Let’s define Conventional investments as those dealing with energy companies discharging hydrocarbon gases, while Green investments are in companies that do not. This article does not attempt to pass judgment, but solely attempts to discuss investment strategies.
Companies dealing with coal, petroleum products and natural gas represent the former. The ones which commercially utilize solar energy, windmills, hydropower, and geothermal energy- and thus do not produce CO2- represent the latter. And then there are the in-betweens; energy providers (alcohol, biomass, etc.), which emit some greenhouse gases, but rely solely on renewable energy sources.
Conventional energy fuels have been used by mankind for millennia, and in spite of their recent reputation as greenhouse gas producers, are still increasing in demand. Developing countries seem to have an insatiable appetite for liquid hydrocarbon fuels, and that is not expected to abate in the foreseeable future. Although coal still generates almost 50% of the electricity used in the US, natural gas is becoming increasingly popular for this application.
Improvements in the techniques of recovering natural gas from shale have opened the potential of self-sufficiency of this fuel for the entire North American continent. Regardless of potential environmental dangers when “fracking” shale rock, it is quite likely that natural gas will be in plentiful supply by the twenties.
So what does this tell us about investments in conventional energy ? Since it appears that for the foreseeable future the demand for liquid fuel, natural gas and coal will continue to rise, we should look at the financial outlook of the organizations that produce these three commodities.
Investments in major oil companies seem to provide good protection against both inflation and the danger of diminishing personal income. When looking at their market performance over the past five years, note that while they have all gone through one major cycle, with few exceptions their stock prices are higher today that they were in 2006/7. Also, their dividends are generally above average (3% to 5%).
Natural gas producers are more difficult to analyze since they include a large spectrum of companies. Also, currently gas prices are low which squeezes profits and thus limits payouts to less than 1%. However, in the long run natural gas is expected to increase its proportional share for use in transportation, home heating and electricity generation and thus improve profits and payout to shareholders.
At present the best investment opportunities, based on their recent performance, are in pipeline companies (both for gas and liquids) which charge a regulated toll regardless of the cost of the transported fluid. Over the past few years their stock prices have increased steadily, and dividends currently range between 5% and 6%.
A major fraction of coal produced in the US is mined by about a half dozen public corporations. Like Big Oil, their stock prices have advanced over the past five years, however, the dividend payout is considerably lower (less than 1%). To an appreciable extent their profitability depends on exports and thus is tied closely to the global economy. However, there is a kicker: Most Appalachian mines also produce “coal” gas which will enhance the profitability of Eastern US coal producers as demand for natural gas increases.
Investing in Green Energy.
We shall restrict discussion of this topic largely to solar energy and windmills. Geothermal power generation while practiced commercially at a number of volcanically active global locations -Iceland and the western part of the US come to mind- there are only a very small number of “pure play” companies. And those are just barely profitable. Companies that produce alcohol fuel from corn, bagasse, or biomass are basically in the agro or chemical businesses. Fuel recovery from cooking oil or grease is still in the developmental stage. There are no pure plays in hydro-power, and nuclear power is a subject all of its own.
Government funding has up to now been essential for the development and commercialization of alternate energy projects. However, with a slow economy and the drive to reduce spending, federal funding and tax credits have been severely curtailed. This has made it more difficult to achieve cost parity with conventionally produced electricity.
Production facilities for solar energy panels, although their early development had largely taken place in this country, have now migrated to the Far East. China produces close to 50% of all panels used in the world, while our remaining facilities are barely eking out a profit, if any (remember Solyndra).
Windmill farms, employing a proven technology, have operated worldwide for decades. In the US – as is the case in most other countries -, their construction and operation depend, as it does with solar panels, on government subsidies. “Pure play” equipment manufacturers are having a difficult time dealing with a greatly reduced number of approved new wind farm installations; also in recent years equipment manufacturing has become concentrated within a small number of international conglomerates. There are also quite vociferous public objections against what environmentalists call “Horizon Pollution”.
