There was much speculation about what the current presidential administration was going to do about estate tax law changes in late 2008 into 2009.  Some of this has quieted down as the stimulus package, unemployment, the auto industry and AIG, and health care reform now dominate the headlines. However, 2010 is upon us and the debate will soon again heat up, so it’s best to stay on top of the issues.

Here’s what we know: The Economic Recovery Act of 2001 says the amount that each individual could exempt from Federal Estate Taxation increased from $600,000 to $3.5 million through 2009. The tax rate on amounts more than the exemption gradually dropped from 50 percent to 45 percent. In 2010, federal estate taxes end, but they return with a vengeance in 2011 with a $1 million exemption and a 55 percent estate tax rate on the balance more than $1 million.

This was intentional. The 2001 Act passed during a time of budget surplus and before the dot- com crash. The act required the government to revisit estate taxes to avoid the penalties of no estate tax revenues in 2010 and significant estate tax payments from estates in 2011.

President Obama did not speak much about federal estate taxes during the campaign, and he has focused on other issues since his term began. The president’s message is consistent, though: He has advocated that the 2009 exemption remain at $3.5 million – indexed for inflation – with a tax rate of 45 percent on the excess estate. He also favors exemption portability, which would allow a spouse to use the unused portion of their deceased spouse’s exemption. This would eliminate the need for bypass trusts and retitling of assets between spouses. The president also advocates the retention of the stepped-up basis provisions.

Both parties in Congress also have introduced several estate tax bills. While there is disagreement about the exemption amount and the estate tax rates, most bills have favored portability, the reunification of the gift tax with the estate tax, and the retention of the stepped-up basis. With the present state of the economy and the projections on the deficit, it is difficult to predict the final numbers when legislation is adopted.

Hopefully, the final legislation will clearly spell out these provisions. The most important things are clarity and predictability. Estate planners need a clear understanding of the law without the necessity of judicial interpretation. And our clients need predictability – how does one do estate tax planning when the exemptions and rates change so often?

These issues need to be addressed at the state level as well. Maryland’s current exemption is $1 million, with a variable estate tax rate that can reach 16 percent. This lack of consistency and coordination between the federal and state approach is another challenge in planning one’s estate.

I would love to hear your concerns about these issues with your federal and state elected officials. Please contact me at jalist@jalistlaw.com or 410.337.5340, or post a comment to the blog.

In the first quarter of 2009, Harvest Investment Consultants, LLC provided information about the structure of corporate bonds and detailed the compelling investment opportunity that we had identified in that sector.  The corporate bankruptcies and onset of global recessionary conditions in late 2008 and early 2009 lead to a credit market freeze and high-quality companies were unable to issue new debt.  Over the last six months, the capital markets have been gradually improving and we believe the corporate bond market has moved closer to “fair value” levels.  High quality corporate bonds that are relatively short in maturity can still provide attractive income opportunities and lower levels of volatility compared to riskier asset classes due to their priority level on a company’s balance sheet.

Harvest continues to scrutinize different areas of the fixed income universe to uncover solid investment opportunities for clients as not all areas of the fixed income universe have recovered at the same pace as corporate bonds.  The purpose of this letter is to provide a brief outline of the structure of other fixed income opportunities that can be combined with corporate, government and municipal bonds to create a broadly diversified fixed income portfolio.  These instruments include:

• Agency Step Bonds

• Zero Coupon Bonds

• Structured Notes

• Variable Certificates of Deposit

Agency Step Bonds:

These bonds are issued by Agencies that have either direct Federal Government backing or implicit Federal Government support and include Federal Farm Credit Bank, Federal Home Loan Banks, Fannie Mae, Freddie Mac and Ginnie Mae.  Often, these bonds may contain a “call” feature, which allows the issuer to repurchase the bond at a specified date prior to the stated maturity.  In a “step” agency bond, the annual coupon that is paid to the investor can change at specified intervals over the life of the bond.  An example is the following six-year Federal Farm Credit Bank bond (FFCB):

Year 1 Coupon: 3.00%
Year 2 Coupon: 3.00%
Year 3 Coupon: 5.00%
Year 4 Coupon: 5.00%
Year 5 Coupon: 7.00%
Year 6 Coupon: 7.00%

In this structure, the increasing coupon rates will help compensate the investor if general market interest rates rise during the life of the bond.

