The rapid development of the emerging stock markets, both in terms of size and activities, is one of the most exciting stories in today's financial markets. These relatively untapped markets promise potentially high long-term investment returns and opportunities to further diversify an investment portfolio. 1

Annual foreign direct investment in emerging markets totaled an estimated $478 billion in 2009, up from $7.5 billion in 1980, according to the United Nations Conference on Trade and Development. Most of this investment has gone to markets in Asia and Latin America, regions that have had rapid economic development over the past decade. In turn, this influx of investment capital has further fueled economic growth in these countries.

Characteristics of Emerging Markets

Emerging markets are those of lesser-developed countries, which are beginning to experience rapid economic growth and liberalization. Examples of emerging market countries include China, India, and Mexico. Generally, these countries are described by a growing population experiencing a substantial increase in living standards and income, rapid economic growth, and a relatively stable currency.

Often, emerging market countries impose strict limits on foreign investment in an attempt to limit foreign ownership of domestic companies. Investors may be prohibited from owning more than a fraction of any one company, and they may also be restricted from repatriating profits from investing activities.

Asia: Profile of an Emerging Market

The potential rewards -- and risks -- of emerging market investing can be readily seen from the experiences of investors in Asia from late 1997 to 1999.

A major collapse in emerging markets began with Asia in July 1997, when the Thai government was forced to dramatically devalue its currency, the baht, after failing to defend it in the face of a very large currency account deficit, foreign debt, and a government budget shortfall. The result ricocheted throughout Asia as currencies in the Philippines, Malaysia, and Indonesia came under attack from speculators. Meanwhile, financial panic would seep into emerging markets throughout the world, from Latin America to Russia, as financial difficulties surfaced in those nations as well. Despite measures including a "rescue package" directed at Thailand by the International Monetary Fund (IMF), and promises of dramatic economic reform from Indonesia's government, investor confidence failed to return to most emerging markets until 1999. That's when signs of economic recovery began to appear in some of the troubled emerging markets, while others were boosted by deals with the IMF to help improve financial and economic conditions.

Emerging Market Capitalization

Lessons From Asia

After the Asia crisis, many investors now realize there's no "free lunch" on Wall Street -- the high return of emerging markets investing comes with high risk, and many factors can trigger trouble. For example, the Thai baht's collapse began with lack of regulation among Thailand's real estate companies, causing a host of financial problems for that nation's government. The banks of both South Korea and Indonesia were practicing unsound lending practices. And in Brazil, a growing federal budget triggered doubts by potential investors that the nation could ever repay its debts.

It's especially important to note that the fortunes of one nation can increasingly affect those of another, as trading ties become tighter between most nations. As one nation devalues its currency, others may be forced to do so in order to keep their exports competitive, as some nations did when Thailand devalued the baht.

When Asia's troubled economies cut their oil purchases, energy-producing nations such as Russia and Ecuador also suffered from falling petroleum revenue. Currency risk can present another risk factor for emerging market investors. As the currency exchange rate fluctuates, so does the value of your investment in U.S. dollar terms. Fortunately, many emerging countries have their local currencies pegged to the dollar, which can result in a relatively constant exchange rate.

Risks and Rewards of Emerging Market Investments

Emerging markets can be volatile; therefore, they are considered appropriate only for long-term investors with an investment time frame of 10 or more years.

With such high risk potential, why invest in emerging markets, which are the underlying support for any country's financial market? One possibility is that emerging economies have the potential to achieve high levels of economic growth. In 2010, for example, emerging economies cumulatively grew approximately 7% while developed economies grew approximately 2%, according to the International Monetary Fund. Consider also that emerging stock markets alone represent only 13% of the capitalization of the world's equity markets. 2

Along with high potential returns, emerging markets also offer potential diversification benefits. Because these markets may not to move in tandem with those of developed countries, they may be rising while other markets are falling. Hence, they may help reduce the overall risk of a portfolio.

Based on these factors, long-term investors may want to consider allocating between 3% and 10% of their stock portfolio to emerging markets, depending on their investment goals and tolerance for risk. 3

How to Invest in Emerging Markets

Be aware that emerging markets in general tend to be volatile, sometimes even when no serious problem presents itself in a specific market. Investors in emerging markets are therefore advised to potentially reduce risk through diversification among many different markets, and to maintain a long-term view.

