Russell Bailyn -

The science of financial planning is relatively new. While pinpointing the career’s starting point is difficult, I’d put it somewhere in the neighborhood of 1969 with Loren Dunton and the Institute of Consumer Financial Education. Dunton had a vision of educating the public on financial planning techniques. His initiatives led to the creation of the College for Financial Planning. The College distributes the Certified Financial Planner designation to students who complete a series of modules. The Certified Financial Planner designation is now a standard of excellence in the industry. Dunton focused the late part of his career on educating financial professionals on how to teach financial planning.

This is a difficult profession to standardize as many of the factors which affect financial planning are variable and involve risks associated with the open market system. The classic example is investing- an aspect of financial planning which has as many theories as it has products. The tax aspect is variable as well since the IRS alters the tax code all the time. Nonetheless, Dunton went on to standardize the process into five segments: Insurance, Investments, Taxes, Retirement, and Estate Planning. With a background in these five areas, an advisor should have the ability to not just place a client into an investment product, but help advise them on the various aspects of the planning process as well.

The affect of raising the bar for industry professionals is allowing the clients to benefit from that improved education. Since simply brokering products (earnings commissions) is quickly becoming an obsolete method, planners now have to rely on fee-based asset management to earn a living. The theory here is that while the advisor is receiving a perpetual fee for managing a client’s assets, they will be more involved in the client's broader financial picture. The topic of advisor compensation has been quite popular recently in financial planning publications. I am an advocate of the fee-based business model as I believe it is beneficial to most clients.

Another affect of improved investor education is a shift of focus away from high-commission items and into low-cost investment products. The discount brokerage rage of the 90s got this pattern started and now people are finding it increasingly easy to manage their money without paying exorbitant fees.

Looking forward, I think the industry is reaching what I like to call phase three. Phase one was the advent of mutual funds and insurance products. Phase two, which we are still in, is the switch from commission-based products to fee-based products with the integration of improved financial services. Phase three will be the inclusion of more complex issues, such as economic factors and personal objectives, into the equation. I stumbled into an article in the June edition of the Journal of Financial Planning which elaborates on this concept in an interesting way. The article, written by William Jahnke, is titled Advancing the Science of Investing in Financial Planning. Jahnke discusses the affect of technology on how we spend and invest our money. He says

“the demands on the financial planner to manage risk in the context of the client’s comprehensive balance sheet and dynamically directed investment management solutions will become the standard of practice in the profession.”

He’s right, and goes on to explain that computer software will be an essential part of this evolution. I’ve used a variety of financial planning software, but I always return to the same few worksheets which I’m used to. They allow me to use the technology for crunching numbers but still utilize my personal style- which the clients are paying money for- to communicate my points. However, if well trained, I’d be open to learning new software which can improve the accuracy of the financial planning process beyond what a clever mind can think up. This is the beneficial end to technology.

Exactly how computer software can include economic factors is still a mystery to me. The idea of adding completely variable factors such as an interest-rate environment or political turmoil to a planning illustration seems a little bit difficult. It may improve the accuracy of the illustration, but presumably by adding in more complicated assumptions. I think it’s worth a try because the current system of using an assumed rate of return isn’t exactly fair to the client. At the same time it’s still the most accurate way an advisor can try to explain a product. An example of this would be an advisor using an 11% average rate of return to show what the future performance of the Dow Jones or a related fund might be. The chart will always look pretty when your assumptions are long-term historical. Maybe software will produce more than one illustration using different sets of assumptions. This could be useful in showing how an asset performs in different environments rather than just the optimal one. Insurance product illustrations already do this by showing a positive market return, negative market return, and a low fixed-rate of return. Naturally, this multiple set of assumptions works well with insurance product because it exemplifies the usefulness of guarantees. This might not work as well with mutual funds or other product where a risk-free rate of return may be available.

Anyway, the Jahnke article goes on to discuss certain factors such as trying to value human capital at different ages- basically quantifying extremely valuable assets which are difficult to include in assumptions. This is similar to the argument people make about the assumptions inherent in GDP data and how they ignore the changes in globalization and industrial structure. An example of this is treating money spent on education as consumer spending rather than investment spending. In my eyes, buying a college education is an investment in one’s future just as buying a printer is an investment in one’s business.

What we can take away from all this is that the science of financial planning isn’t perfect, but it is moving in the right direction. We’ve evolved in a way that allows the financial planning process to truly benefit clients and add value to the goal-planning process. But, in an increasingly changing world, we must be sure our assumptions are accurate and at least consider the almost impossible. Otherwise, all our work will be for nothing. Perhaps the future of financial planning is for the advisor to be a CFA, CPA, lawyer and economist. That would certainly allow for more information to be integrated into every decision. C'mon now, we’re only human, and we’re all going to win the lottery anyway, right?