Zero Coupon Bonds:

Zero Coupon Bonds do not pay interest to the investor at periodic intervals during the term of the bond.  Instead, the bond is issued at a “discounted” price and will mature at a higher price.  Thus, in lieu of receiving periodic cash flow, the investor will gradually see the value of the bond move from the original price to the redemption price at maturity.  Due to specific tax treatment, these bonds are ideal for tax-deferred accounts.  It is important to note that there can be day-to-day volatility as the price appreciates to the final value.  A recent investment for Harvest clients includes the following zero coupon bond issued by Fannie Mae:

Purchase Price: 54.925
Maturity Price: 100.00
Term: 121 months

The effective return of receiving $100.00 at maturity for every $54.925 of purchase price is approximately 6.00% annually for ten years.

Structured Notes:

Structured notes are instruments whose payoff or final value is determined by the performance of some underlying index, benchmark or specific asset.   These notes are typically subject to the credit worthiness of the issuing company and can generally be illiquid and difficult to sell before maturity.  An example of a structured note would be:

S&P 500 Structured Note with 20% “Cap” and Two Year Term
This investment is meant to replicate a portion of the performance of the S&P 500, but it is important to note that the actual investment instrument is a note, not the actual S&P 500.  At the end of the two-year term, the investor in this structured note would receive the original investment back plus the identical percentage return on the S&P 500 up to a total return of 20%.  If the S&P 500 happened to decline over the two year period, the investor would get their original investment back but no additional appreciation.  Put another way, the investor would be giving up any returns on the S&P 500 above 20% in exchange for a maximum loss of 0% if the index happened to fall over the two year period.  As mentioned, these products are often difficult to sell in between the issue date and the maturity date and are intended to be held to maturity.  While Harvest has not yet found structured notes that would be a great fit for clients, we will continue to monitor this market for its ability to provide diversification and risk reduction.

Variable Certificates of Deposit:

A variable certificate of deposit is an investment instrument where the coupon or income paid to the investor may vary based on some other index.  One primary benefit of the certificate of deposit structure is that FDIC insurance is available to protect investors from losses of principal.  Unlike a “Step” Agency bond, the variable payment amounts in a variable certificate of deposit are not known at the time of purchase.  One use of variable certificates of deposit is to provide a “hedge” or diversification benefit or to allow investors to benefit from a change in the interest rate environment.  An example of a variable certificate of deposit would be a five year CD in which the coupon is reset every year based on an interest rate benchmark and a “spread” or amount of additional return above that benchmark.

Variable Certificate of Deposit based on Two Year U.S. Treasury Rates + 2.50%

Year:              Benchmark:        Additional Yield:               Total Return:
1                      1.50%                    2.50%                                    4.00%
2                      2.00%                    2.50%                                    4.50%
3                      1.00%                    2.50%                                    3.50%
4                      1.75%                    2.50%                                    4.25%

In variable certificates of deposit, investors can benefit from rising interest rates, but may also receive lower total returns if the benchmark moves in a disadvantageous way.

It is important to note that Harvest Investment Consultants charges no commissions, mark-ups or additional fees on fixed income products.  Harvest maintains a network of relationships at banks, investment companies and fixed-income trading desks so that it can purchase the fixed income alternatives mentioned in this article directly from the issuer or originator in order to provide the best possible price execution to the client.

Employers are well-advised to review their hiring practices with respect to verifying employment eligibility on Form I-9 as well as conduct an audit of existing Form I-9s. After all, Janet Napolitano, Secretary of the U.S. Department of Homeland Security, has made worksite enforcement a priority. Further, Immigration and Customs Enforcement has conducted high-profile investigations that have resulted in substantial fines based on I-9 violations and criminal charges for employers who knowingly employ undocumented workers.

Employers must ensure that they are using the latest versions of Form I-9, either the most recent version with a revision date of Aug. 7, 2009, or the preceding version with a revision date of Feb. 2, 2009. The new Form I-9s have been required since April 3, 2009. (The revision date can be found in the lower right corner of the I-9 form.) You can find the form on the U.S. Citizenship and Immigration Services (USCIS) Web site under “Immigration Forms.” It is essential that you use either of the latest forms as the law has changed with respect to the documents acceptable for verification of identity and employment eligibility.