Probably the best way an individual can efficiently invest in emerging markets is through a mutual fund. Emerging market funds concentrate on investments in these markets around the world or in a specific country or region. Some global and international funds may also hold a small percentage of their portfolio in emerging markets.

Also keep in mind that some funds that invest in stocks of emerging market companies may also invest in bonds issued in that country. In general, these funds may contain a greater mix of different types of securities than a domestic fund.

Mutual funds offer the advantage of diversification and professional management. Because emerging market investment management may require extensive and expensive on-site company research, annual fund management expenses associated with these investments may be higher than for other types of mutual funds.

Points to Remember

1. Emerging market investments can offer higher potential returns to long-term investors.
2. Allocating 3% to 10% of your stock portfolio to emerging markets may help add a degree of diversification. 3
3. Emerging market investments entail higher political and liquidity risks than domestic investments and, as such, may be more volatile.
4. Currency risks also affect emerging market investments. If the value of the dollar declines against the currency of the emerging market country, your return will be lower. The currencies of some emerging market countries are pegged to the dollar and usually do not fluctuate wildly.
5. Risk can be reduced by holding emerging market investments among different countries and regions of the world.

1Investors in international securities are sometimes subject to somewhat higher taxation and higher currency risk, as well as less liquidity, compared with investors in domestic securities. Past performance does not guarantee future results.

2Source: S&P Global Broad Market Index, December 31, 2010.

3These allocations are presented only as examples and are not intended as investment advice. Please consult a financial advisor if you have questions about these examples and how they relate to your own financial situation. The investor profile is hypothetical.

© 2011 McGraw-Hill Financial Communications. All rights reserved.

July 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Jim Oliver, a local member of FPA.

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As just about every investor knows, it's not what your investments earn, but what they earn after taxes that counts. After factoring in federal income and capital gains taxes, the alternative minimum tax, and any applicable state and local taxes, your investments' returns in any given year may be reduced by 40% or more.

For example, if you earned an average 8% rate of return annually on an investment taxed at 28%, your after-tax rate of return would be 5.76%. A $50,000 investment earning 8% annually would be worth $107,946 after 10 years; at 5.76%, it would be worth only $87,536. Reducing your tax liability is key to building the value of your assets, especially if you are in one of the higher income-tax brackets. Here are five ways to potentially help lower your tax bill. 1

Invest in Tax-Deferred and Tax-Free Accounts

Tax-deferred accounts include company-sponsored retirement savings accounts such as traditional 401(k) and 403(b) plans, traditional individual retirement accounts (IRAs), and annuities. Contributions to these accounts may be made on a pretax basis (i.e., the contributions may be tax-deductible) or on an after-tax basis (i.e., the contributions are not tax-deductible). More important, investment earnings compound tax deferred until withdrawal, typically in retirement, when you may be in a lower tax bracket. Contributions to nonqualified annuities, Roth IRAs and Roth-style employer-sponsored savings plans are not tax-deductible. Earnings that accumulate in Roth accounts can be withdrawn tax free if you have held the account for at least five years and meet the requirements for a qualified distribution.

Pitfalls to avoid: Withdrawals prior to age 59½ from a qualified retirement plan, IRA, Roth IRA, or annuity may be subject not only to ordinary income tax, but also to an additional 10% federal tax. In addition, early withdrawals from annuities may be subject to additional penalties charged by the issuing insurance company. Also, if you have significant investments, in addition to money you contribute to your retirement plans, consider your overall portfolio when deciding which investments to select for your tax-deferred accounts. If your effective tax rate -- that is, the average percentage of income taxes you pay for the year -- is higher than 15%, you'll want to evaluate whether investments that earn most of their returns in the form of long-term capital gains might be better held outside of a tax-deferred account. That's because withdrawals from tax-deferred accounts generally will be taxed at your ordinary income tax rate, which may be higher than your capital gains tax rate (see "Income vs. Capital Gains"). 

Income vs. Capital Gains

Generally, interest income is taxed as ordinary income in the year received and qualified dividends are taxed at a top rate of 15%. A capital gain (or loss) -- the difference between the cost basis of a security and its current price -- is not taxed until the gain or loss is realized. For individual stocks and bonds, you realize the gain or loss when the security is sold. However, with mutual funds you may have received taxable capital gains distributions on shares you own. Investments you (or the fund manager) have held 12 months or less are considered short term, and those capital gains are taxed at the same rates as ordinary income. For investments held more than 12 months (considered long-term), those capital gains are taxed at no more than 15%. The actual rate will depend on your tax bracket and how long you have owned the investment.

