Robert Amodeo & Christine Benz

Uploaded by WealthTrack on 14.12.2012

CONSUELO MACK: This week on WealthTrack, the tax man cometh and he will be taking more
from investors next year. How can you defend yourself? Western Asset Management’s high
performing municipal bond manager Rob Amodeo and Morningstar’s personal finance guru
Christine Benz share tax protection strategies next on Consuelo Mack WealthTrack.
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Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. As Benjamin Franklin
famously said, the only things certain in life are death and taxes. As far as next year
is concerned for investors, one of the few certainties in life is that taxes are going
up. And regardless of what happens with the fiscal cliff, the economy, markets, deficit-
you name it- rates on capital gains, dividends, interest and income are going higher over
the next several years. And revenue raising measures will be occurring on both the federal
and local level, which is why we are devoting this week’s WealthTrack to reducing your
tax bite.
Our guests are two pros in the art of minimizing your tax pain. Christine Benz is that and
much more. She is currently Director of Personal Finance and Senior Columnist for
She has worked at the parent company Morningstar in numerous positions over the years, including
as Director of Mutual Fund Analysis and editor of Morningstar Mutual Funds and FundInvestor
newsletters among others. She is also the author of 30-Minute Money Solutions: A Step
By Step Guide To Managing Your Finances, which I highly recommend because it breaks the process
down into manageable pieces. She gives sound advice on just about every aspect of personal
finance including minimizing your tax burden, which she believes will be increasingly important
in the months and years ahead.
Our other guest is Robert Amodeo. Rob is Head of Municipals at Western Asset Management
and co-manages several of its muni funds including Western Asset Managed Municipals, Short Duration
Muni Fund, Intermediate-Term Muni Fund and Western’s Municipal High Income Fund. Western’s
muni bond team was named “U.S. Fixed Income Municipal Manager of the Year” for 2011
by Institutional Investor magazine. I began the interview by asking Christine Benz why
managing the tax efficiency of our investments was so important for investors.
CHRISTINE BENZ: Consuelo, when we think about the items that we investors actually exert
some level of control over, there aren’t that many, so we don’t control the direction
of the economy. We don’t control the direction of the markets, but we do have some control
over how we manage our investments in relation to taxes- that can entail, do we max out our
tax sheltered accounts? Do we put the right types of investments in the right types of
accounts? And those maneuvers, those tax-saving maneuvers can really be impactful in terms
of improving your take-home bottom line.
CONSUELO MACK: You know, because I was thinking especially over the long term, you know, people
think, all right, I will pay some attention to tax efficiency, but my investment goals
are the most important, are top priority which you would agree with as well; but the tax
aspect, again, it really adds up over time. Right?
CHRISTINE BENZ: Exactly. So you should never put the tax maneuvers ahead of the fundamental
investment considerations. They should always go hand in hand, and really those fundamental
investment considerations should come first, but you can do some of these things around
the margins to improve your take-home long-term return.
CONSUELO MACK: And one of the things that you can do around the margins, Rob, is to
invest in municipal bonds, and actually that’s kind of the first response that people think
about when they want to reduce their taxes, but the municipal bond market has gotten a
really bad rap in recent years. So give us your assessment of how risky is the municipal
bond market today.
ROB AMODEO: Yeah, well, the municipal bond market today, the fundamentals in the market
today are much improved than where they were just a few years ago.
CONSUELO MACK: Well, that’s encouraging.
ROB AMODEO: Absolutely it is, but that’s not to say that the financial flexibility
is back. There’s still low financial flexibility. There are pockets of weakness out there, and
you really need to understand the creditworthiness of the respective issuer. So the marketplace
has gone through a great deal of change, and at the state level in particular, what they
have done is they’ve cut about $500 billion in spending, real cuts in spending. They’ve
raised taxes. They found that fiscal equilibrium that was mostly absent in the years, say a
handful of years ago, so the marketplace, yes, it has its challenges ahead, but today
it’s in much better shape than it was just a few years ago.