USCIS’s new Employer Handbook (M-274) is revised and greatly improved. Again, check the USCIS Web site under “Services & Benefits” for “Employer Information.” The new form is required only for employees hired on or after April 3, 2009, or in any reverification of work authorization for existing employees, i.e., someone whose eligibility expires on or after April 2, 2009.

As you ensure that your I-9 procedures are consistent with the new requirements, you may wish to audit your existing Form I-9s to ensure that none of the I-9s indicate that work authorization has expired and that they were properly completed. Also, consider verifying that the documents presented to establish identity and eligibility were compliant with the previous standards.

We are starting to see some parts of our economy begin to heal from the big bank meltdown that started last fall. And after severe declines in U.S. GDP in the fourth quarter of last year and the first quarter of this year, the second quarter report shows a modest one percent drop in real GDP. However, many areas remain weak – consumer spending, business investment, residential construction and inventory investment all declined, while net exports, due to huge declines in imports, and government spending improved.

Economic Silver Lining: Supply and Demand

Looking forward, one silver lining is the big inventory decline. Inventory corrections like this one usually set the stage for economic recoveries, as production finally lifts to rebuild depleted supplies. I expect we will see modest growth in the economy in the second half of the year. However, I do not expect to see rising employment this year as businesses, small and large, remain cautious.

The July report on employment showed continued, but moderating, job losses, with payroll employment down 247,000 compared to the big 600,000 to 700,000 declines in prior months, and the unemployment rate actually fell slightly. Another July report from the Institute of Supply Management points toward recovery in U.S. manufacturing with new orders, production, vendor deliveries and U.S. exports finally rising, while their employment measure continued to fall. This is typical of a beginning recovery—turnarounds in business activity, while cost control stays in place for some time.

Economic Perspective: Half Full vs. Half Empty

The second-quarter earnings season is more than halfway complete, and so far company earnings reports are generally better than expected. When we view reports from the glass-half- empty side, revenues are weak, with just about everybody cutting back on spending and companies cutting expenses; hence the fall in business investment and employment. The glass-half-full perspective shows company earnings becoming somewhat stronger than expected, though still weak because of all the cost cutting. These new earnings may set the stage for an overall earnings rebound if, as I believe, the economy turns around during the second half of the year.

The consensus of analysts’ 2010 earnings estimates leaves the forward Price/Earnings ratio for the S&P 500 in the 13 to 14 range, despite the significant rise in the price side of the equation since March. This looks to me to be a relatively conservative valuation, not a reflection of an optimistic outlook.

Full Market Recovery: Don’t Count Your Chickens Just Yet

The stock and bond markets have recovered considerably since March reflecting, in my opinion, a better outlook on the economy. However, big items like the redesign of the financial system and regulatory apparatus are underway, and it will be important to get this right. I will be paying careful attention to these reforms and will continue to watch the economic and financial marketplace.

What is a trustee? What do they do? What are their qualifications? Who should we use?

These questions and many similar ones often fill up estate planning appointments. The need for qualified trustees continues to grow for many reasons. Families with disabled members need to provide special needs supports without impacting disability benefits. Family structures have changed, and trustees are necessary to protect second spouses and to protect children from previous marriages. Some trusts are critical for estate tax planning.

Trusts have three parties – the grantor, or the person creating the trust, the trustee, or the manager, and the beneficiaries. Trustees are fiduciaries – they owe a duty to the grantor to carryout his/her wishes. Trustees owe the beneficiaries of a trust a duty of care. What does this mean?

Trustees have to manage the assets that are entrusted to them. If it is commercial real estate, they need to preserve the property, collect the rents and maintain appropriate insurances. If the assets are cash or investments, they need to be prudently invested based on the criteria set forth by the grantor.

Trustees need to protect assets. If a squatter trespasses on trust property, the trustee needs file suit to evict them. If there is a dispute about a property boundary line, the trustee is obligated to research and advocate on behalf of the trust. If the investments are not performing, they need to be changed.