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors
14 E. 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

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WisdomTree Investments plan to launch 20 exchange-traded funds. This is the largest daily release of ETFs to enter the market (June, 2006). The common characteristic of the WisdomTree family is dividends. Each of the 20 funds pays a dividend and the yields are fairly high compared with other equity-based ETFs. The fund family is also geared internationally with 14 non-US funds dominating the six US funds. Of the international funds, three track Europe, three track Japan, two track the broader Pacific and six are broad-based international funds.

This new line follows the trend away from market-cap indexes and into fundamentally-weighted indexes. Jeremy Siegel, the Senior Investment Strategy Advisor to Wisdom Tree commented on the conference call about flaws in the market-cap structure. A market-capitalized index (based on the number of shares outstanding multiplied by the current stock price) assumes an efficient market where the stock price is fairly valued. We’ve recently seen fundamentally-weighted indexes outperforming market-cap indexes. This is because they give small-cap stocks a fair chance in the index rather than a miniscule weighting in the face of giant stocks such as Microsoft. We’ve all seen the small-cap indexes outperforming the large-cap indexes for the past five years, giving reason for investors to consider this new route.

Siegel also pointed out that reinvested dividends have, historically, been the primary driver of total return in US equity markets.

WisdomTree is not the first to base ETFs on fundamentally-weighted indexes. RAFI is one of the more popularly licensed indexes which strays from market-cap weightings and has outperformed the S&P 500 over the last 1, 3, and 5-year periods. PowerShares, which uses a structured-equity approach, has licensed the RAFI for a fund which they added to their already popular ETF line.

In terms of expenses Wisdom Tree plans on staying competitive with others fund families ranging from 28 to 58 basis points. As expected, the international funds will be more expensive than the domestic funds, but that is a natural consequence of offering exotic ETFs.

This new line of funds includes the first ever International Small-Cap Dividend Fund.

WisdomTree also has a “DIEFA” fund which follows the MSCI EAFE index. The advantage to DIEFA is that it currently boasts over a 4.5% dividend, substantially higher than the MSCI EAFE index.

I really like the WisdomTree ETF family for two reasons. The first, as pointed out by Jeremy Siegel and others, the market-cap approach is not necessarily the best approach to investing. It unfairly weights giant companies which don’t fundamentally deserve such a large weighting within the indexes. The second reason has to do with current demographics. As baby-boomers start retiring, portfolio managers will be allocating portfolios towards dividend and other income-oriented products such as those found in the WisdomTree ETF line. Combined with a tax-code which currently favors dividend investing, WisdomTree should remain fairly competitive in the ETF arena.

Russell Bailyn
Premier Financial Advisors
14 E. 60th Street, #402
New York, NY 10022
(212)752-4343 *31
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: NASD/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

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“Roth” is a provision which allows earnings from qualified plans to be withdrawn free of income tax. What you sacrifice with any Roth plan is the ability to take a tax deduction in the year the contributions were made. Take the following example: you’re a teacher who earns $100,000 per year. With the traditional 403b plan offered at your school, you decide to do a total salary deferral of $15,000 for 2006. As a result, your only taxed on $85,000 worth of income. The $15,000 grows on a tax-deferred basis until you reach age 59 ½. If you invested that $15,000 in an aggressive fund which grew to $25,000, there is no capital gains tax owed on that investment when sold. When you eventually retire in 2018, you decide to take a withdrawal from your 403b account. In 2018, you’d pay tax on your withdrawals at your income tax bracket for that year. Whether marginal tax brackets are higher or lower in 2018 than they were in 2006 is anybody's guess. Most financial planning scenarios assume a lower tax bracket during retirement because, well, you're retired!

If you had contributed $15,000 into a Roth 403b in 2006 instead, your tax would be based on $100,000 rather than $85,000. However, you wouldn’t owe any tax on your withdrawals. You pass up the current year tax deduction for the benefit of withdrawing the money later on in life free of income tax.

So which one is better? Personally, I don’t love Roth plans because I don’t trust Congress or the IRS to leave the tax code alone long enough for me to appreciate the benefits. I’d be worried about passing up a current tax deduction for the opportunity to have one thirty years from now. Just think about where taxes where 30 years ago, in 1977. The highest marginal tax bracket was 70%. Would a Roth have been better back then? The argument would have been exactly the same. Do we take a tax benefit today to reduce the amount of our earnings taxed at 70%, or do we wait until we're 59.5 and see how things look then. Nobody knows. I like to keep the equation simple and take a tax deduction when and if one is available.

