Investing in a Messy World

As I read the early news reports about how the former Pakistani Prime Minister Benazir Bhutto was killed in an apparent suicide attack in the military garrison town of Rawalpindi, I was sickened. The news and subsequent images were shocking and disturbing, but the event was also a good reminder that not only do we live in a dangerous world, but as investors, we are constantly reminded that this messy world should be factored into our outlook.

As soon as the story hit the wires, stocks began to sell off. Clearly this was not as dramatic as the terrorist attacks of 9-11, or the subsequent terrorist bombings in Spain or London (all of which markets recovered from in fairly quick order). But the Bhutto murder clearly created an impact, especially in light of a light-volume, holiday-shortened week. Before the news hit the wires, stocks were pointing higher, but when the details of the story emerged, stock futures turned lower and continued to decline throughout the trading day.

I happened to be a guest on Fox Business News yesterday and one guest noted that Pakistan is not a particularly large US trading partner and has absolutely nothing to do with oil production. True enough, but it is a nuclear power and when video of riots there hit our airwaves, most people worried, “Who is in control over there?” The Pakistani turmoil reminds us of our dangerous world, which calls into question the safety of all of our investment assumptions and causes general anxiety. Clearly uncertainty is the enemy of investors. As more details emerged, investors sought safe havens like US Treasury-bonds and physical assets, like gold, both of which gained ground.

Perhaps when a senseless event occurs that throws the world and markets into a chaotic state, it is the best reminder that investors can only control so much. We do not know when the housing slump will end; when a corporate scandal might erupt; or when a geopolitical crisis will cripple some part of the world where the US has a significant interest. For that reason, it is imperative that investors maintain a disciplined approach to risk and create diversified portfolios that help weather the gyrations associated with investing in a messy world.

The Christmas of Small Pleasures

By now you know that this holiday season was not among the best for the nation’s retailers. Although the final results are not yet in, an early projection from MasterCard Advisors, a unit of the credit card company, found that overall spending from Nov. 23 to Dec. 24, when adjusted for inflation, was essentially unchanged over last year -- a weak performance. In many ways, the holiday season is a good metaphor for 2007: the year of reduced expectations and small pleasures.

I keep thinking that despite 2007 being the Chinese Year of the Pig, the year will be remembered more for small indulgences than big ones. In terms of financial stories, the subprime issue grabbed pig-like headlines, but for investors, the housing recession and credit woes got everyone refocused on single-digit investment returns, which frankly, were greatly appreciated, especially considering the alternatives!

On the holiday front, it is obvious that there was no big, “must-have” item either for kids or adults. But somehow, we found delight in some tried and true items: new video games; Apple i-products; and perhaps the strangest category, women’s shoes. While I doubt that most people gave a pair of Jimmy Choo’s or Manolo Blahnik’s to their gal-pals, perhaps a quick, guilty indulgence made its way into our bargain-hunting holiday season.

In entertainment, there was no big movie that blew away expectations, but a few small ones were notable. I loved my friend Adrienne Shelly’s “Waitress” (she wrote and directed the movie before she was murdered in New York City in November, 2006) and if you want a real holiday treat this season, skip the tiresome formulaic pics like “National Treasure” and go directly to “Juno” a quirky film written by first-time writer Diablo Cody and directed Jason Reitman. Meanwhile, on the small screen, the simple pleasure of NBC’s “Friday Night Lights” and “30 Rock” can’t be beat.

But here is the absolute coolest thing about the year and Christmas of Small Pleasures: it hopefully made us all realize just how lucky we are to have so much. As thousands of servicemen and women are stationed overseas in harm’s way, I can’t help but think about the great fortune that we as American citizens enjoy. Next year is likely to be a big year, filled with election-year politics and plenty of vitriol. Try not to forget what a blessing it is to live in a society where we each are given the opportunity to express ourselves -- now that’s a great big gift that we receive each and every year, but rarely take time to appreciate.

A Few of My Favorite Christmas Things…

No money talk on Christmas Eve day---it just seems a bit too crass! It took me a long time to really get into Christmas. I grew up in a Jewish (although not religious) family and although my mother absolutely adores Christmas trees and knows more words to carols than most gentile folks, we pretty much did the “Jewish thing” around Christmas. We did not go near the maddening crowds in the stores and on the day itself, we headed to the movies, followed by a feast at the local Chinese restaurant.