Trustees have to comply with federal and local laws. Trusts, like corporations, are persons in the eyes of the law. Federal and state tax returns need to be filed annually. For some types of special needs trusts, annual reports need to be filed with Medicaid; some minors’ trusts require that annual reports be filed with a court.

Beneficiaries have rights under trusts. This includes access to information and rights to distributions of income (and sometimes principal). Beneficiaries have the right to be treated impartially. Sometimes, beneficiaries have the right to replace trustees under certain circumstances, such as becoming a certain age.

Trustees, in essence, have to be everything – attorney, accountant, stock broker, insurance agent, realtor and diplomat. That is why the selection of a trustee is sometimes so difficult, and why if it is not handled properly, litigation can ensue.

So who should you choose?  There is no requirement that a trustee have all of the skills or backgrounds listed above. Even commercial trust companies delegate some of these functions to outside professionals. The key is that the trustee hires professional advisors in those areas where expertise is needed. If the main asset is stocks and bonds, then a financial advisor is needed if the trustee does not have that background. If tax assistance is necessary, a CPA will fill the need.

Knowledge of and communications about family dynamics is the other key ingredient in selecting a trustee. Trustees should meet with the grantor and the beneficiaries to establish lines of communication and set expectations. These interactions can be stressful, particularly when a parent informs their child that their share of the family estate will be held in a trust. This is preferred, however, to finding out after a death in the family that the financially savvy uncle everyone dislikes and distrusts will be in charge of the trust assets, or the brother-in-law you dislike will be managing a marital trust for your benefit. Avoiding surprise is the key to preventing costly and divisive litigation.

The selection and process for replacing trustees is one of the most important decisions in trust and estate planning. Discuss this issue at length with your team of professionals.

In order to transfer an interest in a privately held business for estate and gift tax planning, a business valuation is required. The first step in this process is to determine the value of the business. The second step is to determine the value of the minority interest in the business by applying discounts for minority interest and lack of marketability.

Determining the Value of the Business

When using a valuation for estate and gift planning purposes, the standard is fair market value.  This is defined as the price at which property would change hands between a hypothetical willing and able buyer and a hypothetical willing and able seller, acting at arm’s length in an open and unrestricted market, when neither is under compulsion to buy or sell and when both have reasonable knowledge of the relevant facts.

There are three approaches that can be used to determine the fair market value of a business. They are the asset-based approach, the income approach and the market approach. The asset-based approach is not used often for operating companies as this approach focuses on the balance sheet of the business and does not reflect the earnings potential of the business. The income approach is the most common approach used for valuing small businesses. In this approach, the company’s future potential income stream is discounted back to present value using a market rate of return. There are two variations of the market approach. In the first variation, the subject company is compared to similar publicly traded companies. The second method involves seeking transactions of companies in similar lines of business and comparing the subject company to the transactions.  A good valuation will utilize as many of these approaches as possible to arrive at a value of the subject company as a whole.

Determining the Value of the Minority Interest

In order to determine the value of the interest in the business, the business valuation analyst will often apply discounts to the overall value.  The two most common discounts are the discount for lack of control (also referred to as the discount for minority interest) and the discount for lack for marketability.

The discount for lack of control is applied because a minority interest has a lower value than a controlling interest because an outsider acquiring a minority interest in a closely held company would have no authority or control over the regular day-to-day operations of the business. To arrive at a discount for lack of control, most business valuation analysts utilize data from control premium studies that are published by Houlihan, Lokey Howard & Zukin’s Mergerstat Review.  Each year a number of publicly traded companies are sold for more than their pre-acquisition market capitalizations. These are control premiums, from which the inverse or minority interest discount may be implied.  In general, these discounts range from 10 to 18 percent.

Determining the Discount for Lack of Marketability

Most often the interest being valued is privately held and, therefore, there is not a ready market for the interest. This is the reason for the application of a discount for lack of marketability. The most common method for estimating the discount for lack of marketability is the analysis of restricted stock transaction and pre-IPO transaction data. This method considers earnings, restrictions on the sale of the security, alternative investments and the time horizon in which an investor might achieve liquidity. Generally, the pre-IPO transaction studies result in a median discount of 30.0 percent and the restricted stock studies have a median discount of 33.0 percent.