The theoretical answer to “which one is better” is that it depends on your personal preferences. If one person invested in a pre-tax 403b, and the other in a Roth 403b, they would both end up with the exact same amount of money in the end, assuming they stayed in the same tax bracket. In life, people generally earn more money as they increase in age and then earn less (enter a lower tax bracket) when they retire. This isn’t the case for everybody, but for the overwhelming majority. If you fall into this scenario, a traditional 403b may offer better tax protection for you.

Another factor is the performance of the market. If you knew the market was going to average a 20% annual return for 10 years, you’d want to be in a Roth because paying income tax on all that growth is going to sting. If the market was going to average a 2% annual return, it might be better to take the tax deduction and avoid the Roth since you aren’t really going to have such a huge tax problem anyway.

Roth fans generally do point out one factor which gives them an edge. Regular IRA accounts require you to take distributions starting at age 70 ½. With a Roth 403b, you can roll your money into a Roth IRA and keep the money growing tax-free until death. If you are wealthy enough to not need the distributions and are looking for a tax shelter, a Roth product might add some value to your portfolio.

Most importantly, Roth 403b accounts are still not an option at most organizations that offer traditional 403b’s. The reason is that it costs money to make an option like this available and companies don’t want to offer it until they are sure the tax code will continue to support it. The provisions which allow Roth 403b plans to exist were technically supposed to expire in 2010. The Pension Protection Act extended them indefinitely. I think we'll continue to see a pattern of tax-friendly government while the problems regarding Social Security and pensions seem to get worse, not better.

I hope this article is helpful and not confusing. Understanding 403b’s is challenging even for financial professionals because of how new and constantly changing the rules about them are. Please feel free to e-mail me with your individual situation or for other advice.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a reigstered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

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In my first few years as a financial planner, taxes were not my best topic. I preferred to help clients choose investments and make recommendations about retirement plans. I learned quickly that having at least a basic understanding of taxes is crucial to any aspect of the financial planning process. The goal of this article is to share the basic tax concepts which I think each person should know for general street smarts. I’m going to focus most of the article on what the steps are to filling out a 1040, the basic individual tax return. Through this explanation you’ll begin making sense of terms like adjusted gross income, standard deduction, tax credits, etc.

Form 1040 is the basic tax return for individuals and may be used by any taxpayer. It’s a two-page form which includes several supporting “schedules.” The number of schedules one needs to fill out depends on how the taxpayer receives income and which deductions or credits the taxpayer may be eligible for. For example, Schedule A is for your itemized deductions. If you itemize your deductions rather than taking the standard deduction (something we’ll discuss this further down) you need to elaborate on those deductions on Schedule A. Here is a list of the other five schedules:

Schedule B – Interest and Ordinary Dividends (income from investments)
Schedule C – Profit or Loss from a Business (self-explanatory)
Schedule D – Capital Gains and Losses (from investments made throughout the year)
Schedule E – Supplemental Income and Loss
Schedule SE – Self-Employment Tax

Some people pay in estimated taxes throughout the year so they don’t get stuck with a giant bill at the end of the year. This is done either automatically through a payroll service or through quarterly payments if you are self-employed. Others overpay on purpose so they get a definite refund at the end of the year. The form you get from new employers that determines how much tax you will have wittheld from your paycheck is Form W-4. Print one out from irs.gov and read the information on top. You'll see this form each time you take a new job. I’m now going to discuss the steps taken to calculate your income tax.

1 – Figure out your “Gross (Total) Income” for the year.

Your gross income includes every source of income you have coming your way during the year except for those items specifically excluded. Examples of income are salary, commissions, interest from investments, business income, rents, partnership income, tips, royalties, etc. Some examples of those items specifically excluded from income are proceeds from a life insurance contract received by reason of death, inheritances, and interest from tax-exempt organizations such as municipal bonds.

2 – Subtract Deductions to get your “Adjusted Gross Income.”

These deductions will reduce your gross income to the figure we call “adjusted gross income.” This is a very important figure in the business world. It’s the last line on the first page of form 1040. Common examples of deductions are contributions to qualified retirement plans (IRA’s), higher education expenses, interest paid from student loans, moving expenses, health insurance deductions, teacher’s out-of-pocket education expenses (up to $250), one-half of the self-employment tax, etc. The rules for deductions are a bit elaborate, so it’s best to check with irs.gov if you have questions about a possible deduction. Tax credits, which are even more valuable, will be discussed later on. The important thing to realize here is that each deduction will be subtracted from your gross income to help compute this “adjusted” number. If you are taxed at a 28% rate and deposit $4,000 into a traditional IRA, you are saving roughly $1,100 on your taxes as a result ($4,000 * 28%). As you can see, paying attention to your allowable deductions can be worth a lot of money to you.