A further difficulty with both solar and wind energy is that optimum locations for their installation are frequently not near areas where electrical demand is high. The cost of providing the required transmission infrastructure and getting the local construction permits could be prohibitive. For wind farms the problems are the vagaries of the winds, and with solar panels it’s the fact that the sun don’t shine for 24 hours every day at most locations on this earth.
This might actually be an opportunity for a remunerative investigation. Think batteries. Power storage must be available to supply electricity at times when none is generated. Also, there is the ever expanding need for larger and more powerful batteries for electric vehicles and other large equipment.
Battery production is pretty much controlled by existing manufacturers, but the raw material which in recent years has become paramount for use in the more powerful batteries is lithium. This element, produced from minerals in rocks or springs has largely been processed by mining companies located in South America and the Far East; however, there are a number of places in North America where easily accessible springs exist that contain dissolved lithium compounds. So far few of the attempts to recover the element in this country have been commercially successful, but because of the expected increase in demand, efforts to make it profitable are continuing.
A number of companies are currently involved in developing such properties and their low cost (penny) stocks can be purchased ‘over the counter’. It is up to you to establish which one will be successful, then buy their stock, and become fabulously wealthy.
WOLF
Germany
The basis for this story is that the above named PIIGS have one thing in common:Their national debts exceed the value of their respective GDPs (Gross Domestic Product). And that, my friends, spells trouble in River City. While all of these countries are in financial trouble, the one on the very top of the heap is Greece with its debt to GDP ratio expected to top 180% by the end of this year. Note that when the euro was introduced in1999 the required ratio for membership in the euro-zone was for it to be less than 60%. To understand the magnitude of their problem, the current Greek debt is half a trillion dollars for a country of eleven million people.
And the wolf, of course, is Germany, the country with the strongest economy in the euro-zone, and thus, by default, the leader in any European Central Bank (ECB) bailout. Even with Germany in the lead it took the euro-zone leaders three month before reaching an agreement in July to supply Greece with enough funds (E109 billion) to muddle through for an unspecified period of time. The demands were severe, the bank insisted on draconian reductions in government expenditures: spending cuts, going after tax evaders, reducing a bloated government workforce, and eliminating the customary extra one or two months of vacation pay that was de rigeur for government employees.
The Greek government largely ignored the imposed conditions, and it took just a few months for the crisis to flare up again. Riots and strikes in Athens and other major cities reduced manufacturing drastically with the result that investors started dumping Greek bonds, forcing interest rates up, and thus raising the cost of borrowing. Once again, default was at hand. Initially the German leadership (Angela Merkel) was reluctant to pour additional money into this bottomless pit, especially with her political coalition having but a razor thin margin in the Reichstag and her recent losses in two by-elections. Indeed, the German public had indicated a strong aversion to using their taxes for bailing out banks that had invested in toxic Greek bonds. None-the-less, in the end the stronger euro-zone economies together with the IMF (International Monetary Fund) stepped in trying to formulate another bailout proposal for Greece. Keeping Greece financially afloat was considered necessary to prevent a domino effect that could bring down the economies of the other PIIGS and thereby contaminate the financial system of the entire Europe Economic Union.
However, there was great doubt in the financial world that another bailout, like the one in July, could solve any long-term problems. Imposing tough spending restrictions onto countries like Greece will greatly reduce liquidity and thus cause interest rates to rise. That, as far as Germany is concerned, is counterproductive since their industrial engine depends on a massive export business which is fueled by cheap money.
So this is the conundrum: a choice between more (endless) financial infusions or a structured bankruptcy. Since almost nobody believes that Greece is solvent, the former option seems to have little chance of success and the second option had therefore to be given serious consideration. A vastly reduced debt load would bring Greece (or any other of the PIIGS) back to the originally required 60% debt ratio, and thus permit these countries to issue new bonds, possibly backed by the ECB, and thereby increase liquidity.