Another method, which is commonly used in valuation practice is the Quantitative Marketability Discount Model (QMDM).  The QMDM is a discounted cash flow (present value) model that values illiquid interests of privately held businesses based on their expected shareholder-level cash flows and the risks associated with those cash flows. The QMDM is particularly sensitive to current market rates of return, dividends or distributions during the duration of the investment and the required holding period for the investment.

In general, the discount for lack of marketability is much more subjective than the discount for lack of control and can range from a low of 10 percent to a high of 40 percent depending on the specific issues surrounding the interest being valued.

Combined Discounted Value

Since the results of these discounts can be quite substantial, transferring ownership interests in a company rather than transferring the entire company can save a business owner a great deal in taxes. As can be seen from the example below, a gift of a 10 percent interest in a company worth $1,000,000 would be valued at $63,750 instead of $100,000, or a $36,250 reduction in value.

Value of Company        $1,000,000
Interest Being Valued        10%
Control, Marketable Value        $100,000
Minority Discount    15%    (15,000)
Minority, Marketable Value        $85,000
Discount for Lack of Marketability    25%    (21,250)
Minority, Non-Marketable Value        $63,750

For an entire generation, investors were swept up in an intoxicating environment of unbridled opportunity: the dismantling of the Soviet empire, the resurgence of capitalism in Asia and Eastern Europe, the Internet revolution, a global credit boom, the trade boom, the housing boom and the energy boom. That was our investment context, and while it lasted every market correction was an investment opportunity. As everyone now knows, the cheap and plentiful credit that supported this giddy expansion has imploded. And that changes everything, though not everyone realizes it yet.

Many of us were first jostled from our American reverie when it was brought to our attention this year that equities have lost money for an entire decade! Whatever happened to that fabled “10.4 percent average annual return over the long term”? Whatever happened to “over long periods of time, stocks earn more than bonds”? As advisors, we have been examining the basic big-picture assumptions investors have long accepted about the world in which we live. Some of our discoveries are a bit unsettling.

One example: Our team at Financial Advantage is convinced that the current GDP contraction is not at all like the brief inventory recessions typical of the past 75 years, and so it is not helpful to examine it through the lens of those experiences. This downturn is far more ominous, of an entirely different species, the illegitimate offspring of a seductive credit cycle and a naive generation of consumers and investors. If past inventory recessions were an unwelcomed fox in the henhouse of our prosperity, this long-overdue credit collapse is a starving 10-foot Kodiak bear mauling our portfolios. This is not a market correction, but the dismantling of the post-World War II investment environment we’ve known and loved, to be replaced by…well, nobody really knows what yet, and that’s what is so unsettling.

In A Nutshell

Here’s a thumbnail of the current situation that every investor must have in mind for decision making: For more than a quarter century, Americans and their government binged on consumption and eschewed savings, and the rest of the industrialized world followed our bad example.

Consumer indiscretion provided a heady operating environment for most businesses, replete with record-high profit margins unlikely to be seen again for a long time. The long consumer boom culminated in beautiful bubbles for house prices, stock prices and commodity prices. The bursting of those bubbles is already in the history books along with tulip bulbs and other manias. But the consequences of the credit boom and bust linger on.

What consequences? For one thing, an intensely competitive business environment that will last until we have shrunk our productive base to match our downsized needs. And, oh yes, debt. What will become of all those obligations we took on when the sky was the limit?

There is a Wall Street adage that says every debt will eventually be discharged, either by the borrower or the lender (e.g, through a repayment or a write-off). Lenders and borrowers (and their respective representatives in the nation’s Capitol) are now locked in an epic struggle to determine just how our $52 trillion mountain of interest-bearing obligations is going to be discharged—or at least reduced enough so that our aggregate economy can grow again. How this struggle is decided will largely determine investment risks and opportunities over the next five to ten years.

I Can’t Like It!

My grandson, William, is almost 3 years old. He is generally a cooperative toddler, but if you try to get him to eat something he doesn’t want, he will look right at you, shake his head and say plaintively, “I can’t like it!” Like William, the stock market doesn’t seem to like what it’s being offered every time the government announces hundreds of billions of dollars of new bailout or stimulus money.