Consider Government and Municipal Bonds

Interest on U.S. government issues is subject to federal taxes but is exempt from state taxes. Municipal bond income is generally exempt from federal taxes, and municipal bonds issued in-state may be free of state and local taxes as well. An investor in the 33% federal income-tax bracket would have to earn 7.46% on a taxable bond to equal the tax-exempt return of 5% offered by a municipal bond, before state taxes. Sold prior to maturity or bought through a bond fund, government and municipal bonds are subject to market fluctuations and may be worth less than the original cost upon redemption.

Pitfalls to avoid: If you live in a state with high state income tax rates, be sure to compare the true taxable-equivalent yield of government issues, corporate bonds, and in-state municipal issues. Many calculations of taxable-equivalent yield do not take into account the state-tax exemption on government issues. Because interest income (but not capital gains) on municipal bonds is already exempt from federal taxes, there's generally no need to keep them in tax-deferred accounts. Finally, income derived from certain types of municipal bond issues, known as private activity bonds, may be a tax-preference item subject to the federal alternative minimum tax.

Look for Tax-Efficient Investments

Tax-managed or tax-efficient investment accounts and mutual funds are managed in ways that can help reduce their taxable distributions. Investment managers can employ a combination of tactics, such as minimizing portfolio turnover, investing in stocks that do not pay dividends, and selectively selling stocks that have become less attractive at a loss to counterbalance taxable gains elsewhere in the portfolio. In years when returns on the broader market are flat or negative, investors tend to become more aware of capital gains generated by portfolio turnover, since the resulting tax liability can offset any gain or exacerbate a negative return on the investment.

Pitfalls to avoid: Taxes are an important consideration in selecting investments but should not be the primary concern. A portfolio manager must balance the tax consequences of selling a position that will generate a capital gain versus the relative market opportunity lost by holding a less-than-attractive investment. Some mutual funds that have low turnover also inherently carry an above-average level of undistributed capital gains. When you buy these shares, you effectively buy this undistributed tax liability.

Put Losses to Work

At times, you may be able to use losses in your investment portfolio to help offset realized gains. It's a good idea to evaluate your holdings periodically to assess whether an investment still offers the long-term potential you anticipated when you purchased it. Your realized losses in a given tax year must first be used to offset realized capital gains. If you have "leftover" losses, you can offset up to $3,000 against ordinary income. Any remainder can be carried forward to offset gains or income in future years, subject to certain limitations.

Pitfalls to avoid: A few down periods don't mean you should sell simply to realize a loss. Stocks in particular are long-term investments subject to ups and downs. However, if your outlook on an investment has changed, you can use a loss to your advantage.

Keep Good Records

Keep records of purchases, sales, distributions, and dividend reinvestments so that you can properly calculate the basis of shares you own and choose the shares you sell in order to minimize your taxable gain or maximize your deductible loss.

Pitfalls to avoid: If you overlook mutual fund dividends and capital gains distributions that you have reinvested, you may accidentally pay the tax twice -- once on the distribution and again on any capital gains (or underreported loss) -- when you eventually sell the shares.

Keeping an eye on how taxes can affect your investments is one of the easiest ways you can enhance your returns over time. For more information about the tax aspects of investing, consult a qualified tax advisor.

Points to Remember

1. Taxes on income and capital gains distributions reduce your after-tax rate of return.
2. Maximize opportunities to invest in tax-deferred and tax-free retirement accounts.
3. Consider your overall investment portfolio when selecting investments for tax-deferred and tax-free accounts. You might first allocate investments that generate interest income to tax-qualified accounts, since withdrawals from these accounts are taxed as ordinary income.
4. Income from municipal bonds is generally exempt from federal and in some cases state and local taxes. Capital gains are taxable, and returns from some types of municipal bonds may be subject to the alternative minimum tax.
5. Tax-managed mutual funds and investment accounts employ strategies aimed at reducing taxable distributions.
6. Realized capital losses can be offset against capital gains, and up to $3,000 in losses can be offset against ordinary income in a given tax year.
7. Maintaining good records of investment purchases, sales, and distributions is essential to evaluating the best method of determining gains and losses for tax purposes and calculating the adjusted cost basis of an investment.

1This information is general in nature and is not meant as tax advice. Always consult a qualified tax advisor for information as to how taxes may affect your particular situation.