CONSUELO MACK: So overall it isn’t, and that means so state finances have really been
improving markedly?
ROB AMODEO: I wouldn’t say markedly, but they have been improving. They have addressed
their challenges head on. What they have done is they’ve increased taxes and, more importantly,
they’re addressing the structural imbalances coming out of the pension systems which we
all know how their challenge is, so they’ve taken on these challenges, and they’re instituting
new programs, and I’ll just give you an example. Out in California, for new public
employees, they’ll receive less benefit when they retire. They’ll be asked to contribute
more money into the plans themselves. They’ll have to work longer. So you won’t see these
savings in this year or next year or the year after that, but in the out years you’ll
see a great deal of improvement.
CONSUELO MACK: All right, and so California, of course, and we’ll talk about that a little
bit more in detail later, but has been like a poster child of how a state should not run
its finances.
ROB AMODEO: Absolutely, absolutely, but they are making changes out there, and they’ve
just raised taxes significantly, and so the revenue will pick up, and on the flip side
they’ve cut spending and adjusted their structural imbalances as well.
CONSUELO MACK: So let me ask each of you before we kind of get into some specific strategies,
let me ask each of you about the big picture, and that is we know that taxes are going to
go up next year. How concerned should we be about the tax outlook from your perspective,
Christine, and also from Morningstar’s?
CHRISTINE BENZ: I think investors should very much have what is happening with tax rates
on their radar and, like you, I think it’s a safe bet that long term at least we will
see higher tax rates. Where we are now is quite low in terms of dividends and capital
gains rates versus historic norms. So to me, investors should stay attuned, but I think
in terms of some of the big cataclysmic changes that we’ve been hearing about, like making
the mortgage interest deduction go away. Is that going to happen realistically between
now and year-end? I don’t think so, so I don’t think investors need to be too concerned
about those changes that they really haven’t heard of until quite recently.
CONSUELO MACK: Between now and yearend, what about next year? Could there be major changes
next year, do you think, and is that anything that we should be planning for now?
CHRISTINE BENZ: Well, I do think that the increase in the dividend tax rate could happen,
and it could be impactful, so dividend taxes right now are 15% for most investors. That
could go up to their ordinary income tax rate which could be as high as almost 40%. So that’s
a big deal, and that is still, in fact, on the table. So investors should be paying attention
to that particular change.
ROB AMODEO: From a municipal bond investor perspective, these are important topics. The
idea of eliminating the benefit of municipal income is on the table.
CONSUELO MACK: It really seriously is on the table. Right?
ROB AMODEO: Well, at least it’s been introduced as an idea for discussion. I don’t think
it’s a credible idea, though, at a time when our infrastructure needs refinancing,
it needs repairing and retooling. The purpose of the public finance arena, the municipal
bond market is to support the infrastructure of our country, so it would be unwelcome development
to eliminate the benefit of municipal income, because that, in fact, would increase the
cost of borrowing at the state level and other municipal authorities. There would be a great
deal of dislocation in the public finance arena which then would filter back into the
markets. So I don’t think it’s a credible idea. The idea, though, that you could cap
the benefit of municipal income, meaning, say, 28 cents on the dollar, so if year-end
tax rate goes from 35 to 39, you won’t enjoy the full benefit of that 39 or 39.6, but you’ll
be capped at 28, and that seems, to us at least, the highest probability. The ideal
situation would be to leave the rules unchanged and, therefore, if tax rates increase, and
they likely will increase, the benefits of municipal income will make investors just
smile that much more.
CONSUELO MACK: Right. It sounds like there are a lot of open questions, and especially
for next year, but for the next couple of weeks at any rate, we can because relax a
little bit as far as our tax changes are concerned. At least that’s what you seem to say, Christine.
I don’t know if Rob agrees with you or not.
ROB AMODEO: You know, the fiscal cliff negotiations are ongoing. You know, here we are following
the election. The balance of power is relatively unchanged, and yet we don’t seem to be any
closer to a solution, at least not at this date.
