January 8, 2013
The Bottom Line
The Investment View from Prescott, Arizona
There was an article recently in InvestmentNews about a loophole that allows certain types of mutual funds to hide fees from their investors and in doing so, show lower expense ratios to these investors.
I have long contended that investors who choose investments by comparing fund expenses are taking their eye off of the ball and often make an expensive mistake.
Sadly, hiding fees in the investment business has become an art form. But it shouldn’t really matter what a fee is called, or even if it ever gets disclosed, because all costs filter down and are reflected in the bottom line return of the fund.
If two funds invest similarly and one has higher expenses, the total return it delivers to its investors should be lower due to the higher expenses. This holds true regardless of how creative management gets in putting lipstick on their expense pig.
The one figure that can’t be fudged is the bottom line return to investors, the sum of dividends paid plus or minus changes in share value. We call that “Total Return” in the investment business.
Selecting investments on any other criteria than the total return they deliver allows the manipulators in the industry to have their way with you, so don’t get distracted by talk about expenses, just buy the investment with the best total return and keep your life simple.
A Slice of Life
By the time you read this I will be back in my office in Prescott, but one of my great pleasures in life is the flexibility that technology has given me to work from just about anywhere.
As I write this issue of the newsletter, I am looking out at palm trees and bougainvillea bushes, listening to the sounds of waves lapping on the Gulf Coast of Sanibel Island in Florida as I spend the weekend with my brother.
Another rough winter day in paradise.
The Death of Munis Is Greatly Exaggerated
Benzinga is an innovative financial media outlet serving both Wall Street Traders and individual investors, and currently averages 1.5 million page hits per month. Last week they began to syndicate some of my articles starting with the following piece about municipal bonds:
A high level of tax exempt interest from municipal bonds attracted the eye of investors this past year. Unfortunately it also attracted the eye of revenue hungry politicians in Washington, DC.
Municipal bond prices were driven down sharply in December by talk about the possibility of Congress beginning to tax the interest on municipal bonds as part of the “Fiscal Cliff” negotiations. Until this point, interest on most municipal bonds has been exempt from federal income tax, and in some cases from state income taxes, too.
This political wrangling creates a great buying opportunity for munis if you think a new tax on them won’t really happen.
The talk of taxing municipal bonds implies that they are the beneficiaries of some loophole in the tax laws which ought to be closed. I think that is wrong. Muni bonds are exempt from taxation due to a constitutional provision, not due to a tax law or loophole.
States rights vs. federal powers was one of the fiercest points of discussion as our Constitution was being hammered out back in the 1780’s. The compromise that was reached back then was that the federal government shall not be allowed to interfere with the business of the states and the states shall not interfere with the business of the feds. Taxation and regulation are the two tools that governments use, so accordingly, the states and the federal government are prohibited from taxing each other.
Any attempt by the federal government to pass a law calling for taxation of the interest paid on municipal bonds would immediately have to face a constitutional challenge, and on the remote chance it were to survive scrutiny by the Supreme Court, it would then open the door for state and local governments to assess property taxes on federal properties such as military bases, post offices and National Forests, none of which pay taxes now. The issue is very much a two edged sword.
If Congress is foolish enough to thumb their nose at the Constitution so that they can raise taxes this way, they will just end up losing even more money to local taxation. In my opinion, it is not likely to happen.
So, don’t get too concerned about the talk of taxing muni bonds. This is just the rhetoric of the class warfare the DC politicians like so much. But as a practical matter it won’t go anywhere.
If anything, this makes municipal bonds a good buy right now. When the rest of the world realizes that muni tax status isn’t going to change, the pace of buying tax exempt municipals should increase driving their price up.
Scottsdale or Prescott Office Date
Please call (928) 778-4000 for an appointment to meet with Will, whether in the Scottsdale or in the Prescott office.
How’s the Market Doing?
The stock market, represented by the S&P 500 Index, finished the year being down .15% from election day through December 31st. This has been and continues to be a nervous market.
Talk of a resolution of the “fiscal cliff” that Washington had been fretting about had the stock market take off like a rocket the first few minutes it opened on January 2nd, but since then it has pretty much just gone sideways. I take that as a knee jerk reaction, but not one of substance that changed the basic character of the markets.
I think when reality sets in and investors realize that nothing has really been solved economically, the headwind that has faced the market these past few months will resume. History suggests that 2013 will be difficult for the stock markets, and adding a significant tax burden onto an already weak economy won’t help.