© 2011 McGraw-Hill Financial Communications. All rights reserved.

July 2011 — This column is provided through the Financial Planning Association, the membership organization for the financial planning community, and is brought to you by Jim Oliver, a local member of FPA.

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Are you thinking of retiring soon, or changing jobs? You may face a major financial decision: what to do about the funds in your retirement plan.

Note: As you will see, the rules on retirement withdrawals are quite complex. They are offered here only for your general understanding. Please call us before taking withdrawals or making other major changes in your retirement plan.

Take a Partial Withdrawal

Partial withdrawals are withdrawals that aren't rollovers, annuities, or lump sums. Because they are partial, the amount not withdrawn continues its tax shelter (see below).

A partial withdrawal will usually leave open the option for other types of withdrawal (annuity, lump sum, rollover) of the balance left in the plan.

Note: Before retirement, partial withdrawals are fairly common with profit-sharing plans, 401(k)s, and stock bonus plans. After retirement, they are fairly common in all types of plans (though least common with defined-benefit pension plans).

Tax Planning. A partial withdrawal is usually taxable and can be subject to the penalty tax on withdrawals before age 59-1/2 except under certain situations (see below) and when the distribution consists of after-tax contributions, such as nondeductible IRA contributions.

Example: Your retirement account totals $100,000, which includes an after-tax investment of $10,000. You withdraw $5,000. $500 of the withdrawal is tax-free ($10,000 / $100,000 x $5,000).

Note: The tax-free portion is computed differently for plan participants who have been in the plan since 5/5/86. Contact us for details.

Exceptions for early distributions from IRAs and other qualified retirement plans include direct rollovers to a new retirement account, you were permanently or totally disabled, you were unemployed and paid for health insurance premiums, you paid for college expenses for yourself or a dependent, you bought a house (certain criteria must be met), or you paid for medical expenses exceeding 7.5 percent of your adjusted gross income. In addition, there are several less common situations where you might be exempt from paying taxes and early withdrawal penalties. Please call us if you would like more information.

Preserving the Tax Shelter. Your funds grow sheltered from tax while they are in the retirement plan. This means that the longer you can prolong the distribution - or the smaller the amount you must withdraw - the more your assets grow. Some people choose to defer withdrawals for as long as the law allows to maximize assets and shelter them for the next generation.

Note: The law has specific rules about how fast the money must be taken out of the plan after your death. These rules limit the ability to prolong a tax shelter.

Withdrawal Before You Reach Age 70-1/2

Until you reach 70-1/2, you do not need to take money out of your retirement account - unless your employer's plan requires it. In fact, there will usually be a 10% early-withdrawal penalty if you make withdrawals before age 59 1/2. This is on top of the regular income tax you owe - at any age - on amounts you withdraw (though there's no tax on after-tax contributions you made, as we discussed above).

Once You Reach Age 70-1/2

Once you hit 70-1/2, withdrawals must begin. Technically they can be postponed until April 1 of the year following the year you reach 70-1/2 - say April 1, 2012 if you reach 70-1/2 in 2011. But waiting until April 1 means you must withdraw for two years - 2011 and 2012 - in 2012. To avoid this income bunching and a possible higher marginal tax rate, we may suggest withdrawing in the year you reach 70-1/2. Call us to evaluate your situation.

The rules allow you to spread your withdrawals over a period substantially longer than your life expectancy. Under these rules, the taxpayer (say, an IRA owner) first determines how much he's saved as of the end of the preceding year. Then he consults a (unisex) IRS table to find the number for his age. The number corresponds to how long he may spread out the withdrawals. The owner then divides that number into the retirement asset total. The result is the minimum amount he must withdraw for the year.

Example: Joe reaches age 70-1/2 in October of this year. Retirement plan assets in his IRA totaled $600,000 at the end of last year. The IRS number for age 70 is 27.4. Joe must withdraw $21,898 ($600,000/27.4) this year.

Example: Two years from now, Joe is 72 and his IRA was $602,000 at the end of the preceding year (when Joe reached age 71). The IRS number for age 72 is 25.6. Joe must withdraw $23,516 ($602,000/25.6) when he's 72.

The number in the IRS table assumes distribution over a period based on your life expectancy, plus that of a beneficiary 10 years younger than you. If your designated beneficiary is a spouse more than 10 years younger than you, his or her actual life expectancy is used to figure the withdrawal period during your lifetime.

