Do You Have Too Much in International Stocks?

The financial press has jumped on the bandwagon yelling, "Sell, sell, sell!" for international stocks, especially in Europe. So our clients ask:

• How much should I have invested internationally?
• How about Europe?
• How does Berno Financial Management decide how much to invest internationally?
• What do other large advisors do?

At Berno Financial Management, we use a multi-asset class strategy for broad diversification. A truly global stock portfolio would be invested about 45% in U.S. stocks and about 55% in international stocks, including about 23% in Europe. Few U.S. investors have that much in international stocks, primarily due to currency and political risk. Our current model portfolio asset allocation includes 30% of the stock portfolio being invested in international stocks. This is our subjective target based on a balancing act to achieve optimum returns within a reasonable risk level. Our core international stock funds have slightly less than 45% of their assets invested in Europe, so a typical client's European investments are about 10% to 15% of their total stock investments (and even less of their total portfolio when including bonds and cash).

What do the big boys do? We cite two examples.

First is TIAA-CREF, which is a large private pension plan available primarily to employees of non-profit groups like universities and hospitals. Being academically minded, they have the best of resources available to them. The CREF Fund (College Retirement Equities Fund), which has about $100 billion in assets and is one of the largest private pension funds in the country, is invested 70% in U.S. stocks and 30% in international stocks. For the record, and this is the truth, we discovered this after we had set our model allocation. We are not copycats!

Second is The Vanguard Group, one of the largest providers of mutual funds for retirement plans. Their Target Date Retirement Funds and Lifestrategy Funds are very popular in 401(k)s and IRAs and have about $118 billion in assets. Their stock allocation likewise is 70% U.S. stocks and 30% international. They actually just increased the international allocation to 30% within the past few years, so we were ahead of them!

So rest easy and sleep well. Broad diversification is your friend. Remember a few years ago when investors were questioning Real Estate Investment Trusts (REITs)? They have turned out to be among the best asset classes after many investors bailed out.

If over $200 billion in assets at two of the largest retirement plan providers in the country have 30% of stocks in international investments, we think you can rest assured that this is a reasonable strategy for you as well!


About Bruce J. Berno, CFP^®
Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

Invest In Stocks and Get A Pay Raise!

How would you like a 15% pay raise? Where? Bonds? No. Stocks? Yes!

The dollar amount of dividend payments underlying the Standard & Poor's 500 stock index is projected to increase 15% this year, according to estimates by Howard Silverblatt, senior index analyst at S&P, and reported by Smart Money.

The news could be even better. If technology companies such as Google, Amazon.com, eBay and Dell initiate dividend payments, following Apple's recent announcement to start a dividend, then your pay raise could be even higher. In 2011, there were 22 companies that announced new dividend payments. Nonetheless, only 397 companies in the S&P 500 now pay dividends, versus an average since 1980 of 413 companies. As further reason for optimism, dividend payments as a percentage of company profits are now about 30% versus a historical average of 52%.

Banks could be another source of positive surprises. Many banks cut their dividends in the global financial crises but have started to restore cash payments to shareholders. Financial companies comprised 29% of the dividends paid in 2007, fell to a low of 9% in 2010 and are up to 13% now. There is more room for dividend growth from banks.

Not only do stocks that increase their dividends give you a pay raise, they also provide better long-term total return according to a study by Columbia University professor Doron Nissim that was published in the Journal of Finance in 2001.

The recent stock dividend yield on the S&P 500 is just over 2%, which is very competitive with interest rates on bonds, but dividends can grow whereas bond interest payments are usually fixed.

Investing in stocks for income is only suitable for long-term investors and investors must be willing to tolerate the price volatility that comes with stocks. Money that may be needed within five years or so should be kept in bonds and cash equivalents.

So consider looking at stock investments in a different way and enjoy pay raises dividend income increases along the way!

About Bruce J. Berno, CFP^®
Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

Investing in Tax-Exempt Municipal Bonds: Is It Right for You?