CONSUELO MACK: Right. So let’s go through some of the tax-efficient strategies that
you’ve written about at Morningstar, and you tell me where you want to start. What
are the most important tax-efficient decisions that we can make?
CHRISTINE BENZ: Well, one thing we can start with is this idea of, if you have tax advantaged
accounts available to you, taking maximum possible advantage of them, so that means
company retirement plans, IRAs, especially Roth IRAs. If you’re expecting a higher
tax regime down the line, the Roth IRA is really attractive because you pay taxes on
your contributions today, so if you can squeak in a contribution between now and April 15th
of 2013, you’ll pay that low tax rate on it, and then you will be able to take tax-free
withdrawals in retirement. So maxing out those tax-sheltered accounts would be a starting
CONSUELO MACK: And let me stop you there, too. As far as the Roths are concerned, because
a lot of people my age, for instance, have traditional IRAs, so the issue is, should
we seriously talk to a financial planner about possibly converting to Roths?
CHRISTINE BENZ: I think you should, and certainly it is something that you’d want to get either
a financial advisor or a tax advisor in the mix to counsel you on whether that’s a good
maneuver or not. Generally speaking, the older a person is, the less advantageous the conversion
will be for them, but there are even people who are in retirement who are older but quite
wealthy who don’t expect to use much of their IRA assets during their own lifetimes.
They’re saving mainly for their kids and grandkids in those IRAs. For them, in fact,
a conversion might make sense even if they are later in life.
CONSUELO MACK: For our younger viewers, though, who are still going to be making a lot of
contributions to IRAs, should they basically be thinking about Roth?
CHRISTINE BENZ: I think so. So Roth IRAs, also Roth 401(k)s are seeing a lot of uptake
at employers. So if you are a young person and you’re sort of on the upward trajectory
in your career- maybe you think you’re salary is low today versus what it might be in the
future- you’re a terrific candidate for making those Roth contributions, because again,
you’re paying taxes at today’s relatively low rates but potentially taking money out
when rates will be much higher in the future.
CONSUELO MACK: And one more question along these same lines before we get to municipal
bond strategy with Rob, is as far as asset location, and that’s what you’re talking
about, is really think where you’re putting certain investments. So just explain quickly
what the rule of thumb is for that.
CHRISTINE BENZ: Generally speaking, if you have high tax cost investments in your portfolio,
so that would be taxable bond income, real estate investment trust income, a high-yield
bond income, any category like that that’s kicking off a lot of income on a year to year
basis, you want to try to house that stuff within your tax advantaged vehicles, within
your IRAs, within your company retirements plans. Tax-efficient investments might be
individual stocks, index, broad-based index stock mutual funds, another good bet for those
taxable accounts, because the tax costs on a year to year basis are pretty low.
CONSUELO MACK: Okay. So Rob, you just explained to us that municipal finances are improving.
Municipal bond market has actually done pretty well, certainly relative to Treasuries this
past year and pretty well over the last several years. So explain to us, what are the values
in the municipal bond market right now? I mean, how do you assess the valuations? Are
they cheap, moderately expensive, or expensive?
ROB AMODEO: I’d say in a relative sense, municipal bond market is offering good value
today. It’s not as compelling as it was two years ago. The curve is still steep but
not as steep as it was, say, two years ago.
CONSUELO MACK: So the curve being the difference in the interest rates between...
ROB AMODEO: The 30-year and, say, shorter maturities, one to two years. That difference
is still fairly generous. When you look at the credit spreads or a difference between
a bond that’s rated single A or triple B and compare it to a similar maturity that’s
rated triple A, that difference in yield is still generous, again, off its wide, it’s
not as generous as it was a couple years ago but still fairly generous.
CONSUELO MACK: So, let me stop you there. So that means that you’re looking at...
if you look at longer maturities, you’re getting more than you are in shorter maturities
and enough to make it attractive, and if you’re looking at a single A credit rating and a
triple A, that if you get in on the single A, that is more attractive than the triple
A, so that again, these are advantages for an investor.