By the end of October, after lengthy debates, the financially more stable European countries cobbled together the following plan: Banks and other major investors in Greek bonds will agree to take losses up to 50% to prevent Greece defaulting on bills it cannot pay; European banks will be required to increase cash on hand to insure solvency; and a new European Financial Stability Facility will guarantee up to $1.4 trillion for backup loans to other cash-strapped PIIGS to make their bonds more investor friendly. Moneys for this slush fund are to be solicited from various financially well heeled nations, including China and Brazil, but not the US
Even with European leaders finally having gotten their act together, the outcome of the proposed restructuring is at this point pure speculation. Also, the Greeks' demonstrated reluctance to accept the austerity rules prescribed by lender nations could torpedo the agreed upon deal before it even had a chance to prove itself. If that were to happen Greece might leave the euro union, go into an unstructured bankruptcy, topple other PIIGS into financial chaos, and generally cause massive financial havoc.
Since 80% of Europe's increasingly dicey debt is held in European banks, many of which are struggling to raise enough money for their day-to-day operations, it begs the question whether US banks with large investments in European financial institutions could become equally enmeshed in this ongoing crisis. It has been estimated that their losses could range from zero to $2 trillion, depending on how well these US loans are hedged against European financial troubles. This is an unknown since banks are not required to report their hedges. And therefore, boys and girls, there is no way for us small time investors to fathom whether we are heading for a best or worst case scenario.
Based on the current negative market performance following Congress' passing of the debt limit bill, I find that there is far too much uncertainty to permit any rational discussion of investments. Also, the imposed advanced deadline is not of much help either.
So, as you will see below, I have restricted myself to a somewhat broad interpretation of the current status of our nation's financial future. There have been numerous similar articles published in recent days, and I can only hope that some of my personal observations may be useful to a few fellow retirees.
These lines were composed as the debt crisis was coming to a stumbling stop making it even more difficult than usual to write intelligently about money matters in general and investments in particular. However, a deadline imposed by the highest order of this newletter forces me to proceed. Thus, to the best of my ability I will try to disentangle and clarify the abomination of an agreement that after a lengthy gestation period was finally delivered by our congressional leaders.
On balance the Democrats lost more than they gained while the reverse is true for the Republicans.
Problem solved? Right?
WRONG!
All spending cuts broadly outlined by the above agreement are to be defined in detail by a special bi-partisan congressional committee which, in addition, will also have the authority to consider tax reform. If you thought that the congressional infighting we have just experienced was deadly; just you wait for the next round. But yet a solution to paying our domestic obligations is quite feasible. Any number of economists and political science gurus from both sides have published articles suggesting solutions. These deal largely with entitlements and tax reform, and are broadly outlined below. In any case it must be recognized that cuts in benefit formulas for both Medicare and Social Security are painfull but necessary.
SOCIAL SECURITY
MEDICARE AND MEDICAID
TAX REFORM
Everybody talks about simplifying our tax code, but recognizes that closing loopholes it is a euphemism for a tax increase. Since it has never been suggested to increase taxes for low income families, the main opposition to any tax incease comes from higher earning individuals. Whether such an increase will cause wealthy people to spend less or leave the country is debateable, but what has been demonstrated from previous economic cycles is that tax hikes are less job-killing than spending cuts. What nearly every bipartisan group (Bowles-Simpson and Domenici-Rivlin commissions) has stated is that some mix of spending cuts and tax increases is required to wrestle the $14,342,841,083,049.67 debt (as of 7/25/2011) to the ground. Note: $10 trillion of this amount is owed to the public (people and countries), the rest is intra-governmental.
Thus, given the uncertainties outlined above, there is very little that can be suggested regarding personal investments and tax planning. If one is inclined to stray from indexed funds and ETFs, my personal inclination is to go heavy on conventional energy, (e.g. oil, gas and pipelines), and select commodeties, (e.g copper and grains). The demand for hydrocarbon fuels and wheat will be with us for a long time to come. Developing nations appear to have an unlimited hunger for those items.