The country at large is pretty divided about the appropriate role of government in solving our “banking crisis” and “stimulating the economy.” Some of us are troubled by the prospect of government-dominated banking, insurance, health care and auto industries. Others are so disappointed at the self-serving behavior by some captains of industry that we’re inclined to shift our hopes from Wall Street to Washington.

It may be that the 40 percent drop in stock prices is fully explained by the terrible GDP data, the rising defaults, the earnings disappointments and the discouraging employment figures. Or it may be that owners of private capital are worried about something bigger, something that threatens the economic world as they know it.

Most of our mothers taught us not to talk about politics in public. It’s hard to deny the wisdom of their instruction. After all, you can upset people; better to be friends. But if we take seriously our responsibility to shepherd our clients’ resources and help them achieve their goals, perhaps we have a duty to look a little closer at the big-picture implications of expensive government proposals. Is there a possibility that what began as “a search for the solution to the credit crisis” could morph into a contest of ideas: socialism and collectivism versus individual responsibility and free markets? If that happens, can we do our jobs without examining these ideas?

If the several trillions of dollars of government programs are pulling us toward a government-dominated economy, it will change our world. It will radically alter the investment landscape. It suggests redistribution and class warfare; it implies bureaucratic red tape rather than market-responsive private industry. It implies an attempt to solve a debt problem by adding more debt, namely government debt that is backed by, well, nothing. These are scary concepts unlikely to inspire the sort of risk-taking that spawns innovation and productivity. Though some of us think these are non-issues, the markets’ behavior suggests that many stockholders are worried about them.

When examining the government solutions being offered up, I feel a little bit like William. I can’t like it.

Yes or No?

We don’t think anyone can cobble together a sound investment strategy without first answering this yes-or-no question: Will the aggressive package of government spending and guarantees jump-start our economy and restore its growth to what we’ve become used to?

In our opinion, there is no hiding from this question, especially not for retirees hoping to preserve the buying power of their nest eggs, and certainly not for the pre-retiree or midlife saver struggling to build a financially secure future.

Our appraisal is that these enormous government programs will eventually prove to have been a mistake, an interference with the market process on such a grand scale that it will only succeed in increasing our national debt, raising our tax burden and raising interest rates. Also it will raise the risk premium for equity capital (in other words, it will lower the prevailing P/E). Furthermore, it will reduce risk-taking and innovation, generally impairing this free-market economy that has been for so long the envy of the world.

At our firm, we’re building portfolios with the expectation that the restoration of economic growth is probably still years away. We also assume that stock prices still reflect an unrealistic expectation for early recovery and assume that interest rates on government debt are artificially low and will eventually be driven higher by inflation expectations. We are in a transitional investment period that requires a kind of diversification quite unlike the formula that worked during the long credit expansion.

We believe for a number of reasons that the smorgasbord of expensive government programs is unlikely to re-energize our economy, and thus that the burden of proof rests on the optimists.

Though no two periods are identical, the history of similar government efforts in similar circumstances does not augur well for rapidly expanding government intervention. Consider the succinct appraisal of Franklin Roosevelt’s Treasury secretary in 1939: “We are spending more money than we have ever spent before and it does not work…After eight years of this administration, we have just as much unemployment as when we started (20 percent) and an enormous debt to boot!” Then there was Japan’s dismal failure to orchestrate a recovery during its “lost decade” of the ’90s by artificially depressing interest rates, propping up banks and spending a trillion dollars on stimulus.

The average citizen is hunkering down, cutting his and her spending and increasing his savings. While this is the right and healthy response, in the short run it means contraction and deflation.

The credit contraction has been deflationary, especially in the notorious housing sector, and provides a financial incentive to put off buying that first home. Much of the money government is throwing at the foreclosure problem will only underwrite the refinancing of existing mortgages, doing little to remove the inventory glut.

Any realistic assessment of the potential number of jobs “created” by the spending programs seems far short of the job losses actually being announced in the private sector. Furthermore, many programs will not actually get under way for three or more years.

