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Asset Dedication Fiscal Cliff

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Asset Dedication Fiscal Cliff

  1. The Fiscal Cliff Implications for Your Clients Presented By: Stephen Huxley, PhD Brent Burns
  2. © Copyright Asset Dedication 2012 For Advisor Use Only Not intended for use with individual clients
  3. © Copyright Asset Dedication 2012 Client Talking Points 1. Uncertainty 2. Taxes will rise 3. Spending cuts will negatively impact the economy 4. Interest rates will likely stay low 5. Financial planning matters
  4. Higher Taxes Spending Cuts
  5. C+ I +G +(X – M) = GDP Consumption Investment Government Spending Net Exports
  6. C+ I +G +(X – M) = GDP Consumption Government Spending
  7. Income Tax Capital Gains Tax Tax on Dividends Estate Tax © Copyright Asset Dedication 2012
  8. © Copyright Asset Dedication 2012 Income Tax Increases Note: All figures subject to change, depending on negotiations Tax Brackets (2012 Dollar Amounts) Marginal Rate Unmarried Filers Married Joint Filers But Not But Not Over Over 2012 2013 Over Over $0 $8,700 $0 $17,400 10% 15% 8,700 35,350 17,400 70,700 15% 15% 35,350 85,650 70,700 142,700 25% 28% 85,650 178,650 142,700 217,450 28% 31% 178,650 388,350 217,450 388,350 33% 36% 388,350 ... 388,350 ... 35% 39.60%
  9. © Copyright Asset Dedication 2012 Other Tax increases • Many changes - Capital Gains, Payroll, AMT, dividend, estate, 20/20 cap on 401(k), etc. • More details: – http://www.bankrate.com/finance/taxes/fiscal-cliff-expiring-tax-laws.aspx – http://www.cpa2biz.com/Content/media/PRODUCER_CONTENT/Newslet ters/Articles_2012/CPA/Aug/2013taxincreases.jsp – http://www.journalofaccountancy.com/Issues/2012/Nov/20126172.htm – http://www.forbes.com/sites/kellyphillipserb/2012/11/10/tax-increases- looming-in-2013-who-pays-how-much-and-will-they-stick/ – http://www.ebri.org/pdf/briefspdf/EBRI_IB_11- 2011_No364_RetTaxRfm2.pdf
  10. © Copyright Asset Dedication 2012 Government Spending
  11. © Copyright Asset Dedication 2012 Baseline Plan Cut $ 110 billion per year over 10 years ½ Defense ½ other Cuts for 2013: 1. $55 billion from Defense (about 8% of its budget) 2. $55 billion from non-defense (varies)
  12. © Copyright Asset Dedication 2012 Projected 2012 Federal Budget Revenues: $2,443 billion* Expenses: $3,540 billion Deficit: -$1,097 billion *All figures approximate. Source: Congressional Budget Office http://www.cbo.gov/sites/default/files/cbofiles/attachments/08-22-2012- Update_to_Outlook.pdf
  13. © Copyright Asset Dedication 2012 Federal Budget Federal Revenues $ Billion As % Federal Revenues $ Billions Income Tax, Income Tax $1,130 46% $1,130 $1,200 Payroll (Soc. Sec./Medicare) Tax $844 35% Payroll Tax, $1,000 Corporate Tax $240 10% $844 Other $229 9% $800 Total $2,443 100% $600 Other Corporate Revenues, $400 Tax, $240 $229 Federal Spending $ Billion As % $200 Soc. Sec. $760 21% $0 Medicare/Medicaid $725 20% Defense $652 18% Income Security (Unempl. Comp. Soc. Sec., Federal Spending $ Billions $760 Food Stamps, etc.) $359 10% Medicare+, $800 $725 Net Interest on Debt $258 7% $700 Defense, $652 Federal Pensions $212 6% Income Other, $574 $600 Security, $359 Other $574 16% Net Interest $500 Total $3,540 100% on Debt, $258 $400 Federal $300 Pensions, Deficit for FY 2011 -$1,097 $212 $200 $100 Accumulated Deficits - National $0 Federal Debt: $16,400
  14. © Copyright Asset Dedication 2012 Incentive to Keep Rates Low Current debt service = 7% of the budget Source: Treasury Direct - Average Interest Rates on Marketable Securities as of 11/31/2012 and Daily Debt Held by Public as of 12/5/2012
  15. © Copyright Asset Dedication 2012 Incentive to Keep Rates Low 1% Interest rate rise Debt service = 10% of the budget Source: Treasury Direct - Average Interest Rates on Marketable Securities as of 11/31/2012 and Daily Debt Held by Public as of 12/5/2012
  16. © Copyright Asset Dedication 2012 Details – Spending Cuts • More details: – http://bipartisanpolicy.org/projects/budget-control- act?project=39&keys=Budget+Control+Act+series – http://bipartisanpolicy.org/blog/2012/01/three- reasons-why-12-trillion-isn%E2%80%99t-really-12- trillion – http://en.wikipedia.org/wiki/United_States_fiscal_cliff
  17. © Copyright Asset Dedication 2012 10 Year US Treasury Bond Yields, 1800-2012 1.93% 1.72% Source: Asset Dedication, U.S. Treasury, and Global Financial Data. Data through 12/16/2012
  18. © Copyright Asset Dedication 2012 Total Return Long Government Bonds, 1980-2012 14.00% 12.00% 10.00% 8.00% 6.00% 4.00% 2.00% 0.00% 1950 1960 1970 1980 1990 2000 2010 Source: Morningstar Long-Term US Government Bond Index 2006-2012, Ibbotson And Associates Long-Term US Government Bond Index 1927-2005