After all the hubbub about the successful Fiscal Cliff negotiations last week dies down, we will see that income taxes will still rise for each of us. Payroll tax hikes and such will make the burden even greater. This is money that is sucked out of the economy by the government, and not available for you and me to spend in productive ways.
I heard that for every $1 in spending reductions included in the deal congress struck last week there were $42 in tax increases. Many of us can agree that it will take a combination of tax increases and spending cuts to restore Washington DC to fiscal sanity, but 1:42 is not a ratio that makes any sense. That is way out of balance.
What’s Going On In Your Portfolio?
With the dividend activity at year end, our Flexible Income* model ended up the year with a gain on par with 6 month CDs. Our goal with this strategy is to exceed the returns of CDs without taking a lot of risk, and despite a lousy period early last year, we were able to deliver that.
The good news is that we are off to a strong start this year. Although interest rates have been creeping up, a condition that normally causes losses for bond investors, the investments we hold, including municipals, floating rate bond funds, and high dividend real estate holdings have done well in this environment and as of this writing on January 6th, Flexible Income* accounts are already showing a profit for the year.
Our growth portfolio* is hedged at the moment to reduce risk in this high risk environment for stock investing, but we still have a profit of over 1% in the first few days of the year. Our growth portfolio* also posted a small gain between election day and year-end vs. a small loss for the stock market, so we are outperforming the stock market as a whole.
Our combination of homebuilder and dividend oriented real estate stocks, along with growth funds and an interesting Israeli pharmaceutical stock have been balanced nicely with a small dose of inverse funds designed to reduce risk if market turmoil returns.
Re-use a wet-wipes container to store plastic bags.
Two College Classes Coming Up
Mark your Calendars
Fundamentals of Investing for Retirees
This course, popular at YC since 1990, is designed to help investors become more confident about their financial decisions. In an easy to grasp format, this class provides a broad knowledge of investments preferred by investors approaching or already in retirement. Learn the ins and outs of stocks, bonds, mutual funds, annuities and more. Topics include recognizing risk, controlling the tax impact of IRA withdrawals, avoiding common investment mistakes and simple risk reducing strategies that anyone can use.
Thursdays, 1-3 p.m., January 31 – February 14, 2013. Tuition is $65, payable to Yavapai College.
Advanced Investment Analysis Using Charts
If a picture is worth 1,000 words, a chart is worth 1,000 numbers. Most of us find it easier to relate to pictures than pages full of numbers. By using charts you can feel better about your investment decisions and perhaps become a better investor as well. Topics will include use of moving averages, trend-line analysis, relative strength analysis, ulcer indexes, breadth and volume indicators and more. We will also explore several web based charting services available to the public.
Thursdays, 1-4 p.m. February 28 – March 7, 2013. Tuition is $65, payable to Yavapai College.
Call Yavapai College at 717-7755 to register for class.
And tell your friends. For many years we have had groups attend class together to make it a social as well as a learning experience.
Our Spotlight Strategy
With our Flexible Income Strategy we strive to provide high total return consistent with Capital Preservation. Your money will be invested in bond or currency funds, including precious metals that may be used as currencies and equity-income investments whose price trend is up. If the price cycles down, holdings are replaced with new investments that are going up. Growth stocks are not used. [Flexible Income]
If you would like a current copy of our SEC Form ADV, Part 2, it is on our website at hepburncapital.com/form-adv.html
* The model accounts mentioned in this article are hypothetical examples of how the strategy may work as designed. Activity in client accounts may be different from that in the model in amount of each investment, specific timing of trades, and actual security used, which may vary from account to account. Not all trades are profitable. It should not be assumed that current or future holdings will be profitable. A list of all trades in these accounts for the past 12 months will be provided upon written request.
** The S&P 500 and Nasdaq Indexes are unmanaged lists of stocks considered representative of the broad stock market. Investors cannot invest directly in the S&P 500 Index.
This newsletter may contain forward-looking statements, including, but not limited to, statements as to future events that involve various risks and uncertainties. Forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause actual events or results to differ materially from those that were forecasted. Information in this newsletter may be derived from sources deemed to be reliable; however we cannot guarantee its accuracy. Please discuss any legal or tax matters with your advisors in those areas. Neither the information presented nor any opinions expressed herein constitute a solicitation for the purchase or sale of any security.