But when I moved to Rhode Island, my friend Joyce introduced me to her family’s Christmas tradition. I fell in love with it—from decorating the tree, to the countless meals involved. They are Italians from Brooklyn, NY so the major thrust of the holiday centered around fish Christmas Eve and the hand-made ravioli on Christmas Day. When I began to split my time between New York and New England, I found a New York-based Italian family to not only take me, but allow me to become part of their rituals.

In a nod to the season, it’s time to recount some of my favorite Christmas things. The list continues to grow, but here is where I am so far:
1) Selecting, schlepping and decorating the tree: Each year, I now purchase a new ornament that has some special meaning for me. Now if I could only untangle the lights!
2) Shopping: The true meaning of Christmas has nothing to do with presents, but I can’t help but throw my self into the gift-buying rat race. I love how beautiful the stores look and I am often amused by the frenzy that surrounds the season.
3) The tree in Rockefeller Center: I walk by the tree as often as possible to look at its beauty and towering glory. If you get a chance, check out the new GE (what else?) lights.
4) Christmas Day and Marie’s lasagna: By the time we have finished the appetizers, I am usually stuffed, but not too much to indulge in the most magnificent lasagna I have ever tasted. The turkey/ham that follows is a sideshow to the main attraction.
5) “A Charlie Brown Christmas”: The best Christmas TV program or movie, which happened to premier on my exact birthday. I love Linus’ soliloquy about the true meaning of Christmas.
6) Christmas Music: Mary Ann in my office asked someone whether it was OK to play holiday music on our system at work, “because I know that Jill is Jewish”. The response was, “Jill LOVES it!” My favorite is probably Bing Crosby’s original recording of “White Christmas.”

Take it from this nice Jewish girl, you do not have to be religious to enjoy this special season. I hope that it finds you and your families gathered together and celebrating the gifts that have been bestowed on you. MERRY CHRISTMAS!!!

The Mute Button

Take it from one who has often inserted one of her size nine feet in her mouth: when it comes to office etiquette, these times demand the utmost of vigilance. Even your unintended, harmless misstep can end up in places that you never dreamed possible. As the year draws to a close and the news is light, today is a reminder of a few handy tips to help you beef up your office etiquette and decision-making abilities.

1) Read and re-read your e-mail body and address line before you hit the send button: I learned this lesson early in the e-mail era. A man who had no intention of working with the firm peppered me with about a million questions and one day, I was so fed up, I forwarded his message to someone in my office, calling the serial questioner a “leach”. Check that…I thought that I had forwarded the message, when in fact I erroneously hit the reply button. As you might imagine, the leach moniker did not go over very well.

2) Beware of the Mute button: Years ago, my investment banking sister was on a conference call when her boss pushed the mute button and said to the roomful of people, “These guys (on the other side of the deal and the phone line) are such idiots. After we close, I hope that I never have to talk to them again.” Imagine his surprise when from the other end of the line, he heard: “believe me, the feeling is mutual!” Mute buttons are tricky – my advice is to never say anything negative while on a call, mute button or not.

3) When you run a public company, try not to curse at analysts and definitely lose the sarcasm: You might think that this is silly advice, but on Wednesday, Sallie Mae’s chief executive Albert L. Lord conducted what could only be called a disastrous call. Clearly the company has gone through some pretty serious troubles, but Lord preferred to avoid the questions and said that he would answer them at a meeting in January.

Folks were not too happy with the evasion, so in a bit of (failed) sarcasm, Lord said: "I can assure you, you will be going through a metal detector." Get it? He was joking about a disgruntled investor storming the shareholder meeting with a gun. Not funny. Well, at least Lord ended the conference call with a bang. He said "Let's go. There's no questions. Let's get the [expletive] out of here." That line ended up on countless blogs almost immediately and is now part of the permanent history of Mr. Lord’s tenure at the firm.

4) Take “The Mirror Test”: The fine team at the Illinois-based Ethical Leadership Group has developed what they call “The Mirror Test” for every professional. Before you do/say/send anything, ask yourself the following three questions, which should help you avoid hot water:

1) Is it Legal?
2) Is it Right?
3) What will Others Think?