3 – Determine your Itemized Deductions

Once you figure out what your adjusted gross income is, you can subtract from that number either your standard deduction ($5,150 in 2006) or your itemized deductions, whichever number comes out higher. It’s important to think through this calculation before just using the standard deduction, because you might have very high itemized deductions. Homeowners, for example, because they can deduct mortgage interest, will generally itemize their deductions. Here is the short list of what you can itemize:
• Medical expenses that exceed 7.5% of adjusted gross income
• State and local income taxes
• Real estate and personal property taxes
• Mortgage interest on both primary and secondary residences
• Investment Interest Expenses
• Charitable Contributions

There are also “Tier II” itemized deductions which are deductible only to the extent that the cumulative total exceeds 2% of adjusted gross income. These deductions include:
• Expenses related to preparing your taxes or investment advice
• Unreimbursed business expenses (transportation, home office, etc.)

If you decide to itemize, you add all these numbers up on Schedule A to arrive at your total figure for itemized deductions. You then deduct this number from your adjusted gross income to reach the next part of form 1040. If you use the standard deduction, you don’t have to fill out schedule A and just drop in $5,150 (if your single, $10,300 if you’re married) into the appropriate box.

4 – Determine your Personal Exemptions

This is a friendly item on the 1040. You will further reduce your tax base by your personal exemption. You can claim an exemption for yourself, your spouse, or your children. The personal exemption amount in 2006 is $3,300, and indexed annually for inflation. There are rules you can read on irs.gov which explain what a “qualifying child” or “qualifying relative” means for you to claim that exemption. There are income phaseout levels for the personal exemptions. If you are married and earning above $225,750, you will begin having trouble taking child exemptions.

5 - Arrive at a Figure for your Taxable Income

You subtract your exemptions to get your “taxable income.” This number started as your gross income and deductions were then taken to arrive at your “adjusted gross income.” Your standard or itemized deductions were then subtracted, followed by your personal exemptions. You base your tax on this final figure.

Once you figure out how much tax you owe, take a look at how much you’ve already paid in. You’ll either be entitled to a tax refund, or have to pay in additional money.

Determining what tax you owe is based on tables (or nowadays tax software). We have a progressive tax system in the United States which means you’re going to pay increasingly higher tax bills as your income passes certain thresholds. You pay 10% tax up to your first $7,550 worth of come. You then pay a 15% rate from $7,550 to $30,650. That rates jumps to 25% for earnings from $30,650 to $74,200. 28% from $74,200 to $154,800, and 33% for $154,800 to $336,500. The highest tax rate is 35% for those earnings in excess of $336,550.

6 – Consider Tax Credits

These are extremely valuable when you qualify for one. A tax credit will reduce the tax you owe dollar-for-dollar. For example, if after filling out your 1040 you see that you owe $2,400, but qualify for the $1,500 Hope Credit, your tax bill will only be $900. This is much better than a deduction which reduces your taxable income, not your dollar-for-dollar owed tax. Again, irs.gov is the best source for finding out about tax credits. Here is a short list of some tax credits that will be relevant in 2006.
• Child Tax Credit
• Qualified Electric Vehicle Credit (new)
• Credit for Dependent Care
• Adoption Tax Credit
• Retirement Savings Contribution Credit
• Mortgage Interest Credit

One final point about tax credits is that they cannot trigger a tax refund. If you owe $800 in tax and have a $1,000 credit, your tax liability becomes 0. The government will not allow issuance of a credit to create a liability for them.

The 1040 is a form every taxpayer must fill out. Resident Income Tax Returns are the form you must fill out for the state you live in. The information on here is similar to the 1040, and having an understanding of the 1040 will make the state return easier to understand. Please note that the above information will cover most questions coming from a salaried employee of a company. If you own your own business, the tax you pay will depend on your form of business. Some corporations (such as LLC’s) have pass-through provisions which allow the income from the corporation to pass-through to the individual owners. If you are not a salaried employee, gather information about your specific entity, whether a sole proprietorship, partnership, or corporation.

As always, please e-mail me with any questions. I am a financial advisor located in Manhattan. My blog is for information purposes only and was started as a financial planning resource to my clients and friends.

Russell Bailyn
--
Wealth Manager
Premier Financial Advisors, Inc
14 E 60th Street, #402
New York, NY 10022
P: 212-752-4343 *31
F: 212-752-7673
rbailyn@premieradvisors.net

Securities and certain investment advisory services offered through: First Allied Securities, Inc., a registered Broker/Dealer. Member: FINRA/SIPC. Premier Financial Advisors, Inc. is a Registered Investment Advisor. First Allied Securities & Premier Financial Advisors are not affiliated entities.

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