ROB AMODEO: Absolutely. We favor the longer end of the curve, although we have pulled
our durations down a little bit over the last year. We’ve taken out a little bit of interest
rate risk out of our portfolios, but we still like those single A, we’ll call it medium
investment grade quality single A, to a smaller degree triple B type securities in predominantly
the revenue bond sectors which is the health care, transportation, smaller degree utilities,
water and sewer, power generation plants and corporate-backed obligations which are industrial
development revenue bonds.
CONSUELO MACK: And explain. You know, those are very specific niches in the municipal
bond market, and when I was growing up on Wall Street, they used to tell me, you know,
for the safest revenue stream in municipal bonds, get a general obligation backed by
the full faith and credit of the state. You know, they can raise taxes to pay this stuff,
but you’re saying not necessarily.
ROB AMODEO: No, not necessarily. I mean, you can find very well-managed revenue bonds.
You can find an entity that the central purpose of the project is there. There’s a well-diversified
community that’s going to support that project. You can assess the management team. You’re
not subjected to a political decision or political committee. There’s all types of investments
in the municipal bond market where you can avoid the general obligation sector or use
it to a lesser degree and focus on the revenue sectors and, more importantly, revenue sectors
tend to yield a little bit more than a general obligation sector, because you have to do
a little more credit work there.
CONSUELO MACK: So when you’re assessing the criteria for assessing whether or not
you make a municipal bond purchase, what are the most important criteria that we should
apply as individual investors as well?
ROB AMODEO: In order to identify value- you hit the nail right on the head- you have to
understand the risk, and the risk within a municipal bond is unique. You have geographic
risk. So for example, if the fiscal cliff hits and there are spending cuts, those spending
cuts will be felt differently across different regions. If it’s defense spending, that
will hurt particular regions. If there’s other types of cuts, depending on which program
they’re going to cut, that’ll be felt by other regions. So it’s a marketplace
you really need to understand the geographic purpose and the essential purpose of the project,
and then obviously the sectors, like health care that’s subject to the regulations and
the challenges within that sector. Is it utilities? Are the regulations coming out in terms of
how they produce their power and if it’s nuclear versus gas versus any other source
of petroleum that they’re generating the electric with. So there’s unique characteristics,
and you have to understand that you need... today investors recognize, if there’s a
biggest change in the market, that municipal bonds, you need to have good sound security
selection backed by fundamental credit analysis .It’s no longer set it, forget it, do-it-yourself
CONSUELO MACK: Right. Putting on your mutual fund hat from Morningstar, Christine, as far
as what you would have advised people to buy previously in municipal bond funds, for instance,
I mean, have you noticed a change given the fact of what Rob is talking about, the variety
that we’re seeing?
CHRISTINE BENZ: Well, Rob runs a fund, but I would say from the perspective of someone
who advises people on whether to buy funds or individual securities, when it comes to
municipal bonds, I’m definitely in favor of funds because of the professional research
that you get. Doing some of this credit research is complicated stuff, and also...
CONSUELO MACK: For him. I mean, for the professionals it is.
CHRISTINE BENZ: Exactly, and then that ability to be diversified. As a small investor, it’s
very difficult to build a diversified basket of individual municipal securities. You can
easily get that with a fund, so I would put in a plug for that fund idea and also I would
say that the bid-ask spreads, the trading costs that small investors can encounter when
attempting to buy and sell individual munis can be pretty impactful and pretty high. So
you can really get hurt even though you might not see it right up front. It can really hurt
your take-home return as a small investor.
CONSUELO MACK: Right. But let me ask you and dig a little deeper on that point, and that
is the fact that we used to have these monoline insurers like MBIA that would basically guarantee
the ratings. You know, everything was kind of triple A, and then they went out of business,
or not out of business, but at any rate that business has really shrunk tremendously. So
for individual investors, for instance, one of the tax-efficient strategies that you’ve
talked about are buying index funds. So are there some markets where index funds just
aren’t appropriate, and is the municipal bond market possibly one of them?