This simple process can truly recalibrate your decision-making process and hopefully will help you think through your actions and words before you insert your foot in your mouth!

Bonus Bust

It seems like just a year ago that Wall Street executives were patting themselves on the back for another stellar year. The total 2006 bonuses for the C-Suite could feed many third world nations and yet a scant year later, the landscape has shifted. Yesterday, the bosses of two major firms announced that bonuses would total the big goose egg.

Bear Stearns, the firm that will likely be remembered as the “tip of the 2007 subprime iceberg” said that its Chief Executive Officer James Cayne and other senior executives would forgo bonuses for this year. This is probably a pretty good idea, especially when the firm is expected to announce its first quarterly loss ever. Across town, the folks at Morgan Stanley announced some news of its own, some bad, and some less-bad.

Morgan Stanley's first-ever quarterly loss was highlighted by a $9.4 billion write-down related to mortgages. But it also said that it was shoring up its capital with a $5 billion investment from China's sovereign wealth fund. Like Jimmy Cayne, Morgan Stanley CEO John Mack will take a pass on a year-end bonus this year. But don’t feel too bad for him—he’ll probably figure out a way to stretch last year’s $40 million bonus to help his personal cash flow withstand the sagging the value of his stock, down over 25% year-to-date heading into the day yesterday.

CEO bonuses notwithstanding, total compensation at Morgan Stanley, including salaries, benefits and bonuses, climbed 18% to $16.55 billion in 2007 from $13.99 billion last year. Year-end bonuses, estimated at about 60% of the total comp, will jump to $9.93 billion from $8.39 billion. In a weird way, it makes sense. After all, the guys in the profitable units---equities, investment banking and wealth management---saved the firm from even worse performance.

When all is said and done, folks in this industry get paid a whole lot of money in both the good years and the bad ones. Yes, it’s obscene, because they are not saving lives, teaching the youth of America or finding a cure for cancer. But still, I for one appreciate when the guys at the top acknowledge that they bear responsibility for the decisions that led to the bad year and accordingly, should not be sucking money out of the company. Now if they can get those risk management departments in line, we may see the other side of this nastiness.

Holiday Cheer Part 3

Today is the final of our three-part year-end financial countdown—we started with using taxable accounts to harvest tax losses; then went to maximizing retirement plans to save taxes and get on track with retirement goals and objectives. Today it’s time to find the real spirit of the holidays and discuss charitable giving.

According to a report published by the Giving USA Foundation, a nonprofit group that supports research and education in philanthropy, U.S. donors gave $295 billion directly to charitable causes last year, up 4.2% from 2005. It’s not just the super-wealthy who dig into their pockets--about 65% of households with incomes of less than $100,000 gave to charity last year, with the average American giving 2% of income and the wealthiest as much as 8% to 10%, the report found.
Most people do not give unless they truly want to give. That being said, Uncle Sam provides some encouragement to those who do make charitable donations. If you are gifting to a non-profit, consider donating appreciated securities in lieu of cash. By giving away stock -- instead of selling it and donating the cash -- you can claim deductions against your federal income taxes for the current market value of shares, and avoid paying capital-gains tax on the appreciation. Most large non-profits can accept stock directly. For a smaller charity that isn't equipped to take stock, contributions can be made through a donor-advised fund or foundation. But don’t wait until New Year's Eve to make stock contributions if you want to include them in your 2007 tax returns --- stock transfers can take weeks.
In addition to gifting stock, an interesting opportunity lies in your IRA account. Consider taking advantage of a law scheduled to expire at the end of this month that could benefit many taxpayers who are over 70½. If you qualify, you can transfer as much as $100,000 this year directly from your individual retirement account to a qualified charity without having to pay income taxes on that money. Also, the transfer counts toward your minimum required distribution for the year. Just make sure the gift is made directly from the IRA to charity. Taxpayers should take advantage of this break this year because it could vanish.

