Now death, a topic no one likes to discuss but a very important topic for all families. Everyone should have health directives and a simple will. For the more complicated estate planning, including trusts, anyone with children, blended families, or complicated investments should consult an attorney specializing in estate planning.
To be prepared for that meeting make a family tree and look at how you would want you’re hard earned assets to be distributed. Protect those that are important to you and they will be grateful that you took the time to think about them. Create a notebook with the things important to you, how to contact advisers, and how you want to be treated and who is responsible for specific matters. Write letters to family members, those are the most cherished items, not the amount of money you leave.

Challenges of Aging and Healthcare

This August 15 th, a Wednesday, I’m teaming up with Brian Robertson of Willamette Investment Advisors to discuss the “Challenges of Financial Planning and Investing as You Age”. This free event will be held at the Corvallis Public Library from 10 am to 11 am and is sponsored by Regent Court Memory Care.

Healthcare planning is an integral part of financial planning and is getting some well deserved attention. Many people are unprepared for life’s unexpected events. The emotional stress and the ability to make wise decisions can be difficult. And even when you think you’re prepared, there is always the unexpected that throws you off. Many people find the topic hard to talk about and even more difficult to share with your children, no matter their age. However, it never hurts to get the conversation started. The easiest place to start putting the pieces together is with your financial planner.

Not only is it important to be invested accordingly, you also need to have a plan in place as you age. A plan should never be static and it’s vital to have a thorough review every few years. Tasks such as checking beneficiaries on all contracts (retirement plans, annuities and life insurance), ensuring you have durable powers of attorney for health care, and having proper documentation are just a few of the things to look at. Medicare doesn’t cover custodial care and may not cover everything you need.

These are a few of the items we will discuss, as well as how to be prepared.

Considering an EER or Enhanced Early Retirement Package?

EER or Enhanced Early Retirement is a way to offer those with years of service and age, adding to 65 or more, to retire early from their company plan. Qualifying employees will receive two months base pay, plus half-month’s salary for each year they’ve been with HP. This total amount goes into the employee’s retirement plan and is capped at 14 months of salary. The other advantage of the package is being able to stay on the company health plan for two years after early retirement.

The disadvantages are that you are not eligible for federal re-training programs or unemployment benefits. The flip side is that if someone doesn’t take the early retirement package there may be layoffs later; this will make you eligible for unemployment and federal programs for re-training.

When talking to a financial advisor about these decisions the advisor should be asking you about your goals, plans and other factors that may allow an early retirement. Be aware of advisors that are just looking to do a rollover for you. If they aren’t asking important questions and explaining all the disadvantages and advantages of the plan, then you need to find a different financial planner. Also, seek the advice of a few different people before making a final decision.

Employees have until June 22 to decide whether to take the early retirement package

Read more about the catch and a discussion from Rep. Sara Gelser Wednesday June 13.

What is Your Money Script

Lately the idea of money and how you think about money has become an interesting topic. As a financial planner I know the advantage of investing, diversifying and planning for major life events. When I sit down with a new client we do the usual gathering of information, flush out some goals and go to work figuring out what they need to do to achieve those goals.

The part that catches me off guard later in the relationship is the “money scripts” people have. These are defined in the book “The Financial Wisdom of Ebenezer Scrooge” by Ted Klontz, Rick Kahler and Bard Klontz. These are beliefs about money that you may or may not be aware of. What I found is that by asking someone what their first true memories about money are, it begins to unravel a thought process that could be a barrier to having a healthy relationship with money. We are caught up in beliefs that may or may not be true. By identifying these behaviors and thoughts you can begin to make some changes to your belief system. Money itself is not evil or bad. It is a means of exchange and the choices we make spending and saving often will determine our success.

Take some time and think about what your first memory of money is. How does it affect your decisions now? Are you afraid to spend money because of something that happened to you or your family in the past? Do you believe that investing is only for wealthy people? Do you not make good choices with your money? If you go back and identify what those money thoughts are you may discover a pattern.

Put Your Family First

Do you have a trust? Do you have a POD or TOD on your single or joint accounts? What is a POD or TOD? When was the last time you reviewed your will, or do you even have one? Estate planning is an important tool when you want to make sure your wishes are carried out as you intended. If you’ve ever been through the probate process or had friends talk about the nightmares of improper estate planning, you know how important it is.

For example, a will is a great tool to simply state how you want your assets to be distributed. The probate process is efficient but it is public record and can be contested by anyone that has a stake in your property. Contested wills take time and money and can hurt those that you were trying to protect in the first place.
Trusts are a great way to avoid these problems. They must be drafted by an attorney and you definitely want an estate planning attorney to do them. Discuss what you are trying to achieve with your advisor and see if a trust may be the way to go.

If you don’t have a large estate the POD (Payable on Death for banks) or TOD (Transfer on Death for brokerage accounts) allow your assets with those institutions to pass on directly to the beneficiaries you list quickly and without going through probate. Also, any account with beneficiaries such as IRA’s, Roth IRA’s, annuities, Employer Retirement Plans, and life insurance policies automatically pass to your beneficiaries without going through probate by contract. If this is the only thing in your estate then you may not need a trust.

Make a list of the things important to you and revisit the beneficiaries listed on your accounts. Next look at your net worth and financial plan. What do you want to happen when you are no longer able to control your finances? And although you may not see the value, involve your family in the process.

Tax Time

It’s tax time and that means 14 more days until your deadline for 2011 Traditional IRA and Roth IRA’s contributions are due. The official deadline is Tuesday, April 17th, 2012 so make sure and get your contributions in soon. Any contributions made to a Traditional IRA will affect your taxes and must be included on your tax form.

If you are automatically depositing to your IRA make sure your tax accountant knows what you deposit for 2011. Many automatic deposit plans are set up to code the deposit in the year it is deposited. For example if you make deposits from your bank account each month, the January, February, March and April deposits will be coded for 2012 unless you notify the institution that you want them credited to 2011. If you have a full year of deposits this won’t matter, but if you start or end in the middle of the year, make sure to double check the deposits and what year they are coded for.

If you have a Roth IRA, those contributions are after-tax money and will not affect your taxes this year. The biggest plus to a Roth IRA is there are no mandatory withdrawals when you hit the magic age of 70 and one half, and they have tax-free withdrawals after you are 59 and one half. Your tax refund is a great way to fund Roth IRA‘s. To make a contribution there are some income limits and you must have earned income to contribute. Check to make sure you can contribute.

Another way to start a Roth IRA is converting your current IRA‘s to a Roth. There is no income limitation this year and it’s easy to do. If the market is down it is one of the best times to convert as you move assets with a lower value into an account that has tax free gains. Ask if this is appropriate for you.