  19. © Copyright Asset Dedication 2012 The Yield Curve • The decline in interest rates affects all maturities, though not to the same degree • Short term maturities usually have lower rates than longer maturities • Changes over time - the “living yield curve:” http://www.smartmoney.com/investing/bonds/the-living- yield-curve-7923/
  20. © Copyright Asset Dedication 2012 Treasury Yield Curve 2012, 2011 Source: www.treasury.gov 12/16/2012
  21. © Copyright Asset Dedication 2012 Treasury Yield Curve 2012, 2008 Source: www.treasury.gov 12/16/2012
  22. © Copyright Asset Dedication 2012 Treasury Yield Curve 2012, 2003 Source: www.treasury.gov 12/16/2012
  23. © Copyright Asset Dedication 2012 Japan 10-Year Govt. Bond Yield 1994-2012 5.00% 4.00% 3.00% 2.00% 1.00% 0.00% Source: Reuters as of 12/19/2012
  24. "We expect to keep the short-term interest rate at exceptionally low levels to at least mid-2015... so long as price stability is preserved, we will take care not to raise rates prematurely.“ -Federal Reserve Chairman Ben Bernanke 10/3/2012
  25. © Copyright Asset Dedication 2012 Advantages of Individual Bonds 1. Predictable 2. Known worst case 3. Safe – Treasuries, agencies, CD’s – Corporate and muni bonds have predictable probabilities
  26. © Copyright Asset Dedication 2012 Default Rates, 1970-2011
  27. Other Income Producing Investments © Copyright Asset Dedication 2012
  28. Dividend payments from companies in the S&P 500 dropped by… 23.9% January 2008 to January 2009 Source: Standard and Poors; S&P 500 Market Attributes Snapshot; January 2009
  29. According to Cohen and Steer’s, publicly traded REITs cut their dividends by 26% in 2009 Source: Cohen and Steer’s; A Case for REITs as a Hedge Against Inflation; June,2011
  30. The risk to principal from currency fluctuations can reduce or eliminate any yield advantage for international bonds € 1,000 ≈ $1,205 € 1,000 ≈ $1,316 € 1,000 ≈ $1,470 -22% Source: Yahoo Finance 12/19/2012
  31. Junk Bond Defaults Tend to Spike When the Economy Struggles
  32. © Copyright Asset Dedication 2012 Waiting for Rates to Rise
  33. © Copyright Asset Dedication 2012 Waiting in Cash for Rates to Rise Consider the cost of buying an 8-year income stream starting at $100,000 plus 3% inflation. • Sum of all cash flows = $889,234 • Can buy income stream now or wait two years to see if it will be cheaper due to rising rates – Current cost of 2013-2020 stream: $841,219 – Current cost of 2015-2022 stream: $807,539 – Future cost of 2015-2022 stream: $841,219 (assuming no change in yield curve)
  34. © Copyright Asset Dedication 2012 Why Buying Now is Cheaper
  35. © Copyright Asset Dedication 2012 Probability of Rise in Rates Rates will have to rise fast enough and far enough to make the future cost of the 2015-2022 stream less than its current cost ($807,539) • The probability of this happening is below 10% based on the history of rate changes (1927-2012) • Given Bernanke’s statements, the probability is probably closer to 0%.
  36. © Copyright Asset Dedication 2012 How Fast Interest Rates Change
  37. © Copyright Asset Dedication 2012 Cost of Waiting Evidence In our white paper of November, 2010, white paper “Cost of Waiting for Interest Rates to Rise,” cost of a 2013-2020 portfolio would have been $770,896. 1. Our recommendation then: Don’t wait! 2. Estimated cost if rates did not rise - $820,088 3. Cost now is $841,219 – $41,000 higher! 4. Our recommendation now: Don’t wait!
  38. © Copyright Asset Dedication 2012 Questions? Email info@assetdedication.com for more information on Asset Dedication white papers
  39. © Copyright Asset Dedication 2012 Disclosures About Asset Dedication Asset Dedication LLC is an SEC-registered investment advisor located in Mill Valley, California. Asset Dedication LLC and its investment adviser representatives are in compliance with the current registration and/or notice filing requirements imposed upon SEC-registered advisors by those states in which we maintain clients. Asset Dedication LLC may only transact business in those states in which it is notice filed, or qualifies for an exemption or exclusion from notification requirements. Past Performance Past performance is not indicative of future results. Therefore, no current or prospective client should assume that future performance of any specific investment or investment strategy (including the investments and/or investment strategies recommended or undertaken by Asset Dedication LLC) made reference to directly or indirectly by Asset Dedication LLC in its website, or indirectly via a link to an unaffiliated third party website, will be profitable or equal the corresponding indicated performance level(s). Risk Different types of investments and/or investment strategies involve varying levels of risk, and there can be no assurance that any specific investment or investment strategy will be either suitable or profitable for a client's or prospective client's portfolio and may result in a loss of principal.

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