This article from the Washington Post indicates that Congress is beginning to eye retirement savings tax breaks (e.g. 401(k) plans, IRA plans, etc.) for possible "reform". In other words, the $200 billion/year in tax breaks currently enjoyed by anyone who is contributing to a retirement plan may be on the chopping block. The article is very non-specific, except for indicating that the head of the House Ways and Means Committee has scheduled hearings to look into this matter.
http://www.washingtonpost.com/business/economy/lawmakers-consider-changing-tax-breaks-on-retirement-savings/2012/04/17/gIQARfV7OT_story.html?hpid=z12&sub=AR
Wednesday, April 18, 2012
Friday, April 13, 2012
Why Companies Continue to Pay Dividends
This article, published on the Bloomberg web site and written by University of Chicago professor Douglas J. Skinner, mentions reasons why companies continue to pay dividends when they may be better off not doing so.
http://www.bloomberg.com/news/2012-04-11/why-u-s-companies-continue-to-pay-dividends.html
One issue that Mr. Skinner does not mention: some investors, such as trusts, require the purchase of dividend-paying stocks. This is often the case when the trust has a "split interest" -- there are current income beneficiaries, but there are also future heirs to the trust who will receive a payout of interest, if not the entire principal, of the trust. Current beneficiaries may be limited to receiving income distributions. Were it not for the dividend requirement, the income beneficiary would be out of luck. In some cases, the purchase of only dividend-paying stocks may be required by state law in which the trust calls home. In other cases, the trust document itself may require that only income-producing assets, such as dividend-paying stocks, must be purchased.
http://www.bloomberg.com/news/2012-04-11/why-u-s-companies-continue-to-pay-dividends.html
One issue that Mr. Skinner does not mention: some investors, such as trusts, require the purchase of dividend-paying stocks. This is often the case when the trust has a "split interest" -- there are current income beneficiaries, but there are also future heirs to the trust who will receive a payout of interest, if not the entire principal, of the trust. Current beneficiaries may be limited to receiving income distributions. Were it not for the dividend requirement, the income beneficiary would be out of luck. In some cases, the purchase of only dividend-paying stocks may be required by state law in which the trust calls home. In other cases, the trust document itself may require that only income-producing assets, such as dividend-paying stocks, must be purchased.
Bond Vigilantes
In the 1980s and 1990s, a new term was coined: Bond Vigilantes. These are/were professional investors active in the bond market whose presence kept the Federal Reserve Board in line in terms of its interest rate policy, and the U. S. Government in line as far as its spending. During that period, Bond Vigilantes had soe much more money to play with than the Federal Reserve Board that the Fed had trouble managing interest rates.
Right now, the Bond Vigilantes have their sights set on Europe, as this blog post by Ed Yardeni mentions:
http://blog.yardeni.com/2012/04/euro-mess-again_11.html
Apparently, the Bond Vigilantes only have so much capital to make the lives of central bankers and national governments difficult.
Eventually, these Bond Vigilantes will turn their sights again on the U. S. Treasury market. But right now, the Federal Reserve Board has expanded its purchasing of bonds to the extent that the Bond Vigilantes feel it is more profitable to play in smaller ponds (Europe) rather than the deep capital pool that is the U.S. bond market.
Right now, the Bond Vigilantes have their sights set on Europe, as this blog post by Ed Yardeni mentions:
http://blog.yardeni.com/2012/04/euro-mess-again_11.html
Apparently, the Bond Vigilantes only have so much capital to make the lives of central bankers and national governments difficult.
Eventually, these Bond Vigilantes will turn their sights again on the U. S. Treasury market. But right now, the Federal Reserve Board has expanded its purchasing of bonds to the extent that the Bond Vigilantes feel it is more profitable to play in smaller ponds (Europe) rather than the deep capital pool that is the U.S. bond market.
Thursday, April 12, 2012
The Wisdom of Marty Whitman
As I noted in my most recent newsletter to clients, Marty Whitman, founder of Third Avenue Funds, is a legendary investor on Wall Street who criticizes indexing and excessive diversification. His quarterly newsletters are written for investors who are fairly knowledgeable about investing. In my newsletter, I decided to quote a passage from his Chairman's Letter, and decipher his statements for the average investor. My plan is to continue excerpting certain parts of his newsletter that provide insight into investing in general, and investing in the current market environment in particular.
Mr. Whitman notes in the Third Avenue Funds Portfolio Manager Commentary and First Quarter Report (2012):
"A primacy of earnings approach clearly is in conflict with the desire of most companies to minimize income tax burdens. Income from operations are taxed at maximum corporate rates. Taxation of capital gains is much preferred, because the taxpayer usually can control the timing as to when the tax becomes payable. And the ultimate corporate tax shelter for businesses which don't need cash return is unrealized appreciation."
Whitman is saying that companies have two options: work to maximize their profits or work to minimize income taxes. Investors who buy common stock in publicly traded companies face double taxation -- the corporate tax in the year that the income was earned, then again at the investor's level as a tax on dividends paid and capital gains (when the common stock is sold). Whitman argues that from an investor's standpoint, companies that tend to minimize dividend payments and maximize the amount of capital appreciation are better for investors who like to decide when they pay a tax. Dividend income is taxed in the year it is distributed. Capital gains (capital appreciation) is taxed only when the investor decides to sell his common stock.
But more importantly, Whitman is saying that companies that retain their earnings, rather than paying dividends, ultimately have a cheaper source of capital to grow their business, because the government is not taking the tax on dividends in addition to the corporate earnings tax in any given year. Instead, only the corporate tax is assessed, and the remaining after-tax earnings are free to be invested as the company sees fit. The company therefore has less need to issue new common stock to investors.
Think about it this way: If the company paid out a dividend of $100, and the stockholder was taxed at a 15% rate, there would be $85 left to reinvest in another stock. So if the company decided to sell more common stock, the stockholder would have only $85 to invest. Yet if the company instead paid no dividend, and retained the $100, there would be more money available to the company for reinvestment in the business.
Mr. Whitman notes in the Third Avenue Funds Portfolio Manager Commentary and First Quarter Report (2012):
"A primacy of earnings approach clearly is in conflict with the desire of most companies to minimize income tax burdens. Income from operations are taxed at maximum corporate rates. Taxation of capital gains is much preferred, because the taxpayer usually can control the timing as to when the tax becomes payable. And the ultimate corporate tax shelter for businesses which don't need cash return is unrealized appreciation."
Whitman is saying that companies have two options: work to maximize their profits or work to minimize income taxes. Investors who buy common stock in publicly traded companies face double taxation -- the corporate tax in the year that the income was earned, then again at the investor's level as a tax on dividends paid and capital gains (when the common stock is sold). Whitman argues that from an investor's standpoint, companies that tend to minimize dividend payments and maximize the amount of capital appreciation are better for investors who like to decide when they pay a tax. Dividend income is taxed in the year it is distributed. Capital gains (capital appreciation) is taxed only when the investor decides to sell his common stock.
But more importantly, Whitman is saying that companies that retain their earnings, rather than paying dividends, ultimately have a cheaper source of capital to grow their business, because the government is not taking the tax on dividends in addition to the corporate earnings tax in any given year. Instead, only the corporate tax is assessed, and the remaining after-tax earnings are free to be invested as the company sees fit. The company therefore has less need to issue new common stock to investors.
Think about it this way: If the company paid out a dividend of $100, and the stockholder was taxed at a 15% rate, there would be $85 left to reinvest in another stock. So if the company decided to sell more common stock, the stockholder would have only $85 to invest. Yet if the company instead paid no dividend, and retained the $100, there would be more money available to the company for reinvestment in the business.
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