Editor's Note: This article was prepared by H/AREA Member Otto Frank who is expressing his personal views.
Disclaimer:
It should be noted that H/AREA makes this information known as a Service to its Home Page Viewers.
H/AREA does not recommend or endorse any of the ideas in this article.
The US economic situation appears to be recovering slowly despite the fact that housing prices continue to decline and nagging unemployment is still with us. What do we do in such a bleak situation? Warren Buffet advises to buy common stocks and hold them for the long run (10+ years). He acknowledges that we may have slumps in the short run (one to three years). It so happens that many of us retirees are more interested in the short run than we are in the long run. The market is “fragile” and volatile. The money market isn’t paying anything. The yield on the bond market is low. The stimulus from QE2 is expiring. Medicare is forecast to go broke in 2024 and Social Security in 2036. The odds on a painful inflation are about 50/50. The whole outlook is scary. Currently, the financial media are bullish on healthcare, energy and technology. At this writing in May, chemicals are very strong. The Price/Forecast Earnings ratio is lower than normal for the big cap stocks because of investor concern. The money handlers are the people making big money these days; those who handle your and my money – banks, brokers, M&A people, investment banks and fund managers. I don’t know where to go with my money. In desperation I purchased a Health Care REIT (Real Estate Investment Trust). They buy, sell and rent out doctors offices, clinics, small hospitals, medical complexes, etc. REIT’s are not liquid; you’re stuck with it. Your return is a mix of capital gains and income which can complicate your taxes. When I browsed through the mountain of paperwork they sent me, I found there were four different entities handling the REIT; broker, banker, manager and insurer all of whom had a staff of high paid people who were getting a piece of the action. I concluded from all of this that the best way to make money is to invest other people’s money after taking your cut.
I can’t remember a time when there were such divergent prognostications among the respected financial gurus about where the economy is going. Warren Buffet, among the bulls, predicts good times ahead. Others warn of catastrophic crashes. Some bears believe the crash is imminent; others, before the end of the year. The only place left for contrarians is “the economy is not going up or down”. Our enormous debt, the nagging unemployment figures and the still depressed housing market are worrisome. Our “shadow unemployment” may be as high as 20% some believe. This includes those who have given up and those whose unemployment benefits have expired. It doesn’t include those who have filled jobs which are much lower paying than the ones they had held previously. Significant reductions of the federal budget will result in even more unemployment. Countering those concerns are the enormous amount of cash, 2 trillion dollars, on the sidelines awaiting the optimum time to make business expansions, the effect of QE2, the amount to be expended on infrastructure and other diverse bright, but small, lights in the economy such as renewable energy and growing consumer confidence. The current PE (March 1) of the S&P 500 is 13.5 which is below the historical average of 16.7 leaving room for a further increase of 24% before the market approaches an “overbought” condition. Corporate earnings have been strong and rising. (If you read the President’s Message, you can stop reading here.) For the first time I am actually hearing politicians mention the “third rail” of cost cutting; Social Security, Medicare and Medicaid. I believe it is crystal clear, and has been for a long time to economists, that if we wish to stop adding to the ominously threatening national debt and even reducing it incrementally, we must modify these sacred cows. I am sure the politicians have known this for a long time but, up to now, no one has had the courage to say it out loud. We, as responsible citizens, must be educated and motivated to accept this concept. I sense a growing public awareness, especially among the young, that we are in trouble. I encourage you to vote for those who have the courage to do whatever it takes to preserve this country’s future and restore our role as a model to the world that a democratic form of government can work. Your comments are invited.