Besides these problems, there are more shoes that are going to drop. We still don’t know the depths of the bad debt problem for banks. There’s even more bad news in the wings for pension plans, state budgets, insurance companies and those who were counterparty to the untold trillions of dollars in derivatives, not to mention a protectionist spiral of currency devaluations.

The government hopes spending will revive the over-indebted economy, but there are compelling reasons to think it could fail. We must ask: How is more debt going to fix the problem of too much debt? Good question, we think!

Investing for the Transition

It is not our job to make government policy. Our job is just to make sound investment decisions for our clients in the policy environment we are given. As someone recently said, the Keynesians have won, so we have a good idea what the policies will be. What should our portfolios look like as we wait to see how things turn out? Here are a few of the things that can help us earn positive returns during an uncertain interim.

We allocate far less to stocks than we have in the past. Overall, stocks seem priced for an economic recovery within six months, which we think is very unlikely in light of the credit system repair that needs to happen.

High quality bonds is a category where current yields promise equity-like returns but also puts us higher in the capital structure at a safer place than stocks.

We also use “short” positions. While the stock market is overpriced, it makes sense to make investments that will benefit from falling prices.

We use paired trades. For example, we are short the 30-year Treasury (i.e. a bet that its price will fall) while at the same time we own an investment-grade bond fund; this combination will allow us to profit from what we believe is the inevitable closing of the unusually wide spread in interest rates between these two bond categories.

We use currency hedges. In the present debt crisis, the government could abuse its power by devaluing the currencies in which debts are denominated. Gold bullion is one obvious place of refuge for those seeking a non-corruptible store of value.

When markets are very volatile, we have more opportunities to take profits and re-purchase stocks we like at a lower price. We call it, “making volatility your friend.”

Like water seeking its level, capital seeks an acceptable risk-adjusted return. Now that the dangers of too much debt have been unmasked, frightened capital has been pouring out of stocks and into Treasuries at a near-zero yield. As capitalists, we think that return is unacceptable. A portfolio properly diversified for our new realities should do much better.

Financial Advantage is an independent, fee-only advisor in Columbia, Md., providing objective financial planning and investment management to retirees and pre-retirees since 1987.

Suspension of the 2009 Required Minimum Distribution (RMD) requirement

President George W. Bush recently signed H.R 7327, the “Worker, Retiree and Employer Recovery Act of 2008.” One of the provisions of the bill suspends the Required Minimum Distribution (RMD) requirements applicable to qualified retirement accounts, such as IRAs and TSAs, for 2009.

Due to this legislation, IRA and TSA owners who are age 70 ½ or older and inherited IRA owners are not required to take an RMD for 2009. This also includes any clients who first become RMD eligible in 2009. However, please be aware that this provision does not apply to any 2008 RMD that is permitted to be made in 2009 because the individual’s required beginning date is April 1, 2009. These individuals will still need to take their 2008 RMD by April 1, 2009.

If you or your clients have a previously established RMD Periodic Partial Withdrawal disbursement arrangement, the companies will continue to honor these payment requests. Any individuals or clients who wish to suspend their RMD PPW arrangement for 2009 will need to contact their respective financial advisor.

Effective 7/1/08, Maryland’s Health Care statutes were revised to recognize Domestic Partnerships.  These revisions legislate the rights of domestic partners to visit their partner in a health care facility and elevates domestic partners to the rights of a spouse to act as one’ health care agent. 

This change not only impacts same-sex couples, but unmarried opposite-sex couples who qualify as domestic partners.  Legally, a domestic partnership is a relationship between two people who are not related to each other, are not married or in a civil union or in a domestic partnership with someone else, and who agree to be in a relationship of mutual interdependence in which each contributes to the maintenance and support of the other, although they are not required to contribute equally.

 Effective January 1, 2009, each individual can gift up to $13,000 tax free to any other individual, an increase from the previous $12,000 Gift Tax Exclusion.

This increase means that more wealth (including LLC interests and closely held stock) can be transferred for estate tax planning purposes. For example, a married couple with two married children will be able to give away up to $104,000 in 2009 with no gift tax implications. (2 x 4 x $13,000).

 To discuss other ways of moving funds to your family or friends in order to reduce the effects of estate taxes, Contact a Maryland Estate Planning Lawyer.