Caution: You can always take out money faster than required - and pay tax on these withdrawals. However, the tax code is strict about minimum withdrawals. If you fail to take out what's required, a tax penalty will take 50% of what should have been withdrawn but wasn't.

Financial Calculator: Required Minimum Distribution
The IRS requires that you withdraw at least a minimum amount - known as a Required Minimum Distribution - from your retirement accounts annually, starting the year you turn age 70-1/2. Determining how much you are required to withdraw is an important issue in retirement planning.

Contact us now if you'd like assistance figuring out how much your withdrawal should be, because getting those numbers right can make a big difference in the quality of your retirement.

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How do lenders determine who is approved for a credit card, mortgage, or car loan? Why are some individuals flooded with credit card offers while others get turned down routinely?

Because creditors keep their evaluation standards secret, it is difficult to know just how to improve your credit rating. It is important, however, to understand the factors and to review your credit report periodically for any irregularities, omissions, or errors. Reviewing your credit report annually can help you protect your credit rating from fraud and ensure its accuracy.

Credit Evaluation Factors

Many factors determine your credit. Here are some of the major factors considered:

• Age
• Residence
• "Authorized user" payment history
• Checking and savings accounts
• Bankruptcy
• Charge-offs (Forgiven debt)
• Child support
• Closed accounts and inactive accounts
• Jobs
• Payment history
• Recent loans
• Collection accounts and charge-offs
• Cosigning an account
• Credit limits
• Credit reports
• Debt/income ratios
• Department store accounts
• Payment history/late payments
• Finance company credit cards
• Income/income per dependent
• Mortgages
• Revolving credit
• Name/alias
• Number of credit accounts
• Fraud
• Inquiries

These factors may be used, and weighted, in determining credit decisions. Credit reports contain much of this information.

Obtaining Your Credit Reports

Credit reports are records of consumers' bill-paying habits. Credit reports are also called credit records, credit files, and credit histories and are collected, stored, and sold by three credit bureaus, Experian, Equifax, and TransUnion.

Recent changes to the Fair Credit Reporting Act (FCRA) require that each of the three credit bureaus provide you with a free copy of your credit report, at your request, every 12 months.

If you have been denied credit or believe you've been denied employment or insurance because of your credit report, you can request that the credit bureau involved provide you with a free copy of your credit report - but you must request it within 60 days of receiving the notification.

Disputing Errors in Your Credit File

The Fair Credit Reporting Act (FCRA) protects consumers in the case of inaccurate or incomplete information in credit files. The FCRA requires credit bureaus to investigate and correct any errors in your file.

Tip: If you find any incorrect or incomplete information in your file, write to the credit bureau and ask them to investigate the information. Under the FCRA, they have about thirty days to contact the creditor and find out whether the information is correct. If not, it will be deleted.

Be aware that credit bureaus are not obligated to include all of your credit accounts in your report. If, for example, the credit union that holds your credit card account is not a paying subscriber of the credit bureau, the bureau is not obligated to add that reference to your file. Some may do so, however, for a small fee.

Fair Credit Reporting Act (FCRA)

This federal law was passed in 1970 to give consumers easier access to, and more information about, their credit files. The FCRA gives you the right to find out the information in your credit file, to dispute information you believe inaccurate or incomplete, and to find out who has seen your credit report in the past six months.

Understanding Your Credit Report

Credit reports contain symbols and codes that are abstract to the average consumer. Every credit bureau report also includes a key that explains each code. Some of these keys decipher the information, but others just cause more confusion.

Read your report carefully, making a note of anything you do not understand. The credit bureau is required by law to provide trained personnel to explain it to you. If accounts are identified by code number, or if there is a creditor listed on the report that you do not recognize, ask the credit bureau to supply you with the name and location of the creditor so you can ascertain if you do indeed hold an account with that creditor.

If the report includes accounts that you do not believe are yours, it is extremely important to find out why they are listed on your report. It is possible they are the accounts of a relative or someone with a name similar to yours. Less likely, but more importantly, someone may have used your credit information to apply for credit in your name. This type of fraud can cause a great deal of damage to your credit report, so investigate the unknown account as thoroughly as possible.

We recommend an annual review of your credit report. It is vital that you understand every piece of information on your credit report so that you can identify possible errors or omissions.

If you need help obtaining your credit reports or need assistance in understanding what your credit report means, give us a call.

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