The gurus believe we have escaped the “double dip” but the economy is still “fragile”. The Christmas shopping season was better than had been hoped for. The year end lame duck congressional compromises, i.e. the START agreement, extension of all tax cuts, extension of unemployment benefits, the omnibus bill and Don’t Ask Don’t Tell all bode well for reduced partisanship and getting things done. There is a record amount of cash in corporate coffers awaiting expansion plans which will involve both increased spending and hiring. (Bloomberg News reports that Honeywell was sitting on $2.6 billion in cash at the end of the third quarter, 2010 - $800 million more than the company had at the end of 2007, when the recession began.) The leading indicators are heading up. Housing sales are up. There is a lot of good news out there. Bu then there are a lot of offsetting factors as well. The unemployment level is still high. There is the debt; federal, state, county, town and personal. Housing prices are not rising. A major unknown factor (at this writing) is how the new congress, with all of those tea partiers, will conduct themselves. Congress’s economic thrust will shift from stimulus to cost cutting and tax reform. Politicians will cite a billion dollar savings here and a billion dollars there but these are trivial compared to the debt. Neither party has shown the gumption to propose major changes to Medicare and Social Security, nor have they suggested tax increases. Either action would hurt many and be a drag on the economy. More important to Congress, it would cost votes. The moment of truth will come (and it must come) when the issue of raising the national debt limit arises, probably in the spring. Conventional wisdom is that January is a bellwether for the remainder of the year. Should the stock market turn up in January (you’ll know by the time you get this Newsletter) and there is an upturn in employment, it might be an opportune time to invest. Having been burned in ’08, many investors and institutions will be hesitant to jump in too quickly but if the stock market gains momentum many will jump in fearing missing the boat. There may even be a bubble before the market settles down to a long term gradual rise. As always, we recommend a balanced portfolio, however, there are always tempting areas, e.g. there are large corporations which now have ridiculously low P/E’s. If their balance sheet looks OK and you have confidence in their business segment, go for it. Alternately, you can spread your risk by investing in mutual funds in that business sector you feel optimistic about after checking their Morningstar ratings and expenses. Check out exchange traded funds (ETF’s) as their expenses are lower and they are more liquid than mutual funds. With your “fun money” take a look at commodities. For example, if you think it’s going to be a cold winter, buy orange juice futures. But that’s not investing, that’s gambling and we certainly don’t encourage that. Another caveat: some one who is near and dear to me loves to buy stock but is reluctant to sell stock. If it goes up significantly, she wants to keep it in the hope it will go up further. If it goes down, she wants to hold it until she gets her money back. Her advisor tells her to lock in her gains and limit her losses but she won’t listen to him (me). Finally, pay close attention to the inflation rate as this can have an enormous impact, especially on your bond portfolio. To all who have read this far, have a profitable New Year!
(Ed. Note: The H/AREA Internet Home Page takes no partisan position regarding political matters; our President has been so advised and vows that his commentaries will reflect no bias. His independent thoughts do not necessarily reflect those of the Honeywell/AlliedSignal Retiree’s Association.)
A 529 plan also known as “qualified tuition plan” is an education saving plan for future college expenses for a designated beneficiary. There are two 529 plans: college savings and pre-paid tuition. Every state has at least one 529 plan and each 529 plan can differ from state to state. The 529 plans are named after section 529 of the IRS code. The plans are a hands-off way to save for college, and the purchaser maintains control. The beneficiary has no rights to the funds.
Pre-paid Tuition Plan:
This plan allows purchasing course credits (or course units), thus, locking in tuition cost at participating universities and colleges for future tuition. Some plans also permit room and board expenses. State governments sponsor this plan with a condition of state residency requirements. The plan is administered by states, state agencies or an educational institution. The investments are backed by states that sponsor pre-paid tuition plans. There are age and grade limits for a beneficiary and there is a restricted enrollment period. The fees and expenses for pre-paid plans are enrollment costs and administrative fees.
College Saving Plan:
This plan, generally, lets a plan purchaser to set up a beneficiary account at any financial institute for eligible college expenses. The plan does not permit one to lock on to college tuition costs but it includes almost all qualified college expenses such as tuition, fees, room & board, books, and computer. The purchaser of this plan can invest on behalf of the beneficiary in any investment option he or she chooses. The growth of the investment is based on market performance, thus subject to market risk, including loss of principal. There is no state residency or age requirement and enrollment is open all year. Many college saving plans have contribution limits in excess of $200,000. The plans are subject to loads, enrollment fees, annual maintenance and asset administration and management fees.