There is one other gifting idea that is set to expire at the end of 2007: the Kiddie Tax Rule. The Kiddie Tax is an obscure tax designed to keep the wealthy from transferring money to their children, who would in turn pay taxes at the child’s, not the parent’s, rate. Those of you with custodial accounts might find that recent changes to the rules result in an increase in taxes in 2008. The good news: there is a window of opportunity between now and the end of the year where you might be able to save on capital gains taxation, if you sell certain assets in 2007.

Here is how it works: For a child subject to the Kiddie Tax, any unearned income (interest, dividends and capital gains) received in 2007 is first exempted from taxation, then taxed at the child’s rate, and finally taxed at the parent’s rate, as indicated in the table below.

Taxation of Child’s Unearned Income 2007
Up to $850* Exempt from taxation
$851 to $1700 Taxed at the child’s rate
Over $1700 Taxed at the parent’s rate
*All figures indexed annually for inflation

Currently the Kiddie Tax impacts children who are under 18. Beginning in 2008, however, dependent children who are 18 will also be subject to the tax as well as dependent full-time students between the ages of 19 and 23. While the rules primarily affect UTMA and UGMA (Custodial) accounts, they can also apply to a child’s individual account once the UTMA/UGMA has been distributed, and to 2503(b) trusts, assuming the child is still claimed as a dependent on your tax returns.

For those who have UTMA accounts, or dependent children with individual accounts, and whose children/students are between the ages of 18 and 22 this year, there is a one time opportunity to sell appreciated assets in order to take advantage of the child’s 2007 5% capital gains rate (up to a child’s taxable income of $31,850). This particularly applies to assets which are earmarked for college and which should be sold in the next few years to pay for tuition costs. The capital gains rate will increase to 15% in 2008 on unearned income above the Kiddie Tax limit. Interest and dividends count too, although most custodial and individual accounts are not large enough to generate sufficient earnings to be taxed at the parent’s rate.

Finally, it’s worth noting that the annual gift tax exclusion permits individuals to give up to $12,000 to an unlimited number of individuals during the calendar year ($24,000 if you are married and gift-splitting is elected), so if you plan to make gift, get going now!

Can’t Lose on a house

For years, I have met with folks who are hyper-focused on purchasing a house as the major financial goal in their lives. They say things like, “renting is like throwing money out of the window”, “real estate is better than the stock market as an investment” and my favorite, “I know that I can’t lose on a house.” To all of these comments, I have been known to say a not-very mature response: “OH YEAH?”

I have always been a bit more agnostic about owning vs. renting. For some, renting is a perfect solution to providing shelter. In fact, my guess is that if many of the people who purchased over the past two years had just stayed put in their affordable rentals, the real estate market might not be in the pickle it is in. That being said, I know that it’s easy to get lured into becoming a buyer by that nagging voice, which goes something like this: “my principal, interest and homeowners insurance would be the same as my rent, so why not buy the house and start building equity?”

Because gentle reader, your payments will not stop with your principal, interest and homeowners insurance. Even if you put down 20% and finance your mortgage with a fixed rate, there are so many more costs associated with home ownership, that the comparison may not be quite as good as you think. In fact, if you invest what would have been your down payment, the whole “throwing money out of the window” argument goes…well, out the window.

As far as the “I can’t lose on a house” thesis, well it’s just not true. Currently, house prices are down by 0.5% to 10%, depending on the measure used and are expected to fall further before we are done with the process. Of course if you hold a house over the long term, it should beat the inflation rate, but so too should the stock market. Like the stock market, real estate can in fact go through corrective periods, but thankfully, most people are not tempted and/or forced to sell at these low points. Since World War II, housing prices have lagged the performance of the stock market, but it just does not seem that way, because few people adjust the value of their homes for inflation—instead they say: I bought this house in 1965 for $40,000 and today it’s worth $400,000!”

I know that the notion of home ownership is engrained in our society—so much so that Uncle Sam helps you out with a mortgage interest deduction. But to quote economist Robert Shiller: “maybe we’ve gone too far in that only so many people can comfortably own homes, and it became an excuse for extravagant lending…Most people think home prices can’t fall for very long. The fact they haven’t since the Great Depression in a massive way is proof to many people … that they can’t fall. And I think the people are lacking the historical perspective that big events might come 70 years apart. And there’s remarkably little interest in historical episodes.”