CHRISTINE BENZ: I think it is. In fact, we have a team of folks covering exchange traded
funds and, in general, they love exchange traded funds, but they say that there are
a couple of areas within that space where they don’t think indexing is the best place
to be. So munis would be one area. High-yield bonds, high-yield taxable bonds would be another
place where maybe the index fund isn’t the best mousetrap.
ROB AMODEO: I couldn’t agree more. The institutional execution makes a difference between the individual
and the institutional investor like ourselves. The diversification, the ability to diversify
a portfolio and the active management. We can anticipate changes in the market, whether
it’s level of rates, whether it’s regulatory environment, monetary policy, throw out there
what you will. We can anticipate that and move the portfolios around to take advantage
of the upcoming opportunities.
CONSUELO MACK: So are there some things that you couldn’t anticipate? I’m thinking
of Hurricane Sandy, for instance. I mean, I don't know how that has affected the New
Jersey municipal bonds and New York municipal bonds and Connecticut. Is something like that
something that is unforeseeable? Is that just one of the risks out there in investing in
ROB AMODEO: Oh, absolutely. However, the way we approach, we’ll call them FEMA risk,
we look at the past, say, 40 years, and we say, “Where have the storms hit, and where
is the most vulnerability?” Then we look to the particular issuer, and we want to make
sure that they’re in sound financial management and that they have financial flexibility.
So if a storm does hit, and the federal government does not come in and support that community,
that they perhaps have the ability to get back on their feet.
CONSUELO MACK: All right, so you do factor that in, kind of the black swan type of events.
ROB AMODEO: Absolutely. Yes.
CONSUELO MACK: And so Christine, knowing that tax rates are going up and for a lot of individuals
at any rate, are municipal bonds an area that some of us who thought that we’re not in
a high enough tax bracket, does it mean that they have a broader appeal? Is it, again,
something that more investors should be considering?
CHRISTINE BENZ: Possibly so, and one tool or set of tools I would urge investors to
check out is that there are these muni bond calculators that they can find on various
fund company’s websites. We’ve got one on, and the idea is that you
plug in the yields of a taxable bond or bond fund versus a municipal bond or a bond fund
and then put in your individual tax rate, what you expect it to be, your estate tax
rate, and see are you better on an after tax basis in the muni or in the taxable bond,
and you don’t necessarily need to be a Neiman Marcus shopper to have the muni bond actually
make more sense for you once your tax rate is factored in.
CONSUELO MACK: Where are you finding the best values? I mean, you mentioned the types of
bonds, the revenue bonds for instance, but should we be looking at California? Should
we be looking at Illinois? Again, the worst states financially, but are there opportunities
with improving finances being created in places that we wouldn’t think of?
ROB AMODEO: Yes. In fact, that’s part of our style. What we like to do is look to those
battered regions like Illinois and California and find the best managed municipal authorities,
find the best projects, the best utilities and what have you and invest in those names,
because people will avoid them because they hear California. No way. Well, our portfolio
is we were void of California general obligation debt for a long period of time, but one of
our largest concentrations came out of the state of California, so we invest in all these
different names within that state, and that holds true across a range of regions. We’re
going to look anywhere in the marketplace to find the best value.
CONSUELO MACK: So this is Western Asset, and it’s more of a contrary. You look where
others are not investing.
ROB AMODEO: Yeah, we look for value, and in understanding value, you really have to understand
the risk.
CONSUELO MACK: Right. Christine, the One Investment for long-term diversified portfolio? You have
a really interesting idea for us.
CHRISTINE BENZ: The idea is to look at a health savings account. This is something that you
have to be participating in a high deductible health care plan to take advantage of, so
you often hear that these health care savings accounts are a best fit for people who are
healthy and wealthy. You do not want a high deductible health care plan if you do have
a lot of ongoing health care outlays, but if you’re someone who doesn’t have much
in the way of health care expenditures and you are participating in one of these high
deductible plans, the health savings account is really unique in that you are able to put
in pre-tax money, and if you are using that money for health care expenses when you withdraw
it, you won’t pay taxes on the way out either. So I think it’s a unique opportunity for
people who are in that healthy, wealthy, ideally on the younger end category.