Tax Considerations:
529 plans contributions are not deductible from purchaser’s federal income taxes, however, many state allow deduction of all or part of the contribution in the state income tax. It is advisable to check with the state about tax laws. Distributions from the plans are exempt from federal tax and for most state tax, as long as the proceeds are used for qualified college expenses. Any non-qualified distribution proceeds from 529 plans are subject to a 10% federal tax penalty on earnings and income tax, and the state may recapture state tax deductions or credits taken. The 529 account losses over the life of plans are tax deductible. The 529 plans contributions are considered as gifts, accordingly, the federal gift tax regulations applies to maximum contributions. It is prudent for the purchasers who are trying to minimize estate taxes to consult an expert on other options such as the Uniform Transfers to Minor Act (UTMA).
Other Considerations:
In general, the 529 account affects a beneficiary’s eligibility for need-based financial aid either loan or grant. The plan asset is included in the financial aid calculation of the expected family contribution towards college costs, thus, reducing the eligibility for the aids. However, if the plan owner is other then parent or student such as a grandparent then the 529 plan asset is not included in the financial aid calculation.
Some 529 plans require investing a certain amount of money over a period of time to keep the plan active; and other 529 plans levy nickel-and dime fees that can seriously cut into the returns.
Since the 529 plans pigeon-hole money only for qualified college education, a better flexible alternative is an investment in a Roth IRA. The Roth IRA can do double duty, as an emergency fund as well as a college fund, by allowing tax-fee withdrawals of principle at any time, for any reason, without any tax or penalty. The first time home buyer can withdraw, penalty free, $10,000 from a Roth IRA. Furthermore, the Roth IRA distribution is non taxable after it has been open for five years so it can be used for a child’s educational expenses.
Before making an investment in a 529 plan it is very important that one understand the rules of the 529 plan and state guidelines. 529 plan rules vary by state-to-state and by plan-to-plan.
By Kundan Patel
Editor's Note: This article was prepared by H/AREA Member Kundan Patel who is expressing his Personal Views on 529 Plans and IRAs.
Disclaimer:
It should be noted that H/AREA makes this information known as a Service to its Home Page Viewers.
H/AREA does not recommend or endorse any of the ideas in this article.
Previous History – Congress established the Individual Retirement Account (IRA) in 1981 to help citizens save for their retirement since Social Security income appeared to be untenable or at least unsustainable at the then current level. Several years later the Roth IRA was created to enable citizens to contribute after tax dollars to grow tax-free. A few years ago during the latest Bush administration another law was passed to permit the conversion of your existing traditional IRA to a Roth IRA. However, you had to pay income taxes on the conversion amount immediately in addition to your other taxable income. This would naturally place you in a higher income tax bracket in the year of conversion. Also if your income exceeded a certain limit ($100,000 for single tax payers or $150,000 for joint returns) you were not eligible to convert. Married couples filing separately were not eligible at all irrespective of their income.
Current changes -- Effective January 1, 2010, a new twist came into effect regarding the conversion. You have the option to spread the income resulting from the conversion and the corresponding taxes over two years, 2011 and 2012. Also the income limit and the ban on married couples filing separately to convert were eliminated making all tax payers eligible to convert. Here are some of the advantages of a Roth IRA:
The above details are only for your information to explore further with your other resources to see how you can benefit from the changes in the tax law. I strongly suggest that you consult your accountant and/or estate planner to address your unique situation.
Samy Palanisamy
Editor's Note: This article was prepared by H/AREA Member Samy Palanisamy who is expressing his Personal Views on IRAs.
Disclaimer:
It should be noted that H/AREA makes this information known as a Service to its Home Page Viewers.
H/AREA does not recommend or endorse any of the ideas in this article.