Income tax season is a good time to ask the question, "Should I be investing in tax-exempt municipal bond funds? And if I am, is it the right thing to do?"

Your decision-making process should address the following points:

1. Consider your total portfolio stock/bond/cash allocation first. Your asset allocation will have the biggest impact on your investment return over time.
   
2. Are your bond investments in a tax-deferred retirement account like a 401(k) or IRA or a taxable account like a single or joint account? Tax-exempt municipal bond funds should only be used in a taxable account.
   
3. What is your "marginal income tax bracket" for federal and state income taxes? This is different than the "effective" income tax rate displayed by income tax software programs or simple calculations of your income tax divided by your income. The "marginal" income tax rate is the tax rate that would be applied to an additional dollar of income. It is outlined in the income tax tables available on paper income tax returns or the IRS or state income tax websites. For example, the federal marginal income tax rate increases from 15% to 25% at a taxable income (after deductions and exemptions) of $70,700 in 2012 for married couples filing jointly and $35,350 for single taxpayers.
   
4. What is the "Taxable Equivalent Yield," or TEY, of the tax-exempt municipal bond fund? This represents the interest rate you would have to earn in a comparable taxable investment. If the TEY is higher, go for tax exempts. Before doing this calculation, be sure you are comparing funds of comparable maturity range and credit quality. A short-term, high-quality fund will have a lower interest rate than a longer term, low-quality fund. Make sure you are comparing apples to apples. Also, be sure you are using a fund’s "SEC Yield" when comparing funds, so that the yield is calculated in an identical manner. Believe it or not, there is more than one way to calculate a "yield." If only life could be simpler!
   
5. The formula for the Taxable Equivalent Yield is the tax-exempt yield divided by (1 minus marginal income tax rate). For example, John and Susie Smith have a taxable income of $50,000 and therefore are in the 15% federal marginal income tax bracket. They are comparing two intermediate-term, high-quality bond funds. One is invested in tax-exempt bonds with an SEC yield of 1.87% and the other is invested in taxable bonds with an SEC yield of 2.83%. The TEY of the tax-exempt fund is 1.87% divided by (1-0.15) which equals 2.2%. Since this is less than the taxable yield of 2.83%, John and Susie are better off in the taxable bond fund.
6. Before investing or making any changes, consider whether you think your income will go up or down in the current year or future years. Also, if you are switching from an existing fund, beware if your current fund has a capital gain. Many funds have capital gains since interest rates have been declining for several years.

In closing, your decision about investing in tax-exempt municipal bonds should be reviewed annually. The current low interest rate environment and low tax bracket environment makes taxable bonds more appealing, but interest rates and income tax rates are always subject to change. This is a simple process to follow to be sure your money is invested most productively.

About Bruce J. Berno, CFP^®
Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

Seven Things Every Self-Employed IT Professional Should Know About Money

1. Cash flow is king. You've probably heard the expression "cash is king." But cash flow is even more important because it reflects having cash available to pay expenses, including your compensation and benefits. Service businesses run by IT consultants need to make payroll and meet expenses just like any other business. So pay attention not only to the amount of cash on hand, but the expected timing of income and expenses. Establish a business line of credit plan through your bank, if necessary, and manage it prudently.
2. Keep business and personal finances separate. You need to create a "firewall" between your business and personal finances―don't intermingle money! Set up a separate business checking account and a separate business credit card. Don't worry about sacrificing frequent flyer miles or bonus points on your personal credit cards; you can get comparable benefits from a separate business credit card either or a personal card that you use exclusively for business. Having separate accounts will simply your affairs whether you hire a professional accountant or do your own accounting using QuickBooks, Freshbooks or a comparable software program.
3. Insurance is the foundation of sound business practices and a personal financial plan for any IT consultant.No one likes insurance companies, but insurance is a necessary evil. Start with property and casualty insurance to cover your business property, including hardware and software, as well as liability insurance. This is particularly important if you have a home office, so make sure your homeowners coverage includes your business.
   