CONSUELO MACK: Right, and again, and the deductibles are what? The first $5,000 you have to cover
yourself or the first $10,000? I mean, is there a better way to go, a better limit to
CHRISTINE BENZ: It depends on the particular plan, but generally speaking the high deductible
plans have out-of-pocket costs that can run as high as six to ten thousand before your
insurance kicks in, but the health savings account allows you to sack some money away
for higher health care costs down the line.
CONSUELO MACK: And the other thing is that you can continue to pass it on year to year.
It builds up in other words. You don’t have to spend it in a given year.
CHRISTINE BENZ: Exactly. Sometimes people get these mixed up with the flexible spending
accounts. And that is, use it or lose it in that calendar year or maybe the calendar year
with a grace period. Health savings accounts do build up, and that’s the beauty of them,
is that when you take the money out, it’s tax free, and you can use it for any number
of things including long-term care when you’re retired. So if you or your spouse end up needing
to be in a long-term care facility, you can actually pull the money out tax free to pay
for costs like that.
CONSUELO MACK: No, that’s just terrific information. It’s something that we really
haven’t covered here on WealthTrack. And Rob, the One Investment for a long-term diversified
portfolio that all of us should own some of, what would it be from you?
ROB AMODEO: Well, I like health care REITs. The demographics indicate that the demand
for health care is going to increase, and I like real estate. So if you combine the
two, I like the health care REITs.
CONSUELO MACK: Do you have some examples of a couple of health care REITs that we should
ROB AMODEO: Well, there are a couple symbols that I follow. HCN is one of them. You know,
it’s provided a pretty good return and also a very generous yield.
CONSUELO MACK: Of course the REITs are known as real estate investment trusts. There’s
an income factor with this as well. And that it’s what, they have to pay 90% of their
ROB AMODEO: That’s right.
CONSUELO MACK: So in an income-starved world they also add...
ROB AMODEO: That’s right. It’s all about income, and they’re going to pay out whatever
they earn.
CONSUELO MACK: So thank you both so much. Christine Benz from Morningstar, always a
treat to have you.
CHRISTINE BENZ: Thank you, Consuelo.
CONSUELO MACK: And Rob Amodeo, thank you so much for joining us for the first time on
WealthTrack from Western Asset Management.
ROB AMODEO: Thank you. It’s my pleasure.
CONSUELO MACK: At the conclusion of every WealthTrack, we give you one suggestion to
help you build and protect your wealth over the long term. This week’s Action Point
follows the advice of economist, John Maynard Keynes who famously said that “The avoidance
of taxes is the only intellectual pursuit that carries any reward.” This week’s
Action Point is: identify some tax avoidance strategies to boost your investment returns!
Christine Benz and Rob Amodeo gave us several strategies including revisiting municipal
bonds, putting your higher tax investments in tax deferred accounts, and emphasizing
tax efficient investments including index funds, exchange traded funds and yes, even
owning individual stocks. Keep the tax man at bay!
I hope you can join us next week. We are going to sit down with two highly respected global
portfolio managers to talk about what they own: star international stock investor Rupal
Bhansali, now of Ariel Investments and proven bond veteran David Rolley of Loomis Sayles
discuss why they are looking in some unusual places for the best opportunities.
If you would like to watch this program again, it will be available on our website starting
on Sunday. Premium subscribers can see future programs 48 hours in advance, and additional
interviews with WealthTrack guests are available in our WealthTrack Extra feature. And that
concludes this edition of WealthTrack. Thank you so much for watching and make the week
ahead a profitable and a productive one.
SPONSOR: Additional funding provided by: Loomis-Sayles - investors seeking the exceptional
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independent thought with in-depth research. [music]