   You should also insure your greatest asset, your ability to earn an income, with disability income insurance. The risk of an illness or disability keeping you from your job is real. Disability insurance isn't just for the physical laborer; a disability can keep you from your keyboard too. Explore a health savings account (HSA) as a way to accumulate cash on a tax-favored basis for current or future health insurance expenses, especially future health expenses since you are the source of "employer retiree health insurance."
4. Don't cash out retirement plans when you leave your old employer to start your new consulting practice. If you were an IBMer, you have great investment choices so consider leaving your money in the IBM plan. The tax penalties from cashing in a retirement plan are punitive and, more importantly, you will lose the tax-deferred compounding benefits of your current balance. Explore every possible source of cash to start your business. Remember to ask yourself, "Do I want to be an IT consultant forever, or do I want to retire someday?"
5. Manage your income taxes properly. Make timely payments either through withholding as you pay yourself or by making quarterly estimated tax payments to the IRS. Set aside reserves during the year, if necessary. Don't think you can "catch up" later. Understand the difference between "pre-tax" and "after-tax" income and remember that you can only spend "after-tax" income. IT consultants can be an IRS agent's dream.
6. Start a retirement plan. An individual 401(k) is ideal for IT consultants and is available at most mutual fund firms. A traditional or Roth IRA may be viable depending on how much you can and want to save. An individual 401(k), either traditional or Roth, allows for more savings than an IRA. Start early, even if you have to start small. If you wait until age 35 you would have to contribute 9% of your income to have the same amount at retirement as a 25-year-old who started out contributing 6%. Starting at 3% of income is better than zero. The amount you contribute has a much bigger impact on your long-term success than your investment returns. Also, minimize fees and expenses to maximize your long-term returns.
7. Have a strategic plan for your IT consultant business.Create a strategic plan that allows you to identify your ideal client; the way you charge for your services; the profitability that provides your compensation and benefits plan; the way your will market yourself so you continue to have clients in the future; and a succession plan or transition plan to your retirement. One of the great benefits of IT self-employment is the ability to have a flexible work schedule and a smooth transition into retirement. You may even choose consulting as a way to supplement your retirement income without having to quit a traditional corporate job cold turkey. Enjoy! 

About Bruce J. Berno, CFP^®
Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

Estate Planning Tips for Second Marriages

Many of you probably took some time last week to celebrate love and your closest relationships. Celebrating the past and present should also lead to planning for the future. Who do you want to care for you if you aren't able to care for yourself? How do you want those most dear to you to be provided for in the future? These decisions are made through a process called estate planning, and it involves more than simply having a will. 

Estate planning is not just about what happens when you die. What if you are paralyzed in an accident, have a stroke or develop dementia? Who will make healthcare decisions for you and who will pay your bills and manage your finances? To complicate matters, many people are in second marriages that include children from previous marriages, so let's make that more complicated scenario the focus of this article. 

First, you need to plan for what will happen both during your lifetime and after you are gone. During your lifetime, you need a financial power of attorney, healthcare power of attorney and a living will. A financial power of attorney, as the name implies, authorizes someone else to make financial decisions for you and execute financial transactions if you are not able to do so yourself. There can be broad or limited powers. You should designate one person and at least one alternate. A healthcare power of attorney and living will designate someone to make healthcare decisions for you and allow you to state your intentions if you are terminally ill. Again, designate one person and at least one alternate. For second marriage situations, picking the right people can add a layer of complexity. These documents are governed by state law and prototypes are typically available via an Internet search. 

Three elements warrant your attention in planning for distribution of your assets after your death: Asset ownership titles, beneficiary designations, and last will and testament or revocable living trusts. In poker language, the first two trump the third: account ownership titles and beneficiary designation precede or supersede a will or trust. If your bank accounts and mutual fund or brokerage accounts are joint with right of survivorship, the assets will automatically pass outright to the surviving joint owner. Your life insurance policies and IRAs will be distributed according to your beneficiary designation regardless of what your last will and testament says.  

A revocable living trust agreement is practically an essential document to control the "who and when" of asset distribution for a couple in a second marriage with children from previous marriages. A trust can hold assets for a surviving spouse's remaining lifetime and then distribute them to children from previous marriages in the proportions you determine. A trust for "him" and a trust for "her" can ensure that "his" assets go to "his" kids and "her" assets go to "her" kids. Asset accounts and real estate can be owned by "his" trust or "her" trust during one's lifetime and life insurance and retirement plans can be payable to the trust at death to provide for survivors. Selection of the trustee is critical; it can be an individual or a corporate trustee (like a bank or private trust company). An experienced attorney specializing in estate planning matters is highly recommended for the estate plans of a second marriage couple. 

Life is never as simple as we wish it could be, but planning ahead will provide peace of mind for you and reduce the risk of family squabbles in the years ahead.

About Bruce J. Berno, CFP^®
Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

Six Early New Year's Resolutions

In the spirit of the holiday season, here is a list of early New Year's resolutions and fun things to do in 2012!

1. Remember, cash flow (income versus expenses) is the key to long-term financial success. If you are gainfully employed, you should be saving 15% to 25% of your income. If you are retired or not fully employed and are drawing on your investment portfolio, your total annual withdrawals should be 3% to 5% of your portfolio value or less. If your savings rate is low or withdrawal rate high, take steps to increase your employment income or reduce your expenses.
2. Insurance is the foundation of sound financial planning. Home and auto insurance, umbrella liability coverage, health insurance, life insurance, disability and long-term-care insurance all require regular review and updating. Consider funding a Health Savings Account (HSA). If you own or are considering long-term-care insurance, pay particular attention to and understand the inflation protection options.
3. In 2011, we've seen renewed volatility in stock market prices. Investors are still bruised from the 2008 global financial crises and pessimism is pervasive. Remember that the stock market is a leading indicator and will turn up before business, consumer and investor attitudes improve. Bond interest rates remain low and pose a challenge for achieving reasonable long-term returns. Broad diversification will be well rewarded and realistic expectations for long-term returns (mid to high single digits) are a must.
4. Are there any family or personal changes that might prompt a review of your beneficiary designations on life insurance policies (both employer provided and individually owned), IRA accounts and employer retirement plans? Were there any changes in employer plans wherein correct beneficiary designations should be confirmed? How about a power of attorney, will or trust documents? Are there changes of address or telephone numbers for people listed in your healthcare power of attorney document?
5. Do your children or grandchildren have employment income that could be used for a Roth or traditional IRA contribution? If applicable, have you funded 529 college savings plans for the calendar year for your children or grandchildren?
6. Do your family members know where to locate important personal financial papers and how to contact your professional advisors in case of an emergency?

Have a safe and happy holiday season. Take good care of yourself. Best wishes for a healthy and prosperous New Year in 2012!

About Bruce J. Berno, CFP^®

Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.

What Is Your Life Expectancy?

Mortality tables will tell you the average life expectancy is in the low 80s. But for many of us, there is a reasonable probability of living to age 90 or 95. An informal scientific analysis may be informative.

One website that may be helpful is www.livingto100.com. It asks 40 quick multiple choice questions and should take about 10 minutes to complete. (Hint: it will be helpful to have your latest blood pressure and cholesterol test results.)

The website provides personalized feedback on all of your answers and a "to-do" list for you and your physician. For example, it may suggest that if you lose "x" pounds or exercise "x" times more a week, you could add "x" number of years to your life expectancy. We do not endorse this website for medical or financial planning advice, but consider it an interesting tool and kind of fun.

"What Is Your Life Expectancy?" could be the question that will make you the life of the party at your family Christmas gathering!

Let us know if you try it and what you learn! 

About Bruce J. Berno, CFP^®

Bruce J. Berno, CFP^® is the founder of Berno Financial Management, Inc. a fee-only comprehensive personal financial planning and investment advisory firm headquartered in Cincinnati, Ohio. Since 1993, Berno Financial Management has been helping individuals and families achieve financial peace of mind. For more information about Berno Financial Management, visit http://www.bernofinmgt.com/.